The relationship between a lender and borrower can be complex. The borrower wants capital to run and grow its business and the lenders want to earn a return and eventually get its principal back.
If the borrower complies with the terms of the loan, all is good. If the borrower breaches then the lender has a number of rights and remedies. Sometimes, however, a lender overreaches. One example of an overreach is when a lender exerts control over the daily activities of the borrower. In that case, a court may determine the lender is guilty of lender liability.
Lender liability cases are rare. Good (i.e. where plaintiff wins) lender liability cases are exceedingly so. In re: Comprehensive Power, Inc., 578 B.R. 14 (Bankr. D. Mass. 2017), however, demonstrates that plaintiffs can bring lender liability cases which can at least withstand motions to dismiss.
Comprehensive Power, Inc. (“Debtor”), a Massachusetts company, was facing financial difficulties and needed financing to continue operations. Moog, Inc was identified as a potential lender and ultimately it made a three year $6 million loan to the debtor, secured by substantially all of the personal property of the debtor.
Pursuant to the loan documents, (i) the loan payments were payable quarterly not monthly; (ii) Moog had the right to appoint a director to the debtor’s board and did appoint a director; and (iii) Moog was granted an option to purchase the debtor’s stock or assets for a cash payment equal to six times EBITDA and, if the option was not exercised, the debtor had the right to extend the maturity date of the loan for six months.
After the loan closed, the debtor pretty quickly began experiencing financial trouble, spent the entire $6 million loan proceeds, and was in default under the loan. Moog exercised its rights under the loan documents and eventually foreclosed on its collateral under Article 9 of the UCC. After the UCC sale, a number of Comprehensive Power’s other creditors filed an involuntary Chapter 7 proceeding.
The Chapter 7 Trustee believed Moog’s actions triggered lender liability. The Trustee sued Moog on a number of theories, including without limitation, (i) recharacterizing debt as equity; (ii) equitable subordination; (iii) actual and constructive fraudulent transfers; (iv) successor liability; and (v) violation of the Article 9 commercial reasonableness standard.
Editor’s Note: To learn more, check out 90 Second Lesson: What is the Difference Between Recharacterization and Equitable Subordination.
Moog moved to dismiss the Trustee’s complaint, however, the Court found that the Trustee had adequately pled most of its claims.
For example, after reviewing the 11 factors courts look to in deciding whether to recharacterize debt as equity, the court noted that the Trustee had alleged facts supporting at least six of those factors including without limitation, the lender’s right to appoint a board member, quarterly rather than monthly payments, and the purchase option granted to the lender. The court consequently declined to dismiss the Trustee’s claim.
Editor’s Note: For more information on recharacterization of debt, read How Unsecured Creditors Push Ahead of Lenders Who in Fact Invested, Part I – What is Recharacterization?
Further, the Trustee alleged sufficient facts to pursue its fraudulent transfer claims. These facts included the lender:
Similarly, the court found that the Trustee alleged sufficient facts showing a “de facto merger” of the debtor and Moog, or a mere continuation of the debtor by Moog. Factors supporting this finding included that Moog continued business with the same customers of the debtor, hired 14 employees of the debtor including some of the senior management, and continued the same general business of the debtor that existed prior to the Article 9 UCC sale.
Finally, the court found that allegations by the Trustee of gross inadequacy of price, failure to adequately market the collateral, the short fourteen day notice of the Article 9 sale, and the fact that Moog was the sole bidder were sufficient to call into question the commercial reasonableness of the sale.
Editor’s Note: To see an alternative where the lender and borrower work together to achieve a beneficial result for all creditors, read Mega RV – Lender Compromise Provides Funds to Creditors.
Comprehensive Power shows that lenders need to be cautious in how they structure and enforce loans to avoid lender liability claims.
Gary Marsh focuses on general commercial litigation and bankruptcy, workouts and debtor/creditor law. He represents creditors and debtors in Chapter 11 reorganization proceedings, out of court restructurings and debtor/creditor tigation. He also represents court appointed receivers, examiners and trustees. Mr. Marsh has extensive experience in representing creditors in and out of bankruptcy court in enforcing their…
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