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Second Circuit: Market Rate Preferred Over Formula Rate For Purposes of Secured Creditor Cramdown in Chapter 11 Issues

Courts and professionals have wrestled for years with the appropriate approach to use in setting the interest rate when a debtor imposes a chapter 11 plan on a secured creditor and pays the creditor the value of its collateral through deferred payments under section 1129(b)(2)(A)(i)(II) of the Bankruptcy Code.  Secured lenders gained a major victory on October 20, 2017, when the Second Circuit Court of Appeals concluded that a market rate of interest is preferred to a so-called “formula approach” in chapter 11, when an efficient market exists.  In re MPM Silicones (Momentive), LLC, 2017 WL 4700314 (2d Cir. Oct. 20, 2017).

In Momentive, the bankruptcy court categorically dismissed expert testimony presented by the lenders to demonstrate a market rate of 5-6+%.  Because the debtor had offered to cash out the lenders (and prepared to borrow the funds necessary to do it), there was direct evidence of the economic terms on which an arm’s-length lender would have been willing to make a loan similar to the obligation held by the lenders after confirmation of the plan.  The bankruptcy court declined to consider this evidence, instead relying on a formula approach offered by the debtor, which started with a risk-free rate and built to a rate of 4.1-4.85%.  The economic difference was large, and justified multiple appeals, since the difference between the two rates translated to approximately $150 million over the term of the plan according to the lenders.

Since the Supreme Court addressed cramdown interest in the very different context of a chapter 13 case involving an automobile in Till v. SCS Credit Corp., 124 S.Ct. 1951 (2004), there has been an ongoing debate about whether building an interest rate through a formula approach or allowing the market to determine cramdown interest is more appropriate in chapter 11.  (For an in-depth discussion of the odd Till plurality, and the very different approaches among the Supreme Court justices, see here, co-authored by our dearly departed colleague Mark Stingley, as well as Leah Fiorenza of our Atlanta office.)

In Momentive, the debtor argued that the Till decision required an application of the formula method.  The Second Circuit reversed the bankruptcy and district court decisions, both of which found in favor of the debtor’s formula-driven interest rates.  Addressing this issue for the first time in the chapter 11 context, the Second Circuit adopted the Sixth Circuit’s two-step process for selecting an interest rate.  Specifically, when an efficient market exists in a chapter 11 case, a bankruptcy court should apply the market rate.  Only when no efficient market exists should a bankruptcy court employ the formula approach.  Momentive, pp.8-11.

The Second Circuit remanded the case to the bankruptcy court for further proceedings to determine whether there was an efficient market for the replacement notes being crammed down on the senior lenders.  In so doing, the Second Circuit added certainty to this issue in an important venue for chapter 11 cases and raised the possibility that the Supreme Court may intervene.

Significantly, the Second Circuit also rejected the debtor’s argument that this issue was equitably moot. Because the secured lenders repeatedly tried to obtain a stay and given the sheer size of this case, the Second Circuit ruled that the additional annual payments that would be required at a higher interest rate over seven years would not unravel the confirmed plan or threaten the debtor’s emergence from bankruptcy.

There are several practical implications of Momentive.  We expect more litigation in the future over what constitutes an “efficient market” for purposes of secured creditor cramdown, particularly in larger cases.  In smaller chapter 11s, it may remain difficult for a creditor to demonstrate that the market is efficient, and it will be the rare case in which a debtor lays the groundwork by undertaking refinancing efforts that result in relevant and comparable interest rate proposals.  (Indeed, could this create the perverse incentive whereby debtors don’t even seek exit financing for fear of creating a discoverable paper trail, and move directly to cramdown instead?)  But even when the evidence is less comprehensive than in Momentive, courts may become more comfortable using market-driven analysis for the value indications it can provide, rather than relying solely on the “build-an-interest-rate” formula approach.  Unless and until the Supreme Court addresses this issue in the chapter 11 context, however, this issue will likely remain the subject of further debate and litigation.

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Tenth Circuit Joins Missouri River to Divide Kansas City Over What Constitutes A Stay Violation

On February 27, 2017, the United States Court of Appeals for the Tenth Circuit joined a minority approach followed by District of Columbia Circuit:  failing to turn over property after demand is not a violation of the automatic stay imposed by 11 U.S.C. § 362.  WD Equipment v. Cowen (In re Cowen), No. 15-1413, — F.3d —-, 2017 WL 745596 (10th Cir. Feb. 27, 2017), opinion here.

