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Handy List of Basic Issues to Consider for the Transactional Workout

While significant energy here at the Bankruptcy Cave is devoted to substantive bankruptcy matters, not all aspects of a general insolvency practice are always fun and litigation.  Oftentimes insolvency lawyers add the most value by helping clients avoid a bankruptcy filing, or by successfully resolving a case through a consensual transactional restructuring.  Below are a few key issues diligent counsel for creditors and debtors should think through in connection with a transactional restructuring.[1]

1. Notice and Demand After Default. As anyone reading this knows, a lender often sends a notice of default and maybe even a demand for payment after its borrower defaults.  However, simply sending a notice of default and demand for payment may not always be sufficient or have the intended effect.  Most loan documents provide a cure period before a breach becomes an actionable default.  Some loan documents will only permit a lender to accrue default interest after specific notice is given to the borrower.  And sometimes no notice or demand is required at all.  While it is generally considered best practice for a lender to notify a borrower of a breach, demand repayment, and affirmatively elect to accrue default interest after a breach, a careful reading of the loan documents is an absolute necessity.  Also, remember that a lender doesn’t always have to react to a breach by attempting to exercise every possible remedy.  Sometimes a simple reservation of rights letter that notifies the borrower of the breach and reserves the lender’s rights and remedies may be sufficient to protect the lender and yet not scare the borrower into precipitously considering extreme countermeasures like bankruptcy.  After all – all you can control is your actions; you cannot control (or sometimes even predict) how others may react or overreact to your actions.

2.  Pre-negotiation Agreements. Post-default discussions between a lender and a borrower can be tense, with both sides guarded so as not to say or do something that they may later regret. A critical tool to cut through some of the tension is a pre-negotiation agreement between the parties, which in general is a contractual agreement regarding the parameters of negotiations between the parties regarding the defaulted debt, an acknowledgment that things said in those discussions will not be used in future litigation, and an acknowledgement that the discussions will result in an agreement regarding the defaulted debt only if put into writing.  Often these agreements will include additional features, such as acknowledgments of defaults and debts or a tolling of the statute of limitations, but the primary function is to allow the parties to negotiate without fear that statements made during negotiations may be used against them in the future.  All it takes is a single offhand comment by a lender or its counsel in an email, such as “we think that sounds like a good proposal” for an unscrupulous debtor to argue that the loan was modified, or a concession was granted by the lender.  The pre-negotiation agreement will prevent these sorts of arguments; we highly recommend them in all workout discussions.

3.  Document Review and Cleanup. A lender will have no better opportunity to scrub its documents and fix any documentation gaps than after a default.  We consider it best practice when in-taking any distressed matter for a lender client to thoroughly scrub all loan documents and identify any potential issues that the lender should address.  We consider it best practice to do the same for a borrower representation.  Did the lender fail to obtain signatures for all of the loan documents?  Do the loan documents contain any significant errors affecting the deal?  Did the lender fail to properly perfect its security interest?  (Consider especially any sorts of unusual collateral, where the perfection rules can be different.)  Did the lender opt at origination not to get a guarantee from the trust holding all of the assets of the borrower’s principals, and now the lender wishes it had?  Did the lender receive non-ordinary course payments recently?  In a situation where the borrower is in default and is probably asking for more time or other financial accommodations, the lender has unparalleled leverage to clean up errors, grab the additional guarantees or collateral that it didn’t require previously, and otherwise manage things like preference exposure.  And where a borrower identifies that some of these issues exist, it too may have significant leverage to obtain the accommodations it seeks.  (By the way, for more specific tips on collateral issues you really need to check in advance of any workout, check out this ABI post by our colleagues Leah Fiorenza and Wendy Godfrey.)

4.  Forbearance Agreements. Sometimes a workout doesn’t result in a waiver of defaults and new deal terms.  Rather, many times a lender may be looking to exit the relationship but may be willing to give a borrower time to get its affairs in order to accomplish a payoff, refinancing, sale, etc.  In this situation, the lender may agree to forbear from exercising rights and remedies with respect to a default for a limited period.  The lender will often agree to modify covenant compliance requirements or other terms of the loan during the forbearance period, but the existing defaults are not waived.  If the borrower doesn’t repay the debt at the end of the forbearance period, the lender then once again has the ability to exercise its rights and remedies due to the default.

5.  Modification Agreements. And sometimes a workout does result in a waiver of defaults and new deal terms.  That is often accomplished through a modification of loan documents, where the parties agree to waive existing defaults and modify the terms of the loan.  While the goal here may still be an early exit (i.e., where the parties agree to shorten maturity), the loan modification will bring the borrower back into compliance and eliminate the threat of default interest and enforcement actions.

6.  Acknowledgments and Reaffirmations. Whether through a forbearance agreement, a modification agreement, or any other variation of agreement, acknowledgments and reaffirmations are critical.  A lender will expect to receive from the borrower and any guarantor in any such agreement an acknowledgement of the debt owing to the lender, an acknowledgment of the loan defaults, and a reaffirmation of all of the loan documents and of the security interests granted to the lender.  These, and the releases discussed below, are often the only consideration, and sometimes the most important consideration, that a lender will receive in a workout.

7.  Releases. Perhaps the most critical consideration that a lender will expect to receive, and any borrower or guarantor should expect to be asked to give, in a workout is a general release of claims.[2]  While releases come in many varieties, a well-crafted release will provide for an immediate and complete release by all borrowers and guarantors in favor of the lender of any and all claims, known or unknown, that may exist as of the time of the written workout agreement, an agreement by the borrowers and guarantors not to bring suit based on any released claims, and an acknowledgment that the release may be pled as a full and complete defense to any such suit. Of course, state law differs regarding releases.  We always recommend a thorough review of applicable state law regarding releases and that practitioners include all relevant statutory release and waiver language where applicable.

8.  Authority. Finally, one of the most overlooked aspects of any transaction, and particularly a workout transaction, is ensuring all necessary corporate, trust, or other authority has been granted for the parties to enter into the agreements evidencing the transaction.  We often see practitioners either ignore this issue or, perhaps, rely on representations in the written agreement along with the provisions of any applicable corporate or LLC statute to confirm the authority of the parties to enter into the agreement.  However, that does not substitute for an actual review of the relevant organizational or trust documents to determine who is actually authorized to sign on behalf of the entity.  For instance, you may find that although your signer is a member of the LLC borrower, the LLC’s operating agreement gives the member no power to enter into agreements on behalf of the LLC and rather all power is vested in a manager or board that must approve all transactions.  Taking the time to analyze these authority issues and obtain the necessary authorizing resolutions as part of the transaction will eliminate any pesky argument down the road that the person who signed the documents had no authority to bind the entity to the agreement.

The foregoing is, of course, just a brief discussion of some of the many issues insolvency lawyers may need to address in a transactional workout, but each is an important component to consider in any distressed debt representation where a transactional workout is a possibility.

