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Lenders 360

Good Times for Lenders

You Never Know Where Your Last Email will be Published

Posted in Good Times for Lenders, Technology Notes

A good piece of advice I once received when I was younger was: “Don’t write an email you wouldn’t want copied to the cover of the New York Times”.  In the past, it would take days of depositions in a lawsuit to get a handle on what someone said or thought to prove a legal point.  Now, emails (combined with searching techniques) can provide a first person narrative usually by people who have no inclination their email conversations will be exhibits in an unexpected and un-filed lawsuit.  Sometimes, and entire lawsuit comes down to one email.  That was the case in a recent 5th Circuit opinion.


Credit: Unknown

Credit: Unknown

The Lawsuit

The lawsuit itself is fairly interesting if you follow the litigation surrounding the WaMu collapse and takeover by JPMorgan Chase Bank.  The lawsuit concerns a developer who was contracted by WaMu (pre-takeover) to acquire land, build a WaMu location and then rent it to WaMu for 20 years.  Prior to acquiring the land but while the developer was under contract, WaMu was taken over by the FDIC.

There has been significant litigation concerning the WaMu leases since the takeover and assignment to Chase which I don’t intend on getting into here.  In fact, the lawsuit is worthy of its own blog post for those of you interested in this “obscure but heavily litigated” matter (as the 5th Circuit put it).  Among one of the more interesting holdings is that the FDIC can be held liable for negligent misrepresentation because “it is reasonable to rely [on the statement] when the federal agency which oversees the banking industry…tells you that your banking lease may be lawfully rejected”.

The Email

In any event, the purpose of this post is to illustrate that a lawsuit and its appeal can boil down to one single email.

The email in question was sent by an executive of the developer to Chase requesting that the lease be rejected quickly so that the developer could cut its losses and be done with it.  The developer, having relied on the FDIC’s representation that the lease could be rejected, believed that rejection was the only outcome.

As it turns out, the FDIC was wrong.  In fact, the agreement between WaMu and the developer was assumed by Chase. When the developer figured it out, he sued Chase for damages for breach of contract (as opposed to being stuck with nothing when the FDIC repudiates a lease).

In the 5th Circuit opinion, the Court of Appeals quotes the email directly five times in support of its holding that there was not mutual termination, which was one of the two issues on appeal.  (The developer won the appeal).  There is no other evidence directly cited by the 5th Circuit to support its holding.

In short, the entire case has now been determined based primarily on one email an executive sent out in the ordinary course of his day.  There is no legalese in the cited portions of the email.  In fact, the executive didn’t use the proper legal terms for what he was requesting from Chase and the FDIC.   I haven’t spoken with the executive, but I think it’s a safe bet that he did not write the email thinking the 5th circuit’s opinion would one day turn on a few quick sentences.

The take home lesson here is likely already known by everyone reading this.  You have no doubt heard this over and over again.  Don’t write an email you would not want to be public.  This post is to illustrate that even the most mundane of emails may win or lose a lawsuit you have no inclination will be filed.   In short, you never know when your last email will be the one pasted into a Federal Appeals Court opinion.

Central Southwest Texas Development, LLC v. JPMorgan Bank, NA, et al., case no. 12-51083, pending in the United States Appeals Court for the Fifth Circuit.  Opinion Entered March 2, 2015.

Tough Times for Lenders

The Plaintiffs Suing the Lender May Not Exist At the Time the Loan Documents Are Signed

Posted in Lender Liability, Tough Times for Lenders, Workout Issues

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]

Tough Times for Lenders

JPMorgan Requests Rehearing Following Loss of Secured Status of $1.5 Billion Loan following “Clerical Error”

Posted in Lender Liability, Tough Times for Lenders

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.


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.

The Trust Indenture Act Provides Minority Bond Holders Avenue to Disrupt Out of Court Restructuring

Posted in Uncategorized

The Trust Indenture Act of 1939, 15 U.S.C. §§ 77aaa-77bbbb (the “Act”) basically provides that holders of notes subject to the Act shall not have their right to receive payment of principal, premium and interest impaired without the holders consent.  In the recent opinion in Marblegate Asset Management v. Education Management Corp., civil case in New York (the “Case”), the Court held (arguably in dicta), that the Act will allow a small minority of noteholders to block an out of court restructuring because the proposed intercompany sale via foreclosure (of substantially all assets) prevented the noteholders from receiving any real recovery from the maker.


