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Lender Liability: Evaluating, Minimizing Lender Liability: Evaluating, Minimizing and Defending Claims

Defending Against Attacks on Loans in Workouts, Defaults and Bankruptcy

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURS DAY, DECEMBER 1, 2011

Today’s faculty features: Thomas J. Hall, Partner, Chadbourne & Parke, New Y

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Thomas J. McCormack, Partner, Chadbourne & Parke, New Y

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S even Rivera, Partner, Chadbourne & Parke, New Y

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LENDER LIABILITY: EVALUATING, MINIMIZING AND DEFENDING MINIMIZING AND DEFENDING CLAIMS: DEFENDING AGAINST ATTACKS ON LOANS IN WORKOUTS ATTACKS ON LOANS IN WORKOUTS, DEFAULTS AND BANKRUPTCY

DECEMBER 1, 2011

5

FACULTY FACULTY

Thomas J. Hall

Liti ti P t Ch db & P k LLP Litigation Partner, Chadbourne & Parke LLP 212-408-5487 thall@chadbourne.com He is Co-Head of the firm's Commercial Litigation Practice and has extensive experience in complex litigation matters such as banking, securities, project finance, real estate, corporate governance, partnership and contract disputes. finance, real estate, corporate governance, partnership and contract disputes. Benchmark's 2011 Guide to America's Leading Litigators recognizes him among the 75 leading commercial litigators and 25 leading bankruptcy litigators in the country. y

6

Thomas J. McCormack

Litigation Partner Chadbourne & Parke LLP Litigation Partner, Chadbourne & Parke LLP 212-408-5182 tmccormack@chadbourne.com He is a trial lawyer with over 25 years of experience handling complex commercial, securities and class action litigations. During the course of his career, he has tried a wide range of cases, involving multi-billion dollar energy supply contracts, bank loans, joint venture agreements, corporate governance and securities claims, drug development projects and many others. He is listed in Chambers USA, Benchmark and other publications as a leading commercial litigator.

7

Seven Rivera

Bankruptcy Partner, Chadbourne & Parke LLP p y , 212-408-5529 srivera@chadbourne.com His practice involves all aspects of bankruptcy and restructuring representing both secured and unsecured lenders, creditors, debtors and creditor committees in complex and high-profile Chapter 11 cases. He also represents buyers and ll i l d h di i i b h i d id f l sellers in sales and other asset dispositions both in and outside formal reorganization proceedings and provides bankruptcy advice concerning corporate transactions.

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PROGRAM

Part 1: Interesting Issues in 2011 Part 2: Borrowers' Defenses Part 3: Other Areas of Potential Lender Liability Part 4: Lender Liability Claims in Bankruptcy Part 5: Q & A: 15 minutes

9

PART 1: INTERESTING ISSUES IN 2011

• A. Claims Against Lenders Arising from

Mortgage Modification Programs

• B. Claims Against Madoff Banks

C Lender Liability for Terrorist Acts

• C. Lender Liability for Terrorist Acts

10

A CLAIMS AGAINST LENDERS A. CLAIMS AGAINST LENDERS ARISING FROM MORTGAGE MODIFICATION PROGRAMS

11

Reyes v. Wells Fargo Bank, N.A., No. C-10-01667 JCS, 2011 WL 30759 (N.D.

• Cal. Jan. 3, 2011)

Background

• Homeowners filed class action suit against Wells Fargo arising from Wells

F ' ll d i l i di d id i l Fargo's alleged mortgage practices relating to distressed residential mortgages.

• Claimed Wells Fargo duped them into signing forbearance agreement, on which

they made six monthly payments in exchange for loan modification thereafter they made six monthly payments in exchange for loan modification thereafter. After making payments, plaintiffs discovered their homes had been sold in foreclosure.

• Complaint alleged Wells Fargo offered "sham" mortgage modification program

to generate revenue from non-performing mortgage loans, without providing customers with the promised consideration of opportunity to retain their homes. p pp y

12

Reyes (cont'd)

• Class action suit asserted causes of action for: (1) breach of contract and

implied covenant of good faith and fair dealing; (2) rescission and restitution; and (3) unfair competition restitution; and (3) unfair competition

• Wells Fargo moved to dismiss arguing complaint did not point to any

provision of forbearance agreements it breached provision of forbearance agreements it breached.

13

Reyes (cont'd)

Holding

• Because plaintiffs were legally bound under their original loan agreement to make

payments, payments made under forbearance agreement did not constitute legally cognizable damages.

• Complaint did not point to any provision of the agreement that promised plaintiffs
• Complaint did not point to any provision of the agreement that promised plaintiffs,

with any degree of certainty, a meaningful opportunity to retain their homes.

• Breach of contract claim cannot survive where plaintiffs do not and cannot allege

p g

• damages. Claims for breach of contract were therefore dismissed.
• Plaintiffs failed to state a claim that defendants breached the implied covenant of

d f ith d f i d li b f l i th h h th t good faith and fair dealing by foreclosing on the homes when the agreement was arguably still in effect. Plaintiffs were able to remain in their homes even after the foreclosure sale and therefore could not assert damages.

14

Reyes (cont'd)

Pl i iff i l d i i d b f f l b

• Plaintiffs not entitled to restitution as to payments made before foreclosure, because

Wells Fargo was owed this money under the original loan agreement.

• Plaintiffs survived motion to dismiss as to the post-foreclosure payments as they might

Plaintiffs survived motion to dismiss as to the post foreclosure payments as they might be able to prove this payment was not required under the forebearance agreement, and because it was made after Wells Fargo foreclosed on the property.