[1]           While we talk here about lenders, borrowers, and loan debts specifically, this discussion is generally applicable to any sort of debtor-creditor relationship.

[2]           Of course, there will be situations where borrowers and guarantors will rightfully expect releases as well. That is not often the case for a general workout in our experience, but these same principals would apply for any release in favor of borrowers and guarantors.

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Helpful Cases for Mortgage Servicers Attempting to Comply with Mortgage Servicing Regulations After a Bankruptcy Discharge

Mortgage lenders and servicers face several regulations in servicing residential mortgages. There are requirements under the Truth in Lending Act (“TILA”), Real Estate Settlement Procedures Act (“RESPA”), the Equal Credit Opportunity Act (“ECOA”), the Fair Debt Collection Practices Act (“FDCPA”), state law, and new regulations implemented by the Consumer Financial Protection Bureau (“CFPB”).  Failure to comply with these regulations and laws may give rise to litigation, as well as statutory penalties.  In many cases, the mortgage borrower files for bankruptcy.  When the mortgage borrower states an intention to surrender the mortgaged property in bankruptcy, non-bankruptcy statutes and regulations often conflict with or at minimum create great uncertainty about the mortgage servicer’s obligations to communicate with these borrowers after discharge.  Neither the Supreme Court nor many of the Circuits have provided clarity for mortgage servicers on whether, how, and to what extent they may communicate with a discharged debtor who still owns the mortgaged property.  Accordingly, for the time being, mortgage servicers must attempt to comply with every applicable statute and regulation while not running afoul of any applicable bankruptcy discharge rules.  The following is a compilation of cases dealing with this dichotomy.

  • “[N]ot every communication from a creditor following the conclusion of a Chapter 7 case violates the discharge injunction.” In re Henriquez, 536 B.R. 341, 345 (Bankr. N.D. Ga. 2015).
  • Correspondence does not violate Section 524 unless it includes a clear demand for payment, accompanied by coercion in the form of a threatened action or some other consequence for nonpayment to induce the debtor to pay. In re Gill, 529 B.R. 31, 40 (Bankr. W.D.N.Y. 2015).

A.  Cases Discussing Foreclosure Notices Required by State Law.

  • Foreclosure notices have been held not to violate the discharge injunction because they are required under both the mortgage and state law. Gill, 529 B.R. at 41; In re Ladebush, No. AP 13-1154-JMD, 2016 WL 675580, at *7 (Bankr. D.N.H. Feb. 18, 2016).
  • The Eighth Circuit has held that foreclosure notices from a secured creditor to a debtor that contain a declaration that they were provided “for information purposes” about the status of the property are not an attempt to collect against the debtor personally, as a matter of law. In re Pennington-Thurman, 499 B.R. 329, 332 (B.A.P. 8th Cir. 2013), aff’d, 559 F. App’x 600 (8th Cir. 2014).
  • Several courts have held that a secured creditor’s communication that acknowledges a bankruptcy discharge has been entered and states the notice is not an attempt to collect personally against the debtor does not violate Section 524. Id.; Pearson v. Bank of Am., No. 3:12-CV-00013, 2012 WL 2804826, at *5-6 (W.D. Va. July 10, 2012); Anderson v. Bank of Am., No. 6:12-CV-00017, 2012 WL 4458474, at *3-4 (W.D. Va. July 11, 2012); In re Mele, 486 B.R. 546 (Bankr. N.D.Ga. 2013); Jones, No. 08–05439, 2009 WL 5842122, at *3 (Bankr. S.D.Ind. Nov. 25, 2009); In re Schatz, 452 B.R. 544, 550 (Bankr. M.D. Pa. 2011).

B.  Cases Discussing Escrow Account Review Statements Required by RESPA and State Law.

 

RESPA and some state law require mortgage servicers to provide escrow account review statements at least annually. 24 C.F.R. 3500.17; see e.g., Fla. Stat § 501.137(2)).

  • Escrow account review statements have been held not to violate the discharge order. Pearson, 2012 WL 2804826, at *5-6; In re Whitmarsh, 383 B.R. 735, 736-37 (Bankr. D. Neb. 2008).
  • One court noted that although the Bankruptcy Code prohibits a mortgagee from exerting pressure on the mortgagor to repay an advance or escrow deficiency, it does not prohibit a mortgagee from providing information or notice to a mortgagor of escrow deficiencies. Chase Manhattan Mortg. Corp. v. Padgett, 268 B.R. 309, 314 (S.D. Fla. 2001).

C.  Cases Discussing Foreclosure Alternative Letters Required by RESPA and Allowed by the Bankruptcy Code.

 

Federal regulations require loan servicers to provide post-discharge communications about loss mitigation options and periodic mortgage statements. Regulation X, which implements RESPA, requires loan servicers to fulfill the “early intervention” obligations of 12 C.F.R. 1024.39 – but to suspend compliance during a borrower’s bankruptcy. Effective January 10, 2014, the CFPB amended Regulation X to require loan servicers to resume compliance upon the first delinquency after a bankruptcy discharge. Comment, 12 C.F.R. 1024.39(d)(1)-2 Cmt.; 12 C.F.R. 1026.41(e)(5)-2 Cmt. In implementing this regulation, the CFPB acknowledged the Bankruptcy Code may prevent attempts to collect a debt personally, but concluded the Bankruptcy Code did not prevent servicers from sending consumers information about the mortgage.

  • Several courts have found that letters offering alternatives to foreclosure have been held not to violate the discharge injunction.   Whitmarsh, 383 B.R. at 736-37; Henriquez, 536 B.R. at 344-45.
  • Letters responding to borrowers’ requests for loss mitigation information have also been held not to violate the discharge injunction. Mele, 486 B.R. at 557.
  • In the situation where the debtor indicates an intention to surrender the property but continues to live in the property, courts have found that information provided to debtors about making voluntary payments post-discharge to avoid foreclosure is allowed under 11 U.S.C. § 524(j). Jones, 2009 WL 5842122, at *3.
  • Regulation X’s “early intervention” requirements also include providing the borrower, at least once every 180 days, with contact information for personnel assigned to assist them and examples of potential loss mitigation options. Similarly, an ECOA statement of the estimated property value must be provided to the property owner without regard to bankruptcy. 12 C.F.R. 1002.14(a)(1); see ECOA Valuation Rule: Compliance Guide, Oct. 3, 2013, at 10 (“The rule covers applications for … loss-mitigation transactions, … covered by Regulation B”).
  • These courts have held that customer relationship letters and property value estimates do not violate Section 524. Henriquez, 536 B.R. at 344-45; Best v. Nationstar Mortgage, LLC, 540 B.R. 1, 10 (B.A.P. 1st Cir. 2015); Leahy-Fernandez v. Bayview Loan Servicing, LLC, — F.Supp.3d –, 2016 WL 409633, at * 8 (M.D. Fla. Feb. 3, 2016)(Covington, J.).