In the Case, the Plaintiffs are dissenting unsecured noteholders subject to an indenture agreement (the “Indenture”) made by the operating subsidiaries (the “EDMC Subs”) of Education Management Corp. (“EDMC”).  The Plaintiffs hold ~$20MM of the ~$1.553BB in secured and unsecured debt owed by the EDMC Subs and guaranteed by EDMC.

Importantly, EMDC and the EDMC Subs operate one of the largest for-profit college systems in the United States.  As such, EDMC derived 78.6% of its net revenue from federal student aid programs under the Higher Education Act and overseen by the Department of Education.  One of the many regulatory requirements imposed on EDMC to permit it to receive the federal funds is that EDMC and the EDMC Subs may not file bankruptcy.  Thus, for practical purposes, if EMDC wants to continue to operate and receive funds it cannot file bankruptcy to restructure.

In 2014, EDMC began to suffer significant financial problems and its EBITA dropped from $662MM to $276MM in one year.  To address the situation, EMDC proposed an out-of-court restructuring that could proceed along one of two paths.

  • First Path: everyone agrees to an intercompany sale and creditors receive new notes and equity in the NewCo entity to be owned by EDMC and EDMC guarantee would be released.
  • Second Path: not everyone agrees and the secured creditors foreclose on substantially all of the assets of the EDMC Subs, release EDMC guarantee as to all creditors (permitted because of Indenture terms) and then re-sell the assets to NewCo owned by EDMC.  The consenting creditors would get new notes and equity in/from NewCo.  The non-consenting creditors would get nothing.

At the deadline for consent/non-consent to the first option 99% of the secured creditors consented and 90% of the unsecured consented.  Thus, the secured creditors indicated they would proceed with the second path.

Faced with the practical reality of receiving nothing because of the transfer of the assets from the EDMC Subs to NewCo, the Plaintiffs brought suit to enjoin the intercompany sale.  (The Court noted that even if the borrower/maker had no assets following the intercompany sale, there was potentially causes of action such as fraudulent transfer which might serve as recovery, even if speculative).

At the heart of the Case is whether the Act provides note holders with only the procedural right to pursue their note claim or the actual right to not have their payment impaired.  The Court held that the notes subject to the Act receive the actual right to not have their payment impaired by the maker (without their consent), and thus EDMC’s restructuring proposal (and related agreements) would violate the protection afforded the Plaintiffs under the Act.  Stated simply, the Court stated that depriving the maker/borrower of any meaningful means to pay the Plaintiffs (ie, the assets) violated the terms of the Act which require that repayment not be impaired by the maker/borrower.

In reviewing the legislative history, the Court indicates that the Act protects dissenting note holders (even this small minority of them) from this type of restructure by the borrower and encourages bankruptcy filing instead if the borrower seeks to restructure.

Notably, the Act does not prevent the secured creditor from simply foreclosing and being done with it.  So, as a practical matter, bankruptcy may be the only avenue for debtors seeking to restructure with multiple creditor constituencies who are subject to the protections of the Act if agreement is not immediately forthcoming.  However, the game of chicken remains the same.  Ultimately, if there is no money except from operations, if operations shut down the unsecured creditors face a difficult road to any meaningful recovery.

Marblegate Asset Management, et. al., v. Education Management Corp., et al., Cause 1:14-cv-08584, pending in the United States District Court for the Southern District of New York.

Good Times for Lenders

The Annual Cocktail Party Talking Points

Posted in Articles, Good Times for Lenders

If you are anything like me, you enjoy discussing bankruptcy and litigation issues at social gatherings.  It’s basically like being the Most Interesting Man in the World , except the opposite of that.  Or, at the very least it will end a conversation with someone you didn’t want to speak with. With that in mind, below I have compiled the first annual Cocktail Party Talking Points.  Please use them as you see fit.