15

B. CLAIMS AGAINST MADOFF B. CLAIMS AGAINST MADOFF BANKS

16

MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268 (2d Cir. 2011)

Background

• Plaintiff MLSMK allegedly invested $12.8 million with Madoff. Defendant JP

Morgan Chase ("JPMC") was allegedly trading partner with Madoff's market- making business and provided banking services to Madoff's investment making business and provided banking services to Madoff s investment company.

• MLSMK allegedly lost entire investment.

g y

• Plaintiff sued JPMC for aiding and abetting breach of fiduciary duty,

commercial bad faith, and negligence. Plaintiff also asserted that JPMC had conspired with Madoff in violation of RICO, seeking treble damages.

17

MLSMK Inv. Co. (cont'd)

• Plaintiff alleged that in late summer 2008, JPMC became suspicious of Madoff

and undertook investigation of his business activities which revealed his and undertook investigation of his business activities which revealed his investment business was a fraud.

• The complaint alleged that from about September 2008 to December 2008,

The complaint alleged that from about September 2008 to December 2008, JPMC conspired to violate RICO by "knowingly and purposely conspiring with Madoff to further his racketeering enterprise by providing banking services that were integral to the functioning of the racketeering enterprise and by engaging in g g g p y g g g various RICO predicate acts."

• JPMC moved to dismiss based on a failure to adequately plead required

elements of state law claims, and argued the RICO claim was barred by Section 107 of the Private Securities Litigation Reform Act, 18 U.S.C. §1964(c).

18

MLSMK Inv. Co. (cont'd) Procedural History

• District court dismissed the complaint in its entirety.
• Plaintiff appealed and Second Circuit Court of Appeals affirmed

the dismissal of state law claims, and dismissing plaintiff's RICO claim in a separate opinion claim in a separate opinion.

• Common law claims dismissed as allegations that JPMC had

actual knowledge was conclusory Claim that JPMC should have actual knowledge was conclusory. Claim that JPMC should have shut down Madoff due to "erratic signs of withdrawal" insufficient as unstable economic climate could cause such erratic withdrawals.

19

MLSMK Inv. Co. (cont'd)

Holding

• RICO Amendment bars civil RICO claims alleging predicate acts
• f securities fraud, even in a case such as this where plaintiff was

l ll l d d f b i i i i i l i i legally precluded from bringing a private securities claim against the bank.

20

Picard v. HSBC Bank PLC, 454 B.R. 25 (S.D.N.Y. 2011); Picard v. Alpha Prime Fund Ltd., 454 B.R. 25 (S.D.N.Y. 2011) Background

• Trustee of Madoff Securities ("BLMIS") brought fraudulent

conveyance claims and common law claims against HSBC and conveyance claims and common law claims against HSBC and

• ther financial institutions.
• Common law claims included unjust enrichment aiding and
• Common law claims included unjust enrichment, aiding and

abetting fraud, and aiding and abetting breach of fiduciary duty based on allegations that HSBC served as a banker and a conduit for BLMIS investments and failed to investigate BLMIS adequately, despite being aware of red flags and indicia of fraud.

21

Picard (cont'd)

Holding

• Court dismissed common law claims on the grounds that Picard does

not have standing to bring claims against third parties on behalf of the creditors of BLMIS. Fraudulent conveyance claims were permitted to proceed before the Bankruptcy Court.

• Picard's powers as trustee of BLMIS arise from the Bankruptcy Code

and the Securities Investor Protection Act ("SIPA"). Neither authorizes a trustee to bring claims on behalf of the customers of a brokerage firm that is being liquidated. Trustee is allowed to bring claims solely on behalf of the estate – in this case, on behalf of BLMIS itself.

22

Picard (cont'd)

• Even if Picard was seeking to bring the common law claims on behalf
• f the BLMIS estate itself he would lack standing based on the doctrine
• f the BLMIS estate itself, he would lack standing based on the doctrine
• f in pari delicto and the Wagoner rule.

A t t d t h t di t b i l l i th t

• A trustee does not have standing to bring a common law claim that

results from a wrong in which the debtor took part. Pi d' l i " l i h ll i f M d ff' l h

• Picard's complaint was "replete with allegations of Madoff's role as the

mastermind of the fraud" and therefore the Wagoner rule barred Picard, as Madoff's successor in interest, from bringing common law claims arising from that fraud.

23

• C. LENDER LIABILITY FOR

TERRORIST ACTIVITIES TERRORIST ACTIVITIES

24

Elmaliach v. Bank of China Ltd., No. 102026/09 (N.Y. Co. 2011)

Background

• Two consolidated suits concerning terrorist attacks perpetrated in 2006 and 2007 by

Hamas and Palestine Islamic Jihad ("PIJ") brought on behalf of victims of attacks. A d i t d f i t i t i ti b th H d PIJ bj t t t i t

• As designated foreign terrorist organizations, both Hamas and PIJ are subject to strict

economic sanctions, enforced by nearly all banks and financial institutions worldwide, intending to severely limit their ability to conduct banking activity that can fund terrorist activities.

• Allegedly in 2003, Bank of China began providing banking services to Hamas and PIJ,

executing millions of dollars in wire transfers, by and through Bank of China's branches in the United States in the United States.

• Transfers sent to an account belonging to a senior operative in both organizations, who

transferred the money to Hamas and PIJ in Israel, for the purpose of terrorist attacks.

25

Elmaliach (cont'd)

• Complaint filed in New York State court alleged Bank participation in wire

transfers violated Israeli law and was the proximately caused injuries caused by transfers violated Israeli law and was the proximately caused injuries caused by these terrorist attacks.