In Cowen, one secured creditor (WD Equipment) repossessed a vehicle in need of repairs for which the debtor (Cowen) could not pay.  Id. at *1.  Another secured creditor (Dring, the debtor’s father-in-law who is likely no longer welcome at Thanksgiving) repossessed a separate vehicle through the use of false pretenses, a can of mace, and five goons helpful colleagues:

“Mr. Dring lured Mr. Cowen under false pretenses to his place of business to repossess the Kenworth [truck].  Mr. Dring asked Mr. Cowen, who had brought along his young son, to leave the keys in the ignition, engine running, and to step out of the truck.  As Mr. Cowen exited the vehicle, Mr. Dring jumped in, grabbed the keys, and declared the truck ‘repossessed.’  When Mr. Cowen asked what was going on, Mr. Dring told him to take his son and leave—immediately.  A group of five men gathered around Mr. Dring while he brandished a can of mace above his head and threatened to use it if Mr. Cowen did not leave.  Mr. Cowen pushed his young son behind him to protect him, and the two left the lot on foot.” Id.

(Editor’s Note from the Bankruptcy Cave:  You can’t find these stories anywhere in the judicial system except in Bankruptcy Court; we love it.  Here is also a Bankruptcy Cave rendering of what we think these fine young lads looked like.)

Dangerous zone



Within days of the repossessions, Cowen filed for chapter 13 bankruptcy protection in the Bankruptcy Court of the District of Colorado and demanded the return of both trucks, but WD Equipment and Dring both refused.  Id.  Cowen then obtained a show cause order from the bankruptcy court, which ordered the Defendants to “immediately turn over” the trucks to Mr. Cowen; “[c]ontinuing failure to turn over the Truck[s],” the bankruptcy court warned, “may result in the imposition of monetary damages against the Creditors for willful violation of the automatic stay.”   Id. at *2.

After the Defendants failed to comply with the bankruptcy court’s show cause order, Cowen instituted an adversary proceeding against Defendants WD Equipment and Dring for willful violation of the automatic stay.  Id.  During the adversary proceeding, the Defendants argued that Cowen’s rights in the trucks had been properly terminated by Defendants before the bankruptcy petition was filed.  But the bankruptcy court did not find the Defendants’ testimony credible, found that Defendants likely manufactured and forged documents regarding transfer of title, and found that because Defendants’ actions contravened Colorado law, Defendants did not effectively terminate Cowen’s ownership interest in the Trucks.  The bankruptcy court ultimately concluded, “[f]ailing to return the Trucks violated § 362(a)(3) of the Bankruptcy Code,” and it imposed actual and punitive damages under 11 U.S.C. § 362(k)(1). Id.

The district court affirmed, noting that the bankruptcy court had applied the majority rule followed by the Second, Seventh, Eighth, and Ninth Circuits: “that the act of passively holding onto an asset constitutes ‘exercising control’ over it, and such action violates section 362(a)(3) of the Bankruptcy Code.” Id. at *4 (citing Thompson v. Gen. Motors Acceptance Corp., 566 F.3d 699, 703 (7th Cir. 2009); Weber v. SEFCU (In re Weber), 719 F.3d 72, 81 (2d Cir. 2013), California Emp’t Dev. Dep’t v. Taxel (In re Del Mission Ltd.), 98 F.3d 1147, 1151 (9th Cir. 1996), Knaus v. Concordia Lumber Co. (In re Knaus), 889 F.2d 773, 775 (8th Cir. 1989), Unified People’s Fed. Credit Union v. Yates (In re Yates), 332 B.R. 1, 4 (10th Cir. BAP 2005).

The Tenth Circuit reasoned that the majority approach relied too much on legislative history and “practical considerations.”  Id.  In choosing to follow the minority approach followed by the D.C. Circuit (see United States v. Inslaw, 932 F.2d 1467, 1474 (D.C. Cir. 1991)), the Tenth  Circuit stated as follows:

Here again is § 362(a)(3), in relevant part: a bankruptcy petition “operates as a stay … of … any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” Breaking down the sentence, “any act” is the prepositive modifier of both infinitive phrases.  In other words, § 362(a)(3) prohibits “any act to obtain possession of property” or “any act to exercise control over property.”  “Act”, in turn, commonly means to “take action” or “do something.” New Oxford American Dictionary 15 (3d ed. 2010) (primary definition of “act”).  This section, then, stays entities from doing something to obtain possession of or to exercise control over the estate’s property. It does not cover “the act of passively holding onto an asset,” Thompson, 566 F.3d at 703, nor does it impose an affirmative obligation to turnover property to the estate.  “The automatic stay, as its name suggests, serves as a restraint only on acts to gain possession or control over property of the estate.”  Inslaw, 932 F.2d at 1474.  Stay means stay, not go.

