Legal Notes

Secured Lender, The, Jul/Aug 2007 by Helfat, Jonathan N, Kohn, Richard M

Beal Sav. Bank v. Sommer, 8 N.Y.3d 318 (Mar. 22, 2007) (Under terms of credit agreement, individual lender in syndicate of lenders lacks standing to enforce remedies.)

In a recent decision, New York's highest state court has held that a lender in a syndicated loan transaction has no right to unilaterally proceed against a non-paying borrower unless the governing loan documents contain an express grant of authority to do so.

In February 1998, Aladdin Gaming LLC borrowed $410 million from the Bank of Nova Scotia, acting as the Agent for the lenders from time to time party to the Credit Agreement. The purpose of the loan was to finance the construction of a casino in Las Vegas. The financial sponsors of the project furnished credit support under a keep-well agreement ( i.e., a contract by a parent company to provide financial support for its subsidiary).

Upon the occurrence of a default under the Credit Agreement, the Agent could, at the direction of the required lenders (defined as holders of at least 66.66% of the outstanding principal of the loan), accelerate the loan and "exercise all rights and remedies in law or in equity," including the right to seek a judgment against the sponsors under the keep-well agreement. However, neither the Credit Agreement nor the other loan documents expressly authorized a lender to take independent action upon the occurrence of a default ( i.e., the documents were silent on this point).

In 2001, Aladdin filed a Chapter 11 bankruptcy case. After the commencement of the Chapter 11, the Agent and 36 of the 37 lenders under the Credit Agreement, who collectively held 95.5% of the loan, entered into a settlement agreement with the borrower, which included the agreement of the Agent and lenders to forbear from exercising any remedies under the keep-well agreement. In exchange, the sponsors agreed to transfer certain property to the Agent for the benefit of the lenders, including BFC Capital Bank, the only lender that did not expressly approve the settlement agreement and who was not an original lender. BFC acquired a 4.5% interest in the loan after the commencement of the Chapter 11 case.

After BFC received its pro rata share of the settlement proceeds, BFC sold its 4.5% interest in the loan to Beat Bank. Beal Bank then filed suit to enforce the keep-well agreement and collect $90 million dollars from the financial sponsors. Both the Credit Agreement and the keep-well agreement provided that they would be governed by New York law.

The Court of Appeals of New York dismissed the lawsuit, holding that Beal Bank could not uni laterally proceed against the sponsors. In reaching its conclusion, the Court focused on the provisions of the loan documents dealing with agent authority and enforcement matters. As the loan documents did not expressly authorize individual lenders to proceed on their own after the occurrence of a default under the loan documents, the Court concluded that the parties intended to grant the "required lenders" ( i.e., holders of at least 66.66% of the outstanding principal amount of the loan) the exclusive right to pursue enforcement through the Agent. The Court held that only the "required lenders" could pursue enforcement (through the Agent) notwithstanding that the keepwell agreement itself included a provision stating it was enforceable by the Agent and each lender.

The opinion was not unanimous. The lone dissenting judge took the position that nothing in the loan documents deprived the individual lenders of the right to sue separately and, therefore, they should be permitted to do so. According to the dissenting judge, the normal expectation of lenders in a syndicated loan transaction is that each lender may sue separately to recover its loan in the absence of express language to the contrary. As such, said the dissenting judge, if the parties intended to prohibit individual lenders from acting on their own, the parties should have said so in the loan documents.

The Court of Appeals of New York makes clear in Beal Bank that, in the absence of express language to the contrary, a lender will be bound by actions of the "required lenders," which was the intention of the parties when the credit agreement was negotiated. Thus, before committing to participate in a syndicated loan transaction, potential lenders should review the loan documents to determine whether individual lenders are expressly permitted to act on their own in the event of a default. Indeed, in the words of New York's highest state court, "for the future, parties should expressly state their intention in this regard." Absent an express grant of authority in the loan documents, at least in situations where the loan documents are governed by New York law, a lender may find itself unable to "break ranks" from the lending group and proceed on its own.

Highland Capital Management LP v. Schneider, 8 N.Y.3d406(April3,2007) (New York's highest state court holds that a promissory note is a "security" within the meaning of Article 8 of the New York Commercial Code.)