Fulbright & Jaworski L.L.P. Document



Pigs Get Fed and Hogs Get Slaughtered – Making Sausage from Butchered Deals[1]

Introduction

This is the tale of the ongoing slaughter of sick and dying real estate deals and financing arrangements born under the blue sky on Go-Go Days Forever Ranch.

Even a blind pig finds a truffle once in a while.[2]

The first part of this paper begins with the sad account of the billionaire and the banker as told by the bankruptcy court in Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club, LLC).[3] Many of the questions raised by this tale now seem as obvious as the snout on a hog’s face but the answers to some remain obscure.

• Did fat, fee-fed lenders mating with genetically flexible appraisers breed morbidly overleveraged deals with short life expectancies?

• Did gluttonous borrowers gorging themselves on loan distributions “for purposes unrelated” to their projects leave nothing in the trough for unsecured creditors and other stakeholders?

• Was too little diligence done and too much still due?

• What made this deal, and so many others, fall ill or die so quickly?[4]

• And what was the role of the attorneys?[5]

A lawsuit is a machine you go into as a pig and come out of as a sausage.[6]

The story descends from the illustrious heights of Yellowstone Mountain to the humble courthouses in the judicial valleys where the ongoing slaughter of failing deals supplies the lawsuit machine with the pork being ground and cooked following virtually the same judicial recipes in use for at least a generation. Judges running the lawsuit machine, for the most part, are rejecting new-fangled legal recipes, and, instead, are using traditional causes of action and established legal theories to carve good claims from bad ones. Even the new statutes of frauds, pre-negotiation letters, and other safety devices installed after the S&L Ranch sent so many deals to slaughter in the early 1990’s have done little to change outcomes: sausage still is about the only thing that comes out of the lawsuit machine. Bad deals just don’t yield much good meat, even when a skilled judge wields the carving knife. It’s simple. If you don’t like sausage, you best avoid the courthouse.

The second part of this paper looks at the workout rodeo in light of the recent cases run through the sausage mill. The goal is to explore afresh how to successfully draft and negotiate workout agreements. The notion is that cooks in a private kitchen will generally cut more good meat from the bone than the sharpest legal claims tried at the courthouse, and the parties, unlike a judge, can season the collateral meal to taste. These are some of the considerations for butchered deals:

• Does a short sale unravel the lasso around the debtor’s neck?

• Does a deed-in-lieu leave you hog tied?

• Does leaning on the forbearance fence cause a collapse?

• Does the receiver-sheriff help?

Part I

A. In re Yellowstone [7]

Those who cannot remember the past are condemned to repeat it.[8]

The same punishment, unfortunately, awaits those who do.

Some cases – fairly or unfairly – come to epitomize an era. In re Yellowstone may become one of the cases. The purpose of the following summary of In re Yellowstone is not to analyze, in detail, the legal justification for the court’s ruling or whether the lender’s actions warranted subordination of the lender’s secured claim. Others have done that far better than we could, and we commend these resources for a detailed analysis of the legal issues presented.[9] The financial follies caricatured in the court’s recitation of the facts beg one to ask: how did those whose conduct now appears so odious not see then what now appears, at least to the bankruptcy court, so obviously “gross and egregious” that it justified subordinating the secured lender’s first lien to the allowed claims of unsecured creditors and DIP financing?

Equitable Subordination: The first lien shall go last . . .

A bankruptcy court may subordinate a creditor’s claim on purely equitable grounds when the claimant “is guilty of [‘gross and egregious’] misconduct that injures other creditors and confers an unfair advantage on the claimant.”[10] The purpose of equitable subordination is to “minimize the effect that [one creditor’s] misconduct has on other creditors,”[11] but this remedial doctrine is rarely invoked to subordinate claims of non-insiders or non-fiduciaries.[12] And, even when it is invoked, courts require elevated standards of pleading and proof of the following elements before equitably subordinating the claim of a non-insider or non-fiduciary:

(1) the claimant must engage in inequitable conduct;

(2) the claimant’s misconduct must injure creditors of the bankrupt or confer an unfair advantage on the claimant; and

(3) equitably subordinating the claim must not be inconsistent with the provisions of the Bankruptcy Code.[13]

In re Yellowstone generated so much discussion because it is one of the relatively few cases in which a bankruptcy court, applying these standards, equitably subordinated a non-insider’s secured claim that arose from an arm’s length loan transaction. The case settled and is arguably a legal outlier that would not have survived appellate scrutiny. But it remains a cautionary tale of the hazards of dealing with hogs.

Observation: During the negotiation of a secured loan, the only heed usually paid to the borrower’s general creditors is ensuring that the lien securing the loan primes any unsecured creditors’ claims. Is this enough? This court says no: a secured lender may not be his unsecured brother’s keeper, but he should not be his murderer either. Courts hear the cries of third-party piggies whose throats are cut unjustly by greedy hogs. And the punishment – equitable subordination – may be greater than a secured lender can bear.[14]

Hogs with Friends in Low Places

Timothy Blixseth (Blixseth), a supposed billionaire with bi-partisan political connections, assembled over 100,000 acres of land in Montana.[15] Blixseth persuaded the Clinton administration and a Democratic Congress, and later the Clinton administration and a Republican Congress, to swap this assembled acreage for 13,500 acres of developable land in Madison County, Montana on which Blixseth planned to develop The Yellowstone Club (TYC), the world’s only ultra-exclusive, private golf and ski resort comprised of 864 fee dwelling units catering to buyers expected to have investable assets of at least $5 million, if not $10 million. To get TYC off the ground, Blixseth sold equity interests in TYC to 25 Pioneer and 15 Frontier members at substantially reduced prices.

Question: Should a project be underwritten differently or more skeptically when the acquisition price is obscured in a quasi-political rather than a purely market transaction or the financing is wrapped in the enigma of tax credits or other non- market mysteries?

Don’t Sell the Bacon – Sell the Sizzle

To join TYC, a prospective resident member need only boast a minimum net worth of $3 million, post $250,000 for a 30-year refundable deposit, and pay annual dues of between $10,600 and $16,000, plus annual property owner association dues of $5,100. Prospective members were advised that “the price is expected to increase during the sell out period.”[16] Exclusivity was the sizzle. And it seems almost everyone became intoxicated by the smell of the bacon.

Question: Why have so many super-luxury developments gone belly up?[17]

Beware Hogs Bearing OPM

Credit Suisse, Cayman Islands Branch, saw only blue skies over this wilderness playground for the wealthy. Jeffrey Barcy (Barcy), a director in Credit Suisse’s investment banking division, sold an initially reluctant Blixseth on the idea of a syndicated term loan, something Barcy described as akin to a “home equity loan,” that would allow Blixseth to take sizeable distributions from the proceeds of the Credit Suisse loan. Blixseth first agreed to take out a $150 million loan – roughly 2.5 times the highest debt level previously carried by TYC and more than 6 times the project’s then outstanding debt. During negotiations lasting almost a year, the size of the loan grew from $150 million to $375 million, $209 million of which could be used “for purposes outside of, and unrelated to,” TYC, and another $142 million of which could be distributed to “unrestricted subsidiaries” for purposes unrelated to TYC development. At closing, $342,110,262.53 was disbursed to the Debtors.[18] Debtors immediately transferred $209 million to Blixseth Group, Inc. (BGI), a company formed by Blixseth. BGI booked the transfer as a loan from TYC and documented with a backdated demand note more than 6 months later. By that time, BGI already had used the proceeds to pay Blixseth’s personal debts.

Question: Where is the meat on the bone and who has skin – upside, downside, or just side – in the game?

You have to do more than read the label on the bacon to know if it’s fresh.

Credit Suisse claimed it did “a fair amount of due diligence” before making the loan. Credit Suisse did a background check on Blixseth, hired an appraisal firm to perform an “independent assessment” of TYC’s cash flows, and engaged a law firm to investigate whether the borrowers owned the assets pledged to secure the loan. Credit Suisse did not ask for audited financials; instead, it relied on historical and future projections provided by Blixseth and the Debtors. Credit Suisse also hired Cushman & Wakefield to do a limited as-is valuation, which came in at $420 million, generating a loan-to-value ratio of only 90%. The bankruptcy court “highly doubted” that Credit Suisse could have syndicated the TYC loan at a loan-to-value ratio of 90%. Credit Suisse must have doubted it too. Credit Suisse commissioned Cushman & Wakefield to devise a new valuation methodology that “relied almost exclusively on the Debtors’ future financial projections, even though such projections bore no relation to the Debtors’ historical or present reality.”[19] In sum, “the Credit Suisse syndicated loan team could not have believed under any set of circumstances that the Debtors could service the increased debt load, particularly when the Debtors had several years of net operating losses, mixed with a couple of years of net operating revenues.”[20]

Question: Is a representation ever a substitute for, as opposed to a supplement to, independent verification and, if so, when?

To Find a Hog, Follow the Money

Credit Suisse and its representatives “only earned fees if they sold loans.”[21] Credit Suisse’s unrelenting drive for fees it extracted from the loans it was selling, the bankruptcy court concluded, was the “only plausible explanation” for “devising a loan scheme whereby it encouraged developers (as if developers need such encouragement) of high-end residential resorts . . . to take unnecessary loans” that authorized developers to divert loan proceeds to purposes unrelated to their project, essentially, in the court’s view, “put[ting] the fox in charge of the hen house.”[22] The court then indignantly proclaimed:

The naked greed in this case[,] combined with Credit Suisse's complete disregard for the Debtors or any other person or entity who was subordinated to Credit Suisse's first lien position, shocks the conscience of this Court. . . . Credit Suisse lined its pockets on the backs of the unsecured creditors. The only equitable remedy to compensate for Credit Suisse's overreaching and predatory lending practices is to subordinate Credit Suisse's first lien position to that of Cross Harbor's superpriority debtor-in-possession financing and to subordinate such lien to that of the allowed claims of unsecured creditors. [23]

How do you know you’re dealing arm’s length with a hog?

You flip a coin for $3.75 million and winner takes all. Really!

The bankruptcy court found a coin flip to be evidence of an arms’ length loan, stating “[n]othing in the record suggests that the loan between Credit Suisse and Blixseth (disregarding, however, the minority shareholders) was not at arm’s length. For instance, Credit Suisse originally sought a transaction fee of 3 percent, but Blixseth wanted the transaction fee reduced to 2 percent. Credit Suisse, via Barcy, and Blixseth ultimately agreed to ‘flip a coin’ to decide the rate. Credit Suisse lost the toss, and Blixseth was thus successful in reducing the transaction fee to 2 percent.”[24] The coin flip is evidence of something but, we would submit, not evidence of an arm’s length transaction.

Question: What should a lawyer do when asked to watch the coin flip?

B. What’s for Dinner? Take-Out Judicial Sausage or Home Cooking at the Workout Rodeo

1. DDJ Mgmt., LLC v. Rhone Group LLC, et al, ---- N.E.2d ----, 2010 WL 2516811 (N.Y.), 2010 N.Y. Slip Op. 05603 (June 24, 2010) (uncorrected and subject to revision) – Don’t Believe Everything the Pig Says

This case wrestles with the nettlesome, fact-intensive question of whether a lender’s naked reliance on a borrower’s financial representations and warranties, without independently verifying their accuracy, is reasonable enough to overcome a motion to dismiss and allow the lender’s fraud claim against the borrower and its agents to go to a jury.[25]

The lender loaned $40 million to a corporate borrower. Before doing so, the lender “went to the trouble” of obtaining typical representations and warranties in the loan documents attesting to the accuracy of the borrower’s financial statements.[26] But the lender did not “go to the trouble” of exercising its contractual right to examine the borrower’s books and records, or of even asking to do so.[27] Had the lender bothered to sniff around, it might have detected the foul odor betraying the borrower’s decaying financial condition.[28]

The borrower, not surprisingly, failed to repay the loan. The lender sued, claiming, among other things, that the borrower, the entities that owned stock in the borrower, members of the borrower’s management, and the borrower’s accountants deliberately inflated EBITDA in the borrower’s financial statements in order to defraud the lender into making the loan.[29] The borrower’s drift[30] defended itself against the lender’s fraud claim on the ground that the lender’s due diligence was so lax that its reliance on the borrower’s financial representations and warranties was unreasonable as a matter of law (i.e., the borrower’s financial statements were so transparently false – or, at least, the assumptions on which they were based were so apparently questionable – that no reasonable banker would have lent the borrower a penny without further inquiry as to their accuracy).[31]

To decide this quotidian question, New York has long followed a common-sense rule that seeks to rid its “courts of cases in which the claim of reliance is likely to be hypocritical.”[32]

[I]f the facts represented are not matters peculiarly within the party's knowledge, and the other party has the means available to him of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, he must make use of those means, or he will not be heard to complain that he was induced to enter into the transaction by misrepresentations.[33]

But New York balances its desire to rid its courts of hypocritical reliance claims against its concomitant concern for protecting the modestly credulous from equivocal hints of deceit. New York law thus affords relief to a party who takes reasonable steps to protect itself against deception even though hindsight suggests that it might have been possible to detect the fraud when it occurred.[34]

In particular, [when a party] goes to the trouble to insist on a written representation that certain facts are true, it will often be justified in accepting that representation rather than making its own inquiry.[35]

The trial court denied the borrower parties’ motion to dismiss the lender’s fraud claim.[36] The Appellate Division reversed the trial court on this point, holding that a lender who fails to examine its borrower’s books and records, as a matter of law, cannot reasonably rely on the borrower’s naked representation that its financial statements are accurate.[37] The Court of Appeals, New York’s highest court, reversed the Appellate Division, declining to hold that a lender’s reliance on a borrower’s representations, even in the absence of any due diligence into the accuracy of those representations, is unreasonable as a matter of law.[38] DDJ Mgmt. reminds us that, although representations and warranties can be legally useful, exclusive reliance on them is practically futile, and, in any case, attempting to use representations and warranties as an alternative to adequate due diligence is predictably brutal.

