To paraphrase Count Ciano, Success has many fathers and failure has many targets.  You may recall a while back I wrote about how a loan to old General Motors (worth $1.5 billion) was accidentally rendered un-secured.  When GM entered bankruptcy, the loan was ultimately determined to be unsecured and lenders (presumably) lost billions.  As you might expect, some people were sued as a result.  One of those folks was the attorneys for GM.  Recently the 7th Circuit entered an opinion in their lawsuit.

By way of brief recap, prior to bankruptcy, GM had (among others) two secured loans.  The first was for $300MM and the other for $1.5B.  About a year prior to bankruptcy, the $300MM was up for maturity and GM was preparing to refinance.

In the $300MM refi GM was represented by Mayer Brown, LLP, a large and well respected law firm.  On the other side, JP Morgan was the agent for the lender syndicate and was represented by another well respected large law firm.

It turns out that at the same time, JP Morgan was also the agent for the $1.5B secured loan.  Both loans were perfected by separate UCC1.  Mayer Brown prepared the documents for the refi transaction.  Unfortunately, on the closing check list and closing documents sent to JP Morgan’s attorneys, the documents contained a release of the $1.5B UCC1.

In what might be the understatement of the year, the 7th Circuit writes:

“The big mistake was that the closing papers for the [$300MM] deal accidentally also terminated the lender’s security interest in the collateral securing the [$1.5B] loan.”

Apparently, all the parties missed the error (save one lone Mayer Brown paralegal, who was ignored).  The important part here is that JP Morgan’s attorney’s affirmatively approved the checklist and loan documents – which included the $1.5B release documents.  JP Morgan’s attorneys even went to far as to tell Mayer Brown “Nice job on the documents”.  (Again, a lesson on your emails being an exhibit).

Despite the colossal oversight and high stakes litigation that followed, no one bothered to tell the syndicate lenders until years later. At which time several brought their own lawsuits.

Strangely, despite the “easy to see” claims against JP Morgan and counsel (7th Circuit’s words, not mine), the lenders sued Mayer Brown.  The arguments are essentially 3 fold:

  • Mayer Brown was an attorney for JP Morgan in other matters, and therefore was acting as an attorney for JP Morgan in this matter,
  • Mayer Brown drafted the documents and therefore owed a duty to JP Morgan, and
  • Mayer Brown had an duty because the purpose of the documents were for JP Morgan’s loan.

In the recently released opinion by the 7th Circuit, Oakland Police, et al. v. Mayer Brown, LLP, the Court affirmed that all three arguments are not supportable and the claims must be dismissed.

There is a lot going on in the background of this case which makes it interesting, but the opinion is a great cite for the transactional lawyers who paper up complex transaction.  Specifically, the Court holds:

“By preparing the first draft, an attorney does not undertake a professional duty to all other parties in the deal”

The lender’s strongest argument (in my humble opinion) was that it relied on Mayer Brown not to misrepresent the effect of the documents.  While everyone seems to agree that the error was simply a mistake, the ruling appears to insulate a non-mistake from liability in exchanging documents.  This puts added pressure on all sides to review (and re-review) all turns of draft to ensure nothing new suddenly appears.

That lack of a complete review of a huge stack of documents on the 8th turn is usually a cost saving endeavor.  However, one should be mindful of such an argument.  The opinion points out that the original inclusion of the wrong release was based on an older UCC search which was used as a “cost-saving” measure by a Mayer Brown paralegal.  (on a $300MM refi).

As a side note, the Court also considers whether Mayer Brown became an “attorney of the transaction” similar to an attorney for a title company.  The Court found that was not the case, but it serves as a reminder that if the law firm holds money in “trust” as part of the transaction the law firm might inadvertently have became an “attorney of the transaction” and thus owe duties beyond its client.

In this case, for some reason, the lenders decided to sue a lawyer who didn’t represent them for malpractice without suing the actual attorneys representing them.  Surely something is going on in the background, but in this case, the alleged failure is on one party and the litigation target was on another.

Oakland Police & Fire Retirement Systems, et.al. v. Bayer Brown, LLP, cause no. 16-2983, In the United States Court of Appeals for the Seventh Circuit.  Decided June 28, 2017.

