The Court of Appeals of New York recently held that, where syndicated loan documents did not expressly grant an individual lender the right to enforce the loan documents, the individual lender did not have standing to sue for breach of contract contrary to the will of the majority of the lenders to forbear from taking action. In so holding, the court determined that "[t]he specific, unambiguous language of several provisions, read in the context of the agreements as a whole, convinces us that, in this instance, the lenders intended to act collectively in the event of the borrower's default and to preclude an individual lender from disrupting the scheme of the agreements at issue." Beal Sav. Bank v. Sommer, 8 N.Y.3d 318, 321, 865 N.E.2d 1210 (2007).
On February 26, 1998, a lending syndicate, originally comprising 13 institutions, lent funds to Aladdin Gaming, LLC for the development of Aladdin Resort and Casino in Las Vegas, Nevada. A credit agreement was the primary loan document governing the loan, and a leep-well agreement was one of many ancillary instruments evidencing the loan. The loan documents were governed by New York law.
Section 9.1 of the credit agreement granted an administrative agent multiple rights and responsibilities, including both administrative functions and substantive ones, such as setting rates of interest and reviewing the borrower's financial statements. The administrative agent was authorized to act when authorized by the "required lenders," defined as those lenders holding at least 66.67 percent of the outstanding principal and participation interests in the outstanding letters of credit. The credit agreement further provided that "[n]o right or remedy conferred upon the Administrative Agent or the Lenders in this Agreement is intended to be exclusive" and "every such right and remedy shall be cumulative … to every other right or remedy contained in the Loan Documents."
Pursuant to the keep-well agreement, certain parties (the sponsors) agreed to make equity contributions to the borrower if the financial ratio fell below a certain minimum. Ultimately, the Aladdin casino filed for bankruptcy protection, and the administrative agent, along with all of the lenders except the plaintiff-appellant Beal, entered into a settlement and forbearance agreement with certain sponsors, including the Sommer Trust. At the time of the settlement, there were 37 members of the syndicate, and 36 of them, holding 95.5 percent of the outstanding principal amount, supported the settlement.
Rather than consent to the settlement, Beal filed a claim under the keep-well agreement, seeking its pro rata share of $90 million or, in the alternative, $90 million to share with the other lenders. The trust filed a motion to dismiss, arguing that Beal lacked standing because only the administrative agent, acting at the behest of a 66.67 percent supermajority of the lenders, could enforce the loan documents.
According to the court, neither the credit agreement nor the keep-well agreement contained an explicit provision that empowered a lender to take individual action or prohibited such individual action. Thus, the court was required to analyze the loan documents, pursuant to the well established principles of contract interpretation that agreements are to be construed so as to give full effect to the material provisions, and that contracts are to be read as a whole so as to give effect to the general purpose and to avoid rendering any portion meaningless.
Section 18 of the keep-well agreement provided that "the Keep-Well is a 'Loan Document' executed pursuant to the Credit Agreement and shall (unless otherwise expressly indicated herein) be construed, administered and applied in accordance with the terms and provisions thereof." The court noted that the keep-well did not contain any express provisions regarding the actions to be taken in the event of default. Rather, section 8.3 of the credit agreement authorized the administrative agent, upon the direction of the required lenders, to give notice of default to the borrower and exercise any or all rights and remedies as the required lenders may direct, including recovery under the keep-well agreement.
Beal argued that it was granted standing to act individually by section 18(b) of the keep-well agreement, which provided that "[t]his Agreement shall … be enforceable by the Administrative Agent and each Lender and their respective successors, transferees and assigns." The court dismissed this argument because, in its view, the section "does not expressly override the specific language of section 8.3 that in the event of default the Administrative Agent at the direction of the Required Lenders may or may not attempt to recover judgment" and, further, "[a]n interpretation favoring Beal's view would render section 8.3 meaningless because there would be no reason to provide that the Required Lenders could enforce the agreements by a supermajority directing the Administrative Agent to act." The court also refused to find authority for individual action in section 10.20 of the credit agreement, which provided that "[n]o right or remedy conferred upon the Administrative Agent … is intended to be exclusive of any other right or remedy contained in the other Loan Documents at law or in equity." In essence, the court read the loan documents to establish a collective design and, in the majority's view, "[h]ad the parties intended that an individual have a right to proceed independently, the Credit Agreement or the Keep-Well should have so provided."