2. Hogs Snort for New Lending Torts

Some borrowers are asking the judiciary to conceive new claims to expand “the boundaries of lender liability . . . in the wake of the recent mortgage crisis.”[39] One offspring of the porcine imagination is a new prima facie financial tort of “lender liability.” It has no essential elements. It is like pornography. A judge can’t define it, but she knows it when she sees it.[40] The judiciary, for the most part, appears content to read the articles rather than peek into the possibility of bringing this amorphous piglet, and its logically deformed littermates, into the world.[41] Another runt – deepening insolvency – did crawl under the fence of rationality for a time, but reports are that the black-robed farmers running the slaughter house have caught the runt and are in the process of dispatching it.[42] As well they should.

a. Headwaters Const. Co. v. National City Mortg. Co., --- F.Supp.2d ---, 2010 WL 744287 (D. Idaho 2010) – Lender Liability is not a Separate Tort

Home-builder borrower sued its construction lender for most of the traditional litany of lender liability claims, as well as a novel claim for freestanding lender liability.[43] The district court noted, and borrower conceded, that “no Idaho court has ever recognized a specific claim for “lender liability.” Idaho had not adopted a lender liability claim, and to the extent borrower’s lender liability claim could have been recast as a breach of fiduciary duty, Idaho had rejected such claims in similar circumstances.[44] The district court turned down the chance to become part of the judicial vanguard expanding “the bounds of lender liability,” humbly declining to “speculate what claims an Idaho court might acknowledge in the current local and economic conditions.”[45]

b. Official Committee of Unsecured Creditors of VarTec Telecom, Inc. v. Rural Telephone Finance Cooperative (In re VarTec Telecom, Inc.), 335 B.R. 631 (Bankr. N.D. Tex. 2005)[46] – The Judicial Wells of Deepening Insolvency Run Dry

The unsecured creditors sued the debtor, VarTec, a one-time telecom pioneer, for continuing to borrow, and its secured lender, for continuing to lend, while VarTec’s finances deteriorated and then arranging for VarTec to pay down a significant portion of the secured debt and to post additional collateral on the eve of VarTec’s bankruptcy filing. Not content to rely on the tried and true claims and remedies for such conduct – fraudulent transfer, avoidable preference, avoidance of security interests, avoidance of replacement liens, disgorgement, disallowance of the secured creditor’s claims, equitable marshalling of assets, and equitable subordination – the unsecured creditors also sued under the “controversial theory”[47] of deepening insolvency. The secured lender moved to dismiss the deepening insolvency claims under Rule 12(b)(6).

The theory started innocently enough. Judge Bernstein, in one of the leading cases discussing the theory, defined deepening insolvency as “the ‘fraudulent prolongation of a corporation's life beyond insolvency,’ resulting in damage to the corporation caused by increased debt.”[48] Judge Bernstein traced its origin as a theory of recovery to Bloor v. Dansker (In re Investors Funding Corp. of New York Sec. Litig.),[49] a case in which a bankrupt debtor’s insiders embarked on a scheme to loot the corporate debtor by first creating a false picture of the debtor's financial well-being, next using that false financial portrait to induce creditors and shareholders to invest more funds in the company, and then misappropriating a portion of the newly injected funds.[50] To rectify these wrongs, the bankruptcy trustee sued the debtor’s auditors, alleging that the insiders used false financial statements to further their scheme. The auditors denied that the insiders’ wrongful conduct should be imputed to them, and even if it were, the debtor had benefited from the infusion of funds.[51] “In words that begat the theory of ‘deepening insolvency,’ Judge Bernstein rejected the notion that acts that prolong a corporation's existence automatically confer a benefit on the corporation:

[E]ven to the extent one focuses upon the artificial financial picture of [the debtor] created by the [insiders] which prolonged [the debtor’s] existence several years beyond its actual insolvency, [the auditor’s] position is not persuasive. A corporation is not a biological entity for which it can be presumed that any act which extends its existence is beneficial to it. The complaint plainly alleges that, as a result of the [insiders’] practices, [the debtor’s] financial situation was caused to deteriorate even further . . . . Accepting the allegations of the complaint as true, it is manifest that the prolonged artificial solvency of [the debtor] benefitted only the [insiders] and their confederates, not [the debtor].[52]

Consistent with the origins of the theory, “most claims of deepening insolvency are brought against officers, directors, accountants, or others who have a fiduciary duty to the debtor.”[53] Unlike officers, directors, and accountants, creditors, absent special circumstances such as the exercise of actual control,[54] ordinarily owe no fiduciary duty to debtors or other creditors.[55] Even so, some courts have allowed “deepening insolvency” claims to be brought against lenders.[56] But the trend, though not complete or universal,[57] is running against recognizing deepening insolvency as an independent basis for recovery and is instead moving toward drawing on traditional tort and fiduciary principles to determine whether actionable wrongdoing occurred.[58] Before imposing liability for increasing a debtor’s debt load, the courts, “[m]uch like the little old lady in the fast food commercials, . . . look at the bottom of the deepening insolvency hamburger bun and [are] forced to ask ‘where's the tort?’” Judge Hale did not find one in Texas:

The wilful and malicious lending of money is not a tort in Texas and likely will not be recognized as one anytime soon through a theory of deepening insolvency. To maintain a cause of action against a lender under such a theory, the complaint must show that the lender took over control of the operations of the debtor and then breached its fiduciary duties. [59]

3. All promises are equal. But some are more equal than others.

The spate of lender liability suits after the S&L debacle – together with intense lobbying by lenders – prompted more than two-thirds of the states to expand state statute of frauds in a general effort to shield lenders from certain kinds of “liability actions and to promote certainty into credit agreements.”[60] These statutes – along with the metastasizing complexity of supersized, securitized, syndicated, structured, subordinated, subdivided, [sic] mezzmerized financing arrangements – have altered, but not ended, litigation over the effect of oral agreements and oral representations in lending transactions.[61] A concern that these statutes provide insufficient protection from such claims has led to the widespread use of pre-negotiation letters. This concern appears well placed. An inordinate confidence in the efficacy of pre-negotiation letters,[62] however, is not.

a. Keenan v. Donaldson, Lufkin & Jenrette, Inc., 529 F. 3d 569 (5th Cir. (La.) 2008) – Does a typical credit agreement statute of frauds protect a pig from what it says to another pig? Not in Louisiana, if both pigs are lenders.

In 1999, borrower began experiencing cash flow problems, and in June of 2000, borrower’s secured lenders notified borrower that borrower was in technical default under its credit facility. Later that month, an unsecured lender came to the rescue with a £6.6 million unsecured loan to enable borrower to cure the default on its secured credit facility and to provide borrower with additional working capital. Unsecured lender alleged, and the secured lenders in the banking syndicate did not dispute, that unsecured lender made the new unsecured loan in reliance on an oral agreement with representatives of a member of the banking syndicate that if unsecured lender made the new loan, all members of the syndicate would waive the technical default on the secured credit facility, develop a new long-term credit facility, and provide borrower with additional funding. All members of the syndicate waived the default, but some members refused to extend additional credit to borrower. This forced borrower into receivership and liquidation, and while the liquidation provided the members of the banking syndicate with full payment on their secured debt (including interest and penalties), unsecured lender was left about £5.9 million short on its £6.6 million loan. Unsecured lender sued the secured lenders for the pound sterling equivalent ($10 million) in damages, asserting the usual litany of claims against them for promissory estoppel, detrimental reliance, fraud, fraud by omission, negligent misrepresentation, negligent omission, and breach of fiduciary duty.

The district court, citing Louisiana’s statute of frauds covering credit agreements, granted summary judgment in favor of the banking syndicate.[63] The Fifth Circuit Court of Appeals reversed, holding that Louisiana’s Credit Agreement Statute of Frauds “was not intended to apply to [the unsecured lender’s] claims.”[64] The court of appeals, taking guidance from cases construing similar statutes in other states and reading the words of the Louisiana statute in light of the evil the statute sought to address, declined the invitation to use the statute to bar claims for oral agreements among co-lenders. “[T]wo lenders entering an accommodation as to a third-party borrower is beyond the purposes of the statute controlling debtors and creditors.”[65]

b. CMR Mortg. Fund, LLC v. Canpartners Realty Holding Co. (In re CMR Mortg. Fund, LLC), 2009 WL 2870114 (Bankr. N.D. Cal. 2009) – Does a pre-negotiation letter protect a senior creditor pig from liability to a junior creditor pig when the senior pig buys, at foreclosure, all of the slop left in the borrower pig’s trough but does not share any of the slop with the junior pig? Not necessarily.

Senior lender and junior lender loaned $55 million and $42.9 million, respectively, to borrower to develop 161 acres (Property) in Hawaii. Both loans were secured by a single deed of trust in which junior lender subordinated its rights and remedies to senior lender. If borrower defaulted, junior lender did not have the right to foreclose; instead, it had the option either to take title or to buy senior lender’s A-Note. If junior lender did not exercise either option, and senior lender purchased the property at foreclosure, junior lender’s interest in the loan terminated. To give the junior lender time to consider and exercise its options, the Co-Lender Agreement between the senior lender and junior lender gave junior lender a right to extend the loan.

The A-Note came due. Borrower defaulted. Junior lender entered into a Pre-Negotiation Agreement with senior lender and paid senior lender the Extension Fee to extend the loan. In the Pre-Negotiation Agreement, junior lender also waived past and future claims against senior lender, including any claim to the Extension Fee. But junior lender’s waiver specifically excluded any claim that senior lender failed to apply that Fee in accordance with the Loan Documents and the Co-Lender Agreement.[66] Junior lender failed to satisfy the other conditions required to obtain the extension. Junior lender did not take title or buy the A-Note. After months of negotiations between junior and senior lender failed, senior lender foreclosed on borrower’s membership interests and then on the Property, thus terminating junior lender’s interest in the Property. Senior lender did not return the Extension Fee. Out $42 million and the Extension Fee, junior lender sued.

A senior lender has very different interests from a junior lender, and, as a result, a senior lender generally has no obligation to protect a junior lender’s interests, unless that obligation is expressly imposed by contact.[67] The bankruptcy court accordingly dismissed junior lender’s claims for breach of fiduciary duty, breach of contract, and various other torts and offenses against equity. But the bankruptcy court refused to dismiss junior lender’s remaining claim, finding that junior lender had stated a breach-of-contract claim with respect to senior lender's application of the Loan Extension Fee paid by junior lender. The Co-Lender Agreement and Credit Agreement were silent regarding the application of the Extension Fee if the loan was not extended, and the Pre-Negotiation Agreement expressly excluded claims concerning the proper application of the Fee. These agreements, the court found, “were reasonably susceptible to the interpretation that, absent extension of the loan, the fee must be returned to the junior lender.” Based on this finding, the court held that junior lender’s allegation that senior lender breached section 9(a)[68] of the Co-Lender Agreement by fraudulently inducing junior lender to execute the Pre-Negotiation Agreement stated a “plausible claim for relief.”[69]

Whether CMR Mort. Fund vindicates the use of pre-negotiation letters is open to question. The bankruptcy court refused to dismiss junior lender’s claim concerning the proper application of the extension fee. Junior lender based its claim squarely on the terms – albeit missing or ambiguous ones – of the Loan Documents and the Co-Lender Agreement, and this claim just happened to be the only claim expressly excluded from the scope of the release in the Pre-Negotiation Letter. Because the court dismissed junior lender’s other claims on independent grounds, the bankruptcy court did not decide whether senior lender’s alleged fraudulent inducement of the Pre-Negotiation Letter could have revived any otherwise viable claims that junior lender purported to waive in the Pre-Negotiation Letter.

c. BACM 2001-1 San Felipe Road Ltd. P’ship v. Trafalgar, 218 S.W.3d 137, 144 (Tex. App. – Houston [14th Dist.] 2007, pet. denied). If the trial judge won’t shoot a squealing hog in the temple with the statute of frauds or the pre-negotiation letter, appeal. Sometimes it just takes more than one judge to slaughter a really big hog.