D.  Property Insurance Lapse Notices Required by RESPA.

 

RESPA requires servicers to issue at least two notices to property owners before obtaining lender-placed insurance. 12 U.S.C. § 2605(l). RESPA then requires a notice to be sent upon each renewal of a lender-placed policy. 12 CFR 1024.37(e). The CFPB has concluded that a bankruptcy discharge does not relieve mortgagees from this requirement, and its final lender-placed insurance rule provides no notice exceptions for bankruptcy, default, or foreclosure. See Mortgage Servicing Rules Under the Real Estate Settlement Procedures Act (Regulation X), 78 Fed. Reg. 10696-01, at 10,767 (Feb. 14, 2013).

  • These cases held insurance notice communications did not violate the discharge injunction. Leahy-Fernandez, 2016 WL 409633, at * 8; Myers v. Bank of Am., No. 8:14-MP-00007-MGW, ECF 24-1 at 28:18-31:4 (Bankr. M.D. Fla. Nov. 18, 2014).

Since the mortgage crisis began in 2008, Congress has passed additional regulations to help property owners retain their homes. More clarity for mortgage servicers is needed on how these regulations are enforced after the debtor receives a bankruptcy discharge. In the meantime, we hope this compilation of situations and applicable caselaw is of use to you.

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How Reporting a Crime May Subject You to Sanctions

You are a creditor and your loan is secured by personal property, let’s say equipment.  The borrower recently filed for bankruptcy protection.  You receive a phone call from a friend advising you that someone has a moving truck outside the borrower’s business location and it looks like they are stealing equipment.  You don’t know who is moving the equipment — but you do know it’s without your permission and in violation of the security agreement.  You are furious.  You think a crime is being committed and you want tell the appropriate authorities.  You call the police, file a police report and hope the police will recover the equipment so your collateral remains intact.  A few weeks later, the chapter 11 debtor files an action against you for willful violation of the automatic stay and requests sanctions again you under 11 U.S.C. 362(k)(1)!  Will you have to pay sanctions?

Believe it or not, the answer may be yes.

Most business professionals know about the automatic stay under 11 U.S.C. 362.  When a debtor files for bankruptcy protection, a creditor may not take any action to collect on its debt without a court order granting it relief from stay.  One exception to the automatic stay is the “commencement or continuation of a criminal action or proceeding against the debtor” but that exception is not absolute. 11 U.S.C. 362(b)(1).  Litigation over this exception generally arises over whether a particular proceeding is in fact a “criminal action or proceeding,” or is it really just a disguised attempt to collect a debt.

Courts have taken two positions on this issue.

  1. Prosecuting Authority Pursuing Criminal Charges: The first is that a criminal proceeding initiated by a prosecuting authority is excepted from the stay, regardless of whether the proceeding results from the debtor’s failure to pay a debt.
  2. Creditor Pursuing Criminal Charges: The courts are split on whether a creditor may pursue criminal charges after a bankruptcy has been filed. Some courts consider the creditor’s motivation for initiating the criminal prosecution: if the creditor did so to collect a debt rather than to benefit the public good, the action violates the stay.  Courts that consider the creditor’s motives generally apply a “stringent” test that finds a stay violation only when the creditor’s primary motive was to collect its debt.

 

  1. Prosecuting Authority: 

The 9th Circuit provides the leading authority on Section 362(b)(1), in County of Los Angeles v. Gruntz (In re Gruntz), 202 F.3d 1074 (9th Cir. 2000) (en banc).  Before Gruntz, a criminal proceeding did not fall under the 362(b)(1) exception if the purpose of a criminal proceeding was to collect upon a financial obligation. Hucke v. State of Oregon, 992 F.2d 950, 953 (9th Cir. 1993).  The Ninth Circuit in Gruntz overruled Hucke and held that Section 362(b)(1) applies to all criminal proceedings regardless of whether there is a financial element.  992 F.2d at 1085-86.  Several other courts around the country follow this ruling. See, e.g., Weary v. Potent (In re Poteat), 2015 WL 4747883, *4 (E.D. Tenn. 2015); In re Dunn, 2013 WL 1091737, *7 (Bankr. E.D. Tenn. 2013); Simonini v. Bell (In re Simonini), 69 F. App’x 169, 170-71 (4th Cir. 2003); In re Bartel, 404 B.R. 584, 590-91 (BAP 1st Cir. 2009).

While that long standing principle is clear enough, Gruntz did not address the issue of criminal proceedings vis-à-vis non-governmental actors. Rather, Section 362(b)(1) is limited to only governmental entities. Weary v. Poteat (In re Poteat), 2015 WL 4747883, *4 (E.D. Tenn. 2015); Bender Industrial Group, Inc. V. Herbert (In re Herbert), 2015 WL 1579575, *3 (Bankr. D. Or. 2015) see also Heath v. Alabama, 474 U.S. 82, 88 (1985) (“The dual sovereignty doctrine is founded on the common-law conception of crime as an offense against the sovereignty of the government”).  The Herbert bankruptcy court reviewed the Ninth Circuit’s opinion in Gruntz and several other authorities, observing that Gruntz refers to state sovereignty several times, and most importantly specifically states that the parties to a criminal proceeding are between the state and the accused. Herbert, at *3.

  1. Creditors:

In In re Byrd, 256 B.R. 246 (Bankr. E.D.N.C. 2000), the court addressed Section 362(b)(1) as it pertains to a creditor.  Byrd involved a violation of the discharge injunction (which is not materially different than a violation of the automatic stay).  In that case, the debtor negotiated two checks pre-petition. While the debtor’s civil liability was discharged, the debtor was subsequently arrested and required to repay the creditor in full to be released from custody. The bankruptcy court ruled that Section 362(b)(1) did not protect the creditor, but nonetheless concluded that the creditor did not violate the discharge injunction because the creditor did not take any affirmative action to collect on his debt.

Conversely, the bankruptcy court in Pearce v. E.L.W. Corp. (In re Pearce), 400 B.R. 126 (Bankr. N.D. Iowa 2009), sanctioned a creditor who filed a post-petition criminal complaint for non-payment of a pre-petition debt.  The court ruled that every creditor has a right under Section 523 to seek to except a debt from a debtor’s discharge or object to discharge under Section 727, but a creditor cannot utilize the criminal process to improve its position at the expense of other creditors. Pearce, 400 B.R. at 132.

The Nevada bankruptcy court reached a similar conclusion as the courts in Byrd and Pearce.  See Fidler v. Donahue (In re Fidler), 442 B.R. 763 (Bankr. D. Nev. 2010).  While the Court did not enjoin the criminal prosecution, it left the bankruptcy court open to determine whether the creditor violated the bankruptcy discharge.