Sometimes government regulators do funny things.  Sometimes their actions reflect that they are non-economic actors, sometimes its political, sometimes its bureaucracy and sometimes there is just no reason at all because no one knows who made the original decision. The recent Ally Bank borrower discrimination settlement in which no one knows who was actually discriminated against is a good example.

M. C. Escher: "ESCHER on ESCHER Exploring the Infinite", p. 66 Published in 1989 by HARRY N. ABRAMS, INC., New York Drawing Hands
M. C. Escher: “ESCHER on ESCHER Exploring the Infinite”, p. 66
Published in 1989 by HARRY N. ABRAMS, INC., New York
Drawing Hands

In 2013 the Department of Justice (“DOJ”) and the Consumer Financial Protection Bureau (“CFPB”) commenced actions against Ally Bank. The DOJ action was a civil action filed in Michigan, while the CFPB action was commenced as an administrative matter before the CFPB.

The crux of the allegations was that “…between April 1, 2011 and the present, Ally engaged in a pattern or practice of discrimination on the basis of race and national origin in violation of the ECOA based on the interest rate “dealer markup”—the difference between Ally’s buy rate and the contract rate—paid by African-American, Hispanic, an Asian/Pacific Islander borrowers who received automobile loans funded by Ally.”  DOJ Consent Order.  Ally did not admit to any wrongdoing.

Long story short, Ally simply agreed to pay $80 million in monetary damages, which were to be paid to the minorities who were allegedly discriminated against with the higher rates.  (This is in addition to $18 million in civil fines.)  The problem was, Ally was legally unable to know the races of any of its borrowers, so the DOJ and CFPB have no idea who gets the money.

To fix the problem, the DOJ and CFPB are using a complex methodology which, based on what I have read, seems to try to identify minorities by last name and location. The methodology, which is admitted to be less than totally accurate, is apparently the best option.

So, in case you missed that, the DOJ and CFPB are looking at last names to find minority borrowers to send money on account of borrower discrimination because the bank has no way of knowing who the minority borrowers are.

As I mentioned above, sometimes government regulators do funny things, like develop complex ways to isolate minority borrowers for compensation for discrimination when the lender has no way of knowing who are minorities they are alleged to have wronged.

In fairness, there may have been some smoking gun piece of evidence that the DOJ found which never made it to the light of day.  But, absent that, it seems at least possible that lenders could get sued by the DOJ and the CFPB for discrimination when even the lender doesn’t know who it is discriminating against.

DOJ consent order is here.

Read more here on The Detroit News.

On occasion I have thought that a chapter 11 bankruptcy case is somewhat analogous to a trip on a plane in a few ways. Among other analogous events, consider checking a bag and then forgetting to pick it up on the conveyor belt after the flight lands. It would be easy enough to do – as the bag is riding in the cargo hold, perhaps it was simply forgotten.  If that has ever happened to you, it likely you went back to pick up the bag from the airport.  On the other hand, in a chapter 11 bankruptcy case, if the debtor-in-possession doesn’t pick up all of its assets when it exits bankruptcy, it will lose them forever.

luggage

To understand how a cause of action could just go away after plan confirmation, it is helpful to understand the legal distinction between the original entity which filed bankruptcy and the debtor-in-possession, or DIP.

I. The Bankruptcy Estate is Something Separate

When any bankruptcy case is filed, an estate (not unlike a trust) is immediately created and all of the assets of the entity are immediately and automatically transferred to the estate pursuant to the bankruptcy code.

  • When the bankruptcy case is filed as a chapter 7 liquidation, a 3rd party is appointed to manage and liquidate that estate for the benefit of the creditors.
  • In a chapter 11 reorganization bankruptcy case, the estate is usually managed by the filing entity- the DIP, which is given possession of the estate to administer for the benefit of the creditors.

As a practical matter, a typical chapter 11 bankruptcy case looks like business as usual by the debtors prior management, but legally, the debtor is acting as a trustee over the bankruptcy estate which was created upon filing.