One judge filed a dissenting opinion, arguing that the default rule ought to be that an individual bank may sue unless the loan documents expressly prohibit individual action. Because the loan documents did not expressly prohibit such individual action, the judge dissented from the majority's decision to read such a prohibition into the loan documents.
The relevant provisions of the documents at issue in the Beal case are common in syndicated loan transactions. Given the Beal court's caution that "surely, for the future, parties should expressly state their intention in this regard," documentation should be very clear that all loan documents, including keep-well agreements and other ancillary documents, are governed by the same rules regarding authority to sue and take other enforcement action.
Fourth Circuit Addresses Lender's Right to Allocate Payment to Principal
On July 10, 2007, the Fourth Circuit Court of Appeals held that section 502(b)(2) of the Bankruptcy Code bars a creditor from applying payments from a non-debtor guarantor against interest that accrued after the filing of a petition by the primary obligor first, and then applying the remainder to principal, holding that to allow otherwise would permit the creditor to collect an amount otherwise disallowed as post-petition interest.
National Energy & Gas Transmissions Energy Trading Power, L.P. (ET Power) was an energy marketing and trading company that entered into a contract with Liberty Electric Power, LLC by which ET Power had an option to purchase energy in return for a monthly payment in addition to variable costs based upon the amount of energy purchased. ET Power's obligations under the contract were guaranteed by National Energy & Gas Transmission, Inc. (NEGT), ET Power’s corporate parent, and Gas Transmission Northwest Corporation (GTN), a subsidiary of NEGT. On July 8, 2003, ET Power and NEGT, along with certain of their affiliates, filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code. ET Power and NEGT moved to reject the contract and, with Liberty's consent, the bankruptcy court granted the motion.
Liberty's claim for termination damages proceeded to arbitration and, while arbitration was pending, NEGT sold GTN to a third party with $140 million held in escrow to provide for any liability to Liberty under the guarantee. Ultimately, the arbitration panel awarded Liberty the full $140 million as of the petition date, plus interest accruing from the date of the rejection of the contract. The dispute then shifted back to bankruptcy court, but to stop the accrual of interest — which had already reached approximately $17 million — the parties agreed that Liberty should receive immediate payment of the escrow funds. Liberty allocated the $140 million it received from GTN first to the $17 million in interest, then to principal. Thus, Liberty asserted that only $123 million of its $140 million claim against the debtors had been satisfied and that the remaining $17 million constituted a claim for unpaid principal.
NEGT and ET Power objected to Liberty's claim, contending that the $17 million claim constituted disallowable post-petition interest, pursuant to 11 U.S.C. § 502(b)(2), which provides that a claim shall not be allowed "to the extent that … [it] is for unmatured interest." The bankruptcy court sided with Liberty, and the district court affirmed.
On appeal, the Fourth Circuit ruled that Liberty's attempt to allocate the $140 million payment to interest first was not determinative, noting that the court was required to "'sift through the circumstances surrounding' the claim to determine the reality of the transaction for purposes of the bankruptcy proceeding." Because ET Power's debt was capped at $140 million on the petition date, and the additional $17 million that was arguably allowable against any non-debtor resulted from the accrual of post-petition interest, the court held that Liberty's remaining claim was for disallowed post-petition interest, no matter how Liberty chose to classify it. Indeed, in reaching its decision, the court stated, "We must likewise look behind Liberty's claim here to find that the claim really constitutes post-petition interest disguised as unpaid principal." Thus, the Fourth Circuit reversed the judgment of the district court.
In a well-reasoned dissent, Judge Duncan pointed out that section 502(b)(2) does not stop interest from accruing against a non-debtor guarantor upon the filing of bankruptcy by the primary obligor. Because bankruptcy law does not govern the relationship between the creditor and non-debtor guarantor, Judge Duncan disputed the ruling that Liberty could not apply the escrow payment to interest first and dissented from the majority's reversal of the district court.
While it is early to tell whether other courts outside of the Fourth Circuit will follow the holding in NEGT, the decision is troublesome for creditors in transactions that include guarantees as an important source of security.