Loan servicer notified borrowers that their three non-recourse loans would be put in default unless borrowers made immediate payments. Borrowers did not pay, and master servicer transferred the loans to special servicer, who sent pre-negotiation letters to borrowers. The pre-negotiation letters stated:

The Parties acknowledge and agree that no compromise, consent, release, waiver, or modification agreement or understanding with respect to the Loan or the Loan Documents shall constitute a legally binding agreement or contract or have any force or effect whatsoever unless and until reduced to writing and signed by the authorized representatives of all necessary Parties to any such agreement. The Parties acknowledge and agree that by executing this letter agreement, they are precluded from claiming that any agreement, consent, waiver, release, or modification, oral, express, implied, or otherwise, of the Loan or the Loan Documents, has been effected except in accordance with the terms of this letter. The Parties further acknowledge and agree that no Party is obligated to reach any agreement or to negotiate for the purpose of reaching any agreement with respect to any Borrower request for consent, waiver, release, or modification of the Loan or Loan Documents.

Borrowers’ authorized representative signed the pre-negotiation letters. Defaults, nevertheless, ensued. And the negotiations continued.

Special servicer invited borrowers to propose a solution. Borrowers accepted the invitation, and in a letter, borrowers proposed, as an alternative to foreclosure, taking a 20% discount on the outstanding principal balances, bringing payments current on the discounted balances, paying net operating income for 4 months, and paying off the discounted balances in full at the end of this 4 month period.

Borrowers’ representative testified that special servicer’s representative, in a telephone conversation that took place 1 or 2 days later, agreed to accept the proposal if borrowers made a $250,000 “good faith” payment before face-to-face negotiations scheduled to take place two weeks hence. Special servicer’s representative, not surprisingly, recalled the conversation differently. At the time of the telephone conversation, however, it was undisputed that borrowers had not made any payments in the previous 5 months and that their combined arrearages, including late fees and default interest, totaled $1.98 million.

The next day borrowers sent special servicer a $250,000 cashier’s check under cover of a letter stating: “[w]ith further reference to my letter and proposal . . . , I am enclosing our cashier's check in the amount of $250,000 as was agreed upon during your telephone conference call to us of yesterday . . . . Please apply it to the 3 loans as you deem appropriate.” On the day special servicer received this check, the employee who allegedly made the disputed agreement with borrowers’ representative in the telephone conversation was on vacation. In his absence, a presumably diligent fellow employee promptly deposited the cashier’s check. Special servicer did not promptly attempt to return it. Borrowers cancelled the scheduled face-to-face negotiations.

After special servicer’s representative returned from his ill-timed vacation, special servicer and borrowers exchanged drafts of proposed forbearance agreements. The parties failed to come to terms, and the negotiations quickly broke down. Special servicer thrust a notice of intent to accelerate at borrowers. Borrowers parried with a letter claiming that “a binding agreement was reached with respect to the [discounted] payoff of the existing loans.” Special servicer thrust back with a foreclosure notice on one of the properties. Borrowers parried again with a lawsuit. After reading the suit, special servicer tendered a refund of the $250,000. Borrowers declined the tender. The lawsuit went on.

Though special servicer’s efforts to foreclose abated, Borrowers’ efforts to make better facts and bigger damages did not. Borrower contracted to sell one of the properties, and the buyer sought lender’s consent to assumption of borrower’s still delinquent mortgage. Special servicer disapproved the requested assumption because special servicer disputed the validity of the 20% principal reduction, insisted on payment of the delinquent principal, interest, and late fees as a condition of its approval, and asserted that borrowers’ proposal required borrower to payoff the mortgage in 4 months. That time had come and gone. Apparently taking the point, borrowers supplemented their lawsuit, alleging that special servicer interfered with the sale of the mortgaged property. Borrowers subsequently contracted to sell the other 2 properties, but these sales’ contracts did not require the buyers to assume borrowers’ outstanding loans.

The parties eventually tried the case to the court. The trial court apparently found that borrowers’ proposal letter, together with lenders’ negotiation of the cashier’s check and the terms of borrowers’ cover letter transmitting it, constituted a signed writing sufficient to satisfy Texas’ statute of frauds. The trial court found that master servicer, special servicer, and lender (collectively, “lenders”) breached this new “repayment agreement,” even though borrowers did not honor their part of that agreement. The trial court ordered lenders to pay borrowers $6,640,222 for the lost benefit of the 20% discount; $5,690,011 for lost equity from the prospective sales; more than $280,000 for prejudgment interest; $300,000 for attorneys' fees through trial; and conditional attorneys' fees of $150,000 for the costs of appeal. Lenders appealed.

The court of appeals reversed the trial court and rendered a take nothing judgment in favor of the lenders. The court of appeals apparently assumed, without saying so, that borrowers’ letters, together with special servicer’s endorsement on the check, satisfied the statute’s writing and signing requirements, but it, nevertheless, stated that the statute of frauds barred enforcement of the new repayment agreement because that agreement did not adequately identify the parties to the agreement, the rate of interest, and other essential terms. But the court of appeals then considered whether the repayment agreement, if viewed as a modification of the loan documents instead of a wholly new agreement, satisfied the statute of frauds. It did. The borrowers’ letters, supplemented by the terms in the old loan documents, supplied the missing terms. But in the end, it didn’t matter. Even though the repayment agreement satisfied the statute of frauds, the borrowers could not enforce it because they did not perform their new or modified obligations. The borrowers’ breach, not the statute of frauds or the pre-negotiation letters, saved the lenders from slaughter.

C. Ruminations about Next Time and Never Again

You have a crisis, followed by some kind of reform, for better or worse, and things go well for a while, and then you have another crisis.[70]

Paul Volcker

Hindsight, it is said, is 20-20. If this were true, wouldn’t there be broad agreement about the causes of and cures for the credit crisis and the real estate bubble? But little agreement exists about the causes; [71] even less about the cures. Markets either failed due to insufficient regulation. Or excessive government intrusion (Fannie, Freddie, and Too-Big-To-Fail) distorted efficient markets. The recently enacted financial reform legislation known as, Dodd-Frank Wall Street Reform and Consumer Protection Act, either ends too big too fail or enshrines it as national policy. For the moment, the storyline of market failures needing more regulation informs the ruling narrative. But Sen. Dodd, with a proud pappa’s tears in his eyes, uttered something inadvertently truthful about the legislation he fathered with Barney Frank: “No one will know until this is actually in place how it works.”[72] Or, whether it will.

Part II.

Should You Go to the Workout Rodeo?

When a project is headed South and it is apparent to both lender and borrower that the loan obligations will not be met as originally intended, what can or should a lender and borrower do? Because relationships between lenders and borrowers go beyond the instant transaction, both parties often have substantial interest in preserving good will and the opportunity to do business together again when there is an improved market or a better project. Settling the parties’ conflicts short of litigation creates value to both parties and is perceived as a better outcome than prevailing after the enforcement of remedies or litigation. These motivations can drive parties to make new contracts and give new promises to work out the problem. Workouts can take the form of forbearance agreements, deeds in lieu of foreclosure, and short sales. In light of the current large number of commercial real estate mortgages defaults and recent court decisions[73], this paper will explore afresh some considerations of short sales, deeds in lieu of foreclosure, forbearances, and receiverships.

It is not new that there are several valid business reasons for lenders and borrowers to compromise and reach agreement. Both parties can steer clear of negative exposure from public proceedings and the lengthy time and cost to enforce and fight remedies through a judicial or quasi-judicial process. Lenders can avoid issues with defects in loan documents, assignments,[74] and notices. Lenders also can sidestep having to defend against bad faith, breach of contract, breach of fiduciary duty, and other claims borrowers raise when fighting enforcement. These agreements allow the parties to settle the dispute independent of a bankruptcy trustee or judge imposing an equitable remedy and to dodge otherwise the uncertainties of a third-party decision maker. Lenders also can view forbearances and short-sales as a means to avoid being an owner of the property with its attendant unknown liabilities. Resolving defaults through agreement may also permit lenders to realize more immediately on the collateral (albeit such realization will not be in full repayment of the debt). Further, if ownership is considered a desirable remedy, deeds-in-lieu are an orderly way for both parties to plan for the lender’s takeover of ownership.

If a lender and borrower are to undertake the workout process, they must believe that they will achieve a better result in the end by entering into a new agreement instead of resorting to their original agreement. For a lender, it must be able to say it achieved more than it would with foreclosure, taking into account any ability to obtain and enforce a deficiency after a foreclosure. The lender must also be able to ensure that no new lender liability was created, including claims by the borrower of lender bad faith, and waiver. It is key that a lender conduct adequate due diligence to protect itself from moving from a bad situation to a worse situation. The lender will not want to help the borrower create a war chest to later sue the lender based on lender’s willingness to consider a workout or the resulting workout documents. A lender should preserve and maintain its rights as a creditor while working not to impede (if not facilitate) some payment on the loan.[75] A borrower likewise will only want to pursue a workout process if the borrower does not create additional liability to its investors or waive defenses it might otherwise have had if the workout fails. With a workout, borrowers and guarantors can obtain a complete and certain release from liability under non-recourse carve-outs loan provisions and guarantees. If the borrower is not able to pay taxes and guarantors are unwilling to fund these expenses, a workout can help avoid a non-recourse loan turning into personal liability.[76] If, as is likely, the lender will not terminate environmental indemnity obligations of the borrower and guarantors, they can rely on consultant reports and their knowledge that the borrower’s activities did not violate environmental laws. Removing the recourse and guaranty liabilities can improve the credit worthiness of the guarantors. Forestalling enforcement of this debt or a bankruptcy may help avoid disruptions to business operations and other transactions and may prevent claims from third parties on other debt obligations. All parties should operate on the assumption that whatever is said and done will be discovered if there is ensuing litigation and that privilege will not offer broad protection. While the end result of a workout may be better than under the original agreement, all parties should recognize that you cannot make a silk purse out of a pig’s ear.

A. Does a Short Sale Unravel the Lasso Around the Debtor’s Neck?

The short sale is a round-up. The goal of a short sale is to attract new money from a third party buyer to pay the lender and other creditors such that the borrower is freed of all obligations and the lender’s bad debt is reduced. With so many distressed property acquisition funds being formed[77], there is a perception that short sale buyers are lined up at the gate. Adding to the lender’s incentive of being paid back some of the debt, the borrower entity often is motivated by being able to dissolve and the disappointed investors by being able to part ways free of insider claims and claims of other creditors. The lender should be cautious not to move from a protected insulated lender role to a potential fiduciary role at a time when the relationship has already been strained and the involved parties have conflicts in interests. The borrower can claim that the lender has a fiduciary relationship to the borrower/short sale seller if the lender gives advice on how to structure and manage the transaction and if it is perceived that the lender is working with the borrower towards a mutual goal. The borrower can claim fraud or negligent misrepresentation if the lender makes a statement of its intent to accept a lower pay-off amount if there is a short sale, knowing the borrower will rely on these statements to proceed to contract with the short sale buyer. Other parties can make claims against the lender: vendors who are told they will be paid off at closing[78] and the short sale buyer relying that the sale will be made and the lender’s lien released. Both the borrower and the short sale buyer can claim that the lender tortiously interfered with the contract or the prospective contract. If a short sale succeeds, everyone wins by losing less. If a short sale falls apart, both the lender and the borrower, without care, may be exposed to liability from the failed transaction or possible waiver or amendment of prior rights.

Given the additional cost and time spent to attempt a short sale, it is important that all stakeholders make a commitment, even if contingent, to the process. If there are multiple participating lenders, it is often difficult to get a consensus from the lender position. The more parties there are, the more herding is necessary to corral all the hungry animals. If the borrower has multiple members and partners, consents from all these parties may be necessary.[79] And since there are always limited funds and not enough to satisfy the loan, the feed must be meted out to the parties in a way that avoids a stampede.

A frequent question from all parties is “Why am I doing this?” It is difficult to keep in mind the potential advantages to be gained. Where there are multiple investors in the borrower, only some of whom are guarantors, it is important that all parties have full disclosure and consent to the short sale transaction. Depending on whether there is insulation from liability for investors, there may be negligible risk from a short sale absent facts that might allow for a piercing of the corporate veil.[80]

Because of the additional contracts and new conduct in connection with a short-sale, it is important that the parties obtain full mutual releases covering all conduct. The entity that takes the lead negotiating role in the short sale can be the target of a breach of fiduciary duty claim. If the release does not completely cover all areas of potential liability and all time periods, the conduct of the various parties can create a fiduciary duty where one did not exist previously and generate claims for a breach of this newly imposed duty.

The objective of the borrower and its investors is to make sure that all known creditors are identified and paid in full or payment claims are settled for a reduced amount. Third parties can have claims for expenses, and it may be difficult to get a full and complete accounting from the borrower parties. Some of these claims can relate to prior years and survive the closing, thereby subjecting the borrower and possibly the third-party buyer to liability. For example, taxing authorities can have the legal authority to retroactively evaluate past due property and transfer taxes and encumber the land with liens to secure any past due amounts.[81]

In a workout, the managing member or partner of the borrower may be asked to represent and certify a list of known claims from other creditors. The members or partners of the borrower may want to exclude this representation from any mutual release given between them to have protection if this certification is later found to be incomplete. If expenses cannot be identified and paid, it may be advisable for the parties to reserve for future unknown or disputed claims. However, if the reserve is an escrow, it may be considered a part of the borrower’s estate and be a target for claims by other creditors.[82] The parties will be better served if the documents clearly describe the terms of when the escrow is released to creditors, lender, or the borrower.