The distinct, but parallel, existence of the estate from the DIP is important when considering the effect of confirming a chapter 11 plan.  When a chapter 11 plan is confirmed, one of the effects is to re-vest assets into the debtor who will then operate under the plan going forward.

The rub is: anything that is not transferred out of the estate to the debtor does not belong to the debtor.  This is where the cause of action issue comes up.

 II. Take it or Leave It

A cause of action (or perhaps an affirmative defense) is an asset of the debtor before filing bankruptcy and it remains so during bankruptcy.  As an asset of the estate, it must be transferred under the plan to the debtor in order for the debtor to use it after confirmation of the plan.

Among others, the Fifth Circuit has held that if a cause of action is not specifically and unequivocally reserved and transferred to the debtor post plan confirmation, it will not belong to the debtor post confirmation.

More simply, if the confirmed plan does not sufficiently identity a cause of action which will leave the estate and be given back to the debtor after plan confirmation, that cause of action functionally disappears.  So, if the DIP doesn’t take the cause of action, it leaves it.

III. The Recent Case

The recent Rossco Holdings v. McConnell case in the Fifth Circuit provides a good excuse to write about the topic.  The opinion was entered last week.  In the case, post-confirmation chapter 11 debtors sued their alleged attorneys for malpractice in connection with the bankruptcy case.

The attorney/defendants moved to dismiss the lawsuit asserting that the confirmed plans of the plaintiffs did not transfer the causes of action from the DIPs to the debtors after confirmation. Therefore, the plaintiffs would have no right to bring the lawsuit.

The Fifth Circuit agreed and affirmed the dismissal of the lawsuit because the plaintiff/debtors did not specifically enough transfer the claims back into the debtor from the estate and therefore they no longer existed.

IV. Things to Consider

 The first thing to consider if you are a lender, is that if you are being sued by a post-confirmation debtor you should review the plan to see if the plan properly transferred the claim from the estate into the post-confirmation debtor.

Additionally, the opinion also denies a couple of the plaintiffs’ arguments simply because they were raised too late in the proceedings – particularly with regard to choice of law.  In short, the plaintiffs attempted too late to argue that 9th circuit law (which is more favorable for the plaintiff than 5th circuit law) applied and thus waived the argument.

In summary: All of the assets of the pre-bankruptcy debtor are along for the ride once in bankruptcy.  However, if a cause of action is not properly transferred by the DIP to the debtor upon exit, that cause of action will not belong to the post-confirmation debtor.

The opinion is here.

It is often surprising to me how often people are unaware of the fairly high risk of being sued in connection with a chapter 11 bankruptcy case when there is money in the case.  Many times, non-debtor parties’ falsely comfort themselves with the belief they will not be sued because existing management wouldn’t want to ruin a business relationship.  The reality is that in large chapter 11 cases, you are just as likely to be sued by the creditors committee as anyone else as a lender.

get sued

Bankruptcy, at its most basic, is the attempt to monetize and equitably (and constitutionally) distribute whatever assets exist of the bankrupt entity.  Outside of bankruptcy, the obvious assets are normally the tangible widgets.  Inside of bankruptcy, the causes of action also become value for trade.

To understand how a third party lender can be sued by an unknown entity on a cause of action which makes no business sense, a quick review of statutory committees is helpful.

Under the Bankruptcy Code a committee of unsecured creditors may be formed to represent the interests of the larger body of unsecured creditors.  Importantly, this committee will have its attorneys’ fees paid by the bankrupt debtor.  This committee, now funded and represented will go about to seek the best recovery for its constituents.  One source of recovery is lawsuits, which are typically unencumbered.

Of course, a committee that did not exist prior to the bankruptcy filing will not typically have standing to sue for pre-bankruptcy wrongs.  However, the Bankruptcy Code and Court’s provide a mechanism to assign those causes of action to the unsecured creditor’s committee as payment on their unsecured debt.

Meaning – if you are a lender you might get sued by a group of angry unsecured creditors after the bankruptcy is filed. The bankruptcy case of Energy Futures Holding (“EFH”) provides a good illustration.