The Energy Bubble.  With the Saudis keeping the pedal to the metal on production while the US is in the midst of an energy boom, the cost of oil and gas has tanked.  With margins burning off, the E&P firms who had been surviving of cheap liquidity may be in for a correction.  Read about it on Bloomberg.

Radio Shack is still Kicking Along.  The beleaguered tech retailer Radio Shack continues its attempt to not default on its various lines of credit and stave off bankruptcy.  As it attempts to cut $400MM annually from the budget, the retailer must obtain lender consent to close stores.  Meanwhile, the company’s credit default swap spread is at 144%.  Read about it on CNBC.

East Cleveland Considers Bankruptcy.  The city of East Cleveland, which is a suburb of Cleveland, is “on the verge of collapse” according to the Ohio state auditor.  While the city is relatively small, the emergence of another municipality on the brink of bankruptcy is a reminder that municipalities are still in trouble and the economy has been slow to work through their financial issues.  The city will decide whether to file bankruptcy in Q1 2015.  Read more about it on Reuters.

The Fed Ups the Capital Requirement for 8 Largest Banks.  Under the new Fed guidelines, “the eight largest U.S. banks would need to have an additional capital buffer of between 1% and 4.5% of their risk-weighted assets, based on the relative threat a bank poses to the financial system as calculated by the Fed.”  According to Janet Yellen, this rule “would encourage such firms to reduce their systemic footprint and lessen the treat that their failure could pose to overall financial stability.”  The biggest impact is expected to be on JP Morgan which faces an apparent shortfall of $21B.  Read more about it on the Wall Street Journal.

That Argentina thing is Still Going on.  Earlier this year, Argentine defaulted on bonds governed under US law and has been embroiled in lawsuits both before and after.  It’s still going on.  To further its troubles, Argentina made a bond offering under is local laws and raised about 10% of the $3B being offered.  Notwithstanding, the Argentina Economy Minister presented the participation as evidence of investors’ confidence in Argentina.  Read more about it on Bloomberg.

And finally, a palette cleanser…

California Family Judge gets mean.  In California, ex-state family law judge Healy was admonished (which is a sever finger-wagging at in legal speak) for telling a mother accused of drunk driving that she didn’t “understand the beatdown that was coming…”.  After discussing the drug and alcohol use by the husband and wife, the Judge wondered aloud if “they’re trying out for Jersey Shore.”  The Judge summed up the wife as a “total human disaster”.  Finally, in another hearing, the Judge informed the mother that her daughter would no doubt end up as a “hooker” based on the mother’s attitude.  Formal document is here.

Have a happy and safe holiday.  Look for my next post in January 2015.

Technology Notes

Bankrupt Bitcoin Exchange Mt. Gox begins to Pay Back Account Holders in Bitcoin

Posted in Technology Notes, Workout Issues

Bitcoin is one of several crypto-currencies which are exchanged generally outside of sovereign control and all electronically.  In early 2014, a Bitcoin exchange named Mt. Gox filed bankruptcy in Tokyo and subsequently sought additional protection in the US by filing a chapter 15 bankruptcy petition.  Just recently, the bankruptcy trustee in Tokyo has announced he will begin to pay back account holders in Bitcoin using a US based bitcoin exchange.

Dogecoin is another crypto-currency and is my personal favorite because of the mascot.

Dogecoin is another crypto-currency and is my personal favorite because of the mascot.

First, some background.  Skip this is you are familiar with Bitcoin

Bitcoin is not a “coin” at all in the traditional sense.  Rather, one bitcoin is essentially a complex mathematical code which is recorded on a public ledger as one bitcoin.  That bitcoin has a two security keys which permit the bitcoin to be owned by (and transferred) by a person.

  1. The public key allows the bitcoin to be utilized by the bitcoin exchanges.
  2. The private key is what is used by the bitcoin holder to transfer the bitcoin value to the recipient.

So, in a sense, your bitcoin “wallet” will not hold any coins (or currency), but rather your bitcoin private keys.  When you spend bitcoins from your wallet, you are using your private key to tell the online public ledger to reflect a transfer of bitcoin to a new owner.  That new owner gets a new private key and the bitcoin transaction is complete.