There are courts that hold that a creditor does not violate the automatic stay when it reports a crime to the police or applies for a criminal warrant that would initiate a criminal complaint pursuant to state law.  In re Dunn, 2013 WL 1091737 at *2 (Bankr. E.D. Tenn. 2013).  In Dunn, the bankruptcy court recognized the split of authority among the courts.  While the Court believed the facts created a close question, it was ultimately persuaded that it should apply the unambiguous language of § 362(b) to except all criminal proceedings from the automatic stay regardless of who initiated the criminal proceeding or the purpose for which the proceeding was brought.  It noted that “Congress was capable of being very specific when it intended to be.” Id. at *7.  Interestingly, the District Court in Tennessee in Poteat (2015 WL 474883 *5) recognized the bankruptcy court’s reasoning in Dunn.  It accepted the Dunn holding but distinguished it by stating “to the extent that the criminal prosecution exception of subsection (b)(1) covers the actions of private parties, the scope of the exception is limited to conduct that fundamentally advances the important state interest at stake – the commencement or continuation of a criminal action or proceeding.” Poteat, *5.  However, the § 362(b) exception does not apply to an action beyond that purpose to include collecting a debt.

It appears that if a creditor is accused of violating the automatic stay (or discharge injunction) by initiating a criminal complaint or proceeding, then at least some bankruptcy courts will require the creditor to prove that it did not intend to collect on its debt when it initiated the criminal prosecution. Whether the creditor’s intent is ultimately exonerated, it will require the creditor to defend itself before a bankruptcy court, which will likely include an expenditure of attorney’s fees, cost, and attendant risk.

Word to the wise: if a creditor is truly concerned about its collateral, the safest avenue is to bring the issue to the attention of the bankruptcy court or bankruptcy trustee as soon as possible.

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The Un-Bankruptcy: A Texas Receivership as an Alternative to Bankruptcy (and fourteen ways to appoint a receiver in The Lone Star State)

Creditors seeking to exercise control over a borrower or collateral may utilize a number of remedies. They may seek a foreclosure or UCC sale, assignment for the benefit of creditors, file an involuntary bankruptcy petition under Section 303 of the Bankruptcy Code (if they hold unsecured claims),[1] or, seek the appointment of a receiver.

Bankruptcy and receivership provide a particular advantage because they allow creditors to take control of the debtor or collateral without the risk of taking possession.  (See the prior post by my colleagues Jay Krystinik and Keith Aurzada on ways lenders may minimize risk in wresting control of a property away from a obligor, here.)  Receiverships provide the additional benefit of flexibility and, often, are more easily obtained and less costly than an involuntary bankruptcy.[2]  Both federal[3] and state laws provide for the appointment of receivers.

Receivership laws vary from state to state and, indeed, most states provide a veritable cornucopia of receivership statutes.  Here, we will look at the receivership laws in the State of Texas to demonstrate the breadth and scope of state receivership laws.

Availability of Receivership

Texas law provides for the appointment of a receiver in many ways:

  • by a vendor to vacate a fraudulent purchase of property (Texas Business Organizations Code section 11.403(1));
  • by a creditor to subject property or funds to the creditor’s claim (Texas Business Organizations Code section 11.403(2));
  • between partners or others jointly owning or interested in property or funds (Texas Business Organizations Code section 11.403(3));
  • by a mortgagee of the property for the foreclosure of the mortgage and sale of the property (Texas Business Organizations Code section 11.403(4)):
  • for a corporation that is insolvent, is in imminent danger of insolvency, has been dissolved, or has forfeited its corporate rights (Texas Civil Practices and Remedies Code 64.001(5));
  • “in any other case in which a receiver may be appointed under the rules of equity” (Texas Civil Practices and Remedies Code 64.001(6));
  • to rehabilitate a domestic or foreign entity (Texas Business Organizations Code section 11.404, 11.409);
  • to liquidate a domestic or foreign entity (Texas Business Organizations Code section 11.405, 11.409);
  • to preservation and protection marital property during a divorce proceeding (Texas Family Code 6.502);
  • over the assets of a missing person (Texas Civil Practices and Remedies Code 64.001(d));
  • to preserve mineral interest or leasehold interest under a mineral lease owned by a nonresident or absent defendant (Texas Civil Practices and Remedies Code 64.091);
  • to sell property incapable of division (Texas Rule of Civil Procedure 770);
  • over property in a municipality that is not in compliance with certain life, health, and safety ordinances (Texas Local Government Code 214.0031); and
  • over property of a nonprofit housing organization that presents a life, health, or safety risk (Texas Local Government Code 214.0031).

Flexibility of Remedy

In addition to their widespread availability, state law receiverships are also valued for their flexibility and adaptability.  Under the Texas general receivership statute, a receiver is authorized to take charge and keep possession of property, receive rents, collect and compromise demands, make transfers, and perform other acts as authorized by the court.  Texas Civil Practices and Remedies Code 64.031.  Indeed, Texas courts are authorized to broadly define a receiver’s powers to accomplish the objectives of the receivership and to modify the scope of the receiver’s powers.  Texas Business Organizations Code 11.406(5) (“[The Receiver] has the powers and duties that are stated in the order appointing the receiver or that the appointing court: considers appropriate to accomplish the objectives for which the receiver was appointed and may increase or diminish at any time during the proceedings.”).  A receiver’s authority and duties are governed by the receivership order and, thus, can be tailored to each particular circumstance and the needs of the creditor. It is this flexibility that makes receivership uniquely useful to creditors.

Conclusion

Receivership is one of several remedies creditors may utilize in seeking to exercise control over a borrower or collateral.  Receiverships may be particularly attractive to creditors because they avoid the need to take possession of the property, are available in a number of circumstances, and offer flexibility that is not available under bankruptcy or other remedies.

 

 

[1] 11 USC § 303.

[2] An involuntary bankruptcy requires a trial to determine whether the debtor is paying its debts as they come due, and mandates an award of attorneys’ fees against the petitioning creditors if the court does not grant relief.  See 11 USC § 303(h).

[3] Under federal common law, a district court may use its equitable powers to appoint a receiver.  Appointment of a receiver by a federal district court is akin to the entry of an injunction and is not a statutory remedy.  Although no federal statute authorizes the appointment of a receiver, federal equity receivers are subject to a number of statutes governing their behavior.  See, e.g., 28 U.S.C. §§ 754, 2001, 2002, 2004.

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The Guarantor Chronicles – Can a guarantor waive its right to a foreclosure confirmation proceeding?

Editor’s Note #1: This post first appeared last week on Bank Bryan Cave, a top blog on regulatory, M&A, and litigation issues for those in the banking world, located at http://www.bankbryancave.com/. Given the close relationship of this post’s topic to the world of distress, we are cross-posting it here.