Id. The Tenth Circuit concluded: “[a]nd so, adhering to the text of the statute, as we must, we adopt the minority rule: only affirmative acts to gain possession of, or to exercise control over, property of the estate violate § 362(a)(3).  Id. at *5.

Despite the reversal, the Defendants were not absolved of liability.  While simply refusing to turn over the trucks did not constitute affirmative acts of the Defendants, the Tenth Circuit stated that the Defendants’ manufacturing of paperwork, forging of documents, potentially perjured testimony, and coaching of witnesses, “would qualify as post-petition acts to exercise control over the debtor’s property in violation of the automatic stay.”  Id. at *6.

Potential Ramifications

Cowen could prove useful to banks and credit card companies who are faced with allegations that account freezes violate the automatic stay.   Cowen will also necessitate that lawyers practicing on the borders of the D.C. or Tenth Circuits (such as in Kansas City, which is divided between the Eighth and Tenth Circuits) be mindful of the location of repossessions and turnover demands and denials.

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Fifth Circuit Rules for PACA Claimants, and Weakens PACA, All in One Curious Ruling

Set of colored vegetables for kids

Most restructuring practitioners are aware, either vaguely or through punishing experience, of the power of PACA creditors.  PACA (or the Perishable Agricultural Commodities Act, 7 U.S.C. § 499a et seq. for those who hate brevity) requires that buyers of produce hold such produce – and their proceeds – in trust for the benefit of produce sellers.  General creditors of the produce buyer receive nothing, even if they hold a lien on the buyer’s assets, until produce sellers are paid in full on any valid PACA claims (including their interest and attorneys’ fees in most instances).

But sometimes, or many times, the PACA trust assets needed to pay produce sellers are not present.  Accounts must be collected, by use of employees, lawyers, collection agents, or other parties.  Inventory must be preserved and then sold, incurring further costs.  In short, assets to pay PACA claims don’t magically appear, and if no one is paid to pound the pavement to sell that inventory and collect those funds, nothing will be collected, and nobody gets paid.

The Bankruptcy Code deals with the problem very simply.  If assets are being collected for the benefit of unsecured or priority creditors, the post-petition costs and expenses incurred to liquidate such assets are granted first priority of payment.  11 U.S.C. § 503(b)(1)(A).  Alternatively, if assets are being collected (or costs incurred) for the benefit of a secured creditor, the secured creditor’s collateral can (and should) be surcharged.  11 U.S.C. § 506(c).  If the secured creditor complains or balks, the trustee or DIP can (and should) abandon the collateral and force the secured creditor to pay its own costs to liquidate the collateral.

However, a recent Fifth Circuit opinion rejects this common sense approach when PACA is involved.  In Kingdom Fresh Produce, Inc. v. Stokes Law Office (In re Delta Produce), the Fifth Circuit held that the trust structure of PACA mandates that produce sellers be paid in full even prior to the costs of counsel which collected every single dollar needed to pay those very produce sellers’ claims.

The case has limited reasoning.  It borrows from cases holding that PACA creditors are ahead of secured creditors or other creditors, and expands that principal to cover everything.  A utility keeps the power on at the food warehouse so the inventory can be preserved and sold?  That is a foolish utility, unless it knows to a certainty the proceeds can pay PACA sellers in full, leaving funds left over to pay the utility bills.  Employees show up to make collection calls, or process payments?  Good luck getting paid for such efforts, if despite their work funds are insufficient to pay PACA claims in full.  In short, Kingdom Fresh turns a food business in wind-down into a charity for the benefit of PACA claimants, with everyone providing pro bono service to enhance the PACA trust.