How could that happen?  If a bankrupt debtor unjustifiably fails (or is unable) to pursue a cause of action, the unsecured creditors committee may petition the court to be permitted to pursue the cause of action.  That is what the unsecured creditors committee is currently doing in the EFH case.

In the EFH case, certain subsidiaries were obligated on the LBO debt of the holding company.  The subs didn’t receive the money and even had a provision in the loan documents which essentially said they were only obligated to the extent that the obligation wasn’t a fraudulent transfer in bankruptcy.  Nonetheless, they allegedly paid a disproportionate share of debt service which payment are alleged to be fraudulent transfers.

After the bankruptcy case was filed, the lenders included a provision in the post-petition financing agreement that the bankrupt debtors would not sue the lenders for the pre-bankruptcy payment by the subs (now debtors in bankruptcy).

After the order permitted in the post bankruptcy financing was entered, the unsecured creditors committee in the EFH case was created.  Just recently, the unsecured creditors committee has requested that it be permitted to pursue fraudulent transfer causes of action against the lenders because the Debtor has waived the ability to do so.  The total asserted liability is $8 billion.

At present, the EFH bankruptcy court has not ruled on the request by the unsecured creditors committee.  However, it would not be unusual for the Court to grant such a request.  The legal issues are somewhat technical, but the practical considerations are fairly straightforward – the $8 billion lawsuit is not going to be pursued for legal and business reasons by the bankrupt borrowers but regardless it remains a valuable asset for potential recovery for creditors.

The take home consideration for lenders is this: the lenders sought pre-bankruptcy loan language they thought would shield them from a lawsuit, the lenders sought and obtained a post-bankruptcy waiver of pursuit of the lawsuit by the borrowers – however, the lenders are now facing the prospect that the unsecured creditors committee (who did not exist until after the post-bankruptcy waiver) will sue the lenders for $8 billion.

The loan document language may be of some comfort to you.  However, as a lender, in bankruptcy it might not be the borrower who sues you.

In re Energy Future Holdings Corp., case no. 14-10979, pending in the United States Bankruptcy Court for the District of Delaware.

Motion of the EFH Official Committee for Entry of an Order Granting Derivative Standing and Authority to Prosecute and Settle Claims on Behalf of the Luminant Debtors’ Estates. [dkt 3605]

It’s an old saying that lessons are expensive and good lessons are really expensive.  A recent 2nd Circuit Case provides a good lesson on attention to detail and, unfortunately, it is also a really expensive lesson to JPMorgan and their attorneys.  In the 2nd Circuit’s recent opinion, the Court determined that a UCC3 (termination statement) which “accidently” was filed served to unsecure a $1.5 billion (“BB”) loan which could not be re-secured because of GM’s bankruptcy filing.

bank_error_in_your_favor

A Quick Background

By now you have likely heard about the recent opinion out of the GM bankruptcy case (which is now called “Motors Liquidation”) regarding JPMorgan Chase Bank.  However, I will briefly recap for those of you who have not received the emails circulating around.

Before I get into the case, it is helpful to be familiar with two legal concepts.  They are the bankruptcy code’s strong arm provisions and perfection and termination of a personal property lien.

  • Strong Arm Provisions:  This is a legal concept that exists under the Bankruptcy Code.  While it is a little complex, the crux of the law is that if there is a defect in a secured creditor’s perfection at the time of the bankruptcy filing, the secured creditor will generally be deemed unsecured.  Thus, the bankrupt debtor (and often unsecured creditors) will scour the perfection documents of creditors to determine if any collateral can be un-secured and thereby made free and clear.
  • Perfection and Termination:  In order to ensure that a secured creditor maintains its secured position to the exclusion of third parties, the secured creditor must perfect its lien.  For personal property, this usually means filing a form UCC1 with the state secretary of state.  When the secured loan is paid off (or released for some other reason), the secured creditor will file a form UCC3, which terminates the UCC1.

A Tale of Two Loans

In the case, two loans to GM pre-bankruptcy are relevant.  One was a secured term in the amount of $1.5BB which was secured by substantially all of GM’s U.S. equipment.  The other loan was a loan (a “synthetic lease”) in the amount of $300MM, which had other security.  JPMorgan was the agent on both the loans.  Both of the loans’ secured interest was perfected by the filing of a UCC1.  The $300MM loan had two UCC1s filed and the $1.5BB loan had one UCC1 filed.