• Plaintiffs alleged that during a 2005 meeting between the Prime Minister of

g g g Israel, China's Ministry of Public Security, and China's central bank, Israeli

• fficials told Chinese officials that the Bank of China wire transfers were being

used to fund the terrorist attacks, imputing actual knowledge to Bank.

• Plaintiffs asserted Bank "knew or should have known" that the wire transfers

were funding terrorist attacks prior to the 2005 meeting, because the transfers d i h f d i hd i hi d f b i i d d were made in cash, funds were withdrawn within a day of being received, and the transfers were large. Plaintiffs alleged that banks recognized these practices as indicative of illegal activity, and they are under an obligation to monitor, report and refuse to execute such suspicious and irregular transactions

26

report and refuse to execute such suspicious and irregular transactions.

Elmaliach (cont'd)

• Complaints alleged violation of Sections 35 and 36 of Israel's

Civil Wrongs Ordinance creating a civil wrong of negligence and Civil Wrongs Ordinance, creating a civil wrong of negligence and imposing liability on a person who injures others by committing acts, or refraining from action, under circumstances in which a reasonable person would have done otherwise, and Section 63 of Israel's Civil Wrongs Ordinance, which imposes liability where a person violates an enactment that is intended for the benefit or p protection of another person.

• Bank moved to dismiss
• Bank moved to dismiss.

27

Elmaliach (cont'd)

Holding

• If Bank had actual knowledge of its customers' terrorist activities, it is

not protected by the usual rule that banks do not owe non-customers duty to protect them from the intentional torts committed by their customers to protect them from the intentional torts committed by their customers.

• "Red flags" raised before the 2005 meeting, which would have imputed

l t ti k l d t B k ld b i ffi i t f li bilit

• nly constructive knowledge to Bank, would be insufficient for liability.
• Insofar as one of the attacks alleged in complaint occurred before Bank

ll dl h d l k l d l i l d hi i id b allegedly had actual knowledge, claims related to this incident may be subject to dismissal at a later date.

28

• Actual knowledge claims survive motion.

PART 2: BORROWER DEFENSES

A Economic Duress

• A. Economic Duress
• B. Lender Control Over Borrower's Operations
• C. Impossibility and Commercial Impractibility
• D. Fraudulent Inducement
• E. Waiver and Estoppel

29

• A. ECONOMIC DURESS

30

Interpharm, Inc. v. Wells Fargo Bank, National Association, 655 F.3d 136 (2d

• Cir. 2011)

Background

• Borrower drug manufacturer entered into a line of credit with bank that

Borrower drug manufacturer entered into a line of credit with bank that fluctuated based on the value of accounts receivable and inventory.

• Decline in revenue puts borrower in default.
• Lender and borrower entered into a forbearance agreement with financial targets

and a release of claims against lender. Borrower failed to meet the financial targets and defaulted under the forbearance agreement.

• Borrower and lender entered into a series of additional forbearance agreements

l f l i i t l d D i thi i d l d (1) i d i t t releases of claims against lender. During this period, lender (1) increased interest rates, (2) excluded certain accounts receivable, and (3) decreased the credit available based on inventory.

31

Interpharm, Inc. (cont'd)

Procedural History

• Borrower repudiated the forbearance agreements and sued lender for

breach of contract and other claims. Lender moved to dismiss based on the releases in forbearance agreements.

• Borrower argues releases were induced by economic duress because it

would not have agreed to them if lender had not wrongfully reduced the credit it extended to borrower.

• District court granted the motion as essential element of economic

g duress – a "wrongful threat" by the lender – was lacking.

• Plaintiff appealed to the Second Circuit.

32

pp

Interpharm, Inc. (cont'd)

Holding on Appeal

• A party must show that there has been a "wrongful threat" to void a release on

the grounds of economic duress.

• A "wrongful threat" is one that is "outside a party's legal rights."
• A lender's threat not to do something it has no obligation to do is not wrongful.

A threat is not wrongful simply because a party benefits from unequal bargaining power and its counter party lacks other viable options power and its counter-party lacks other viable options.

• Lender's interest rate increase after the borrower defaulted under the first

forbearance agreement was not wrongful even if the financial targets in the first forbearance agreement was not wrongful even if the financial targets in the first forbearance agreement were unreasonable. Lender had no obligation to enter into the forbearance agreement and was entitled to impose conditions that might be characterized as "unattainable."

33

Interpharm, Inc. (cont'd)

• Lender's exclusion of accounts receivable was not wrongful because the credit

agreement provided the lender with "reasonable discretion" to exclude receivables. g p

• Exclusion of accounts receivable from wholesale customers was reasonable because

those accounts were subject to reductions in value based on prices negotiated with d il d l d i h bl i h l d l downstream retail customers, and a lender might reasonably wish to exclude less desirable assets from the collateral base.

• Lender's reduction in the credit it extended based on the borrower's inventory was

Lender s reduction in the credit it extended based on the borrower s inventory was not wrongful because the credit agreement provided the lender with discretion to exclude inventory from the collateral base. Lender's decision to lower the credit it would extend from 50% to 39% of the value of the inventory was within the discretion granted by the credit agreement.

34

• B. LENDER CONTROL OVER

BORROWER'S OPERATIONS BORROWER S OPERATIONS

35

• C. IMPOSSIBILITY AND COMMERCIAL

IMPRACTIBILITY

36

Force Majeure/Impossibility Allows a party to suspend or avoid performance when a supervising event beyond its control makes performance impossible The event must not have been foreseeable at the time

• impossible. The event must not have been foreseeable at the time
• f contract, and generally the event must be shown to be a

proximate cause of the failure to perform. Typical force majeure i h i l d A f G d ( h l di ) i events might include Acts of God (such as natural disasters), riots, strikes, wars or government actions.