The mathematics and cryptography are significantly more complicated than that.  But, from a consumer standpoint, this is essentially what the transaction looks like.

Unlike sovereign issued (and backed) currency, Bitcoin has no government backing and very little government regulation.

  • There is no Federal Reserve or similar body for bitcoin.
  • There is no government producing bitcoin.
  • Regulations (or lack of regulation) vary significantly globally.
  • All bitcoins are produced by “mining” which is basically utilizing a very complex mathematical proof to create a one-of-a-kind number, which is the bitcoin.

The amount of computing power to mine bitcoins is not insignificant because of the complexity.  Thus, Bitcoin exchanges, such as Mt. Gox will commit resources to do so and will offer exchange services, payment services, wallets and other ancillary quasi-banking services to consumer account holders.

Second, what is going on in the Mt. Gox Case.

When Mt. Gox filed bankruptcy, one of the stated reasons for the bankruptcy was that it had lost 850,000 bitcoins.  At the time, the value of these was about $500,000.00 (USD).

After the bankruptcy was filed, the bankruptcy trustee found about 200,000 of the lost bitcoins.  However, much of the remaining unaccounted bitcoins belonged to account holders at Mt. Gox.  Although, Mt. Gox did hold bitcoin on its own account.  The loss was attributed to hackers and technical issues with the exchange site itself.

After proceeding with the bankruptcy case, the bankruptcy trustee had suggested that the Mr. Gox bitcoins be converted to USD and then used to repay the account holders at Mt. Gox who had lost their bitcoins.  In an interesting turn of events, the creditors demanded to be repaid in bitcoin.  The reasons probably vary, but it is likely the creditors did not want the already volatile bitcoin market to tank when the bitcoins were exchanged for cash.

In order to go about that, the bankruptcy trustee has enlisted the help of another bitcoin exchange named Kraken, which is based in the US.

Finally, things to consider

From an overview perspective; the first thing to consider is that Bitcoin specifically, and perhaps the other crypto-currencies, are not going away despite high profile failures such as Mt. Gox.  Some domestic retailers are now accepting Bitcoin for day-to-day exchanges as they would cash.  Notwithstanding, the market remains very volatile.

At a more narrow level, a bankruptcy court (even in Japan) that pays the creditors in non-sovereign backed crypto-currency should raise a few eyebrows. In this case, it appears that the payment in bitcoin was at the request of the creditors.  However, it is not clear what would happen if account holders had demanded USD (or yen), but received bitcoin while non-account holder creditors were paid from liquidating traditional hard assets in cash.

Obviously there are significant other issues to consider which are not covered in this humble blog post.  Regardless, these issues and others are on the horizon.

Tough Times for Lenders

Bankrupt Individuals Can’t Strip Down Senior Lenders in Ch. 7, but the SCOTUS will decide if they Can Strip Off – Leaving Junior Mortgage Lenders Unsecured

Posted in Tough Times for Lenders, Uncategorized, Workout Issues

The SCOTUS has recently decided to hear an appeal to consider whether junior mortgage liens, which are out of the money, on chapter 7 debtor’s homes may be voided simply because there is no equity in the home to attach to the junior lien at the time of the bankruptcy filing.  The effect of a win by the debtor would be to permit bankrupt individuals to wipe out junior mortgages in chapter 7 when the senior lender’s lien debt is greater than the value of the home.

home underwater

In bankruptcy, a secured creditor’s claim is considered to be bifurcated for the purposes treatment under a plan (see chapter 11 or 13 usually).  More simply, when the secured claim exceeds the value of the collateral, the secured claim equals the collateral value and the portion of the debt above the collateral value is considered to be unsecured.

In a chapter 13 bankruptcy case (an individual’s version of chapter 11), some secured claims may be stripped downie, the secured portion is reduced to the collateral value.  Similarly, in chapter 13, junior lien holders who’s debt is behind a senior lien debt which is greater than the collateral value may be stripped off (rendered unsecured entirely).

In chapter 7, there is no plan treatment, and thus the distinction between debt is trumped by the general rule that a lien rides through bankruptcy, and thus – regardless of the valuation of the collateral – the secured lender is entitled to its entire secured claim against the property.  The debt is generally not enforceable against the individual, through, after discharge.  The SCOTUS has ruled in the past that a chapter 7 debtor may not strip down a lien.

