legal notes

Secured Lender, The, Sep/Oct 2008 by Helfat, Jonathan, Kohn, Richard

THE LEGAL SIDE OF ABL

The cases we have selected for this issue of The secured Lender address several interesting topics: Lender liability for failing to correct misrepresentations made by a Chapter 11 debtor, lender liability for tortious interference with business relationships, the ability of an oversecured creditor to recover default-rate interest from the proceeds of a � 363 sale and the recognition of a foreign insolvency proceeding by a U.S. bankruptcy court. We hope you find these case notes to be interesting and instructive.

JONATHAN HELFATAND RICHARD KOHN

In re American Business Financial Services, Inc., 384 B.R. 80 (Bankr. D. Del.) (A DIP lender may be liable for "fraud on the court" if it knowingly fails to contradict alleged misrepresentations made by the debtor with respect to the value of the collateral.)

In January 2005, American Business Financial Services, Inc. and certain of its subsidiaries filed Chapter 11 bankruptcy cases in the United States Bankruptcy Court for the District of Delaware. On March 10,2005, the Bankruptcy Court entered a final financing order authorizing the debtors to enter into a secured $500 million debtor-in-possession financing facility with Greenwich Capital Financial Products, Inc.

A few months later, Greenwich declared a default under the DIP loan facility. As a result, the Chapter 11 bankruptcy case was converted to a Chapter 7 bankruptcy case and a Chapter 7 trustee was appointed.

In September 2006, the Chapter 7 trustee commenced an adversary proceeding against Greenwich, asserting, among other claims, a claim for fraud on the Court. The trustee alleged that Greenwich failed to advise the Court that it appraised the debtors' assets at almost $300 million less than what the debtors openly represented to the Court. According to the trustee, Greenwich remained silent so that the Bankruptcy Court would approve the DIP financing motion (which it ultimately did) and Greenwich, among other things, could collect the accompanying $15.75 million closing fee.

In response, Greenwich pointed to the terms of the final financing order and the DIP loan documents, which expressly provided that Greenwich had made no representations regarding the value of the debtors' assets and that the debtors had not relied on any such representations. Based on this language, Greenwich argued that the Chapter 7 trustee's claim was barred by the terms of the financing order and moved to dismiss the claim.

According to the Bankruptcy Court's opinion, the basis of the Chapter 7 trustee's claim was not that Greenwich made representations upon which the debtors relied, but rather that Greenwich intentionally misled the Bankruptcy Court into approving the DIP financing motion. As such, the Bankruptcy Court found that the Chapter 7 trustee's claim was not barred by terms of the final financing order and denied Greenwich's motion to dismiss.

A debtor will often make representations to the bankruptcy court regarding the value of its assets, especially in connection with a motion to obtain debtor-in-possession financing. In light of American Business Financial Services, DIP lenders, especially DIP lenders whose borrower has commenced a bankruptcy case in Delaware, are at risk if they know their borrower/debtor has misrepresented the value of its assets to the bankruptcy court and fail to contest these misrepresentations.

Tradition Homes, LLC v. Textron Fln'l Corp., et al., 2008 U.S. Dist Lexis 24361 (M.D.Fl. March 27,2008) (A lender may be liable for tortious interference with business relationships based on statements the lender makes to another lender regarding the financial troubles of a mutual borrower.)

Tradition Homes, LLC entered into separate financing arrangements with Textron Financing and 21st Mortgage. Eventually, Tradition Homes began experiencing cash flow difficulties and was not able to meet its obligations under its financing arrangements with Textron. As a result, Tradition Homes presented only Textron with a workout plan developed to allow Tradition Homes to satisfy its debts to Textron.

Immediately after this plan was presented to Textron, during a cocktail reception at a trade show, a representative of Textron spoke to a representative of 2ist Mortgage about Tradition Homes, their mutual borrower. The next day, 2ist Mortgage conducted a surprise on-site inventory audit of Tradition Homes. After conducting this audit, 21st Mortgage terminated its credit facility with Tradition Homes and notified Tradition Homes' customers to remit payment directly to 21st Mortgage.

Tradition Homes sued Textron in the United States District Court for the Middle District of Florida, alleging, among other things, that Textron's actions amounted to tortious interference with the business relationships that Tradition Homes had with its customers and with its other lender, 21st Mortgage. Specifically, Tradition Homes claimed that, at the cocktail reception, Textron shared confidential financial information about Tradition Homes with 21st Mortgage and that based on this information, 21st Mortgage terminated its credit facility with Tradition Homes. Tradition Homes also claimed that the notices sent by Textron to Tradition Homes'customers damaged its reputation and ultimately forced it to cease all business operations.