Often the goal of the borrower and guarantors is to be free of debt obligations (selling the animals at auction and shutting down the farm). To accomplish this, after the short sale is completed, the borrower will want to dissolve and be free of further liability. The short sale should be planned to ensure that dissolution requirements of the applicable jurisdiction are satisfied. In order to dissolve, the borrower will have to ascertain who its known creditors are. It may not be that easy to determine the identity of all known creditors and determine that the full amount of the debt has been paid. Some states require that known creditors be given notice of the pending dissolution.[83] If a borrower is able to pay known creditors and give its members and partners some degree of confidence that payment has been made, there is still the issue of unknown creditors. In some states, if the claimants are not known or if they cannot be found after reasonable diligence, the statute requires the dissolving entity to deposit funds with a designated governmental entity.[84] Further, applicable law may provide that an existing claim against a dissolved entity is extinguished after the expiration of a stated time period.[85] Even if the entity is dissolved it is not free of exposure from claims of fraudulent or preference transfers brought within the applicable statutes of limitations.[86]

Before a short sale, operating revenue is often insufficient or non-existent. Parties may be tempted not to put everything in the workout trough. If refunds, escrows, security deposits, or miscellaneous income is retained by any borrower parties without disclosure and consent by the lender, there likely will be claim of breach of loan covenants. In the Blue Hills case,[87] a $2,000,000 settlement payment in connection with a rezoning of a neighboring property was paid to an attorney trust account and then disbursed to guarantor insiders, bypassing borrower’s accounts. This payment without notice to and consent by the lender created a loan default on the $33,149,000 loan and was used as the basis to lock large cash management accounts. Borrower requested to meet with the special servicer, and the asset manager at the time responded it would meet to discuss the status of the loan. The person acting as asset manager changed and there never was a meeting. The borrower claimed that the lender had frustrated its legitimate aims and that the lender had breached a covenant of good faith and fair dealing. The court dismissed these claims stating that the lender did not use its contractual rights as leverage to obtain an advantage to which the lender was not entitled to under the loan documents.[88] The receipt of the settlement payment by the insider-guarantors created a cascading effect where the loan was accelerated, the property was foreclosed, and the guarantors were found liable under the nonrecourse carve-outs for a deficiency of over $10,000,000.[89]

Entering into a short sale and other workout documents may create a claim by a borrower that the lender and the borrower entered into a venture. The fact that there is no written joint venture document may not be dispositive of such claims. In Colorado as an example, a venture can be deemed to have occurred if there is an express or implied agreement to share profits and losses, there is a joint interest in the property and there are actions and conduct showing cooperation.[90] When the lender and borrower divvy up the short sale proceeds or agree in a forbearance agreement to allow money from the property to be used for expenses instead of for debt payments, there can be facts sufficient to claim a sharing of profits and losses. Lenders generally obtain an assignment of leases, and this interest has been alleged by at least one litigant in an unreported case as proof the lender had an interest in the collateral and alleged the collateral was joint venture property. The workout effort itself can be viewed as evidence of cooperation.

Does a Deed-In-Lieu Leave You Hog Tied?

Deeds-in-lieu are seen as a means of allowing a lender to gain title to the property more quickly. This is true especially in states that have judicial foreclose. While the negotiation of a deed-in-lieu may take months instead of years, much needs to be accomplished and the advantage of speed can be outweighed by unexpected claims and liabilities. A better practice is for the borrower to be the one to suggest a deed-in-lieu. If the borrower makes the request, there is less risk to the lender if the lender later determines it does not want to accept a deed-in-lieu. The borrower cannot argue as easily that the lender made an offer to the borrower that the borrower can accept or that the loan documents are amended expressly to permit the borrower to deed the property to the lender. If a pre-workout letter has been signed (See Attachment B), then both parties are protected from unintended offers, amendments, or waivers of rights. Because the deed-in lieu is viewed as a settlement of the dispute, lenders also will want the borrower to waive any redemption rights. Absent these and other protections, the lender may think it has received fee title but instead the lender may only have an equitable mortgage.[91]

In most cases, the lender will want to keep its mortgage on record. The lender should not release the debt regardless of the fact the lender likely will release the guarantors for personal liability under any guaranty and the borrower for any carve-outs to nonrecourse liability. This practice allows the lender the option of foreclosing later to rid the property of claims by junior creditors or, at a minimum, creates leverage to negotiate with them. Having a different lender controlled entity take title under the deed-in-lieu than the lender entity in the mortgage and writing clear language to evidence the intent to retain the mortgage will help prevent legal title of the deed merging with the interest of the mortgagee in the mortgage. Additionally, in states with transfer taxes, it is essential to keep the mortgage in place to avoid paying applicable transfer tax in connection with the conveyance of the deed.[92]

In accepting a deed-in-lieu, the lender and non-managing members and partners should understand they will not have security for future claims,[93] and the lender will not have recourse to the borrower and any guarantors. With a deed-in-lieu, there is no one to back up warranties in the deed or any certificate or estoppel obtained from the borrower, and it will be difficult later for the lender or non-managing members and partners to prove or collect on a fraud claim. For this reason, the lender should consider obtaining estoppels from tenants, vendors and easement parties and obtaining springing recourse against the borrower or guarantors. In addition, the lender should demand an assignment of warranties. If construction has taken place in the last few years, the lender should require an assignment of underlying construction contracts so that the lender may be able to fully stand in the shoes of the borrower and obtain the rights the borrower may have to bring future claims for property condition defects.

Although one advantage to a deed-in-lieu is that the lender can exert control over the property sooner and avoid potential lender liability for lender involvement that may occur when the borrower remains in title, the lender may be thrown into ownership unprepared. The property may be an untamed hog. Existing tenants may have tried to operate in a poorly managed property and may have offsets for the borrower’s failure to perform. Taking title under a deed-in-lieu can confuse tenants about the lender’s role, and tenants may have less sympathy if they view the lender as simply a new owner who took title to the property at a discount. Because the mortgage is being held open, tenants may request SNDAs that can be awkward for a lender who is both fee owner and mortgagee.

Lenders have to consider the possibility of defending a deed-in-lieu as a fraudulent transfer or preference.[94] Accordingly, it is important for a lender to obtain a solvency affidavit and perform sufficient due diligence to be satisfied the affidavit is true.[95] There must be consideration for a deed-in-lieu, new value given to the borrower that is not based on the antecedent debt.[96] As a proof matter, it is therefore important to identify the new value and recite the value in the deed-in-lieu instrument. There may be problems inherent in existing leases, with past and future expense reconciliations, brokerage claims, and “leakage” in the landlord recovering costs of operating expenses. Even if such problems are uncovered prior to accepting the deed-in-lieu, there may not be any money forthcoming from the borrower to cure these issues. A borrower is more likely to give a deed-in-lieu where there is little equity left in the project. After the borrower has decided to give the keys back, there is little incentive for the property to be managed well and on-going leasing activities can be interrupted. The lender can be forced to beg if the borrower can hold out for more concessions on the threat of a wrongful foreclosure action or other lender liability claims.

Lenders may not be in the position to know complete information about the property and the borrower’s operation. However, recent case law has imposed on lenders a duty to investigate matters further if there is information they know that would induce a reasonable person to pursue further due diligence.[97] Further, lenders are required to meet their own underwriting standards,[98] and if a lender’s due diligence indicates insolvency, a court has held its lien can be avoided as a fraudulent transfer.[99] Even in a market where values have plummeted, the lender still needs to be confident of its appraisal.[100] Where a lender seeks to enforce its right to foreclose, obtain a receiver or take other enforcement actions, the disparity between the debt and the value of the property is a factor in the court’s decision on a fraudulent transfer claim.[101]

Does Leaning on the Forbearance Fence Cause a Collapse?

Often lenders and borrowers believe more time will fix the problem. A forbearance agreement can allow more time, but frequently the obligations and liabilities remain a moving target and do not in actuality standstill as the parties continue to interact. The conduct of the parties can give rise to claims of lender liability and bad faith. Admissions of default may not overcome claims that the lender interfered with the borrower’s attempt to refinance. The release delivered in connection with a forbearance may cover conduct up to the date of the forbearance, but it may not protect on a going forward basis unless the release is refreshed. The mechanism to refresh may simply be to require a monthly reaffirmation of the release in exchange for continuing forbearance or if a borrower or guarantor brings a lender liability claim, to have the release of them be automatically revoked. No matter how much time has been given, a borrower always will be reluctant to give up its property and its hog-heaven dream. Having a deed-in-lieu executed and automatically released from escrow upon the expiration of the forbearance period may expedite the lender gaining possession of the property, but it may not answer issues that require performance by the borrower.

Does the Receiver-Sheriff Help?

In some instances, a lender will want more time to decide its workout options but is concerned that the collateral will deteriorate, or the lender may think that with some expenditures the value of the collateral could increase. The lender may view the appointment of a receiver as a way to take action without incurring lender liability for any perceived control of the collateral by the lender if these actions were taken outside of a receivership. The lender should take into consideration that the lender will not be in a position to approve or direct the acts of the receiver. A lender may prefer a receiver over bankruptcy, but having a receiver does not preclude the borrower from filing bankruptcy.[102] Even if the loan documents expressly permit seeking a receiver, appointment is not certain, and the court has broad discretionary power to weigh the harm to the lender who is denied appointment against the injury to the borrower if appointment is granted. While appointing a receiver is an extraordinary equitable remedy, there is no precise formula for determining when a receiver may be appointed. In the Canada Life case,[103] the Ninth Circuit considered, among a host of other factors, that the borrower had concealed a material fact about whether tenants would renew their leases at reduced rental rates or would renew at all. The court also considered the fact that taxes were not being paid and that expert testimony stated that the value of the property was less than the debt (almost on par, valued at $170,000 less than the debt). Other courts have looked at whether there was a risk of fraud and whether adequate restraints were already in place.[104] The receiver is an officer of the court and is paid fees. The question is whether a receivership is a cost-effective and efficient process to protect, operate, and maximize the value of the asset.

Courts do distinguish between a receiver who will collect rents pending a foreclosure versus one who will have additional powers to manage the property. There are several questions a lender must ask itself to determine if there is added value to the collateral in appointing a receiver. Is the need for the receivership to have a safe holding period prior to foreclosure or is it a place to maximize the value of the property? Is the lender willing to fund up-front costs needed to capture this value? Are there sales of the collateral the receiver could execute that will be missed if there is a delay? Are there other liens on the collateral that could be transferred by the receiver to the proceeds of a sale? Would this transfer of other liens facilitate the sale, help fund money needed to preserve and enhance the remaining property, and speed the liquidation of the collateral? Will the receiver quickly be able to evaluate the property’s needs and be nimble enough to work through the bureaucracy? Will seeking the appointment of a receiver avoid a fight with the borrower or just create another place and earlier time to fight?

Conclusion: With Foresight Can There Be a Celebration If Not a Hoedown?

Lenders and borrowers are subject still to traditional causes of action and legal theories when loans go bad, and the best advice is to underwrite loan transactions well in the first place. Case law shows that lenders are exposed to claims if their underwriting does not independently verify information from borrowers. If it doesn’t make sense and it’s too good to be true, reliance on representations may not be reasonable. In such cases, even whether the parties are operating at arm’s length can be questioned. Further, the use of experts will not protect lenders or borrowers if they are not qualified, are perceived to have conflicts of interest, and do not use generally accepted methods to arrive at their opinions.

Workouts can be an advantage over court ordered settlements for the lender, the borrower, and the guarantors. However, a bad loan can make an even worse workout if there is lack of information, honesty and cooperation. A hasty or greedy workout in the end can create greater liability and loss.[105] Because relationships between lenders and borrowers go beyond the instant transaction, both parties often have substantial interest in preserving good will and the opportunity to do business together again when there is an improved market or a better project. When workouts are successful no one may want to dance at the hoedown, but there still can be cause for celebration. Unfortunately, the only way totally to avoid all snares in the contemporary commercial real estate market is to follow the advice of old Polonius:

“Neither a borrower nor a lender be.

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry.”

- Hamlet Act 1, Scene 3, 75-77

.