Kingdom Fresh recognizes this “free rider problem“: why would anyone work even one iota for an insolvent produce buyer, if payment for their efforts comes behind all the PACA claimants?  But while the Kingdom Fresh Court notes this problem, its proposed solutions are, frankly, illusory.  The Court notes (remarkably, in the view of The Bankruptcy Cave) many professionals will be willing to work to collect assets for PACA creditors, and bear the risk of their fees being behind millions of dollars of such PACA creditors.[1]  Wow.  Second, the Fifth Circuit states that a court-appointed Special Master could do the collections work.  Yet this is not at all what Special Masters do under Federal Rule 53.  Third, the Kingdom Fresh Court notes that PACA allows recovery of attorneys’ fees – and so presumably attorneys working for the estate to collect A/R can get paid from the account debtors?  We guess so, but this is also speculative.  And who is to say the unpaid produce sellers cannot glom onto an attorneys’ fee award the same way they have a senior interest in an underlying claim or judgment owed by a third party to a debtor?  The opinion is silent.

Kingdom Fresh can be viewed as a victory for produce sellers and other beneficiaries of PACA – once again, such creditors are declared to be first among all other creditors.  But its slavish devotion to PACA renders every insolvency case involving the sale of produce much harder – things will grind to a halt until professionals employed to collect and liquidate assets negotiate with PACA creditors to be paid.  By depriving courts of the power to surcharge PACA trust assets, collection of those assets will be delayed or just won’t happen at all.  No one benefits, not even those which PACA is supposed to help.  Kingdom Fresh is, in fact, one of the most anti-PACA cases we at The Bankruptcy Cave have seen, despite its protestations to the contrary.

[1] This is an astounding and unsupported assumption. People taking on greater risk need greater compensation.  No one will take on risk of non-payment for free.

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A Lender’s Federal Post-Judgment Interest Quandary

Post-judgment interest is not something most lenders consider when making a loan. In fact, it is not ordinarily the subject of significant analysis even when litigation becomes necessary.  Where the United States District Court is the preferred venue, however, parties easily can fall into the quandary of being stuck with the federal statutory post-judgment interest rate, which is currently less than 1% per annum.

Pre-judgment, a lender often has solid rights to contract interest and potentially very high default interest rates, which often approach double-digits, added to a recovery when a solvent obligor is on the other side. But a final judgment may be a game-changer on the rate of interest a lender is able to receive.  Recent circuit court decisions are developing the law on post-judgment interest in a way contrary to the economic recovery of contracting parties, and lenders in particular.  It may be possible, however, to draft around this problem.

Current State of the Law

In cases pending before the United States District Court, “post-judgment interest is governed by federal law,” even where jurisdiction is based upon diversity, because post-judgment interest is viewed as a procedural issue. Citicorp Real Estate Inc. v. Smith, 155 F.3d 1097, 1107 (9th Cir. 1998). Federal post-judgment interest is governed by 28 U.S.C. § 1961(a), which provides for “a rate equal to the weekly average 1-year constant maturity Treasury yield” (currently 0.79% and 0.46% a year ago, see here under 1-year Treasury bills).

While federal case law uniformly holds that an “exception to § 1961 exists when the parties contractually agree to waive its application,” there has been significant recent litigation concerning how explicit contracts must be to constitute a waiver. See Fidelity Federal Bank, FSB v. Durga MA Corp., 387 F.3d 1021, 1023 (9th Cir. 2004).  Importantly, a typical contract imposing interest at a specific rate upon a default “until paid” is insufficient under the case law in the Second, Fifth, and Tenth Circuits. FCS Advisors, Inc. v. Fair Finance Co., Inc., 605 F.3d 144 (2d Cir. 2010); Tricon Energy Ltd. v. Vinmar Int’l, Ltd., 718 F.3d 448 (5th Cir. 2013); In re Riebesell, 586 F.3d 782 (10th Cir. 2009). The Fifth Circuit has gone so far as to hold that the term “post-judgment” should be used in order to evidence a clear intent by the parties to waive 28 U.S.C. § 1961 and impose the default contract interest rate post-judgment. Tricon Energy Limited, 718 F.3d at 459.

The Ninth Circuit is the only jurisdiction with an arguable basis in which to assert that a contractual default rate should apply to post-judgment interest. In Citicorp Real Estate, Inc. v. Smith, the court affirmed a judgment awarding post-judgment interest greater than that provided in 28 U.S.C. § 1961 because: 1) the promissory note at issue included an agreed-upon interest rate upon a default; and 2) the parties had previously stipulated to an arbitration award establishing liability that included an interest rate at the rate specified in the note “after judgment until collected.”  155 F.3d at 1108.  It is not clear from the Citicorp holding whether the outcome would have been the same if the parties had not stipulated to an arbitration award with a post-judgment interest rate.  Some trial courts within the Ninth Circuit, however, interpreted Citicorp to allow the application of a contractual default rate of interest to post-judgment interest based solely on a default interest clause. See Mission Produce, Inc. v. Organic Alliance Inc., 2016 WL 1161988 *11 (N.D. Cal. Mar. 24, 2016); Abbate Family Farms Ltd. Part. v. GD Fresh Dist., Inc., 2012 WL 2160959 *6 (E.D. Cal. Jun. 13, 2012); Best Western Intern., Inc. v. Richland Hotel Corp. GP, LLC, 2012 WL 608016 *11-12 (D. Ariz. Jan. 18, 2012); Beaulieu Group LLC v. Inman, 2011 WL 4971701 *5 (D. Ariz. Oct. 19, 2011).