37

Commercial Impracticability Restatement (2d) of Contracts, § 261: "Where, after a contract is made, a party's performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or p g , g g circumstances indicate the contrary."

38

Walden Fed. Sav. & Loan v. Slane, No. 09 Civ. 1042 (DLC), NYLJ 1202490025504, at *1 (S.D.N.Y. April 5, 2011)

Background

• Walden made $2.9 million in loans to Oxford Landing.

Walden made $2.9 million in loans to Oxford Landing.

• Charles Slane, Daniel Slane and the Slane Company, Ltd. ("Defendants")

guaranteed repayment of the notes.

• Oxford allegedly defaulted by failing to make payments.
• Walden brought claim against Defendants to recover on guarantees.

Defendants asserted defense of temporary commercial impracticability, arguing performance on guarantees impossible due to ongoing financial crisis.

39

Walden Fed. Sav. & Loan (cont'd)

Holding

• Court ruled in favor of lender on summary judgment holding defense of
• Court ruled in favor of lender on summary judgment, holding defense of

temporary commercial impracticability is not available under New York law.

• "New York courts refuse to excuse performance where difficulty is occasioned

New York courts refuse to excuse performance where difficulty is occasioned

• nly by financial difficulty or economic hardship, even to the extent of

insolvency or bankruptcy."

• Court based its decision on the Seventh Circuit's analysis in Hoosier Energy

Coop., Inc. v. John Hancock Life Ins. Co., 582 F.3d 721 (7th Cir. 2009).

• Court rejected defendants' contention that a New York trial court's decision in

Twin Holdings of Delaware LLC v. CW Capital, LLC, CW, 906 N.Y.S.2d 784 (Nassau Co. 2010), had allowed this defense.

40

Walden Fed. Sav. & Loan (cont'd)

• In Hoosier, the Seventh Circuit Court of Appeals found that New

York does not recognize the defense of temporary commercial impracticability although it will recognize the defense of impracticability, although it will recognize the defense of impossibility.

• Hoosier court held an impossibility defense requires a showing

that the new event could not have been foreseen or guarded against in the new contract.

• Hoosier court said New York law "takes a very dim view of

impossibility defenses and has never suggested that when an impossibility defenses and has never suggested that, when an impossibility defense is unavailable, a temporary commercial impracticability defense might serve instead."

41

• D. FRAUDULENT INDUCEMENT

42

Branch Banking & Trust Co. v. Thompson, No. 2009-CA-001427-MR, 2011 WL 255149 (Ky. Ct. App. Jan. 28, 2011)

Background

• In 2002, lender made a $3.5 million loan to a real estate investor, secured by real

estate. B 2006 i t i t l d f lt l t Th ti t d i t

• By 2006, investor was in perpetual default on loan payments. The parties entered into

a forbearance agreement, extending maturity and authorizing an auction of properties to pay down the debt. Agreement included a release of the lender from existing claims. When auction proceeds did not satisfy the debt, the lender filed foreclosure action When auction proceeds did not satisfy the debt, the lender filed foreclosure action against the remaining properties.

• Borrower counterclaimed, charging that the lender had defrauded him and that his

l i b d b h f b b i f d l l claims were not barred by the forbearance agreement because it was fraudulently induced.

• Borrower claimed he had not read the forbearance agreement before signing it

43

Borrower claimed he had not read the forbearance agreement before signing it because it was only sent via e-mail.

Branch Banking & Trust Co. (cont'd) Procedural History

• Jury entered a $10.6 million verdict in the borrower's favor.

T i l t d d b k th i i l i t t d l t f

• Trial court awarded bank the principal, interest, and late fees

borrower was obligated to pay under the loan agreement, offsetting borrower's damages by almost $2 million.

• Bank moved to set aside the verdict, asserting the forbearance

agreement was not fraudulently induced and claims were barred by agreement was not fraudulently induced and claims were barred by forbearance agreement. T i l t d i d ti

44

• Trial court denied motion.

Branch Banking & Trust Co. (cont'd)

Holding on Appeal

• Borrower's fraud in the inducement claim fails because he did not prove

the necessary element of reasonable reliance.

• Borrower emphasized at trial that from 2004 to the date of signing

forbearance agreement, he felt lender had defrauded him, stolen his money, and ruined his business. y,

• Trial court did not find lender owed borrower a fiduciary duty and

borrower was incapable of demonstrating any relationship of trust and p g y p confidence between the parties at the time of forbearance agreement.

45

Branch Banking & Trust Co. (cont'd)

• The fact that the borrower failed to read forbearance agreements, despite having

h i d d h b i id h b the opportunity to do so, and there being no evidence that borrower was discouraged from doing so or that the borrower was discouraged from obtaining separate counsel to examine the agreement, all weighed against the fraudulently inducement claim inducement claim.

• "Where a party signs a contract he chooses not to read, and thereafter asserts a

claim of fraud based upon a misrepresentation of the other contracting party as to claim of fraud based upon a misrepresentation of the other contracting party as to the contents of that contract, the jury should decide whether the party claiming fraud exercised ordinary care in relying upon that misrepresentation only where that misrepresentation was accompanied by circumstances reasonably calculated p p y y to deceive one while exercising ordinary care for his own protection."

• Fraudulent inducement verdict reversed.