Apparently, what happened was GM informed JPMorgan it was going to pay off the $300MM secured obligation.   GM instructed its attorney, a Meyer Brown partner, to prepare the documents.  The Meyer Brown partner assigned an associate to prepare the closing checklist.  The associate assigned a paralegal to run the UCC search to determine which UCC1 to terminate.  Unfortunately, the paralegal was not aware of the $1.5BB loan.  So, when the Delaware UCC search came up with 3 hits, the paralegal did not know that the 3rd UCC1 secured the $1.5BB loan and only two secured the $300MM loan.

Apparently, no one noticed that all three UCC1 were listed on the closing checklist to be terminate.  Apparently, no one checked to be sure that they had the correct UCC1s after the checklist was created and approved by all parties, including the attorneys for JP Morgan.  Thereafter, the closing company dutifully filed all UCC3s thereby un-securing the $1.5BB loan.

GM filed bankruptcy without anyone catching the errant UCC3 filing.  JPMorgan (who now had bankruptcy counsel) quickly realized there was a problem in light of the strong arm provisions.  JPMorgan was promptly sued by the creditors to declare them unsecured.  In bankruptcy court, JPMorgan essentially said, “we never meant to release the $1.5BB so therefore the $1.5BB UCC3 was filed without authority and not effective.” (my language, not theirs).  The Bankruptcy court agreed.

However, the decision was appealed directly to the 2nd circuit.  After certifying a portion to the Delaware Supreme Court, the 2nd Circuit held that JPMorgan authorized the filing of the UCC3 document, even if it didn’t intend the content to release the lien.  Thus, the $1.5BB lien was released.

The Request for Rehearing

Unsurprisingly, JPMorgan has recently requested a re-hearing on the matter and seeks to have the entire 2nd Circuit hear why they should not lose their $1.5BB lien.

In their request, JPMorgan frames the issue as a “seismic shift in agency law…”.  As part of their argument, JPMorgan infers that the volume of document precluded holding JPMorgan and its attorneys responsible for authorizing the filing of the errant UCC3.  Additionally, JP Morgan maintains that up and down the chain of command, no one on the JPMorgan side had any authority to release the liens on the 1.5BB loan.

Whether or not this is a seismic shift in law or the work-a-day application of law to an extremely large amount of money is, for now, an ongoing dispute.

Regardless, the attorneys’ fees alone in this case will make this an extremely expensive lesson for everyone involved.  If the loan remains unsecured, the cost of the lesson will be staggering.

 Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A. (In re Motors Liquidation Company, et al.), cause no. 13-2187 in the United States Court of Appeals for the Second Circuit.

I always assume that people who like NASCAR are really watching for the wrecks.  The cars loop around the track for hours, but only the wrecks make the highlight reels.  In a recent Texas Supreme Court case, the high court considered whether a supermarket was liable for destruction of evidence when it retained only the video recorded around the time of a slip and fall after its looped camera system deleted the rest.

shake and bake

The case is Brookshire Brothers Ltd. v. Aldridge at the Texas Supreme Court (for those of you outside of Texas, Brookshire Brothers is a supermarket).

In the Brookshire case, a slip and fall claim made it to the SCOTX because Brookshire had allowed a security camera (on a loop) to record over all but a few minutes before and after of the actual fall.  At the heart of Brookshire’s reasoning for recording over the video was the risk manager’s mistaken belief that the time prior to the fall was “not relevant”.

Even folks not familiar with the law have a general concept that destroying evidence is a bad thing.  The question in practical terms in a real lawsuit is – what is “evidence”.  At the heart of that question is relevance to the dispute.  That concept fills volumes of scholarly papers.  I won’t go into it here.

It is enough to know in the Brookshire case that the deleted portion of the looped tape was relevant, destroyed and the subject of the appeal. The Brookshire opinion is helpful for a few reasons, but primarily because it attempts to give a bright line to follow for dealing with a potential spoliation issue (which is the fancy name for “destroying evidence”).