Editor’s Note #2: For prior posts of interest to those involved in guarantor litigation, see Ninth Circuit Decides Issue of First Impression, Protects Insider Guarantor from Preference Liability, located at http://bankruptcycave.com/ninth-circuit-decides-issue-of-first-impression-protects-insider-guarantor-from-preference-liability/.

Can a guarantor waive his right to a confirmation proceeding under Georgia law, after a non-judicial foreclosure results in a deficiency still owing? Yes.  Last week, in case closely watched by Georgia commercial real estate lenders, borrowers, and guarantors, the Supreme Court of Georgia issued its opinion in PNC Bank, N.A.  v. Smith, 2016 Ga. LEXIS 169 (Ga. Sup. Court Feb. 22, 2016). The case was before the Georgia Supreme Court on two certified questions from the United States District Court for the Northern District of Georgia.  The two Certified Questions were: (1) Is a lender’s compliance with the requirements contained in O.C.G.A. § 44-14-161 a condition precedent to the lender’s ability to pursue a borrower and/or guarantor for a deficiency after a foreclosure has been conducted?; and (2) If so, can borrowers or guarantors waive the condition precedent requirements of such statute by virtue of waiver clauses in the loan documents?

In answering the first question in the affirmative, the Georgia Supreme Court upheld its reasoning in First Nat. Bank & Trust Co. v. Kunes, 230 Ga. 888, 890-91 (1973).  The Georgia Supreme Court echoed the reasoning in Kunes by stating “that notice to both sureties and guarantors is necessary to satisfy the purpose of the confirmation statute— ‘to limit and abate deficiency judgments in suits and foreclosure proceedings on debts’ and to enable sureties and guarantors ‘an opportunity to contest the approval of the [foreclosure] sales.”

The Court’s analysis of the critical second question focused on the Georgia Court of Appeals’ ruling in HWA Properties, Inc. v. Cmty. & S. Bank, 322 Ga. App. 877 (2013), holding that a lender is entitled to pursue a guarantor for any deficiency remaining on a debt after a foreclosure, regardless of whether the lender has confirmed the foreclosure sale, if the guaranty included language waiving all defenses to collection of the debt.  As set forth in Bryan Cave’s amicus curiae brief filed on behalf of the Georgia Bankers Association,[1] a ruling by the Georgia Supreme Court upholding HWA and its progeny, Cmty. & S. Bank v. DCB Investments, LLC, 328 Ga. App. 605 (2014), will do much to correct the current abuse of Georgia’s foreclosure confirmation statute, O.C.G.A. § 44-14-16, which some commercial borrowers and guarantors have used to draw out foreclosure proceedings and prevent collection of any deficiency.  In support of this argument, Bryan Cave’s amicus brief focused on Georgia’s long standing recognition of the freedom to contract, and more specifically, the ability of a party to waive certain defenses.

Justice Melton, writing for the majority in the PNC Bank case, agreed with the reasoning in HWA and DCB Investments reiterating that “a guarantor retains the contractual ability to waive the condition precedent requirement.”  In fact, the PNC Bank opinion explicitly states “[t]his result creates an appropriate balance between the statutory protections of the confirmation statute and the freedom of a guarantor to enter contracts deemed beneficial.”  Accordingly, the Georgia Supreme Court’s opinion upholds HWA and DCB Investments by affirming that guarantors may waive compliance with the confirmation statute.

In a concurrence, Chief Justice Nahmias expressed concerns with the consequences of the decision and suggested that the legislature may wish to examine the issue. We will continue to watch both legislative and judicial activity on this issue and keep readers apprised of any further developments.

[1] Those of you who regularly visit The Bankruptcy Cave will recall the prior post noting that Bryan Cave, on behalf of the Georgia Bankers Association, filed an amicus curiae brief in support of a common sense approach to this matter, allowing parties to freely negotiate as to what notices are warranted, and the waiver of defenses by parties who chose to guaranty debt. http://bankruptcycave.com/bryan-caves-atlanta-office-files-amicus-brief-for-georgia-bankers-association-regarding-guarantor-deficiency-claims/

 

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11th Circuit Holds Consumer Lenders Can’t Include Estimated Expenses In Pre Closing Reinstatement or Payoff Letters; What You Should Do About This Remarkable Opinion

Editor’s Pre- / Post-Script:  The original post about this case was, frankly, a bit sarcastic toward the consumer borrower, and made light of a serious matter.  (Your author Mark Duedall is to blame for that.)  When the post found its way to the borrower’s counsel, he was kind enough to let us know, as Paul Harvey would say, “the rest of the story.”  And that was this – the borrower was down on his luck, a hard working public servant, but eventually managed to come up with the funds needed to pay his bills (including this loan) in full.  Truly, an individual deserving to be treated fairly in all respects.  But when he paid the loan in full, including the estimated future charges, the lender then refused to refund the estimated future charges that the borrower had paid in full (and that the lender did not incur).  Yikes; the consumer had no choice but to sue to get back his money for these phantom charges.  We here at the Bankruptcy Cave don’t like over-reaching at all, and especially when it comes to how one treats consumers.  Anyway, while we still disagree with this ruling from a legal standpoint, we start to kind of like it from a karma standpoint.  We appreciate getting more of the story, and the opportunity to correct this post.  Lesson learned by the dwellers of the Bankruptcy Cave.

Anyway, on to the post, as corrected . . .

Consumer borrowed money from Lender.  Consumer defaulted, and Lender began to foreclose, including all the usual steps: arranging for property  inspection, hiring counsel, etc.  After about a year,[1] Consumer sought to reinstate the loan, and asked Lender how much it would cost.  Lender responded in writing, with an itemized list of expenses to be paid, plus an estimate of additional costs (clearly marked as estimates) that Lender may incur over the next month if it continued to exercise remedies, in case Consumer did not make good on the loan.)

Consumer paid the entire amount required to reinstate the loan, including Lender’s estimated out-of-pocket expenses.  A few months later, Lender refunded the estimated expenses which it didn’t incur after all (although Lender first refused any and all efforts by the consumer to get any refund).  So what’s the big deal?  Why is this unusual?  Why are you reading this, and why did we write it?  Well, in the 11th Circuit, as of last week, including any estimated future charges or expenses in a reinstatement letter (or a loan payoff, as your authors can’t see any reason why this remarkable ruling wouldn’t also apply to payoff letters) violates the federal Fair Debt Collection Practices Act (FDCPA)[2] if your loan documents don’t clearly allow for that inclusion (and most don’t – we checked).  This is the ruling in Prescott v. Seterus, Inc., 2015 U.S. App. LEXIS 20934 (11th Cir. Dec. 3, 2015).

