Tough Times for Lenders

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.

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.)

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

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.

Believe it or not, when you (the good guy) accidently produce in discovery an internal memo which is subject to attorney-client privilege to the bad guys (the guys suing you), the bad guys might not give back all the copies.  And, if you are really unlucky, the bad guys will distribute it to other bad guys also suing you for similar reasons.  You might even litigate the issue to the Fifth Circuit court of appeals and win, but the cat will be out of the bag.

In the Fifth Circuit case Exxon Mobil v. Hill, No. 13-30830 the Court held that an internal memo discussing the radioactivity of material (and its harm) was subject to attorney-client privilege. The Court held that the nature of its creation precluded the need to provide the memo in discovery (even though people got very sick from the radiation).  However, the cautionary tale is that even though the plaintiff returned a copy, he did not return all copies of the memo that was accidently shared.  What ensured was years of litigation.

At the center of the case is a memo drafted by Exxon’s in-house counsel concerning whether to provide radioactivity test results (related to drilling pipe) to a potential contractual counter party who was offering to clean the drilling pipe as a contractor.  In the memo, the in-house counsel opines that Exxon should only provide the information specifically requested by the contractor and that Exxon would not provide the additional information which showed a significantly higher level or radioactivity.

Not surprisingly, litigation ensued over the course of many years after numerous workers became sick from the radioactivity on the drilling pipe.  In the course of one of the many lawsuits “Exxon accidently produced..” the memo.  Exxon’s counsel realized the mistake and invoked the claw back provision (which should require the other side to give back the document).  The opposing counsel did, in fact, return the copy he received.  But, the attorney also “kept a copy of the [] memo and distributed it to other plaintiffs’ attorneys, who in turn attempted to use it in the other cases.”

What following was another parallel set of litigation in which Exxon sought to assert the privilege over the memo in numerous state and federal courts with mixed results.

The 5th circuit, in considering whether to permit the assertion of privilege over the document, held that the memo was privileged.  While the court construed Louisiana state law, the Louisiana version of the rule of evidence is fairly similar to the Texas rule governing privilege.

The 5th circuit stated “The []memo reflects the advice by in-house counsel concerning the disclosure of certain data during negotiations.  Context here is key: The document was prepared during contract negotiations in which both side were assisted by legal counsel.  The negotiations, according to the record, involved a number of legal issues, including indemnity for downstream tort claims, storage and handling of nuclear residue, licensure, trade secrets and other issues.”

Thus, the memo was subject to attorney-client privilege.  But, the general counsel reading this post are not now reaffirming their belief in the technical protections of the attorney-client privilege. Rather, the underlying lesson here is: don’t accidentally send documents that are subject to the attorney client privilege out the door.  Easier said than done (and paid for).  Here, Exxon won the battle and lost the war.

In some litigation arenas, the trend is to produce everything and then figure out what was subject to privilege (for cost reasons).  For lenders who might be exposed to other similar litigation, the relief you have in not paying for a more thorough vetting of documents might be replaced by the anxiety of litigating about it more years.

In some parts of the country, a recovering local economy means the special asset (or problem loan) groups are reducing staff, as loan production groups come back to life.  Leaving the special asset group under-staffed could be a mistake if the staff is not able to properly complete basic foreclosure tasks.  One basic task is inspecting the property prior to taking title to the property (whether through foreclosure or a deed in lieu of foreclosure [FAQ series for information on deeds in lieu]).  Here’s a decision tree that might help you in deciding if an inspection “really” is needed, and a recent example that should energize you to look before you leap (into ownership of the collateral).   Decision tree: verify that your mortgage loan documents give you the right to enter the property, then

  • Current Inspection Report: ask yourself this question: “when was the last time that someone looked at every part of the property?” If the answer is “more than a few months” then a current inspection should be a priority
  • Court Ordered Entry: if the borrower does not allow you to inspect the property, then investigate (with your lawyer) the available court orders that could give you access to the property (in order to inspect it)
  • Extraordinary Situations:  of course, there are situations where inspecting the property just is not possible, with the result that –
    • Foreclosure is the only option (for example, the lien itself is about to lapse or expire) (I’m having a tough time thinking of other justifications to not inspect)
    • Receivership is the better option (for example, you already know of problems and your presence on the property [during an inspection] could cause you problems)

Still not convinced that an inspection should be a top-shelf priority item? Once Upon a Time . . . The phone rings and you’re called to meet with City officials at the police precinct office near your “new” apartment project (shortly after you foreclosed on what seemed like just another project). At the meeting, you’re introduced to the Chief of Police and representatives from the Mayor’s office, the zoning department, the City health department and a lawyer from the local District Attorney’s office.   They vaporize you with a list of alarming health and safety issues at the apartments. The bottom-line message was simple: you have 30 days to show some “progress” on the issues or the City would take enforcement actions. Their list included the following:

  • an active farm growing illegal plants
  • sewage flowing into one of the units
  • on unit has a 50 foot hole in it, with dirt piled up to the window
  • organized dog fighting

As always, it is the basic stuff that jumps up to bite you.  (And gets the immediate attention of your insurance group.) Please share your comments below.