Duane Morris LLP – Lender liability is alive and well, as recent bankruptcy case shows

Although the bankruptcy court found that much of the factoring company’s conduct was permitted under the agreements, the court nonetheless found that the factoring company breached both the agreements and the duty. good faith and fair dealing.

In Bailey Tool & Mfg. Co. v. Republic Bus. Credit, LLC, 2021 Banker. LEXIS 3502 (Bankr. ND Tex. Dec. 23, 2021), the United States Bankruptcy Court for the Northern District of Texas clarified how aggressive a secured lender can be when asserting their rights. The 145-page opinion details how a loan deal went “terribly wrong” and why the award of millions in damages was justified.

Background

Bailey Tool & Manufacturing Company, with its two subsidiaries, Hunt Hinges, Inc. and Cafarelli Metals, Inc. (collectively, “Bailey”) operated a metal fabrication business primarily serving the automotive industry. Like many auto suppliers, Bailey faced some setbacks during the economic downturn of 2008-2009. Despite its best efforts to expand its business, Bailey was unable to regain previous income levels, and when Bailey’s original bank terminated its loan agreement, the company was forced to find a replacement lender. Bailey subsequently entered into both a factoring agreement and an inventory loan agreement with a factoring company.

Months after the agreements were executed, the factoring company said Bailey was in an “over-advanced” position (a term not defined in either agreement). The factoring company then restricted Bailey’s access to funds she needed for payroll and suppliers, among other things. The factoring company also took control of certain aspects of Bailey’s operations, such as (i) directing Bailey’s customers to pay the factoring company directly; (ii) decide which employees and suppliers to pay; (iii) posting armed guards to patrol Bailey’s factory as an intimidation tactic; and (iv) drafting an employment contract to replace the President and CEO of Bailey with a consultant hand-picked by the factoring company.

Bailey eventually filed a voluntary Chapter 11 petition under the United States Bankruptcy Code. The bankruptcy case was later converted to Chapter 7 of the Bankruptcy Code and a Chapter 7 bankruptcy trustee was appointed. The syndic then initiated adversarial proceedings against the factoring company, asserting the liability claims of the lenders. Bailey’s former owner has filed independent adversarial proceedings against the factoring company asserting similar claims.

Decision

The bankruptcy court ruled in favor of the trustee and owner, holding that (i) the lender may be liable under a theory of tortious interference if, among other things, the lender intentionally interferes with the management of the borrower’s business or its commercial contracts, and (ii) the bankruptcy of the company and the former owner would probably have been avoided but for the inappropriate actions of the factoring company. Although the bankruptcy court found that much of the factoring company’s conduct was permitted under the agreements, the court nonetheless found that the factoring company breached both the agreements and the duty. good faith and fair dealing.

The bankruptcy court also found that some of the factoring company’s behavior constituted fraud and tortious interference with Bailey’s business and contractual relationships. Regarding the fraud, the bankruptcy court found, among other things, that the factoring company had improperly and repeatedly informed Bailey that it was in an “over-advanced” position, creating the false impression that Bailey had defaulted on its collection obligations under the agreements. With respect to tortious interference, the bankruptcy court found that the factoring company improperly interfered with Bailey’s affairs and began to micromanage his expenses, including deciding which employees would and would not receive payment. The factoring company also interfered in many of Bailey’s long-term contracts by threatening the clients with legal action if they chose to pay Bailey instead of the factoring company.

Further, the bankruptcy court found that the factoring company deliberately violated the automatic stay under Section 362(k) of the Bankruptcy Code and that its conduct satisfied the elements of equitable subordination under the Section 510(c) of the Code. The court awarded the trustee compensatory and punitive damages for the factoring company’s violations of the automatic stay and found that the factoring company’s claims in the Chapter 7 case (if any) were subordinated to all other categories of creditors and interests.

Separately, the bankruptcy court ruled that the factoring company had committed fraud against Bailey’s longtime owner when, among other things, it levied an invalid lien on the owner’s personal and exempt property. The factoring company told the homeowner that if he gave them some of the proceeds from the sale of his house, it would cure Bailey of his “over-advanced” position and the factoring company would resume financing Bailey. The bankruptcy court ruled it was fraud and awarded the owner more than $1 million in damages.

Conclusion and commentary

The Bailey confirms that actions for the liability of the lender in the event of bankruptcy are possible, even today. Although the conduct described in the notice appears extreme, bankruptcy courts will continue to review a lender’s conduct before and after the petition if there is evidence that the lender’s actions forced the borrower into bankruptcy. or prevented the successful reorganization of the borrower.

For more information

If you have any questions about this Alertplease contact Marcus O. Colabianchi, Malcolm M. Bates, one of the attorneys in our Corporate Reorganization and Financial Restructuring Practice Group, or the attorney at the firm with whom you regularly interact.

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