So what can you do about this ruling?  First, fix your loan forms.  In  Prescott, the loan documents listed all the things a consumer must pay to reinstate a loan – estimated out-of-pocket expenses through the payoff date was not included as something Lender could collect as a condition to reinstatement.[3] (And please don’t think “my loan documents surely must be state of the art and already contain this.”   The originating lender in this case was one of the largest in the U.S., with top, up-to-date forms and rigid standardization to ensure everyone uses the proper documentation.  Its loan documents still did not allow for the inclusion of estimated expenses in payoff statements.)  Your loan documents should clearly state that any reinstatement or payoff statement can and will include estimates of charges through the payoff date (which will be promptly refunded if those charges are not actually incurred).  Second, change your reinstatement and payoff letters, to provide the same.[4]  Third, bear in mind the “least sophisticated consumer” mandate of the FDCPA: your consumer loan documents must spell everything out in painful, page-after-page detail, thus devolving to the lowest common denominator of consumer borrowers.[5]

Your helpful and devoted Bryan Cave Bloggers have blogged before about our efforts to improve lender forms to avoid ridiculous decisions.  Of course, this is nothing to think about as the Holidays approach.  Go here instead, and pick a wonderful day to celebrate.  And then, put a note on your calendar to call us after the start of the year; we do loan document house-cleaning for many clients, and would love to help you out.  Until then, enjoy the egg nog and watch out for including estimated out-of-pocket expenses in any payoff or reinstatement letters, unless your loan documents expressly allow it.


 

[1] The property was in Florida, a state requiring judicial foreclosure, so exercising remedies against collateral takes forever.

[2] 15 U.S.C. § 1692 et seq.

[3] Prescott, 2015 U.S. App. LEXIS at *2 and *7.

[4] Our angst over this maddening opinion is informed by another recent ruling, Kaymark v. Bank of America, 783 F.3d 168 (3d Cir. 2015). In that case, the lender was chastised for including estimates of future costs in a foreclosure complaint. This violated the FDCPA because the estimates were not labelled as such. Id. at 175. So, the Lender in Prescott followed this ruling, and did note which charges in the reinstatement letter were estimates. And then it refunded the amounts not actually incurred a few weeks later. It is still liable for violating the FDCPA. The world has turned upside down, we think.

[5] Id. at *6-*8 (citing, among other cases, Jeter v. Credit Bureau, Inc., 760 F.2d 1168, 1175 n.6 (11th Cir. 1985), holding that you must assume you are dealing with a borrower “on the low side of reasonable capacity.”).

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Putative Class Actions in Bankruptcy for Violations of the Discharge Injunction and Bankruptcy Code Section 524(j)

Red Foreclosure Home For Sale Real Estate Sign on White

There has been a relatively recent uptick in plaintiffs’ counsel filing putative class actions in multiple state and federal courts for alleged violations of a debtor’s bankruptcy discharge injunction based upon the debtor’s receipt of post-discharge mortgage-related communications. These claims assert putative class action challenges to post-discharge communications alleged to be attempts at personal collection of the discharged mortgage debt.

Bankruptcy Code Section 524(j) expressly allows a secured creditor with a security interest in the debtor’s principal residence to communicate with the debtor in the ordinary course of business provided the creditor is seeking periodic payments associated with a valid security interest in lieu of pursuing in rem relief to enforce the lien. This section is under-developed in case law, but is receiving some attention because, effective January 10, 2014, 12 C.F.R. 1024.39 and 1026.41 allows mortgagees/servicers to provide debtors with periodic statements regarding the status of the mortgage loan and loss mitigation options post-discharge.

While a discharge extinguishes the debtor’s personal liability on his or her creditor’s claims, a discharge does not extinguish a creditor’s right to enforce its in rem rights against surrendered property. Johnson v. Home State Bank, 501 U.S. 78, 84-85 (1991). A bankruptcy discharge does not affect a secured creditor’s lien in collateral; the lien survives and is enforceable after the bankruptcy proceeding in accordance with state law. Dewsnup v. Timm, 502 U.S. 410, 417 (1992). Further, while the Code provides a discharge of personal liability for debt, it does not discharge the debtor’s post-petition burdens of owning property such as insurance and taxes. In re Arsenault, 456 B.R. 627, 631 (Bankr. S.D. Ga. 2011). Thus, until foreclosure or other transfer of title, the debtor still owns the property, and the secured creditor is entitled to, and sometimes obligated under non-bankruptcy law, to communicate with the property’s owner about the status of the property post-discharge. One such communication a secured creditor is expressly entitled to make under the Bankruptcy Code is to seek periodic payments in lieu of pursuing in rem relief to enforce the lien. 11 U.S.C. § 524(j).

Congress specifically authorized a mortgagee/servicer “seek[] or obtain[] periodic payments associated with a valid security interest” so that debtors might have the option of staying in their homes. Section 524 specifically provides that a debtor may voluntarily pay a debt in spite of the discharge in order to discourage the mortgagee from foreclosing on the property. 11 U.S.C. §§ 524(f) and 524(l ). Information provided to debtors about this option does not violate § 524. In re Jones, No. 08-05439-AJM-7, 2009 WL 5842122, at *3 (Bankr. S.D. Ind. Nov. 25, 2009).

Nonetheless, plaintiffs are attempting to create an independent class action based upon a single debtor’s claim for an alleged violation of his § 524 discharge order. Section 524 does not provide for a private right of action for a discharge injunction violation, much less a class action. Pertuso v. Ford Motor Credit Co., 233 F.3d at 421 (analyzing the legislative history of § 524, contrasting § 524 with Congress’s choice in § 362(h) to create private causes of action for violations of bankruptcy stays, and concluding § 524 does not impliedly create a private right of action)); Walls v. Wells Fargo Bank, N.A., 276 F.3d 502, 509 (9th Cir. 2002) (tracking and adopting Pertuso’s analysis); and Cox v. Zale Del., Inc., 239 F.3d 910, 917 (7th Cir. 2001) (agreeing with the result in Pertuso and concluding that a contempt action in the bankruptcy court that issued the discharge is the only relief available to remedy alleged § 524 violations); In re Joubert, 411 F.3d 452, 456 (3d Cir. 2005) (adopting the reasoning of Pertuso, Walls, and Cox in the context of § 506(b) post-petition assessment of fees); see also, Bessette v. Avco Fin. Servs., Inc., 230 F.3d 439, 444-45 (1st Cir.2000) (refusing to address whether § 524 implies a right of action, because, in the First Circuit’s view, a bankruptcy court’s contempt power under § 105(a) offers sufficient remedies).