Attachment A

| |BACM 2001-1 San Felipe Road Ltd. P’ship v. Trafalgar Holdings I, Ltd., 218 S.W.3d 137 (Tex. App. – Houston [14th Dist.] 2007, pet. |

| |denied). |

| |Bank of Am. Prestance Corp., 160 P.3d 17 (Wash. 2006). |

| |Blue Hills Office Park LLC v. J. P. Morgan Chase Bank, 477 F. Supp. 2d 366 (D. Mass. 2007). |

| |Canada Life Assurance Co. v. LaPeter, 563 F.3d 837 (9th Cir. 2009). |

| |CapitalSource Fin. LLC v. Blaichman, No. 09-CIV-3283 (LTS), 2010 WL 764300, (S.D.N.Y., Mar. 05, 2010). |

| |CMR Mortg. Fund, LLZC v. Canpartners Realty Holding Co. (In re CMR Mortg. Fund, LLC), 2009 WL 2870114 (Bankr. N.D. Cal. 2009). |

| |CSFB 2001-CP-4 Princeton Park Corpo-Rate Ctr., LLC v. SB Rental I, LLC, 980 A.2d 1 (N.J. 2009). |

| |DDJ Mgmt., LLC v. Rhone Grp. LLC, ___ N.E.2d ___, 2010 WL 2516811 (N.Y., June 24, 2010). |

| |111 Debt Acquisition LLC v. Six Ventures, Ltd., 2009 WL 414181, (S.D. Ohio 2009). |

| |Farmers Bank and Trust v. Wilmott Hardwoods, Inc., 171 S.W.3d 4 (Ky. 2005). |

| |FDIC v. Prince George Corp., 58 F.3d 1041 (4th Cir. 1995). |

| |First Nationwide Bank v. Brookhaven Realty Assoc., 223 A.2d 618 (N.Y. App. 1996). |

| |Fleming Irr., Inc. v. Pioneer Bank & Trust, 661 So. 2d 1035 (La. Ct. App. 2d Cir. 1995), writ denied, 664 So. 2d 427 (La. 1995). |

| |Garcia v. World Sav., FSB, 183 Cal. App. 4th 1031 (2010). |

| |Greenwich Capital Fin. Prod., Inc. v. Negrin, No. 2946,600462/08, 2010 WL 2161807 (N.Y. App. Div. June 01, 2010). |

| |Headwaters Constr. Co. v. National City Mortg. Co., ___ F. Supp.2d ___, No. CV09-119-E-EJL-REB, 2010 WL 744287 (D. Id., Feb. 26, |

| |2010). |

| |Hotel 71 Mezz Lender LLC v. Falor, 869 N.Y.S.2d 61 (N.Y. 2008). |

| |Jones v. Wells Fargo Home Mortg. (In re Jones), No. 03-16518, 2007 Bankr. LEXIS 2984 (Bankr. E.D. La. Aug. 29, 2007). |

| |Keenan v. Donaldson, Lufkin & Jenrette, Inc., 529 F.3d 569 (5th Cir. 2008). |

| |Lehman Bros. Holdings Inc. ex rel. LH 1440 v. Lehman Commer. Paper, 416 B.R. 392 (Bankr. S.D.N.Y. 2009). |

| |In re Louis A. Gencarelli, Sr., 501 F.3d 1 (1st Cir. 2007). |

| |Meecorp Capital Mkt. LLC v. Tex-Wave Indus., 265 F. App’x 155 (5th Cir. 2008). |

| |Mercantile-Safe Deposit and Trust Co. v. Chicago Title Ins. Co., Civil No. CCB-05-22217, 2007 U.S. Dist. LEXIS 23685 (D. Md. March |

| |20, 2007). |

| |Norwest Bank Lakewood, Nat’l Ass’n v. GCC P’ship, 886 P.2d 299 (Colo. Ct. App. 1994). |

| |R&G Props., Inc. v. Column Fin., Inc., 968 A.2d 286 (Vt. 2008). |

| |River E. Plaza, LLC v. Variable Annuity Life Ins. Co., 498 F.3d 718 (7th Cir. 2007). |

| |Santa Rosa KM Assocs., Ltd., P.C. v. Principal Life Ins. Co., 206 P3d 40 (Kan. Ct. App. 2009). |

| |In re Si Restructuring Inc., 532 F.3d 355 (5th Cir. 2008). |

| |Sundance Apartments I, Inc. v. General Elec. Capital Co., 581 F. Supp. 2d 1215 (S.D. Fla. 2008). |

| |Teachers Ins. and Annuity Ass’n of Am. v. Criimi Mae Servs. Ltd. P’ship, 681 F. Supp.2d 501 (S.D.N.Y. 2010). |

| |Tousa ex rel. Official Comm. of Unsecured Creditors v. Citicorp N. Am., 422 B.R. 783 (S.D. Fla. 2009). |

| |UIP Ltd., v. Lincoln Nat’l Life Ins. Co., No. CV09-0006-PHX-NVW, 2009 WL 4497233 (D. Ariz. Nov. 30, 2009). |

| |Univex Intern., Inc. v. Orix Credit Alliance, Inc., 914 P.2d 1355 (Colo. 1996). |

| |Official Comm. of Unsecured Creditors of VarTec Telecom, Inc. v. Rural Tele. Fin. Coop. (In re VarTec Telecom, Inc.), 335 B.R. 631 |

| |(Bankr. N.D. Tex. 2005). |

| |Wells Fargo Bank, N.A. v. LaSalle Bank Nat’l Assoc., 643 F. Supp. 2d 1014 (S.D. Ohio 2009). |

| |Credit Suisse v. Official Comm. of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Case No. 08-615061570-11, Adv. |

| |09-00014 (Partial & Interim Yellowstone Order) (Bankr. D. Mont., May 13, 2009) (Docket No. 289) (Bankr. D. Mont. May 12, 2009), |

| |vacated, Credit Suisse, Cayman Islands Branch v. Official Comm. of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Ch. |

| |11 Case No. 08-61570-11, Adv. No. 09-00014, consolidated with, Adv. No. 09-00017 (Docket No. 299) (Bankr. D. Mont. June 29, 2009) |

| |(order vacating Dkt. No. 289); see also Credit Suisse v. Official Comm. of Unsecured Creditors (In re Yellowstone Mountain Club, |

| |LLC), 415 B.R. 769 (Bankr. D. Mont. June 11, 2009) (Memorandum Decision and Order on fraudulent transfer and breach of fiduciary |

| |duty claims against Blixseth). |

Attachment B

This letter is written in connection with the Loan (as defined above). Lender, Borrower, and Guarantors (collectively, the “Parties”) have agreed to discuss the Loan, notwithstanding current defaults by Borrower, only on the condition that any negotiations and discussions both before the date of this letter and afterwards, will be governed by this letter. It is expected that the discussions may be lengthy and complex. While the Parties may reach agreement on one or more issues, none of the Parties shall be bound by any agreement on any such issue or issues until agreement is reached on all issues, and the Parties and other parties deemed necessary by Lender to approve, authorize and consent to such as agreement, have signed and delivered a written agreement on all issues (“New Agreements”). The Parties may only amend this letter by a written amendment signed by all signatories.

This letter shall not be an agreement by the Parties to participate in discussions or to continue to participate in such discussions. A Party may elect to participate in, continue, or terminate any discussions or negotiations at any time now or in the future, and such election may be made independently and in its or their sole or absolute discretion, and without incurring any liability to any other Party. This letter is not, and each Party affirms it is its intent that this letter shall not be construed to be, a "contract or agreement to negotiate," an "agreement to agree," a "letter of intent," or any similar agreement or contract requiring the Parties to engage or to attempt to engage in discussions or negotiations. It is the express intention of the Parties that no covenant of good faith and fair dealing, express or implied, shall require or be deemed to require any of them to participate in discussions or negotiations if a Party elects to discontinue such discussions or negotiations for any reason whatsoever. This letter is solely to set forth terms that will govern in the event the Parties commence or continue discussions and negotiations. Until any such termination, this letter will apply to any and all discussions and negotiations, and communications between the Parties in whatever form of transmission made, including but not limited to, written, electronic, and telephonic. In the event of a New Agreement, this letter shall terminate automatically and the obligations and rights of the Parties shall be governed by the New Agreement.

The Parties acknowledge that any discussions and negotiations may not produce any written agreement relating to the Loan. Accordingly, none of the Parties hereby waive any of their rights and remedies under the Loan Documents. Borrowers and Guarantors should evaluate, consider and not by pass any alternative opportunities that might arise during such discussions and negotiations. All payments with respect to the Loan must be made in strict accordance with and subject to the Loan Documents, except as they may be modified by a New Agreement.

This letter constitutes the Parties’ entire agreement concerning its subject matter and supersedes any prior or contemporaneous representations agreements not continued herein concerning the subject matter of this. [Conform this paragraph to applicable law requirements]

This letter shall inure to the benefit of and be binding upon the Parties hereto and their respective predecessors, successors, assigns, parents, subsidiaries, affiliated corporations, divisions, trustees, directors, officers, owners, partners, members, managers, shareholders, agents, attorneys, insurers, employees, spouses, heirs and contractors, past, present and future and the absence of any signatures called for below shall not negate this letter or the benefits to and the binding effect on the Parties signing below. This letter shall be governed by _____ law without reliance to conflicts of law provisions. This letter may be executed in one or more counterparts. Each signatory of this letter represents that he or she has the authority and legal power to bind himself, herself or the entity on behalf of which he or she is signing.

Notwithstanding (a) any other provisions of this letter, (b) any discussions, negotiations or other action Lender enters into or takes that is or are governed by this letter, and (c) any claim of any Party to the contrary, none of Lender, Borrower or any Guarantor has waived, and do not waive, their respective rights to enforce any of the Loan Documents, nor has Lender, Borrower or any Guarantor agreed, and they do not agree, to any modifications of any of the Loan Documents. The Loan Documents remain in full force and effect unless and until modified by a new Agreement. This letter is not and shall not be construed as an Agreement to forbear by Lender and, absent an express, separate written agreement to the contrary duly authorized, signed and delivered by Lender, Lender expressly reserves all of its rights and remedies under the Loan Documents arising on account of any existing defaults and any future defaults under the Loan Documents at law or in equity, including, without limitation, the right to initiate or continue foreclosure or other proceedings for the enforcement of any security held by Lender whether or not any discussions or negotiations are taking place or are continuing. This letter does not establish a custom or course of dealing. This letter is not intended to be a complete list of any defaults that may currently exist under the Loan Documents. This letter shall not be construed or have the effect of curing, waiving, or releasing Borrower or Guarantors from any existing or any future defaults under the Loan Documents. Borrower, Guarantor, and any other non-Lender signatory to this letter agree that no course of dealing or course of conduct claim is or shall be supported by any action or actions taken or not taken by Lender during the course of discussions and negotiations, and Borrower, Guarantor, and any other non-Lender signatory to this letter release Lender and Lender’s predecessors, successors, assigns, and their parents, subsidiaries, affiliated corporations, divisions, trustees, directors, officers, owners, partners, members, managers, shareholders, agents, attorneys, insurers, employees, spouses, heirs and contractors, past, present and future from any such claims that may now or hereafter exist, whether or not known to Borrower and such other non-Lender signatories.

The Parties agree that all conduct and communications of any nature whatsoever (whether verbal or nonverbal, or express or implied) of any signatory below in connection with the discussions and negotiations contemplated by this letter or in any meetings or correspondence relating to the possibility of the Loan Documents shall constitute settlement communications and are inadmissible for any purpose whatsoever in any judicial or similar proceeding pursuant to Rule 408 of the Federal Rules of Civil Procedure and its state and foreign counterparts.  To the extent any such conduct or communications are held not to constitute settlement communications, the parties agree that such conduct and communications are still not admissible for any purpose whatsoever in any judicial or similar proceeding. 

-----------------------

[1] Thomas M. Whelan, shareholder, McGuire, Craddock & Strother, P.C., is the author of Part I of this paper, and Jane Snoddy Smith, partner, Fulbright & Jaworski L.L.P., is the author of Part II of this paper.

[2] Swine root with their snouts, using their sense of smell, not sight, to find food. The aphorism is not a fatalistic commentary on blind luck; instead, it is an admonition to dig deeper and follow your nose, not your eyes, because appearances can be deceiving. Or, as Machiavelli says in The Prince, “[e]veryone sees what you seem to be, but few touch what you are, and those few will dare not oppose themselves to the opinions of the many . . . .” Niccollo Machiavelli, The Prince Ch. XVIII (Leo Paul S. de Alvarez trans., University of Dallas Press (1980)).

[3] Credit Suisse v. Official Comm. of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Case No. 08-61570-11, Adv. 09-00014 (Partial & Interim Yellowstone Order) (Bankr. D. Mont., May 13, 2009) (Docket No. 289) (Bankr. D. Mont. May 12, 2009), vacated, Credit Suisse, Cayman Islands Branch v. Official Comm. Of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Ch. 11 Case No. 08-61570-11, Adv. No. 09-00014, consolidated with, Adv. No. 09-00017 (Docket No. 299) (Bankr. D. Mont. June 29, 2009) (order vacating Dkt. No. 289) (hereinafter, “In re Yellowstone”); see also Credit Suisse v. Official Comm. of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), 415 B.R. 769 (Bankr. D. Mont. June 11, 2009) (Memorandum Decision and Order on fraudulent transfer and breach of fiduciary duty claims against Blixseth).

[4] D. Faten Sabry and Dr, Chudozie Okongwu, How Did We Get Here? The Story of the Credit Crisis, Journal of Structured Fin. (Spring 2009) (reprinted and available at Nera Publications (February 19, 2009) at ); Dr. Elaine Buckberg, et al, Subprime and Synthetic CDOs: Structure, Risk, and Valuation, NERA Publications (June 3, 2010) (available at ); Dr. Elaine Buckberg and Dr. John Montgomery, The Fed’s Expanding Playbook: Economists’ Views, NERA Publications (December 22, 2008) (available at ) (noting that the Fed and US Government had provided funding commitments totaling $3.2 trillion, or 23% of 2007 GDP).