Even Ninth Circuit courts now may require more explicit language before finding a waiver of the federal statutory post-judgment interest rate. While not binding precedent, the Ninth Circuit’s March 16, 2016 holding in the unpublished opinion OREO Corp. v. Winnerman, 642 Fed. Appx. 1951 (9th Cir. 2016), seems to signal that a typical default interest rate in a contract is insufficient to waive § 1961.  In OREO, the court reversed a trial court’s award of post-judgment interest at a promissory note’s default rate.  In doing so, the Ninth Circuit took a very narrow view of Citicorp and reasoned that post-judgment interest at the default rate was allowed in Citicorp  only because the parties had stipulated to an arbitration award with a higher rate of interest.


Plaintiffs should carefully consider the likely application of the federal statutory post-judgment interest rate when analyzing the benefits of filing in federal court. Unless the contract at issue includes a provision expressly applying the default interest rate post judgment, there is a strong probability the court will impose post-judgment interest at only the federal statutory rate, which is presently less than 1%.

Lenders and other contracting parties currently crafting documents would be wise to include language making clear that the parties intend for the default interest rate to apply not just upon an event of default, but also to post-judgment interest to the extent a lawsuit is necessary.

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The Little Airline That Couldn’t

The Little Airline That Couldn’t

July 27, 2016

Authored by: Clif Burns

Editor’s Note:  Our colleagues at Bryan Cave’s Export Law Blog, your one stop shop for helping clients navigate export matters, customs, cross-border, and all the daily evolutions in those practices, allowed us to cross-post this piece on the intricacies of Article 4A of the UCC (it covers funds transfers – we at the Bankruptcy Cave had to look it up!).  Anyone dealing with funds transfers (which is just about everyone) should read this great post.  

[Copyright © 2016 Clif Burns. All Rights Reserved.]


Remember Sabena, the ill-fated Belgian airline that declared bankruptcy in 2001?  Well, to quote Ford Madox Ford, this is the saddest story I have ever heard.

One of the things that Sabena did, other than fly people back and forth to Brussels, was to provide repair and technical services to other airlines.  One of those was Sudan Airways, which originated a wire transfer of $360,500 to pay Sabena.  One day before the wire transfer, on November 3, 1997, President Clinton blocked the assets of the government of Sudan, including those of Sudan Airways.  So when the wire from Sudan Airway’s bank hit Bankers Trust in New York on November 4 on its way to Sabena’s bank in Belgium, Banker’s Trust blocked the transfer and put the funds in a blocked account where they sat for more than a decade.

In 2009 Sabena requested that OFAC unblock the funds. In 2012, OFAC issued a license to Banker’s Trust (by then Deutsche Bank) to release the funds. The receivers for Sabena were doing a happy dance over getting the license from OFAC when their celebration was abruptly cut short.  Deutsche Bank relied on the license Sabena obtained and sent the funds not to Sabena’s bank but to Sudan Airways bank.  It’s something like renting a hall and a band for a party and then not being allowed to attend but rather forced to watch through the windows as your guests eat all your food and drink all your champagne.

So the receivers for Sabena decided to get even: they sued Deutsche Bank for not sending the money to them. But poor Sabena just can’t get a break.  On July 14, a New York appeals court dismissed the Sabena complaint and upheld the return of the unblocked funds to Sudan Airways.

To get there, the appeals court relied on Article 4A of the Uniform Commercial Code that governs fund transfers.  Specifically the court relied on two provisions.  First, it relied on section 4A-212, which says that an intermediary bank, like Bankers Trust, has no liability to the beneficiary of the funds transfer.  Second, it relied on section 4A-402 which requires the intermediary bank to return to the sender any uncompleted funds transfer.  Once the funds were blocked, then the transfer order was cancelled under section 4A-211(d) five days after the intermediary bank received a transfer request and did not execute it.  And once cancelled, then section 4A-402(d) requires the funds to go back to the sender.