46

PROTECTIVE STRATEGIES FOR PROTECTIVE STRATEGIES FOR LENDERS:

• Encourage borrowers to be represented

g p by counsel

• Protective clauses

no reliance  no reliance  merger clause

47

• E. WAIVER AND ESTOPPEL

48

WAIVER "Waiver is an intentional relinquishment of a known right." Gilbert Frank Corp. v. Fed. Ins. Co., 70 N.Y.2d 966, 968 (1988).

49

ESTOPPEL "[E]stoppel is an equitable doctrine; its purpose is to prevent wrong [E]stoppel is an equitable doctrine; its purpose is to prevent wrong and injustice." Sherman v. Town of Rhinebeck, 133 A.D.2d 77, 79 N.Y. App. (N.Y. App. Div. 1987). Estoppel will be invoked "to t th i fli ti f i bl i j d l prevent the infliction of unconscionable injury and loss upon one who has relied on the promise of another." Am. Bartenders School,

• Inc. v. 105 Madison Co., 59 N.Y.2d 716, 718 (1983).

50

PART 3: OTHER RECENTLY LITIGATED AREAS OF POTENTIAL LENDER AREAS OF POTENTIAL LENDER LIABILITY

• A. Breach of Confidentiality Agreement

B Lender Environmental Liability

• B. Lender Environmental Liability
• C. Third-Party Beneficiaries
• D. Multi-Lender Loan Issues

51

A BREACH OF CONFIDENTIALITY

• A. BREACH OF CONFIDENTIALITY

AGREEMENT

52

Courtesy Outdoor Fin., LLC v. Bass Ltd., No. 10-1382, 2011 WL 933957 (W.D.La. Mar. 16, 2011)

Background

• Issuer executed two promissory notes in favor of payee, each

secured by a guarantor, in the total amount of $4.5 million plus interest interest.

• Payee alleges issuer failed to make required payments, thereby

d f l i h defaulting on the notes.

• Payee moves for summary judgment against issuer and guarantor.

y y j g g g

53

Courtesy Outdoor Fin. (cont'd)

• Issuer submitted an affidavit stating it believed with discovery it

could establish counterclaims for the payee's wrongful use of confidential information. confidential information.

• Issuer alleged payee had shared confidential information,

i l di fi i l i f ti ith t th i d including financial information, with two other companies, and negotiated with one of the companies in the context of the confidential information concerning a buyout of the assets of issuer.

• Issuer also contended that while payee asserted a blanket lien

against all its collateral, issuer had been unable to verify whether a against all its collateral, issuer had been unable to verify whether a lien claim by a third party may exist.

54

Courtesy Outdoor Fin. (cont'd)

Holding

• "Court finds that defendants have presented sufficient specific

facts establishing that discovery is necessary in order to provide defendants with an opportunity to rebut … claim of the absence of defendants with an opportunity to rebut … claim of the absence of a genuine issue of fact."

• Court held that under these circumstances summary judgment
• Court held that under these circumstances, summary judgment

was inappropriate, and granted defendants 45 days to conduct all discovery.

55

B LENDER ENVIRONMENTAL

• B. LENDER ENVIRONMENTAL

LIABILITY

56

State v. Estate of Roberts, 935 N.E.2d 450 (Ohio Ct. App. 2010)

Background

• Bank extended credit to manufacturing business, which used chemicals that

generated hazardous waste.

• Borrower defaulted on its obligations and the bank "took over" the

property.

• Ohio Attorney General filed a complaint against borrower, claiming stored

chemicals had become unusable and hazardous during the time in which the bank had possession of property, in violation of Ohio's air-pollution control laws.

• Borrower argued bank had duty to ensure the chemicals did not become

57

hazardous, as it had possession of the property.

State v. Estate of Roberts (cont'd) Procedural History

• Trial court granted bank's motion for summary judgment.

H ld th t b k h d t t l d t t di t d t

• Held that bank had no contractual duty to remediate, respond to,
• r clean up hazardous waste at the premises.
• Contract specified duty was on borrower and although bank had

discretion to perform any duty or covenant the business failed to perform there was no obligation to do so perform, there was no obligation to do so.

• Manufacturing business appealed.

58

State v. Estate of Roberts (cont'd)

• Ohio Court of Appeals reversed, finding a question of fact as to whether the

bank breached its duty under Ohio's air-pollution control laws by failing to dispose of the collateral in a commercially reasonable matter.

• Federal Comprehensive Environmental Response, Compensation, and Liability

Act, exempts lenders from liability so long as they treat collateral in a i ll bl commercially reasonable manner.

59

PROTECTIVE STRATEGIES FOR LENDERS: LENDERS:

• Avoid entering chain of title
• Avoid entering chain of title



Momentary ownership can trigger liability

• Use special purpose vehicle

60

C THIRD PARTY BENEFICIARIES

• C. THIRD-PARTY BENEFICIARIES

61

Basic Capital Mgmt., Inc. v. Dynex Commercial, Inc., No. 08-0244, 2011 WL 1206376 (Tex. April 1, 2011)

Background

• Two real estate investment trusts, both single-asset, bankruptcy-remote entities

Two real estate investment trusts, both single asset, bankruptcy remote entities ("SABREs") and company that managed the trusts ("Petitioners"), brought action against lender for breach of $160 million loan commitment and three promissory notes secured by commercial buildings.

• Lender signed a written agreement with the trust management company,

promising to loan the real estate investment trusts $37 million to acquire and rehabilitate three commercial buildings, if trust management company would propose other acceptable SABREs to borrow $160 million over a two-year period.

• When market interests rates rose, lender refused to provide further funding or

make any other loans under the agreement.