[5] Compare Report of the ACREL Working Group on Ethics and Professionalism (September 27, 2004) (quoting definition of professionalism in ABA Professionalism Committee Rep., Teaching and Learning Professionalism 6 (1996) (“A professional lawyer is an expert in law pursuing a learned art in service to clients and in the spirit of public service; and engaging in these pursuits as part of a common calling to promote justice and public good[]”) with Jonathan Swift, Gulliver’s Travels Ch. V (ebook #829 (2009)) (“Here my master [a Houyhnhnm], said [to Gulliver], ‘it was a pity, that creatures endowed with such prodigious abilities of mind, as these lawyers . . . must certainly be, were not rather encouraged to be instructors of others in wisdom and knowledge.’ In answer to which I assured his honour, ‘that in all points out of their own trade, they were usually the most ignorant and stupid generation among us, the most despicable in common conversation, avowed enemies to all knowledge and learning, and equally disposed to pervert the general reason of mankind in every other subject of discourse as in that of their own profession.’”).

[6] Ambrose Bierce.

[7] See supra note 3 and discussion of Partial and Interim Yellowstone Order in Part I infra at notes 10 – 24 and accompanying text.

[8] George Santayana, The Life of Reason, Volume 1 (1905).

[9] See John C. Murray, Equitable Subordination in Bankruptcy: An Analysis of In re Yellowstone (2010) (available at ); Baxter Dunaway, The Law of Distressed Real Estate Ch. 24 (updating and expanding John C. Murray, The Lender’s Guide to Single Asset Bankruptcy, 31 Real Prop. & Tr. J. (Fall 1996)).

[10] In re Kreisler, 546 F.3d 863, 866 (7th Cir. 2008); see also First Alliance Mortg. Co. v Lehman Commercial Paper, Inc. (In re First Alliance Mortg. Co.), 471 F.3d 977, 1006 (9th Cir. 2006) (holding that “the level of pleading and proof is elevated; gross and egregious conduct will be required before a court [can] equitably subordinate a claim” of a non-insider or non-fiduciary); Benjamin v. Diamond (In re Mobile Steel Co.), 563 F.2d 692, 699, fn. 10 (5th Cir. 1977) (citing Dairy Queen, Inc. v. Wood, 369 U.S. 469, 478 (1962); Beacon Indus., Inc. v. Westover, 359 U.S. 500, 506-10 (1959); and 1 S. Symons, Pomeroy on Equity Jurisprudence § 217, at p. 367 (5th ed. 1941) for proposition that “disallowance of wrongdoer’s claim on non-statutory grounds would be an inappropriate form of equitable relief”)); see also Bostian v. Schapiro (In re Kansas City Journal-Post Co.), 144 F.2d 791, 803-04 (8th Cir. 1944) (stating “[t]he inequity which will entitle a bankruptcy court to regulate the distribution to a creditor, by subordination or other equitable means, need not therefore be specifically related to the creditor's claim, either in its origin or in its acquisition, but it may equally arise out of any unfair act on the part of the creditor, which affects the bankruptcy results to other creditors and so makes it inequitable that he should assert a parity with them in the distribution of the estate[.]”). See generally Murray, Equitable Subordination in Bankruptcy, supra at note 9; Dunaway, The Law of Distressed Real Estate Ch. 24, supra at note 9.

[11] In re Kreisler, 546 F.3d at 866; Waslow v. MNC Commercial Corp. (In re Paolella & Sons, Inc.), 161 B.R.107, 119 (Bankr. E.D. Pa. 1993) (noting that equitable subordination is seldom used in a noninsider, non-fiduciary scenario).

[12] In re Paolella & Sons, Inc., 161 B.R. at 119.

[13] See In re First Alliance Mortg. Co., 471 F.3d at 1006 (9th Cir. 2006); Feder v. Lazar (In re Lazar), 83 F.3d 306, 309 (9th Cir.1996) (citing In re Mobile Steel Co., 563 F.2d at 699-700).

[14] “Cain rose up against his brother Abel and slew him. And the Lord said unto Cain: ‘Where is Abel thy brother?’ And he said, ‘I know not: Am I my brother’s keeper?’ And he said, ‘What hast thou done? The voice of thy brother’s blood crieth from the ground. . . . When though thou tillest the ground, it shall not henceforth yield unto her strength; a fugitive and a vagabond shalt thou be in the earth. And Cain said unto the Lord, ‘My punishment is greater than I can bear.” Genesis 4:8-10, 12-13.

[15] See George Draffan and Janine Blaeloch, Commons or Commodity? The Dilemma of Federal Land Exchanges (Western Land Exchange Project (January 2000) (excerpt republished and available at ); Susan Dominus, Club Med for the Multimillionaire Set, New York Times Magazine (March 5, 2006) ().

[16] Partial and Interim Yellowstone Order, at p. 4 & fn. 3; see Yellowstone Club Luxury Ski Resort Google Add posted February 1, 2008 (available at ).

[17] See, e.g., Partial and Interim Yellowstone Order, at p. 16 (“Numerous entities that received Credit Suisse’s syndicated loan product have failed financially, including Tamarack Resort, Promontory, Lake Las Vegas, Turtle Bay and Ginn. If the foregoing developments were anything like this case, they were doomed to failure once they received their loans from Credit Suisse.”); David Doyle, Lloyds Banking Group Faces Losses from US Luxury Resort (Sea Island Company), (August 12, 2010) (available at ).

[18] Yellowstone Mountain Club, LLC (YMC), and its affiliates, Yellowstone Development, LLC (YD), Big Sky Ridge, LLC (BSR), and Yellowstone Club Construction Company, LLC (YCCC) (collectively, Debtors).

[19] Partial and Interim Yellowstone Order, at p.18. See generally Robin Paul Malloy, Lender Liability for Negligent Real Estate Appraisals, 1984 U. Ill. L. Rev. 53 (1984).

[20] Partial and Interim Yellowstone Order, at p.18.

[21] Partial and Interim Yellowstone Order, at p.17.

[22] Partial and Interim Yellowstone Order., at pp.17-18.

[23] Partial and Interim Yellowstone Order, at p.19.

[24] Partial and Interim Yellowstone Order, at p.9.

[25] DDJ Mgmt., LLC, ---- N.E.2d ----, 2010 WL 2516811 (N.Y.), 2010 N.Y. Slip Op. 05603, at pp. 8-9 (June 24, 2010) (citing Schlaifer Nance & Co. v. Estate of Warhol, 119 F.3d 91, 98 (2d Cir. (NY) 1997); see also Banque Arabe et Internationale D'Investissement v. Maryland Nat'l Bank, 57 F.3d 146, 153 (2d Cir. (NY) 1995) (stating that to prove fraud under New York law, a claimant “must prove five elements by clear and convincing evidence: (1) a material misrepresentation or omission of fact, (2) made with knowledge of its falsity, (3) with an intent to defraud, and (4) reasonable reliance on the part of the plaintiff, (5) that causes damage to the plaintiff.”).

[26] DDJ Mgmt., slip op., at p. 5 (Borrower represented and warranted in the loan agreement that its financial statements “present fairly in all material respects the financial position of [Borrower] and the results of [Borrower’s] operations and cash flows for the period then ended;” that the statements were prepared in accordance with GAAP; that no event had occurred between the end of the previous period and the closing date, “which alone or together with other events, could reasonably be expected to have a Material Adverse Effect on [Borrower’s] business, assets, operations or prospects or its ability to repay the loans; and that ‘no information contained in the loan agreement, the other loan documents or the financial statements being furnished to the [Lender] contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained therein not misleading in light of the circumstances under which they were made.’ ”)).

[27] DDJ Mgmt., slip op., at p. 5.

[28] DDJ Mgmt., slip op., at p. 5. There were plenty of hints that might have put the lender on guard. The borrower’s outside auditors did not complete their audit for 2003 until the day the loan closed in March 2005. Some aspects of the borrower’s unaudited 2004 financials – a remarkable and sudden improvement in profitability in the last month of the year – “might have seemed too good to be true.”

[29] DDJ Mgmt., slip op., at p. 5.

[30] A drift is a herd of pigs.

[31] See DDJ Mgmt., slip op., at pp. 9-11 (citing JP Morgan Chase Bank v. Winnick, 350 F. Supp. 2d 393, 409-11 (S.D.N.Y. 2004)).

[32] DDJ Mgmt, slip op., at p. 7.

[33] DDJ Mgmt., slip op., at p. 6 (quoting Schumaker v Mather, 133 N.Y. 590, 596 (1892)). But see Lampert v. Mahoney, Cohen & Co., 218 A.D.2d 580, 582 (N. Y. App. Div. [1st Dept.] 1995) (dismissing fraud claim when lender admitted “he loaned some $3 million to a corporate entity and its principal without ever investigating the financial condition of the business beyond obtaining some vague verbal assurances from its accountant.”).

[34] DDJ Mgmt., slip op., at p. 5.

[35] DDJ Mgmt., slip op., at p. 8. This may be true as a statement of law, but it is really bad practical advice.

[36] DDJ Mgmt., LLC v. Rhone Group LLC, 60 A.D.3d 421, 422, 875 N.Y.S.2d 17, 18 (N.Y. App. Div. [1st Dept.] 2009), reversed, 2010 WL 2516811, 2010 N.Y. Slip Op. 05603 (N.Y. June 24, 2010).

[37] DDJ Mgmt., 60 A.D.3d at 424.

[38] DDJ Mgmt., slip op., at p. 11 (stating that lender made “a significant effort to protect themselves against the possibility of false financial statements” by obtaining financial representations in loan documents).

[39] Headwaters Constr. Co. v. National City Mortg. Co., --- F.Supp.2d ----, 2010 WL 744287 (D. Idaho Feb. 26, 2010).

[40] Jacobellis v. Ohio, 378 U.S. 184, 197 (1964) (J. Stewart, concurring) (“I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it.’”).

[41]See, e.g., Trustees of the In re Gluth Bros. Construction, Inc. Creditor Trust, 424 B.R. 379 (Bkrtcy. N.D. Ill. 2009) (citing Fisser v. Int'l Bank, 282 F.2d 231, 238 (2d Cir.1960) and Official Comm. of Unsecured Creditors v. Austin Fin. Servs., Inc. (In re KDI Holdings, Inc.), 277 B.R. 493, 515-16 (Bankr. S.D.N.Y.1999) for proposition that, in order to bring a claim for lender liability under improper control theory, the plaintiff must demonstrate: “(1) control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and (2) such control must have been used by the defendant to commit fraud or worse, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest and unjust act in contravention of plaintiff's legal rights; and (3) the . . . control exercised and breach of duty must proximately cause the injury or unjust loss complained of.’”); see generally Sabin Willett, The Shallows of Deepening Insolvency, 60 Bus. Law 549 (2005); William N. Medlock, Stemming the Tide of Lender Liability: Judicial and Legislative Reactions, 67 Denv. U. L. Rev. 453 (1990); Jeffrey John Hass, Insights into Lender Liability: An Argument for Treating Controlling Creditors as Controlling Shareholder, 135 U. Pa. L. Rev. 1321 (1987); K. Thor Lundgren, Liability of a Creditor in a Control Relationship with its Debtor, 67 Marq. L. Rev. 523 (1984).

[42] See, e.g., Official Comm. of Unsecured Creditors of Propex, Inc. v. BNP Paribas (In re Propex, Inc.), 415 B.R. 321 (Bankr. E.D. Tenn. 2009); see generally Tracy Bateman Farrell, "Deepening Insolvency" as Cause of Action in Tort, 23 A.L.R. 6th 457 (2007 & Supp. 2010); David C. Thompson, A Critique of "Deepening Insolvency," A New Bankruptcy Tort Theory, 12 Stan. J.L. Bus. & Fin. 536 (2007) (arguing that deepening insolvency cause of action is “fundamentally flawed”), and Ian T. Mahoney, The CitX Decision: Has the Tort of "Deepening Insolvency" Gone Bankrupt?, 52 Vill. L. Rev. 995 (2007) (noting the “unmistakable and growing trend, within federal jurisprudence, toward significantly restricting claims for deepening insolvency.”); Sabin Willett, The Shallows of Deepening Insolvency, 60 Bus. Law. 549, 553, 556 (2005) (“In short, a new loan, however onerous or ill-advised, can never ‘deepen’ balance-sheet insolvency. . . . When we penetrate the confused rationale of deepening insolvency cases brought against lenders, we always find that the real gravamen of the complaint is that the board continued operating when it should not have done [so]. The not-so-subtle leap is that the lender should be accountable for this.”).

[43] Count I: Unjust Enrichment; Count II: Intentional Interference with Contract; Count III: Negligent Interference with Contract; Count IV: Breach of Contract (Assignment); Count V: Breach of Contract (Third-Party Beneficiary); Count VI: Promissory Estoppel; Count VII: Lender Liability; Count VIII: Negligence; and Count IX: Priority of Liens.

[44] See Idaho First Nat'l Bank v. Bliss Foods, Inc., 121 Idaho 266, 824 P.2d 841 (Idaho 1991); Black Canyon Racquetball Club Inc. v. Idaho First Nat'l Bank, N.A., 119 Idaho 171, 804 P.2d 900 (Idaho 1991).

