While case-law developments in 2010 impacting commercial lending did not quite match those of 2009, recent court rulings in important cases will impact the banking industry. In one case, a long-standing practice in the handling of collateral was called into question. In the other, an attempt to get around restrictions on loan syndications was shot down.
The first case is In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010), which affects the recovery of collateral in plan-of-reorganization sales. A secured lender’s ability to credit bid for the purchase of its collateral -- in foreclosure and bankruptcy sales -- has long been a fundamental right. The premise of such a bid is simple: The borrower already owes to the lender money that’s secured by collateral, so the lender shouldn’t have to pay out more money to the borrower to get back its collateral. Rather, the lender should be able to purchase the collateral by reducing (i.e., crediting) the amount of the loan by the purchase price. The lender’s offer to purchase collateral in this manner is known as a credit bid.
In the bankruptcy setting, credit bidding can occur when debtors sell collateral either prior to or as part of a plan of reorganization. The Philadelphia Newspapers case involved an asset sale as part of a debtor’s plan of reorganization. The Philadelphia Newspapers case involved an asset sale as part of a debtor’s plan of reorganization. However, instead of allowing the secured creditors to credit bid in connection with the sale, the debtor’s plan of reorganization sought to deny that right and instead provide the secured lenders with the “indubitable equivalent” of their claims under terms of the U.S. Bankruptcy Code.
Based on a strict interpretation of the code, the Third Circuit Court of Appeals agreed with the debtor and denied the secured lenders the right to credit bid. The secured lenders were able to gain control over their collateral by making a cash bid, the proceeds of which ultimately were remitted back to them as proceeds of their collateral, but the case has created great controversy and uncertainty.
The Philadelphia Newspapers case joins a similarly decided 2009 case from the Fifth Circuit Court of Appeals, In re: Pacific Lumber Co. The cases have prompted secured lenders to incorporate credit-bidding rights into their cash collateral and debtor-in-possession financing documents. That language has appeared in pre-bankruptcy loan agreements, even though those provisions likely aren’t enforceable in bankruptcy. Secured lenders also have become increasingly aware that they may have to make a cash bid for collateral in the context of a plan of reorganization sale, particularly in jurisdictions comprising the Third Circuit (Delaware, New
Jersey and Pennsylvania) and the Fifth Circuit (Texas, Louisiana and Mississippi).
The other major ruling this year affected sales of participation interests in syndicated loans, which came in Empresas Cablevision v. JPMorgan Chase Bank, N.A., 680 F. Supp. 2d. (S.D.N.Y. 2010). In a syndicated-lending arrangement, a group of lenders acting through an agent makes loans -- usually very large sums -- to a borrower or group of borrowers. A fundamental component of any such arrangement is each lender’s ability to sell all or part of its share of the loans.
Sales of syndicated loans are typically made by assignments to other lenders who in turn become parties to the existing credit agreement among the borrowers, the lenders and the agent. New lenders that have purchased loans by assignment thus have a direct contractual relationship with the other parties to the credit agreement. As a result, sales by assignment are tightly controlled by the credit agreement and most require consent of the borrowers.
Sales of syndicated loans also may be accomplished by selling participation interests. In this type of arrangement, the buying lender has rights and remedies only against the selling lender under the participation agreement -- not against the other parties to the credit agreement, as is the case in an assignment. This means sales of participation interests are not as tightly controlled as loan sales by assignment and typically do not require consent of the borrowers.
These arrangements usually work well to facilitate a healthy secondary market in syndicated loans. However, the Cablevision case illustrates what can happen if a selling lender stretches the rules of the road to accomplish a loan sale.
In the Cablevision case, JPMorgan made a $225 million loan to finance Cablevision’s purchase of Empresas Bestel, a large Mexican fiber-optic company. The bank’s plan was to syndicate through assignment the loans to other lenders after closing. When the market changed in 2008, JPMorgan was unable to syndicate the loans as planned and turned for funding to Banco Imbursa. However, this Mexican bank is affiliated by common ownership with Empresas Bestel’s largest competitor.
Cablevision would not consent to an assignment to Banco Imbursa, but Banco Imbursa would not agree to a typical participation from JPMorgan.
The two banks’ answer to this dilemma was to structure a participation with various sweeteners more typically found in the context of an assignment. These included the participant’s right to request and receive extensive information about Cablevision from the selling lender and a provision whereby the participation would actually convert into an assignment if the borrower defaulted under the credit agreement.
When the Cablevision discovered JPMorgan’s plan, it sued to stop the sale, alleging the deal was really a disguised assignment that required its consent.
The Cablevision/JPMorgan credit agreement -- like most syndicated credit agreements -- did not describe every term and condition that should or should not be in a participation agreement. Rather, it described only the essential terms and conditions of a participation agreement, and left other terms to be determined by the parties to the participation. The terms contained in the JPMorgan/Banco Imbursa participation agreement were not specifically prohibited by the related credit agreement. So the N.Y. bank argued the participation agreement didn’t violate the credit agreement and should be allowed.
The court, however, read the participation provisions in the credit agreement in conjunction with the implied covenant of good faith and fair dealing that applies to all contracts. The court concluded JPMorgan had acted in bad faith when it structured an otherwise impermissible assignment as a permissible participation.
In the wake of the Cablevision case, lenders must be aware that the facts and circumstances surrounding their participation transactions can’t be considered irrelevant even if the participations otherwise comply with the terms of the related credit agreement.