62

Basic Capital Mgmt. (cont'd)

P d l Hi Procedural History

• Jury found in favor of Petitioners, awarding $25 million in damages for

breach of contract, accounting for lost profits and increased costs in

• btaining alternate financing.
• Lender moved to set aside verdict on basis that real estate trusts were

not parties to, or third-party beneficiaries of, the agreement. Agreement was signed solely by lender and trust management company, although role of the named real estate trusts was explained therein.

• Trial court granted the motion and rendered a take-nothing judgment in

g g j g favor of lender.

• Appellate court affirmed and Petitioners appealed.

63

pp pp

Basic Capital Mgmt. (cont'd)

Holding on Appeal by Texas Supreme Court

• Real estate trusts were intended beneficiaries of the $160 million loan

commitment.

• The agreement clearly spelled out the benefit to the real estate trusts because

h i l b i h their role was basic to the agreement.

• SABRE-borrowers provided a mechanism for real estate trusts to hold

investment property directly but in a way that would provide lender with greater investment property directly, but in a way that would provide lender with greater

• security. If lender and trust management company did not intend the agreement

to benefit the real estate trusts directly, it had no purpose.

• It would be unreasonable to require the real estate trusts to create SABREs for

no business purpose, merely so that those entities could be parties to the agreement and sue lender.

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g

Basic Capital Mgmt. (cont'd)

• Jury was correct in awarding damages for lost profits, which were foreseeable at

the time the agreement was executed. g

• Lender knew that trust management company's purpose in arranging the $160

million loan commitment was to ensure financing for the trusts' real estate i h l d di d i h h i i d d f h

• investments. For months, lender discussed with the company its intended uses of the

financing and negotiated detailed requirements for the loans to be made under the agreement.

• Lender knew that if interest rates rose, its refusal to honor the agreement would

leave the trust management company having to arrange less favorable financing. Lender therefore cannot claim it was unforeseeable that its breach would also cost the trust management company business.

• Texas Supreme Court reversed and remanded for further consideration.

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PROTECTIVE STRATEGIES FOR PROTECTIVE STRATEGIES FOR LENDERS:

• Disclaim third-party beneficiaries

i l in loan agreements

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• D. MULTI-LENDER LOAN ISSUES

1 I di id l l d i h i di

• 1. Individual lender right to exercise remedies
• 2. Agents and fiduciary duties
• 3. No action and related clauses

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NO ACTION AND RELATED CLAUSES

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Teachers Ins. & Annuity Ass'n of Am. v. CRIIMI MAE Services Ltd. P'ship, 763 F. Supp. 2d 665 (S.D.N.Y. 2011)

Background

• Plaintiffs invested in a trust comprised of nine fixed-rate mortgage loans, with a

principal balance of $967 million, created pursuant to the Pooling and Services Agreement ("PSA"). CMSLP was a special servicer of the trust. g ( ) p

• PSA established a distribution priority on the borrowers' principal payments whereby the

senior class with a principal balance was to be paid in full prior to the next class receiving i i l t principal payments.

• One of the loans ran into financial difficulties. CMSLP sold the loans, putting the

proceeds toward the principal balance of one class of certificate holders, reducing future p p p g interest payments to the class.

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Teachers Ins. & Annuity Ass'n of Am. (cont'd)

• Affected class holders brought suit contending that the special servicer

breached the PSA by modifying and selling the loan. Plaintiffs charged the special servicer did this to advance its personal interests, as its parent the special servicer did this to advance its personal interests, as its parent

• wned lower-priority principal-receiving certificates, and the sale harmed

plaintiffs financially.

• Special servicer relied on a "no action clause" in the PSA, which

provided that a certificate holder could bring a suit only if at least 25 percent of the certificate holders of each affected class first made a percent of the certificate holders of each affected class first made a demand to bring suit on the trustee.

• In an earlier decision court had explained this clause meant that
• In an earlier decision, court had explained this clause meant that

plaintiffs may sue only if they represent 25 percent in interest of every class of certificates that was affected adversely by the sale of the loan.

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Teachers Ins. & Annuity Ass'n of Am. (cont'd) Holding

• Court enforced no action clause and granted summary judgment

in favor of special servicer.

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RJ Capital, S.A. v. Lexington Capital Funding III, Ltd., No. 10 Civ. 25(PGG), 2011 WL 3251554 (S.D.N.Y. July 28, 2011)

Background R J C i l h ld i d b L i C i l

• R.J. Capital held notes issued by Lexington Capital.
• An indenture governed the notes, and designated the Bank of New York

as indenture trustee, which entailed serving as an agent for payments of principal and interest.

• The indenture further provided Harding would serve as collateral

manager, and Lexington Capital entered into a Collateral Management Agreement with Harding to formalize the arrangement.

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RJ Capital, S.A. (cont'd)

• Indenture contained "no action clause," setting forth several

diti t h ld i d t t b f b i i it conditions a noteholder was required to meet before bringing suit under the indenture.

• Noteholder was required to notify the trustee of default, ensure

that holders of 25 percent of the outstanding notes request that the trustee institute proceedings to correct the default offer to trustee institute proceedings to correct the default, offer to indemnify the trustee for its legal expenses, and then wait 30 days, at which point noteholder could bring suit if the trustee had not i iti t d di d th j it f t h ld h d t initiated a proceeding and the majority of noteholders had not instructed the trustee to refrain from bringing suit.