However – the code section that provides for the distinction between the secured vs. unsecured portion of the debt also states that the lien of a purported secured creditor is “void” if the underlying claim is not an allowed secured claim.

Here is the issue:

  • A couple of chapter 7 bankrupt debtors in Florida have claimed that a junior lien which is junior to an already underwater senior lien is not a “secured creditor” and thus has no allowed secured claim (ie, there is no secured portion of the claim).
  • Thus – they argue – the second lien on their residential mortgage is void under the law because it is not a secured claim.

The Bankruptcy Court agreed with this argument over the objection of Bank of America, who is the junior lien servicer/holder.

BofA, seeing that this might be a little bit of a nationwide issue, promptly appealed two of the rulings to the SCOTUS, which has not yet heard the appeals.

The effect on residential lenders will be a little different depending on their respective position in the lien stack:

  1. The issue to be determined is of some consequence to senior lien holders because, if the junior lien is voided in a chapter 7 on undersecured collateral, the senior lien holder may have a little more flexibility in deciding whether to negotiate or take back the home.
  2. For junior mortgage holders, the issue is of greater consequence.  While the junior lien may have been out of the money at the time the bankruptcy was filed, the house may appreciate in value before the senior lender forecloses or the borrower sells.

Once the SCOTUS rules on the pending appeals, the ruling will affect the treatment of junior chapter 7 mortgage holders nationwide.

(As a side note, I missed last week’s post because I was in trial.  I would also like to thank the folks at Apple, Inc. for the traffic viewing the last post.  Swing by anytime.)

Tough Times for Lenders

Confidential Information May Not be so Confidential in Bankruptcy. Just Ask Apple.

Posted in Tough Times for Lenders, Trade Secrets, Workout Issues

It is said that when the debtor files bankruptcy the debtor is in a fish bowl.  The reason is simple:  the debtor in bankruptcy is required to make honest and sworn disclosure of all manner of financial and operational information on request and at regular intervals per the bankruptcy code.  Often, new and exciting liabilities and obligations are discovered by the lenders when their borrower files bankruptcy.  The policy behind this is obvious.  Moreover, rarely does a debtor find itself in bankruptcy because it was too honest.  However, sometimes this statutory preference for sharing collides with the real need to keep trade secrets, secret.

Apple Fish Bowl

Many of you probably heard of the Apple, Inc. vendor who filed bankruptcy.  The vendor, who is GT Advanced Technologies, Inc. and affiliates, made the screens for Apple phones.  The bankruptcy filing made the news because of the stunning possibility that anything related to Apple could be in financial peril.

The screens are technically difficult to make, but Apple sold over 10 million IPhone 6 phones in the first week.  Compare that to reports of Amazon Fire Phone sales of 34 thousand after two weeks.

As it turned out, the sheer scale of endeavor was too much for GT.  Also, it turned out that Apple requires, what some may call, significantly one sided contract provisions.

Two of the many things the contracts between Apple and GT required were:

i.            Attempt to make a bankruptcy remote entity, and

ii.            Keep Apple’s secrets, secret.

As it turns out, it only kind of worked.

For confidentiality, Apple’s terms provided that GT would be liable for $50 million in liquidated damages for each occurrence of disclosure by GT of protected information.  The information protected from disclosure was extremely broad and included disclosing “the nature of their business relationship” and the terms of the contract itself.

For the bankruptcy remote entity, it filed bankruptcy also.  It was faced with the specter of the enormous burden of the liquidated damages, among other things.

In a typical bankruptcy, GT would be required by law to disclose many parts of the business relationship with Apple on a regular basis, typically monthly as well as the terms of the agreements.  The potential for liquidated is therefore large.

However, the wayward debtor is not without salvation.  The bankruptcy code also allows the Court to “protect an entity with respect to a trade secret or confidential research, development, or commercial information;…” upon request.

Piece of cake, right?