In the lead case, Pertuso, a group of discharged Chapter 7 debtors brought a purported class action in district court against a common secured creditor, alleging the creditor violated the discharge injunction. Pertuso, 233 F.3d at 420. The issue before the court was whether § 524 impliedly creates a private right of action. After examining the factors to be considered in determining whether a private right of action exists for breach of a federal statute and the legislative history of § 524, the Sixth Circuit determined that, unlike the private cause of action created by Congress for violations of the automatic stay in § 362, Congress did not impliedly create a private right of action in § 524 for violations of the discharge injunction. Id. at 421–422. The Eleventh Circuit has similarly held the power to sanction contempt of the discharge injunction is jurisdictional and exclusive to the issuing court. Alderwoods Grp., Inc. v. Garcia, 682 F.3d 958, 970 (11th Cir. 2012) (the court that issued the injunctive order alone possesses the power to enforce compliance with and punish contempt of that order). Given § 524 does not accord a plaintiff with a private right of action for a violation of the discharge injunction, it would be improper for the court to recognize one based on state consumer protection laws.

The First Circuit is in a distinct minority allowing this procedure. Bessette v. Avco Fin. Servs., Inc., 230 F.3d 439, 444-45 (1st Cir. 2000). The Third, Sixth, Seventh, and Ninth Circuits do not allow it.   The Eleventh Circuit provides the seminal case which limits redress of alleged discharge injunction violations to civil contempt proceedings. In re Hardy, 97 F.3d 1384, 1390 (11th Cir. 1996). Hardy held that § 524 does not authorize an independent claim for damages, and a plaintiff’s remedy for a § 524 violation was under the contempt powers conferred by § 105. Hardy, 97 F.3d at 1389. Civil contempt is a sanction to enforce compliance with an order of the court or to compensate for losses or damages sustained by reason of noncompliance. McComb v. Jacksonville Paper Co., 336 U.S. 187, 191 (1949). It is not an independent cause of action because it is entirely dependent upon the defendant’s knowledge of a pre-existing order in the original case. Hardy, 97 F.3d at 1390; Blalock v. United States, 844 F.2d 1546, 1550-51 (11th Cir. 1988) (per curiam). To sustain a class action, there must first be a cognizable cause of action. Contempt of court is not an independent cause of action, and § 105 does not provide one.

Bankruptcy Rule 9020 states contempt proceedings are contested matters governed by Rule 9014. Fed. R. Bankr. P. 9020. Bankruptcy Rule 9014 specifically excludes from contested matters several rules applicable only in adversary proceedings. Rule 7023 for class actions is excluded and does not apply to contested matters. Fed. R. Bankr. P. 9014. Further, the bankruptcy judge has discretion under Rule 9014 not to apply Rule 7023 in any contested matter. Reid v. White Motor Corp. (In re White Motor Corp.), 886 F.2d 1462, 1463-64 (6th Cir. 1989). Bankruptcy courts routinely exercise that discretion not to invoke Rule 7023 in contested matters. Only occasionally will bankruptcy courts apply Rule 7023 in a contested objection to a proof of claim filed by a pre-petition, putative class-action plaintiff. Reid, 886 F.2d at 1464. Outside the claims objection process, there is no need to apply Rule 7023 to contested matters because contested matters are not sufficiently complicated to warrant the application of adversary rules. In the Matter of Baldwin-United Corp., D.H., 52 B.R. 146, 150 (Bankr. S.D. Ohio 1985). Further, contempt proceedings are fact-specific inquiries which routinely fail to meet the stringent requirements for class certification. In re Montano, 488 B.R. 695, 712, reconsideration denied, 493 B.R. 852 (Bankr. D.N.M. 2013) (Proposed debtor class members, in order to establish discharge injunction violation, would have to present individualized proof of coercive effect which credit union’s conduct had on them, which prevented named class representatives from showing significant questions of law or fact common to class. Citing Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011)).

Thus, a clear majority of courts have held that § 524 does not create a private right of action, making a class action a rare remedy for post-discharge mortgage communications. The development of case law under Section 524(j) should add further clarity.

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Debtors Cannot Void Junior Liens on Underwater Property in Chapter 7

On June 1, 2015, the Supreme Court released its opinion in Bank of America, N.A. v. Caulkett, No. 13-1421, 575 U.S. ____ (2015), in which it held that a Chapter 7 debtor may not void a junior mortgage under Section 506(d) of the Bankruptcy Code merely because the debt owed on a senior mortgage exceeds the present value of the property and the creditor’s claim is secured by a lien and allowed under Section 502. For now, this opinion cuts off a Chapter 7 debtor’s ability to “strip off” an underwater junior lien.

In Caulkett, the debtor had two mortgage liens on his home; Bank of America held the junior lien. The amount owed on the senior mortgage exceeded the value of the home, rendering Bank of America’s junior mortgage fully “underwater,” or with no current economic value. Generally, where the value of a creditor’s interest in its collateral is zero, a creditor’s claim cannot be a “secured claim,” and the lien securing the junior mortgage can be voided in a Chapter 7 case.

The authority for this voiding procedure lies in Section 506 of the Bankruptcy Code. Under Section 506(a), “[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” 11 U.S.C. § 506(a)(1). Under Section 506(d), “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” 11 U.S.C. § 506(d). Based on this understanding of Section 506, the Caulkett debtor argued that Bank of America’s junior lien should be void.

But in a 1992 opinion, Dewsnup v. Timm, 502 U.S. 410 (1992), the Supreme Court adopted a different construction of the term “secured claim” that focused on two things: (1) the validity of the creditor’s perfected security interest in its collateral; i.e., Does the lender have a valid lien? and (2) whether the creditor’s claim was “allowed” under Section 502, which governs the allowance of claims in bankruptcy cases; i.e., did the lender file a proper claim in the bankruptcy case, and did anyone object? Notably, the Dewsnup construction of “secured claim” did not take into consideration the collateral’s value.

The Supreme Court in Caulkett explained that it was bound by the Dewsnup construction. Accordingly, the debtor could not void Bank of America’s junior mortgage because the mortgage was (1) secured by valid a lien and (2) supported by an allowed claim to which no party had objected.

In a footnote, which Justices Kennedy, Breyer, and Sotomayor declined to join, the Court acknowledged that “[f]rom its inception, Dewsnup . . . has been the target of criticism.” This is because it appears to be at odds with the plain language of Section 506. In addition, Dewsnup has generally not been applied to Chapter 13 cases, where the stripping off of underwater liens is common, and debtors can rely on other similar sections of the Bankruptcy Code.

On the other hand, preserving a junior lien is especially important during times of depressed real estate prices. Once a creditor’s lien has been stripped, upon the sale of the property—even where the value of the property has later appreciated—the junior mortgage creditor gets nothing, and the benefit goes to the debtor. Under Caulkett, the lender is not harmed by a temporary drop in real estate prices, as it may retain its lien even if the property appears to be completely underwater. Chapter 7 debtors like the one in Caulkett may argue that, under Dewsnup and now Caulkett, they are unduly burdened by a lender’s lien, and that the “fresh start” they hoped a bankruptcy case would afford them is diminished.