The moral of the story is this: intended recipients of blocked fund transfers should not waste their time trying to get an unblocking license.

Photo Credit: Sabena Airbus A321-211 by Aero Icarus [CC-BY-SA-2.0 (], via Flickr [cropped and color processed]. Copyright 2010 Aero Icarus.

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Banks and Marketplace Lenders Absorb a Blow Under the Supreme Court’s Refusal to Hear Madden v. Midland Funding, LLC

Editor’s Note:  Our great friends at BankBryanCave, one of the top blogs out there for banking, regulatory, financial institution M&A, and related banking matters, allowed us to cross-post this compelling post on the impact of  the Supreme Court’s denial of cert of the 2nd Circuit’s decision in Madden.  We think this is pretty important stuff, especially for parties in the consumer debt secondary market.  

In a blow to banks and the marketplace lending industry, on June 27, 2016, the U.S. Supreme Court denied the petition by Midland Funding to hear the case Midland Funding, LLC v. Madden (No. 15-610).  That case involves a debt-collection firm that bought charged-off credit card debt from a national bank.  The borrower’s legal team argued that a buyer of the debt was subject to New York interest rate caps even though the seller of the debt, a national bank, was exempt from those state law rate caps due to preemption under Section 85 the National Bank Act.  The borrower won on this startling argument in the 2nd Circuit Court of Appeals (the 2nd Circuit’s opinion is here) and the debt collector appealed to the Supreme Court.  The Office of the Comptroller of the Currency (the regulator for national banks), the U.S. Solicitor General, and various stakeholders in the banking and lending industries vigorously argued that the 2nd Circuit’s decision contravened established law.  (Links to the petition, various amicus briefs, and the like can be found here.)  The fear was that, if preemption strips loans of their usury-exempt status when the loans are sold, then banks’ ability to sell consumer loans, including the common practice of banks originating and quickly selling those loans to investors and marketplace lenders, would be significantly limited, if not curtailed.

The Supreme Court denied the debt collector’s appeal without explanation, which means the 2nd Circuit’s ruling is binding law in that Circuit, which includes New York, Connecticut and Vermont. However, the 2nd Circuit’s ruling is not the law outside of the 2nd Circuit.

As of today, these are some of the key takeaways for banks and the lending industry:

  1. For the immediate future, consumer loans originated to consumer borrowers in states other than New York, Connecticut and Vermont are not affected.
  2. Conceivably, the implications of the case could largely disappear, depending on what happens upon remand to the District Court. If the District Court decides that the loans were “valid when made” notwithstanding usury caps that only apply to a subsequent buyer of the loan, then the practical effect would be to return jurisprudence to its pre-Madden norm. It is likely that the OCC and the banking industry will vigorously pursue every opportunity to reach that result.
  3. Many marketplace lenders originate loans through state-chartered banks, which rely on interest rate and fee exportation under Section 27 of the Federal Deposit Insurance Act, not preemption under the National Bank Act. However, most industry observers are very concerned that future court challenges will not distinguish between exportation and preemption and will also discard exportation with respect to state interest rate caps.
  4. The Supreme Court’s ruling makes New York, already a difficult state for a non-bank lender to make consumer loans, even less hospitable.  An investor or marketplace lender that wants to buy New York consumer loans from a bank must have a lender license to charge up to 25% or be subject to the 16% rate for unlicensed lenders. This will make unsecured personal loans unprofitable for a large segment of consumers and accelerate the trend of many marketplace lenders avoiding New York altogether.  Connecticut rate caps for unsecured loans range between 11% and 17%, which makes that state even less profitable than New York.  Vermont has a similarly restrictive rate environment.  All three states will likely see a substantial withdrawal from the market by a variety of consumer lenders.  In addition to the withdrawal by non-banks, banks will see a steep increase in their costs to make or hold consumer credit in these three states.  Banks will need to sharply discount consumer debt if they wish to sell it to a non-bank or, if the discount is too steep to be palatable, simply hold the debt on their own books.  Either way, the increased costs and reduced profitability will make consumer lending less available and more expensive to the consumer.
  5. Securitization of consumer debt originated in the 2nd Circuit states is much more difficult (and probably impossible if the stated rates on the debt exceed state law usury caps for non-banks).  The current practice is to use a national bank as the trustee of the securitized debt to rely on the traditional preemptive power of a national bank.  If securitization is limited or stopped, this will also increase the costs of making these loans.
  6. Business purpose lending is not affected at all because state law usury caps only apply to consumers.  In the future, we may see sole proprietor businesses attempting to assert consumer defenses, but so far this has not succeeded in a meaningful way.  Similarly, real estate lending (including consumer mortgages), is generally not affected as such lending is generally excluded from state law usury caps.
  7. Some marketplace lenders are strategically pursuing their own lender licensing to give themselves the option of originating loans without a bank and to take advantage of the higher rate caps available to licensed lenders.  Lending under one’s own license also avoids a “true lender” lawsuit in which the consumer argues that the originating bank should be ignored and that consumer compliance should be evaluated solely based on the purchasing investor / marketplace lender.