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RJ Capital, S.A. (cont'd)

• Suit arose from a dispute over the method of calculating the amounts of principal

payments on the notes The indenture contained provisions setting forth an "account payments on the notes. The indenture contained provisions setting forth an account payment priority." Initially, Lexington Capital calculated distributions of principal and interest payments without applying the account payment priority. BoNY distributed those payments into RJ Capital's accounts as trustee.

• Lexington Capital later revised its principal payment distributions to incorporate the

account payment priority, and as a result, RJ Capital allegedly received i tel $500 000 le i i i l e t di t ib ti th it the i e approximately $500,000 less in principal payment distributions than it otherwise would have, and sued to recover its losses.

• RJ Capital argued the no action clause did not apply to its breach of contract claims

RJ Capital argued the no action clause did not apply to its breach of contract claims because they were based upon allegations of mismanagement, and because the terms did not apply to actions against indenture trustees, such as BoNY.

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RJ Capital, S.A. (cont'd)

Holding

• Court rejected assertion that claims of mismanagement removed suit from the scope of a

no action clause. Court noted RJ Capital alleged it had not received proper payment on the notes, an event plainly constituting a default under the indenture, and falling within th f th ti l the scope of the no action clause.

• With regard to its claim against BoNY, RJ Capital had already given notice to the

trustee, BoNY, of its alleged breach. The court held to require RJ Capital to comply g q p p y further with the no action clause and request that BoNY bring suit against itself would present an absurdity. Contractual claims against BoNY were permitted to go forward.

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PART 4: LENDER LIABILITY CLAIMS IN BANKRUPTCY

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Overview

• Recent Developments in Fraudulent Conveyance Law
• Equitable Subordination Risks
• Equitable Subordination Risks
• Recharacterization of Debt as Equity
• Preferences

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RECENT DEVELOPMENTS IN FRAUDULENT CONVEYANCE LAW

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Fraudulent Conveyance Overview

The possibility that a transaction might be characterized as a fraudulent conveyance is probably the best known risk for secured l d i b k t ( id f i l d it ) lenders in bankruptcy (aside from simple undersecurity). A transaction may be considered fraudulent if there is (a) actual fraud or (b) constructive fraud. Actual fraud is found where a transaction was designed to frustrate Actual fraud is found where a transaction was designed to frustrate a debtor's creditors. I t t t ti b h ld t b t ti l In contrast, a transaction may be held to be constructively fraudulent if it is made while a debtor is insolvent or renders that debtor insolvent and was made for less than reasonably equivalent

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value.

Enron Creditors Recovery Corp v. Alfa, S.A.B. de C.V. (In re Enron): Expanding the Settlement Payment Defense

• Shortly before its collapse in 2001, Enron redeemed

approximately $1.1 billion in unmatured commercial d l paper at accrued par value.

• As part of the redemption, the noteholders transferred

their commercial paper to JPMorgan, Enron’s primary broker and received payment through the Depository broker, and received payment through the Depository Trust Company (“DTC”).

• Following Enron’s bankruptcy filing, it sought to avoid

these transfers as fraudulent conveyances due to the

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y above-market price paid.

In re Enron (cont’d.)

• The noteholders moved for summary judgment, arguing that the

payments were protected by the so-called “settlement payment defense” under section 546(e) of the Bankruptcy Code. defense under section 546(e) of the Bankruptcy Code.

• 546(e) provides that “settlement payments” are generally unavoidable

f d l ( f ) l l ( as fraudulent conveyances (or as preferences) unless actual (as

• pposed to constructive) fraud exists.
• Settlement payments are broadly defined as “a preliminary settlement,

a partial settlement payment, an interim settlement payment, a settlement payment on account a final settlement payment or any settlement payment on account, a final settlement payment, or any

• ther similar payment commonly used in the securities trade.”

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In re Enron (cont’d.)

• The bankruptcy court rejected the settlement payment defense
• n the grounds that the payments in question were not “made

to acq ire title to the commercial paper ” to acquire title to the commercial paper.”

– The crux of the bankruptcy court’s distinction appears to have been that the payments were not for purchasing the securities but were, instead, made to retire the debt.

• The district court reversed on interlocutory appeal and held
• The district court reversed on interlocutory appeal, and held

that “a settlement payment is any transfer that concludes or consummates a securities transaction.”

• The Debtors appealed the district court’s decision to the

d i i f l

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Second Circuit Court of Appeals.

In re Enron (cont’d.)

• On appeal, the debtors argued that the district court’s definition of settlement

payment was overbroad in three respects:

– Payment must be of a type commonly used in the securities industry; – A settlement payment must cause title to securities to change; and – A financial intermediary must take a beneficial interest in the securities during the transaction.

• The Second Circuit declined to approve any of the Debtors’ proposed

limitations in turn:

– The “commonly used in the securities industry” language applies only to the final, catch-all provision and was intended to “underscore the breadth of the 546(e) exemption” rather than to limit it. Imposing the Debtors’ proposed restriction would exclude payments made on – Imposing the Debtors proposed restriction would exclude payments made on

• rdinary loans from the safe harbor.

– The definition of settlement payment imposes no requirement that a financial intermediary acquire a beneficial interest in the securities

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intermediary acquire a beneficial interest in the securities.

EQUITABLE SUBORDINATION RISKS

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Equitable Subordination Overview

Section 510(c) of the Bankruptcy Code permits a bankruptcy court to (a) equitably subordinate all or part of an allow claim to all or t f th ll d l i d (b) t f li i part of another allowed claim and (b) transfer any lien securing a subordinated claim to the estate. Generally, equitable subordination is applied where a creditor has engaged in inequitable conduct that caused injury to other creditors

• r conferred an unfair advantage on the subject creditor
• r conferred an unfair advantage on the subject creditor.