But the Court emphasized that it wasn’t asked to overrule Dewsnup, and the Court concluded that, under Dewsnup, a Chapter 7 debtor may not void a junior mortgage lien under Section 506(d) merely because the debt owed on a senior mortgage lien exceeds the value of the collateral. With the Court appearing to have left open the possibility of revisiting its Dewsnup decision, it is likely that this contentious issue will remain in play.

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Spring Cleaning, Avoidance Actions, and Time to Tweak the Loan Forms, Just In Case

Winter is over; time for spring cleaning. Alas, your authors are so desperate to put off such drudgery that they decided to write about avoidance actions, and form language for notes and security agreements. If you represent lenders, try taking five from the cluttered garage, dust-bunnied closet, or bursting kitchen junk drawer, and read this; you may save your lender client a buck or two.

The Basics: Workout lawyers all agree on certain principles. For instance, fully secured creditors with undisputed claims deserve to be paid. Further, if the collateral value exceeds the amount of the secured creditor’s claim then payment must include interest, costs, and attorneys’ fees, if the loan documents so provide.[1]

The Wrinkle: But add a wrinkle – the kind of wrinkle rarely considered when structuring a loan, in the glorious salad days of the lending relationship. That wrinkle: Upon the obligor’s bankruptcy, what if the obligor, or its bankruptcy trustee, sues the lender to recover a preference or fraudulent transfer to the lender made prior to the bankruptcy?[2] If the lender defeats such an action, then surely the principles listed above would allow the lender to automatically add its defense costs to its claim, and collect those costs from the collateral or the bankruptcy estate. A recent California ruling says “yes” but notes that some less than ideal loan drafting made it a very hard call.[3] It also notes other rulings featuring unhappy lenders left with large, unpaid legal bills despite a failed attempt by a borrower/trustee to claw back monies properly and validly paid to the lender. So read below, tweak your forms on the front end (see suggested language at the end of this missive), and try to avoid this ever happening to your lender client.

The Facts: The obligor, Mac-Go (the “Obligor”) and its affiliates enter into various loans with a bank (the “Lender”). Later, the Obligor enters bankruptcy and a trustee (the “Trustee”) is appointed. The Trustee asserts various avoidance actions against the Lender, alleging that the Obligor previously paid money to the Lender actually owed by other affiliates, the Obligor did not receive value for the loans, the Obligor preferred the Lender over other creditors, and other claims. The Trustee and the Lender litigate for three years. The Trustee loses. And the Lender has spent $350,000 in attorneys’ fees.[4]

The Problem: There are enough funds in the bankruptcy estate to pay secured claims in full, including the Lender. But the problem is the Lender’s loan documents, and the nature of an avoidance action. Here, the Lender’s documents required the Obligor to pay all fees and costs of collection. And all costs and fees incurred by the Lender to enforce the loan. And all costs, expenses, and fees to enforce the Lender’s collateral and lien rights. Indeed, one loan document stated that enforcement costs included fees and legal expenses in bankruptcy proceedings.[5] Unfortunately, a Trustee’s suit to recover past payments to the Lender, and the Lender’s efforts to protect prior payments, isn’t really “collection.” Nor is it “enforcement,” as the Lender is trying to keep what it has, instead of an effort by the Lender to get what it doesn’t. And although the Trustee’s avoidance suit took place in a “bankruptcy proceeding,” the Trustee’s suit was not part of the Lender’s “enforcement” of its rights (and the word “enforcement” modified all subsequent phrasing in the loan documents). As such, the Bankruptcy Court struggled with whether the Lender was entitled to add its $350,000 in attorneys’ fees to its claim amount, despite the Lender’s defeat of the Trustee’s avoidance action.

The Ruling: After surveying the case law, including the many cases where attorneys’ fees provisions were not sufficiently broad, the Court ruled in the Lender’s favor. But it was only due to California case law, which (for the most part) does not narrowly construe fee clauses in contracts.[6] And the ruling was despite another Ninth Circuit ruling that a preference suit challenging the creation of a security agreement was not an action regarding the “enforcement” of the security agreement – in that case, the Lender won the suit, but got $0 added to its claim for fees or costs.[7] Indeed, the impartial reader may think the Mac-Go Court was struggling to find a way to rule in the Lender’s favor, despite other cases holding that “enforcement” and “collection” have nothing to do with fighting off an effort to claw back what a lender or other creditor has already received.

The Solution: Revise your form note and security agreement. Make sure the attorneys’ fees provision covers fighting off efforts to reclaim or avoid prior payments. Your authors suggest a provision such as the below; the bolded language may be an unusual thing to add at the start of a lending relationship, but could indeed be helpful on the back end, when debtors or trustees try their worst:

Borrower agrees to pay, upon demand, all of Lender’s costs and expenses,[8] including Lenders’ reasonable attorneys’ fees, legal expenses, court costs, and any other costs of any type or kind incurred by Lender: (i) to enforce this Agreement, (ii) to collect any amounts owed to Lender, (iii) in any bankruptcy, insolvency, assignment for the benefit of creditors, receivership, or other similar proceeding relating to Borrower or its assets, (iv) in any actual or threatened suit, action, proceeding, or adversary proceeding (including all appeals) by, against, or in any way involving Lender and Borrower, or in any way arising from this Agreement or Lender’s dealings with Borrower, and (v) to retain any payments or transfers of any kind made to Lender by or on account of this Agreement, including the granting of liens, collateral rights, security interests, or payment protection of any type. Lender may hire or pay someone else to enforce this Agreement or protect Lender’s rights under this Agreement, the costs of which are included in the amounts set forth above and are part of Lender’s right to payment by Borrower.

 

 

[1]           See 11 U.S.C. § 506(b).

[2]           See, e.g., 11 U.S.C. § 547(b), 548(a)(1).

[3]           In re Mac-Go Corp., Case No. 14-44181, Memorandum Decision at Docket No. 235 (Bankr. N.D. Cal. March 20, 2015).

[4]           Id. at p. 1; see also Poonja v. First National Bank (In re Mac-Go-Corp.), Adv. Proc. No. 14-04148, Order on Summary Judgment at Docket No. 80 (Bankr. N.D. Cal. May 23, 2014).

[5]           In re Mac-Go, Docket No. 235, at pp. 2-3.

[6]           Id. at pp. 6-8.

[7]           Id. at p. 11 (citing Williams v. Official Unsecured Creditors’ Comm. (In re Connolly), 238 B.R. 475 (9th Cir. B.A.P. 1999)).

[8]           Revised drafting may be needed if the applicable state law allows the recovery of a set percentage of the loan as “reasonable attorneys’ fees.” See, e.g., O.C.G.A. § 13-1-11(a)(2) (providing that “reasonable attorneys’ fees” in a note automatically means 15% of the first $500 owed and 10% of the amount owed that is greater than $500). But even in that situation, you should make sure the events giving rise to a fee claim include a trustee’s or debtor’s subsequent avoidance action, and not just the more generic “enforcement” or “collection.”

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