The District Court ruling enables lender strategies in forbearance cases – bankruptcy / bankruptcy / restructuring
After a loan default, borrowers and guarantors often make a variety of claims and defenses to improve their bargaining power. A recent ruling from the U.S. Fifth District Court of Appeals1 provides a prime example of this scenario and a lender’s successful arguments for rejecting these claims on the borrower’s side. In
Lockwoodthe court refused to invalidate a personal guarantee and used a high standard of coercion contesting loan agreements. Equally important, the Court concluded that lenders had a right to insist that defaulting borrowers hire a senior restructuring officer. the
Lockwood The opinion also serves as an important reminder of how lenders can use loan forbearance to their strategic advantage.
Facts about Lockwood
In Lockwood, several affiliates (collectively, the “Borrowers”) have entered into revolving credits (collectively, the “Bonds”) that represent loans made by two lenders (collectively, the “Lenders”). After the Borrowers breached some of their obligations, the Lenders required that the sole owner of the Borrower (the âGuarantorâ) provide a personal guarantee (the âGuaranteeâ) for the outstanding debt. The lenders also recommended or insisted, as the borrowers claim, that borrowers should retain a chief restructuring officer (“CRO”) to help reorganize businesses.
After this restructuring, borrowers’ finances continued to deteriorate and they defaulted again. Lenders issued an ultimatum to borrowers: give the CRO full authority to conduct the business or threaten to withdraw collateral and accelerate the loan. The borrowers agreed and gave the CRO full authority to “properly size their deals”. To avoid speeding up, the Borrowers and the Guarantor have also signed a deferral agreement in which the Guarantor: (i) acknowledges that its obligations under the Guarantee are lawful, valid and binding; and (ii) waived any objection or claim against the Lenders. As this deferral agreement was due to expire, the Guarantor and the Borrower signed a second deferral agreement containing similar provisions and waivers.
After the second deferral agreement had expired, protracted legal disputes arose. The lenders tried to enforce the notes and the guarantee. For their part, the borrowers and the surety asserted numerous tort claims against the lender. The guarantor argued, among other things, that he had been fraudulently induced to sign the guarantee. The court of first instance concluded that the waiver and indemnification provisions in the forbearance agreements precluded any right to fraudulent incitement.2 In the appeal, the surety focused on his coercive argument, claiming that economic coercion forced him to guarantee the debt and carry out the forbearance agreements. He alleged that if he did not give full authority to the CRO, the lenders would have wrongly threatened him with a credit hurry.
The Fifth Ward rejected this argument, stating that financial distress does not mean coercion. Although the lenders used their bargaining power to obtain a delegation of powers to a CRO, the court argued that the use of leverage “is what negotiation is about”. Much of the basis for this participation lay in commercial realities and public order. the
Lockwood The court recognized that many loans would be countervailable if a financial hardship resulted in a forced defense. The court also found that forbearance options would be limited if a distressed borrower could later invalidate the forbearance documents because of economic pressure at the time they were executed.
In order to establish coercion, the court ruled that the defending party must prove: (i) the lender threatened something to which it was not legally entitled; (ii) unlawful extortion or fraud or deception; and (iii) an imminent restriction that destroys the victim’s freedom of action and leaves them without means of protection.
The guarantor’s coercive defense failed to meet the first element as there was no evidence that the lenders threatened illegal action. What is important is that the court found that the surety did not demonstrate that the lenders had âno legal rightâ to require the companies to authorize the CRO. It is important that the court instructed:
We are also not aware of anything that prevents a lender from requesting a change in management as a condition for a loan change.
the Lockwood Decision is important for several reasons. First, the ramifications of this case may be beyond the jurisdiction of the Fifth Circuit, a respected federal appeals court. The expert opinion offers a compelling power of persuasion that can be followed in other legal systems.
With regard to compulsory avoidance, the court set a high standard that borrowers and guarantors must meet in order to invalidate loan documents. In fact, it will be a rare occurrence where a borrower can prove that their lender was involved in illegal or fraudulent behavior.
Although the Lockwood In a decision that focuses on coercion, the court’s reasoning can be used to thwart other claims and defenses. For example the Lockwood The court held that an unequal negotiating position did not result in an actionable claim. Lenders can rely on this justification to undermine claims and objections based on a borrower’s financial distress.
Additionally, the appraisal provides an important reminder of how the forbearance process can be used to isolate lenders from claims and objections. Waiver and exemption provisions are an important part of deferral documents. As this case shows, such provisions prove to be an effective means of fending off objections and claims after payment default.
LockwoodThe discussion regarding the retention of the CRO is also imperative. In lender liability suits, borrowers often argue that their lenders exercised “improper control” or improperly interfered with the running of the company. As noted above, the court recognized that the lenders had the right to request a change in management in return for deferring loans. Lenders may argue that this waiver also applies to lender liability claims based on a request from a lender for a change in management or the appointment of a CRO.3
1. Lockwood International, Inc. v Wells Fargo Bank, NA, et al., 2021 WL 3624748 (5NS Circ. 2021).
2. A guarantee that can otherwise be challenged due to fraudulent induction or coercion can no longer become invalid after ratification. Lee v. Wal-Mart Stores, Inc.,943 F.3d 554, 560 n.11 (5NS Circ. 1991)
3. The Lockwood The opinion did not specify whether the lender was hiring a particularly CRO or whether borrowers are free to choose their own candidate. This can be a critical difference in any lender liability lawsuit. In addition, when evaluating the use of a CRO or other legal remedy, lenders should consider potential claims that may be brought by unpaid creditors who claim that the lenders have exercised extensive control over the borrowers and, as such, the unpaid debts of the creditors be liable .
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.