Inequitable conduct includes: (a) causing a debtor to become d it li d (b) i i f d ( ) i i d bt undercapitalized, (b) engaging in fraud, (c) mismanaging a debtor entity and (d) breaching of a fiduciary duty owed to the debtor or

• ther creditors.

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In re Washington Mutual, Inc.: Clarity on Limits of Equitable Subordination

• Washington Mutual Bank (“WMB”) failed during the 2008 financial crisis:

– Seized by regulator and FDIC appointed as receiver; – FDIC sells substantially all assets of WMB to JPMorgan Chase Bank, N.A. FDIC sells substantially all assets of WMB to JPMorgan Chase Bank, N.A. (“JPM”) – WaMu, WMB’s parent company, files for bankruptcy; – Almost immediately, disputes arise between the FDIC, JPM and Debtors over y, p ,

• wnership of certain assets.
• March 12, 2010, various parties agree to a plan and global settlement to resolve

h di h l d b h the disputes. The plan was supported by, among others:

– The Debtors; – Certain large creditors (the “Settlement Noteholders”); and – The Creditors’ Committee.

• The Plan was opposed by:

Th E i C i

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– The Equity Committee; – Holders of “Trust preferred securities”; and – Various other creditors.

In re Washington Mutual, Inc. (cont’d)

• Judge Walrath of the Bankruptcy Court for the District of

Delaware concluded that the plan and global settlement were reasonable but denied confirmation on other grounds most of reasonable, but denied confirmation on other grounds, most of which related to the inclusion of certain third-party releases in the plan.

• Following the plan’s initial rejection, it was modified and

resubmitted for consideration.

• The Equity Committee objected to the revised plan requested authority

to prosecute actions, based on alleged insider trading, to: to prosecute actions, based on alleged insider trading, to:

– equitably subordinate the Settlement Noteholders’ claims; or – equitably disallow the Settlement Noteholders’ claims.

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In re Washington Mutual, Inc. (cont’d)

• Standing motions are generally granted if:

– a creditors’ or equity committee states one or more “colorable claims” on behalf

• f a debtor’s estate; and

; – the debtor unjustifiably refuses to prosecute those claims.

• As to the second prong, the Court found that by joining an objection to

p g, y j g j the standing motion, the Debtors indicated a refusal to prosecute the claims at issue.

• However, as the first prong, the Court concluded that the equity

committee failed to state a colorable claim for equitable subordination on the grounds that debt cannot be equitably subordinated to equity under the grounds that debt cannot be equitably subordinated to equity under section 510(c) of the Bankruptcy Code and, as a result, the relief sought by the equity committee would not address the harm complained of.

– The court did however grant standing with

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– The court did, however, grant standing with respect to claims for equitable disallowance.

INSIDER TRADING

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Insider Trading Overview

In bankruptcy, claims may be subordinated, disallowed or

• therwise penalized if claimholders have engaged in insider

t di trading. Courts generally Recognize two forms of insider trading:

• Classical – corporate insider trades in the securities of his

corporation on the basis of material non-public information in corporation on the basis of material non public information in violation of a fiduciary duty owed to its shareholders. Mi i ti t “ t id ” i i id

• Misappropriation – a corporate “outsider” engages in insider

trading where he misappropriates confidential information for securities trading purposes in breach of a duty owed to the

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source of the information.

In re Washington Mutual, Inc.: Bankruptcy Settlement Discussions as Inside Information

• As previously mentioned, the Equity Committee in WaMu sought

standing to prosecute equitable disallowance actions against certain claimholders on the basis of insider trading. claimholders on the basis of insider trading.

• The WaMu reorganization has been characterized by multiple rounds of

plan negotiations plan drafts and confidentiality periods as the parties plan negotiations, plan drafts and confidentiality periods as the parties involved sought to negotiate an acceptable plan of reorganization.

When parties entered into confidentiality agreements in order to receive company – When parties entered into confidentiality agreements in order to receive company information and participate in settlement talks, they were also required to restrict their claims trading. – The agreements in question provided that, upon termination of the confidentiality periods, the debtors would release all material non-public information in order to allow parties to resume claims trading free from the risk of insider trading li bili

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liability.

In re Washington Mutual, Inc. (cont’d)

• When the Equity Committee sought standing to pursue equitable

disallowance claims based on insider trading, it argued, among other things, that: things, that:

– Parties to the confidentiality agreements were not entitled to rely on the debtors’ agreement to disclose all material non-public information; and – The confidential positions taken by parties during the negotiations (which were not subsequently disclosed by the debtors) amounted to material non-public information.

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In re Washington Mutual, Inc. (cont’d)

The bankruptcy court concluded that:

• Knowledge that a settlement was being discussed and of the relative stances the parties

were taking during negotiations constituted material non-public information.

– Materiality hinged on the magnitude and probability of the potential settlement occurring. – The magnitude of the settlement was not in question and that “the [settlement] negotiations may have shifted towards the material end of the spectrum” because acts such as the exchange of term sheets and the execution of confidentiality agreements provided evidence of the probability of the settlement.

• Certain noteholders traded on that non-public information;
• Those noteholders became temporary insiders of the debtors when the debtors gave them

confidential information and allowed them to participate in the settlement negotiations; and/or

• The noteholders became non-statutory insiders of , and acquired fiduciary duties to,

the debtors by acquiring blocking positions in two creditor classes; and

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• The noteholders acted recklessly in their use of that

material non-public information during trading.

CONCLUDING REMARKS

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PART 5: QUESTIONS Q

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