For the lawyers reading, the SCOTX sets forth the test to determine after the fact whether evidence has been spoiled.

  • The trial judge gets to decide whether spoliation has occurred.
  • If so, did the party have a duty to reasonably preserve the evidence and did the party negligent breach that duty by failing to do so.

If the Judge determines that evidence has been destroyed, then the Judge gets to decide the remedy (which might include a spoliation instruction to the jury).

Important for the lenders on the front end – According to the SCOTX:

  • The duty to preserve arises when a party reasonably knows there is a substantial chance that a claim will be filed, and
  • That evidence in its possession or control will be material and relevant to the case.
  • Substantial chance of litigation means: when litigation is more than an abstract possibility or fear.

For the lenders, the take home rule is that if you spoil evidence either intentionally or negligently, after being aware of the claim you might be liable.

(A side concern is when does the duty actually arise?  In a future post I may go over litigation hold letters if anyone is interested)

Once you have spoiled evidence, the remedies are wide-ranging and unpleasant.  In Texas, if the spoliation was intentional then the jury may be instructed that all the spoiled evidence will reflect negatively on the spoiler.  Meaning, even if the destroyed evidence actually showed you doing the right thing, the court may instruct the jury that you were doing the wrong thing.

The Brookshire’s case is more than important to lenders.  Forget for a moment that this is a slip and fall grocery store case.  Rather, assume this is a lender liability suit and consider the volume of data that is aggregated and deleted daily in your databases.  For lenders, that alleged bad act rarely occurs in the branch office, but rather in the broader lending relationship.  The email statements, verbal statements, internal memos, meeting notes, calendar entries, etc. may be evidence at the next lender liability lawsuit.  At what rate are those being deleted and by whom?  Importantly, what does your retention policy look like?

Some clients have systems that automatically delete data as the data stream goes forward.  (Not to say that a doc retention policy can’t do that, but when a duty to preserve arises it generally will trump the retention policy.)  The lesson here is that regardless of whether your data is being deleted on a loop or not, you still want to be able to preserve all the information about the crash and not just the crash itself.

I have found this to be true over and over again.  Maybe it’s just my line of work.

Grump Cat

Part of my regular practice is being called in by the transactional lawyers (paper pushers) as they paper up a new loan or re-fi.  My job in those situations is to give my thoughts on what will happen should the worst occur (eg, default, receivership, bankruptcy, lawsuit, etc.) and how to minimize the risks to the lender.

Often times, identifying potential fraudulent transfer exposure on the front end is of concern when the lender creates some type of relationship with a non-borrower affiliate or insider of the borrower. The usual situation is a guarantor, but other situations exist such as payment from a non-borrower affiliate.  A recent 5th Circuit case discusses such a situation.

The BackgroundSkip this if you are Familiar with Fraudulent Transfers

There are a few types of “fraudulent transfers” under both federal and state law.  Generally speaking, however, a fraudulent transfer occurs in two ways:

  1. When bad guy transfers something of value to the other guy in exchange for something that is less than reasonably equivalent value.  Think, cow for the beans. Or,
  2. When the bad guy transfers something to 2nd bad guy in an out-and-out fraudulent scheme.

I have oversimplified it to fit into a minimal of bullet points.  The gist is to recover value when the transferor (sender) transfers value to another party when the transfer would reduce the overall value of the transferor.  The underlying idea being that other creditors need protection from a transferor sending all its assets to his buddy in exchange for minimal or no value in order to defeat collection by other creditors.

Many of you have already had to deal with this issue in lending.  For the un-litigated, this arises for lenders in situations where the bank is receiving payments from a non-borrower on account of an existing loan.  In that situation, the bank may be receiving money (the value) but not giving anything back to the non-borrower in exchange.  (In a normal repayment, the funds paid by a borrower credit the debt, thus equivalent value exchange).

The Recent RulingThe Netting Effect

 In the case of a lender who is taking funds from a non-borrower in good faith, there is some protection when sued for fraudulent transfer under the bankruptcy code.  This was the issue recently discussed in Williams v. FDIC in the Fifth Circuit.