Nope. The Bankruptcy Judge in GT didn’t feel that the information provided to him under seal was worthy of protection – notwithstanding the $50MM liquidated damages – and ordered the majority of it to be made public.  So – the information that was provided to the Court to justify the secrecy was in turn simply filed on the docket for all to see after the Judge made the ruling.

If you were interested in the business relationship between Apple and GT and their sapphire screens, unprecedented attempt to meet demand and ultimate downfall – it’s on the docket.  I should note, though, when I checked there was nothing of a purely technical nature.  Thus, the ruling is more a bench mark for expectation of what may actually be confidential in bankruptcy.

For borrowers, this is clearly a difficult path to thread.  For investors, this is a cautionary tale of how to protect your value.  For lenders, this provides some backstop to the idea that all trade secrets will be secret in bankruptcy.  Of course, if the borrower’s income exists because of a trade secret and it becomes public, you might not be getting paid back.

In re GT Advanced Technologies, Inc., et al., case no. 14-11916, pending in the United States Bankruptcy Court for the District of Delaware

Money for Nothing and Overdraft Fees

Posted in Uncategorized

Between 2005 and 2007, a major bank is California  made a paltry $1.4 billion in overdraft fees.  However, a California Federal Court found that those fees were a result of misleading practices and ordered that major bank  pay $203 million in restitution.  The award was recently affirmed by the Federal Appeals Court in the Ninth Circuit. 

Overdraft fees put clients in dire straights

Overdraft fees put clients in dire straights

At the heart of the issue in the case was the bank’s practice of posting debits at the end of the day “high-to-low”; meaning, the largest debit was posted first and sequentially less debits were posted after in order of decreasing amount.  The alternative methods identified by the Court would have been “low-to-high” and “chronological”.

  • In high-to-low posting, the funds in the account are depleted more quickly, the result being that the remaining smaller debits create a larger number of overdrafts.  Thus, the overdraft fees are “maximized”.
  • On the other hand, the low-to-high posting allows the smaller debits to be satisfied first, leaving a lower number of overdrafts and thus lower overdraft fees.

The plaintiffs sued the bank under California law for unfair, unlawful, or fraudulent business practices.  The bank countered claiming that Federal Law, namely, the National Bank Act preempted (trumped) the state law, and therefore the bank was free to post the debits however they wanted.

The trial court found that:

  1. The “decision to post debit-card transactions in high-to-low order was made for the sole purpose of maximizing the number of overdrafts assessed on its customers”,
  2. The bank hid and misrepresented the way debit transactions were posted in their disclosures,
  3. Federal Law did not preempt the state law and the Bank was liable for being both unfair and fraudulent in its posting high-to-low, and
  4. The plaintiffs (as a class) were entitled to $203 million in restitution, among other things.

The bank appealed.  In the first appellate opinion in this case (entered in 2012), the Ninth Circuit held that Federal Law permitted the high-to-low posting of debit transactions, and preempted the state law claim that the high-to-low posting was unfair.


The Ninth Circuit held that the bank was liable under the fraudulent prong of the state Unfair Competition Law.   Specifically, the Ninth Circuit affirmed the trial court’s holding that the Bank’s failure to disclose the effect of the high-to-low posting combined with the bank’s “misleading statements” combined to make [the bank] liable under a fraud theory as a misleading statement. Further – this type of state law violation “is not preempted by the National Bank Act”.

Litigation continued until October 29, 2014, when the Ninth Circuit affirmed (in an unpublished opinion) the trial court’s award of $203 million in restitution and related injunction against the Bank for violation of California’s Unfair Competition Law which prohibits misleading statements.

Normally, I would wrap up with how this would affect lenders, but I think it’s self-evident.  However, it is worth summing up a couple of things to consider:

First, lenders might want to take a look at their motivations and disclosures regarding overdraft fees.

 Second, lenders should be aware that their activities may be perfectly legal under Federal Law, but nevertheless may subject to them to liability under state law.

At the moment, the ruling considers only California Law, but it’s a safe bet that bank clients around the country who are being charged fees for having no money will be looking at those overdraft fees.

Tough Times for Lenders

How to Delete Your Way Into Liability

Posted in Lender Liability, Remedies, Tough Times for Lenders

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.