[45] Headwaters Constr. Co., 2010 WL 744287, *7.

[46] Official Comm. of Unsecured Creditors of VarTec Telecom, Inc. v. Rural Tel. Fin. Coop. (In re VarTec Telecom, Inc), 335 B.R. 631 (Bankr. N.D. Tex. 2005).

[47] Fehribach v. Ernst & Young LLP, 493 F.3d 905, 908-09 (7th Cir.2007).

[48] Kittay v. Atlantic Bank of New York (In re Global Service Group, LLC), 316 B.R. 451, 456 (Bankr. S.D.N.Y. 2004) (Bernstein, C.J.) (quoting Schacht v. Brown, 711 F.2d 1343, 1350 (7th Cir.1983)).

[49] 523 F. Supp. 533 (S.D.N.Y.1980).

[50] In re VarTec Telecom, Inc., 335 B.R. at 637 (citing and quoting Bloor, 523 F. Supp. at 541).

[51] In re VarTec Telecom, Inc., 335 B.R. at 637.

[52] In re VarTec Telecom, Inc., 335 B.R. at 637.

[53] In re Gluth Bros. Constr., Inc., 424 B.R. at 379, 389-90 (stating that even if Illinois were to recognize the theory of deepening insolvency, it would only do so in the context of a claim of fraud).

[54] See In re Del-Met Corp. 322 B.R. 781 (Bankr. M.D. Tenn. 2005) (discussing New York and Delaware case law addressing fiduciary relationships more broadly-involving majority or controlling shareholders, lenders and other parties exercising control of a corporation); see Harriman v. E.I. DuPont De Nemours & Co., 372 F. Supp. 101, 105-06 (D.Del.1974) (citing Allied Chem. & Dye Corp. v. Steel & Tube Co., 120 A. 486 (Del. Ch.1923) for proposition that “[i]t is only when a person affirmatively undertakes to dictate the destiny of the corporation that he assumes such a fiduciary duty.'”); Brickman v. Tyco Toys, Inc., 731 F. Supp. 101, 107 (S.D.N.Y.1990) (interpreting Delaware law); New York State Med. Care Facilities Agency v. Bank of Tokyo Trust Co., 163 Misc. 2d 551, 621 N.Y.S.2d 466 (N.Y. Sup. Ct. 1994) (“Under New York Law, ‘a fiduciary relationship exists from the assumption of control and responsibility’”) (quoting Beneficial Commercial Corp. v. Murray Glick Datsun, Inc., 601 F. Supp. 770, 772 (S.D.N.Y.1985) (citing Gordon v. Bialystoker Ctr. & Bikur Cholim, Inc., 45 N.Y.2d 692, 412 N.Y.S.2d 593, 385 N.E.2d 285 (1978))).

[55] In re Gluth Bros. Constr., Inc., 424 B.R. at 390; see Whitley v. Taylor Bean & Whitacker Mortg. Corp., 607 F. Supp.2d 885, 902 (N.D.Ill.2009) (“Under Illinois law, a lender ‘has no duty to refrain from making a loan if the lender knows or should know that the borrower cannot repay the loan.’”) (citing N. Trust Co. v. VIII S. Michigan Assocs., 276 Ill.App.3d 355, 212 Ill. Dec. 750, 657 N.E.2d 1095, 1102 (Ill. App. Ct.1995)).

[56] See, e.g., Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Techs., Inc.), 299 B.R. 732, 750-51 (Bankr. D. Del. 2003) (refusing to dismiss complaint alleging “that the Lenders caused the Debtors to acquire GNB Dunlop so that they could obtain the control necessary to force the Debtors fraudulently to continue its business for nearly two years at ever-increasing levels of insolvency”).

[57] In re Trafford Distrib. Ctr., Inc., --- B.R. ----, 2010 WL 2607289, at fn. 157 (Bankr. S.D. Fla. June 30, 2010) (citing Alberts v. Tuft (In re Greater Southeast Cmty. Hosp. Corp)., 353 B.R. 324, 338 (Bankr.D.C.2006) for proposition that “[d]eepening insolvency is a valid theory of damages for breach of fiduciary duty[,]” reasoning that “‘[r]ather than attempt to discover a separate common law tort which must then be neutered, this court prefers to treat deepening insolvency as the theory of harm that it was always meant to be, and will rely on other, more established (not to mention less convoluted) common law causes of action to ascertain whether the defendants in this case have engaged in a legal wrong . . . [;] deepening insolvency will remain a viable theory of damages in this jurisdiction regardless of whether the injury occurred as a result of negligence or fraud.”); Dwek v. Sun Nat’l Bank (In re Dwek), No. 3:09-cv-5046, p. 4, 2010 WL 234938, *2 (D. N.J. January 15, 2010) (holding that “there is a substantial difference of opinion as to whether New Jersey would recognize an independent tort for deepening insolvency”).

[58] See, e.g., In re Propex, Inc., 415 B.R. at 326-31; see generally Tracy Bateman Farrell, "Deepening Insolvency" as Cause of Action in Tort, 23 A.L.R. 6th 457 (2007 & Supp. 2010).

[59] In re VarTec Telecom, Inc, 335 B.R. at 644, 646

[60] Madison, Dwyer, and Bender, 2 Law of Real Estate Financing, Lender Liability Statues of Frauds § 14:37 (2009) (citing Univex Intern., Inc. v. Orix Credit Alliance, Inc., 914 P.2d 1355, 1361 (Colo. 1996)). See Ala. Code § 8-9-2(7); Alaska Stat. § 09.25.010(a)(13); Ariz. Rev. Stat. Ann. § 44-101(9); Ark. Stat. Ann. § 4-59-101; Cal. Civ. Code § 1624(g); Colo. Rev. Stat. § 38-10-124; Conn. Gen. Stat. § 52-550(a)(6); Fla. Stat. § 687.0304; Ga. Code Ann. § 13-5-30(7); Ill. Rev. Stat. ch. 17, paras. 7101-03; Ind. Code § 32-2-1.5; La. Rev. Stat. Ann. §§ 6:1121-6:1123; Kan. Stat. Ann. §§ 16-117, 16-118; Md. Cts. & Jud. Proc. Code Ann. § 5-315; Minn. Stat. Ann. § 513.33; Neb. Rev. Stat. §§ 45-1, 112-115; Nev. Rev. Stat. § 111.220(4); N.C. Gen. Stat. § 22-5; N.D. Cent. Code § 9-06-04(4); Okla. Stat. tit. 15, § 140; Or. Rev. Stat. § 41.580; S.D. Codified Laws Ann. § 53-8-2(4); Tenn. Code Ann. § 29-2-101(b); Tex. Bus. & Com. Code Ann. § 26.02 (Vernon); Utah Code Ann. § 25-5-4(6).

[61] See Claudia G. Catalano, Promissory Estoppel of Lending Institution Based on Promise to Lend Money, 18 A.L.R. 5th 307 (1994 & Supp. 2010); Tochner, Limiting Lender Liability in Florida: The Application of a Statute of Frauds to Credit Agreements, 44 Florida L. Rev. 807 (1992 & Supp 2010); Lori J. Henkel, Bank's Liability for Breach of Implied Contract of Good Faith and Fair Dealing, 55 A.L.R. 4th 1026 (1987 & Supp. 2010).

[62] See Part II, Attachment B for text of pre-negotiation letter.

[63] Keenan v. Donaldson, Lufkin & Jenrette, Inc., 529 F.3d 569, 570-72 (5th Cir. (La.) 2008). La. Rev. Stat. Ann. § 6:1122 (2005) provides that “[a] debtor shall not maintain an action on a credit agreement unless the agreement is in writing, expresses consideration, sets forth the relevant terms and conditions, and is signed by the creditor and the debtor.”

[64] 529 F.3d at 579.

[65] 529 F.3d at 579.

[66] The Pre-Negotiation Agreement also contained a broad integration clause, providing that the “[p]arties agree that there are no oral agreements between the Parties as of the date hereof.”

[67] In re CMR Mortg. Fund, LLC, 2009 WL 2870114, at *5; see New Bank of New England, N.A. v. Toronto-Dominion Bank, 768 F. Supp. 1017, 1021 (S.D.N.Y.1991) (stating that “[c]ourts have generally refused to rewrite agreements to provide minority lenders with any rights . . . . which are not expressly set forth in the agreements.”)

[68] Section 9(a) provides: Subject to Section 9(d) below, if a Continuing Event of Default occurs under the Loan that has not been timely cured under Section 10 hereof, including, without limitation, any Event of Default arising from the maturity of the A Loan, A Note Holder and B Note Holder hereby agree to use reasonable efforts to reach an agreement with each other on an appropriate manner for responding to such Continuing Event of Default. . . . If A Note Holder and B Note Holder cannot reach an agreement within ten days following the expiration of the applicable cure period . . . then A Note Holder may initiate foreclosure proceedings or any other Enforcement Action.

[69] In two controversial decisions, Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Aschroft v. Iqbal, 556 U.S. __, 129 S. Ct. 1937 (2009), the U.S. Supreme Court ruled that to survive a motion to dismiss under Rule 12(b)(6), a claimant must give notice of a “plausible claim for relief.” Rule 8 of the Federal Rules of Civil Procedure “does not require detailed factual allegations,” but it does “demand[] more than an unadorned, the defendant-unlawfully-harmed-me accusation.” 129 S. Ct. at 1949. To state a “plausible claim for relief,” a claimant must “plead[] factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged[;] . . . [t]hreadbare recitals of the elements of a cause of action, supported by mere conclusory statements” will not suffice.” Id. at 1949.  The upshot, especially for non-litigators, is that a claimant asserting a lender liability claim in federal court is not supposed to be able to “unlock the doors of discovery . . . armed with nothing more than conclusions.”  Id. at 1950. Time will tell.

[70] Louis Uchitell, Volcker Pushes for Reform, Regretting Past Silence, The New York Times (July 20, 2010) (reprinted and available at ).

[71] See Richard A. Posner, A Failure of Capitalism (Harvard Univ. Press 2009) (“The movement to deregulate the financial industry went too far by exaggerating the resilience – the self-healing powers – of laissez-faire capitalism.”); Joseph E. Stiglitz, Freefall (W.W. Norton & Co. 2010); D. Faten Sabry and Dr, Chudozie Okongwu, How Did we Get Here? The Story of the Credit Crisis, Journal of Structured Fin. (Spring 2009) (reprinted at ); see generally Henry Hazlitt, Economics in One Lesson (Harper & Brothers 1946).

[72] Lawmkers Guide Dodd-Frank Bill for Wall Street Reform into Homestretch, The Washington Post (June 26, 2010) (quoting Sen. Dodd). Dodd-Frank delegates to various agencies the responsibility for promulgating over 240 rules and order almost a dozen different agencies to conduct just under 70 studies.

[73] See Attachment A for an alphabetized list of recent cases.

[74] See In re Foreclosure Cases, 521 F. Supp. 2d 650 (N. D. Ohio 2007) (requiring a recorded copy of the assignment of the mortgages in order to prove the lenders were the holder and owner of the note and mortgage as of the date the complaint was filed.) See also id. at 651 (stating that such a procedural requirement was necessary to preserve judicial integrity and that there had not been an understandable mistake and determining the proper party to sue was not difficult.). See also id. at 652 (admonishing the financial institutions by stating that the plaintiffs’ arguments “reveal a condescending mindset and quasi-monopolistic system.”).

[75] In order to achieve this goal, a best practice is to have a pre-negotiation or pre-workout letter. For an example of helpful language, see Attachment B. Note there is not a pre-filing waiver of a bankruptcy stay provision in this letter; depending on the facts, a court may enforce such a waiver if a bankruptcy filing occurred soon after the waiver was given and the borrower was advised by bankruptcy counsel. See supra Part I, note 65 and accompanying text.

[76] See Blue Hills Office Park LLC v. J. P. Morgan Chase Bank, 477 F. Supp. 2d 366 (D. Mass. 2007) (finding that the guarantors were liable for a deficiency judgment where the borrower did not pay taxes when the lender refused to allow disbursements from a cash management account on the basis the borrower had defaulted under the loan when guarantor insiders received a $2,000,000 settlement without notice to and consent by the lender).

[77] Starwood Capital Group has raised more than $4.4 billion since January 2009 with the closing in April 2010 of the Starwood Global Opportunity Fund VIII and Starwood Capital Global Hospitality Fund II.

[78] See In re Osborne, 42 B.R. 988, 996 (Bankr. W.D. Wis. 1984) (ruling that claims of a trade creditor had priority over a mortgagee’s secured claims due to the mortgagee’s misrepresentations regarding the debtor’s ability to pay the trade creditor.)

[79] See In re Wilf v. Halpern, 599 N.Y.S. 2d 579, 194 A.2d 508 (N.Y. App. Div. [1st Dept.] 1993) (viewed an unwilling partner as acting solely for personal gain due to the failure of such partner to consent to a necessary refinancing of the partnership debt where the partnership agreement required “each partner to execute any documents necessary or expedient to the achievement of the partnership’s purposes and to cooperate with each other to effectuate and advance its goals.”).