At issue was what happens when a unknowing lender has received a fraudulent transfer from a non-borrower because of actual fraud, but the non-borrower transferor actually received some (but not full) indirect benefit.  Specifically, the non-borrower affiliate company directly paid the mortgage payment to the lender on commercial property as “rent” thereby staving off foreclosure on behalf of the building owner (who was the borrower).

In this case, the Fifth Circuit said that the good faith lender is liable for fraudulent transfer, but the lender was only liable for the net amount received greater than the benefit obtained by the transferor.

  •  Ex:  Lender was paid $100.  Non-Borrower transferor obtained $70 in value.  Bank is liable for $30.

Why is this important?  The lender need not be a party to a fraudulent scheme to get tagged with a fraudulent transfer lawsuit.  In that situation, even if the lender can show that it exchanged reasonably equivalent value (the normal bank defense), if the payment was part of an actual fraudulent scheme the bank had no idea existed – the bank will still be liable for the “net” positive it received over the transferor’s “net” negative.

This type of risk is, of course, inherently difficult to quantify.  A valuation of the unknown benefit is obviously a difficult proposition on the front end.  This remains true at the time the lender determines to accept payment from the non-borrower.  Additionally, the retrospective value determined may not always be the prospective value anticipated.

Just something to think about when you are assessing the risk of accepting funds from non-borrowers and looping in insiders and affiliates to the obligation stack.

Last week Regions Bank sued Comerica Bank seeking a declaration that Regions is not liable to Comerica in connection with their $53MM syndicate loan to a plant nursery that went very wrong.  Regions Bank v. Comerica Bank, civil action 3:14-cv-3607, pending in the United States District Court for the Northern District of Texas.

In short:

  • The two banks loaned $53MM (total) to the plant nursery based on allegedly massively fraudulent inventory numbers.
  • The nursery filed bankruptcy and basically everyone apparently got sued for the alleged fraud.
  • Comerica allegedly has been threatening Regions with a lawsuit for misrepresentation or fraud for talking them into the syndicate.
  • Rather than wait for the lawsuit, Regions filed its declaratory judgment action.
  • In the lawsuit, Regions asserts that Comerica contractually waived any reliance on facts or representations that Regions provided to Comerica.  Thus, argues Regions, Regions cannot be liable to Comerica on account of Comerica relying on any information Regions forwarded to Comerica about the borrower.

There are a number of issues related to the lawsuit that are worthy of analysis.  (There are also a number of one-liners about money not growing on trees).  However, as the case is only a week old it provides a good avenue to illustrate the two levels of reliance waivers in Texas.

Money Dino

What kind of waiver am I talking about?  Contracting parties can waive reliance on representations of the other which are not contained in the contract.  It seems straightforward – if the representation is not in the contract, then forget I said (or failed to say) anything prior to signing.  Why the two levels then?

  •  The Basic Waiver: The typical waiver of reliance in a contract will essentially say that the parties waive any reliance on non-contractual representations.  However, the SCOTX has pointed out that such a contractual provision, like any contractual provision, is subject to avoidance for fraud.  Essentially, even if you waive reliance on prior non-contract statements, if someone made a fraudulent misrepresentation that lead to the execution of the contract (without the representation), the contract risks being avoided for fraud.
  • The Super Wavier: On the other hand, the SCOTX recognizes that some parties may contractually agree to waive any reliance non-contractual representations, regardless of how fraudulent they might be, if the parties so intended. Thus, the super waiver.

So, which waiver is in your contract?  It depends on what the Court thinks you meant when you signed the contract (containing the waiver).  Any answer that begins with “it depends” is not a lot of comfort for lender clients and the SCOTX has been somewhat unclear about which is which.

The SCOTX has said that “The contract and circumstances surrounding [the contract’s] formation determine…[how expansive the waiver is]”.  Schlumberger v. Swanson, 959 S.W.2d 171.  The Court goes on to instruct that lower courts should consider the sophistication of the parties, course of dealings and representation by counsel and, importantly, did the parties intend to put a final end to a long running dispute to determine whether the waiver is basic or super.  (Both terms I made up for ease of reading this post so don’t Google them).