So, while marketplace lenders and banks have taken a blow in the Supreme Court’s refusal to hear Madden, the blow is not as bad as it could have been because the effects are limited to the 2nd Circuit.  And, even those effects may be muted depending on future developments in the case. Business practices can be adjusted.  But, as is usually the case with bad law, consumers will pay the price in terms of more expensive and less available credit.

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From Across the Pond – An Unsecured Creditor, Even with Contractual Rights Against the Secured Creditor, Cannot Enforce Common Law Duties on the Manner of Enforcement Against the Collateral

Editor’s Note:  Our good London colleague Ed Marlow recently published this as a Bryan Cave client advisory.  When we Yanks saw it, we found it fascinating, not only based on the arcane facts, but also to realize that British tribunals struggle with the same things we do here in the States – whether (or how) to protect junior creditors which allege that a secured creditor did not maximize value in disposing of the collateral.  Different countries, same insolvency challenges!  Our sincere thanks to Ed for this analysis; for a introduction to how Bryan Cave can assist with your corporate trust matters in England, France, Germany, or other EU countries, please click here.

Summary and Holding:

Including an unsecured creditor in an agreed payments waterfall does not by itself confer on that unsecured creditor the benefit of a mortgagee’s usual duties on enforcement of security, or a direct claim against the sale proceeds.

Background, Facts, and Reasoning:

The English Court of Appeal in PK Airfinance v Alpstream had to address a mortgagee’s duties on the enforcement of security (in this case over a number of aircraft).  In a reassuring case for secured lenders, the Court’s judgment confirms existing English law both as to the time and manner of realisation of the secured assets and when a mortgagee might buy the secured assets. Interestingly, the Court also had to consider whether the position of an unsecured creditor as a party in the agreed payments waterfall (of the realisation proceeds of the security), resulted in an exception to the principle that a mortgagee’s duties on enforcement do not extend to unsecured creditors.

Overturning the judge at first instance, the Court held that a mortgagee only owes its duties on enforcement, such as the duty to take reasonable care to obtain a proper price, to persons with an interest in the value of the equity of redemption in the secured assets. Those persons are the mortgagor, a subsequent mortgagee and (because of a guarantor’s subrogation rights) any guarantor of the mortgage debt. This was so even though in this case the relevant unsecured creditor, Alpstream, appeared in the agreed payments waterfall (albeit at the bottom) and so had a contractual right to repayment out of the balance of the sale proceeds after the secured creditors had been repaid in full. Holding otherwise would involve a departure from established authority, which the Court did not believe to be justified. Alpstream had expressly agreed in the intercreditor arrangements that its debt would be subordinated to the mortgagee and that it would not take any security in respect of its debt.

Therefore unsecured creditors are not owed the mortgagee’s usual duties when the mortgagee realises the secured assets, even though it may be foreseeable that the unsecured creditors might be adversely affected by the outcome of the sale. Nor will an unsecured party’s contractual right to receive payment out of the balance at the end of the payments waterfall confer a direct claim against the secured assets or their proceeds.

The Court was also concerned to give effect to the transaction documents to which the parties had agreed. Equitable duties (a mortgagee’s duties arise in equity) can be amended by agreement. The Court’s decision was consistent with the transaction documents.

There is an increasing trend in Europe for secured financings to permit unsubordinated unsecured debt. This case is perhaps a timely reminder of exactly where unsecured creditors stand.

A final observation: the Court was satisfied that the proceeds in this case from the sale to the mortgagee were higher than anyone else would have been willing to pay in the circumstances. The mortgagor had therefore benefited (and potentially Alpstream as unsecured creditor). Would the court have taken a different view on any of the issues if this had not been the case?