[80] In the United States, piercing the corporate veil is the most litigated issue in corporate law. Robert B. Thompson, Piercing the Corporate Veil: An Empirical Study, 76 Cornell L. Rev. 1036, 1074 (1991). U.S. courts have not articulated a bright line rule for piercing the veil and standards can differ dramatically from jurisdiction to jurisdiction. Most courts consider a number of facts and circumstances, including fairness to a claimant who, absent piercing the veil, might not otherwise have redress for a legitimate claim. The theory of "alter ego" is the chief basis for piercing the veil, and piercing the corporate veil typically is most effective with smaller, privately held business entities. Through legislative or court action, many jurisdictions apply the concept of piercing the corporate veil to LLCs and other business entities. See, e.g., Colo. Rev. Stat. § 7-80-107 (2010) (applying the doctrine to LLCs); Cal. Corp. Code § 1710(b) (2010) (stating that LLC member liability is the same as corporate shareholder liability); 805 Ill. Comp. Stat. 180/10 (2010); Minn. Stat. § 322B.303(s) (2010); N.D. Cent. Code § 10-32-29(3) (2010); Wis. Stat. Ann. § 183.0304(2) (2010). See also, e.g., Sheffield Servs. Co. v. Trowbridge, 211 P.3d 714 (Colo. Ct. App. 2009); Equity Trust Co. v. Cole, 766 N.W. 2d 334 (Minn. Ct. App. 2009); Four Seasons Mfg., Inc., v. 1001 Coliseum, LLC, 870 N. E.2d 494 (In. Ct. App. 2007).

[81] As an example, the statute of limitations period for the City of Chicago to evaluate retroactively whether transfer taxes were properly paid in connection with a transfer of land is four years unless the taxpayer improperly remitted less than 75% of the tax due, in which case the look back is almost seven years. See Chicago. Il. Mun. Code § 3-4-120 (2010) (“the director may issue a notice of tax determination and assessment to a taxpayer or tax collector for all periods that commenced on or after six calendar years prior to the January 1 immediately preceding the date on which the notice of tax determination and assessment is issued).

[82] Another method to secure this obligation is to use a letter of credit; however, obtaining a letter of credit may not be possible given the credit condition of the borrower unless short sale proceeds are used to obtain one. If a letter of credit is obtained from the borrower, the lender will want to ensure that the condition to drawing on the letter of credit does not violate the automatic stay in the bankruptcy case of the borrower/debtor. Since a letter of credit is a contract between the bank that has issued the letter and the beneficiary of the letter, the act of drawing on the letter of credit does not violate the automatic stay. The collateral pledged by the borrower/debtor as security for the letter of credit pledged, however, is considered part of the debtor’s estate and may be recoverable as an avoidable transfer if pledged during the preference time period. See Int'l Fin. Corp. v. Kaiser Group Int'l Inc. (In re Int'l Inc.), 399 F.3d 558, 566 (3rd Cir. 2005); In re Air Conditioning, Inc., 845 F.2d 293 (11th Cir. 1988); Kellogg v. Blue Quail Energy Inc. (In re Compton Corp.), 831 F.2d 586 (5th Cir. 1987). Lenders could ask for the collateral to come from a source other than the borrower, but if the source is a third party source, this could raise an issue as to whether there was reasonably equivalent value given to the third party. See also Marquis Prods, Inc. v. Conquest Mills, Inc. (In re Marquis Prods., Inc.), 150 B.R. 487 (Bankr. D. Me. 1993).

[83] See Tex. Bus. Orgs. Code Ann. § 11.052(a)(2).

[84] See id. at § 11.352. These funds escheat to the state after a stated time period if no claim has been made on the funds.

[85] See id. at § 11.359.

[86] The applicable statutes of limitations vary depending on the basis for the claim.  The statute of limitation to bring actions under the Bankruptcy Code for a preference payment made by a debtor to third parties is within 90 days (or paid to insiders within 1 year) preceding a bankruptcy filing under 11 U.S.C. §547 (2010), or for a fraudulent conveyance under 11 U.S.C. §548 (2010), is generally the earlier of (i) two years from the bankruptcy filing date (which may be extended if a trustee is appointed during this period), or (ii) the date the bankruptcy case is closed.  11 U.S.C. §546(a) (2010).  The statute of limitations for actions based on state fraudulent conveyance statutes may range from two to six years, depending on the applicable jurisdiction.

[87] See Blue Hills Office Park LLC v. J. P. Morgan Chase Bank, 477 F. Supp. 2d 366, 377 (D. Mass. 2007).

[88] Id. at 376.

[89] Id.

[90] See, e.g., Sleeping Indian Ranch, Inc. v. Wet Ridge Group, LLC, 119 P.3d 1062, 1069 (Colo. 2005).

[91] The question is whether the deed is a security instrument for the debt or the deed discharged the debt.

[92] See, e.g., 35 Ill. Comp. Stat. 200/31-45(1) (2010) (exempting transfers of real property pursuant to a deed in lieu of foreclosure from transfer tax liability).

[93] Unless the lender obtains as a part of the deed in lieu transaction an escrow or other security, the lender merely has the property and has released the borrower and guarantors from personal liability.

[94] Under Section §548(a)(1)(B) of the Bankruptcy Code, a transfer can be deemed "constructively fraudulent" if (1) the debtor/transferor voluntarily or involuntarily received less than a reasonably equivalent value in exchange for the transfer, and (2) the debtor/transferor either (a) was insolvent on the date of the transfer or became insolvent as a result of the transfer, (b) was undercapitalized or became undercapitalized as a result of the transfer, (c) intended or believed it would incur debts beyond the debtor's ability to pay as they became due, or (d) made such transfer to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.  11 U.S.C. §548(a)(1)(B) (2010).

[95] A take away from the Yellowstone case discussed in part I of this paper is that lenders must evaluate the financial statements a borrower provides. See supra Part I, note 3 and notes 10 – 24 and accompanying text.

[96] "Reasonably equivalent value" is not defined under the Bankruptcy Code.  Section 548(d)(2) provides that "'value' means property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor."  11 U.S.C. §548(d)(2) (2010).  A bankruptcy court will analyze all of the circumstances surrounding the transfer to determine whether a fair economic exchange has occurred without a precise mathematical formula.  See 5 Collier on Bankruptcy ¶ 548.05[1][b] (Alan N. Resnick & Henry J Sommer eds., 16th ed. 2009).  In evaluating whether a transferee's consideration constituted "reasonably equivalent value," the court's focus is on the net effect of the transfer on the debtor's estate and the funds available to unsecured creditors.  Stanley v. US Bank Nat'l Ass'n (In re TransTexas Gas Corp.), 597 F.3d 298, 306 (5th Cir. 2010); EBC I, Inc. v. America Online, Inc. (In re EBC I, Inc.), No. 09-1154, 2010 U.S. App. LEXIS 11183, *4-5 (3rd Cir. June 1, 2010); Frontier Bank v. Brown (In re Northern Merch., Inc.), 371 F.3d 1056, 1059 (9th Cir. 2004); Harman v. First Am. Bank (In re Jeffrey Bigelow Design Group, Inc.), 956 F.2d 479, 484 (4th Cir. 1992). See infra note 98.

[97] In the DDJ Mgmt case discussed in Part I of this paper, the court evaluated whether as a matter of law it was not reasonable for a lender to accept a borrower’s financials as accurate without further evaluation. See supra Part I, note 24 and accompanying text. In Lehman Bros. Holdings Inc. ex rel. LH 1440 v. Lehman Commer. Paper, 416 B.R. 392 (Bankr. S.D.N.Y. 2009), there were two loans (one to acquire property and the other to maintain, improve and pay interest payments on the acquisition loan). There were three separate promissory notes but there was a single participation fee and a single interest rate cap. The acquisition loan referenced all three loans. The acquisition loan was fully funded and was sold in a pool of thirty-six loans. The other two loans were not fully funded and the borrower claimed that the three loans were a unified financing package and the purchaser of the pool of assets that included the acquisition note should be required to advance funds on the other two notes. The question before the court in Lehman was whether the circumstances alleged were sufficient to place the purchaser of the pool on inquiry notice and to make further inquiries. Id. at 398. The court concluded that the customary practice in a repo transaction was to focus on the aggregate value of the assets rather than the specific assets within the pool. Id. at 399. A “repo transaction” is a short-term transaction where the seller sells the asset with an agreement to repurchase the asset in the future. Notwithstanding this conclusion, the borrower was allowed leave to amend its complaint to indicate whether the purchaser of the pool knew or had any reason to suspect the loans could not be separated.

[98] Wells Fargo Bank, N.A. v. LaSalle Bank Nat’l Assoc., 643 F. Supp. 2d 1014 (S.D. Ohio 2009). In Wells, the court held that the trustee of a pool of over $400 million commercial real estate mortgages (treated as real estate mortgage investment conduit) had proved that the depositor, LaSalle Commercial Mortgage Securities, Inc. had failed to meet its own underwriting guidelines and that this was competent evidence of LaSalle’s failure to meet industry standards. Id. at 1030.

[99] Tousa ex rel Official Comm. of Unsecured Creditors v. Citicorp N. Am. 422 B.R. 783 (S.D. Fla. 2009). In the Tousa case, subsidiaries gave upstream loan guaranties in connection with a credit facility to its residential homebuilder parent-borrower on July 31, 2007. When the parent and its subsidiaries filed for Chapter 11 bankruptcy protection in the Southern District of Florida less than six months after the closing of the credit facility (January 29, 2008), the Creditors’ Committee sought to avoid the liens as a constructive fraudulent transfer. In Judge Olson’s one hundred plus page opinion, the court found that the subsidiaries were insolvent when the guaranties were given and were made even more insolvent after the loan. The court held the Defendants failed to show “either through fact witnesses, documents, or expert testimony,” that the subsidiaries “received reasonably equivalent value-or, indeed, any substantial value” from the loan. Id. at 848. The court rejected that the subsidiaries had received indirect benefits from a single business enterprise or based on synergy between the parent and the subsidiaries. Id. at 847-869. Facts in the case include that the parent was heavily in debt, including, $1.061 billion in principal owed on bonds, id. at 787; the Defendants argued that the valuation of the real estate did not have reliable comparable current sales transactions for undeveloped land and that the appraiser was not licensed. Id. at 821, 823; the solvency opinion was obtained from a company that had not provided an opinion in the last two years for a homebuilder (last opinion was before some time in 2005 and current opinion given June 2007, id. at 839, and that the fee was contingent (consultant paid $2 million if the opinion given was that the parent was solvent immediately following the loan and paid only time and costs if the consultant could not so opine (less than half the premium fee, id. at 840; the insolvency opinion was requested by the lender when there was public information available that the parent was insolvent (bond ratings for parent downgraded twice and there were financial forecasts for a drop in new home sales, id. at 870; and CEO of parent wrote an internal memo stating that the parent was “[o]ver-leveraged” and at risk of “crashing and burning” even if it could successfully execute its de-leveraging plan. Id. at 797.

[100] Central to the DDJ Mgmt case discussed in Part I of this paper is the reliability of the appraisal. See supra note 24. Using the new valuation of Cushman & Wakefield that relied on the Debtor’s future financial projections rather than rely on the limited “as is” valuation which showed a 90% loan to value. The lender and the borrower were overfed fees and loan distributions. The bankruptcy court in Tousa (see supra note 98) stated that the consultant that opined in the insolvency opinion that the parent entity was solvent immediately following the loan “blindly relied” upon unsupportable financial projections of the parent. Id. at 843. The consultant’s engagement letter stated that consultant would “not take any action to verify the accuracy or completeness” of the information provided it and in fact, it did not do so. Id. at 840.

[101] Canada Life Assurance Co. v. LaPeter, 563 F.3d 837 (9th Cir. 2009). See supra note 93 and accompanying text.

[102] See 11 U.S.C. § 543 (2010).

[103] Canada Life, 563 F.3d at 837.

[104] Hotel 71 Mezz Lender LLC v. Falor, 58 A.D. 3d 270, 869 N.Y.S.2d 61 (N.Y. App. Div. [1st Dept,] 2008), reversed, in part, on other grounds, 14 N.Y.3d 303, 925 N.E.2d 1202, 900 N.Y.S. (N.Y. Ct. App. 2010). The issue was whether a court can appoint a receiver and attach the interestof guarantors in foreign limited liability companies. The Supreme Court (trial court) issued an order restraining the defendants from disposing of or diverting their ownership and/or management interest in companies domiciled outside of New York and apported a receiver. The Appellate Division held that there was no jurisdiction to attach guarantor’s intangible property intersts in companies domiciled outside of New York and held that the lender was not entitled to appointment of a receiver and viewed the restraining order as a legitimate restraint on the conduct for which the lender sought protection. The Court of Appeals (highest court) held that Supreme Court did not abuse its discretion by appointing receiver and reversed the Appellate Division’s order that Supreme Court did not have jurisdiction to attach guarantor’s nondomiciliary property interests and reinstated the Supreme Court’s order of attachment).

[105] The Yellowstone case illustrates how a court can unmake the contract the parties thought they had when the court finds “naked greed” by one party to the contract. See supra See supra Part I, note 3 and notes 10 – 24 and accompanying text.

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