I have not parsed through the complaint in the Regions case and Comerica has not yet answered.  Also, I am not opining on the merits of either parties’ positions.  However, the case provides a good excuse to point out that even if two parties waive any reliance on prior representations, in Texas, that waiver may not be enough to waive claims of fraud.  Meaning, the Court may let the case proceed even if a waiver of reliance is contained in the contract regardless of whether the fraud claim is ultimately determined to be without merit.

Lenders should be cautious and deliberate when drafting these waivers of reliance to attempt to remove as much risk as possible that a court will later find that the borrower may sue the lender for fraud.

If you’re the bank’s attorney, the answer is always going to be the Cayman Islands.  Nothing against Odessa, they just don’t have much of a beach.

But, if you are the bank, chances are you would rather be local if you need to sue.  In the recent Fifth Circuit case Monkton Insurance Services v. Ritter, case 13-50941, the Fifth Circuit agreed with Cayman Island bank Butterfield Bank (Cayman) Ltd. that a lawsuit against the bank needed to be filed in the islands.

In the Monkton case, William Ritter formed a Cayman Island insurance company which was managed by the Cayman Island management company, Monkton.  David Self was the Monkton employee that was in charge of managing the insurance company.  Presumably, the insurance company was conducting legitimate business and performing reasonably well, because it had about $500K in its Butterfield Bank account which Self, allegedly, made off with.

Allegedly, Self forged Ritter’s signatures.  Ritter was somewhat upset and demanded repayment, which Self paid by (again, allegedly) simply taking funds from other clients’ accounts.  Lawsuits ensued.

Whereas Ritter lived in Odessa, Texas, Monkton sued Ritter for return of the cash that Self had paid to Ritter personally.  Ritter then filed a third-party lawsuit against Butterfield Bank in Odessa (as part of the Monkton lawsuit).  Basically, Ritter was claiming lender liability for failure to spot the forged withdrawal documents.

Quick to note that they did not like Odessa, Butterfield Bank moved to dismiss the claims against the bank for lack of jurisdiction.  Basically, Butterfield Bank argued that they lacked enough connection with Texas to permit a Court in Texas to hear a lawsuit against them.

The Trial Court agreed; and the Fifth Circuit also agreed with Butterfield.  Notwithstanding 1) phone calls and wired transfers to and from Texas, 2) a website accessible from Texas for Texas clients, and 3) Butterfield Bank maintaining an account for a client doing business in Texas – the Courts agreed that Butterfield was not subject to being sued in Texas.

The underlying legal issues involving subject matter jurisdiction are discussed in the case, and are more technical than most non-lawyers would care to read about.  I find them interesting, though, so feel free to give me a call to discuss.

The take home message from this post for lenders is this: simply because you are doing business for a foreign entity in Texas does not mean you will necessarily get to sue them in Texas if things go bad.  Proper venue and jurisdictional clauses in agreement are a must as well as venue creation tools, such as SPEs.  The business world is getting smaller and you might prefer not to send your attorneys around to the world when a deal goes bad.

Change for the common good?

As in . . . 

 

A penny here . .  . a penny there . . .  to pay for making lenders take care of vacant property after foreclosure.

In May of ’09, I asked you to watch for change at your State House, based upon a growing number of States that require a lender to register a loan as part of the foreclosure process.

In August of ’10, I asked you to watch for change in your City, based upon the City of Los Angeles passing its own version of a foreclosure registration process, which the City uses to enforce code violations.

Recently, Henderson County, Florida voted to strengthen its foreclosure registration ordinance to cover almost every type of property, from residential to commercial.

The trend is the new reality.  Cities are in the foreclosure process because it is good business.  

And one industry organization has the statistics to prove it; and the good research to help you monitor your loan portfolio with their work product:

Clearly, Cities need the cash.  Enforcing code violations is not cheap.   So, they have jumped into a line of business traditionally reserved by the State.

This is not simply chump change.  It is change that when added up, could make cents (sense).

Or not.

Please post your comment or local experience below.