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Second Circuit Decision Reminds Us to Double-Check Documents

Official Committee of Unsecured Creditors v. JPMorgan Chase Bank, N.A. (In re Motors Liquidation Co.), Appeal No. 13-2187 (2nd Cir. Jan. 21, 2015)

Second Circuit Decision Reminds Us to Double-Check Documents

In a decision that sent a shiver down the spine of attorneys and lenders alike, on January 21, 2015, the U.S. Court of Appeals for the Second Circuit (the “Second Circuit”) ruled that JPMorgan Chase Bank, N.A. (“JPMorgan”) had released its security interest on a $1.5 billion loan to General Motors (“GM”) by inadvertently filing a UCC-3 termination statement. The Second Circuit held that although JP Morgan and GM did not intend to terminate the security interest at issue, the termination was effective because JP Morgan authorized the filing of the UCC-3 termination statement.

In October 2001, GM entered into a synthetic lease financing transaction (“Synthetic Lease”), by which it obtained approximately $300 million in financing from a syndicate of lenders (the “Lenders”) including JPMorgan who served as the administrative agent. The Synthetic Lease was secured by mortgages on several pieces of real estate, which were perfected by the filing of two UCC-1 financing statements by JPMorgan (the “Synthetic Lease UCC-1s”). Separately, GM entered into an unrelated term loan facility (the “Term Loan”). JPMorgan also served as the administrative agent on this loan. The Term Loan was secured by security interests in a variety of GM’s assets, including equipment and fixtures at forty-two facilities throughout the United States. JPMorgan properly filed UCC-1 financing statements to perfect its security interest in the various assets, including one such statement filed in Delaware covering all of GM’s equipment and fixtures at 42 of the facilities (the “Term Loan UCC-1”).

In September 2008, as the Synthetic Lease was nearing maturity, GM decided to pay-off the loan and contacted its counsel to prepare the necessary documentation, including documents to release the Lender’s security interests. In order to prepare the documents necessary to terminate the Lender’s security interests, GM’s counsel ordered a search for UCC-1 statements that had been recorded against GM in Delaware. This search yielded three UCC-1s: the Synthetic Lease UCC-1s and the Term Loan UCC-1. As part of the transaction, GM’s counsel prepared a closing checklist and UCC-3 termination statements to terminate all three security interests, mistakenly including the Term Loan UCC-1. Although all parties and their counsel reviewed the checklist and the draft documentation, no one caught the error. In October 2008, GM paid off the Synthetic Lease and the three UCC-3 termination statements were filed with the Delaware Secretary of State.

The mistake went unnoticed until 2009 when GM filed its Chapter 11 bankruptcy. JPMorgan became aware of the inadvertent filing of the UCC-3 statement relating to the Term Loan. JPMorgan advised the Official Committee of Unsecured Creditors (the “Committee”) appointed in GM’s bankruptcy of this filing mistake and asserted that the Term Loan was secured nonetheless because the filing was ineffective because it was unauthorized. The Committee commenced the underlying action against JPMorgan seeking a determination that, despite the error, the UCC-3 statement with respect to the Term Loan was effective and the Term Loan was unsecured. JPMorgan opposed this determination under UCC §9-509(d)(1) because it did not intend to terminate the security interest related to the Term Loan, therefore, the filing was not authorized and was not effective. The United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) agreed with JPMorgan and held that the mistaken UCC-3 statement was unauthorized and therefore not effective to terminate a secured lender’s interest in a debtor’s property. The Committee filed a direct appeal of the Bankruptcy Court’s decision to the Second Circuit.

The Second Circuit certified the question related to interpretation of UCC §9-509(d)(1) to the Delaware Supreme Court because it presented a significant issue of Delaware state law. The Delaware Supreme Court held that under UCC §9-509(d)(1) if the secured party of record authorized the filing of the UCC-3 statement, that statement is effective regardless of whether the secured party subjectively intended or understood the effect of filing the statement. The Second Circuit then held that although JP Morgan never intended to terminate the Term Loan UCC-1, it clearly authorized the filing of the UCC-3 statement with respect thereto. Accordingly, the Second Circuit held that the UCC-3 with respect to the Term Loan was effective, reversing the Bankruptcy Court’s decision, and thereby rendering the Term Loan unsecured.

This decision provides a terrifyingly simple, and for parties involved costly, reminder to always double check your documents.

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