April 3, 2015
Authored by: Mark Duedall
Winter is over; time for spring cleaning. Alas, your authors are so desperate to put off such drudgery that they decided to write about avoidance actions, and form language for notes and security agreements. If you represent lenders, try taking five from the cluttered garage, dust-bunnied closet, or bursting kitchen junk drawer, and read this; you may save your lender client a buck or two.
The Basics: Workout lawyers all agree on certain principles. For instance, fully secured creditors with undisputed claims deserve to be paid. Further, if the collateral value exceeds the amount of the secured creditor’s claim then payment must include interest, costs, and attorneys’ fees, if the loan documents so provide.
The Wrinkle: But add a wrinkle – the kind of wrinkle rarely considered when structuring a loan, in the glorious salad days of the lending relationship. That wrinkle: Upon the obligor’s bankruptcy, what if the obligor, or its bankruptcy trustee, sues the lender to recover a preference or fraudulent transfer to the lender made prior to the bankruptcy? If the lender defeats such an action, then surely the principles listed above would allow the lender to automatically add its defense costs to its claim, and collect those costs from the collateral or the bankruptcy estate. A recent California ruling says “yes” but notes that some less than ideal loan drafting made it a very hard call. It also notes other rulings featuring unhappy lenders left with large, unpaid legal bills despite a failed attempt by a borrower/trustee to claw back monies properly and validly paid to the lender. So read below, tweak your forms on the front end (see suggested language at the end of this missive), and try to avoid this ever happening to your lender client.
The Facts: The obligor, Mac-Go (the “Obligor”) and its affiliates enter into various loans with a bank (the “Lender”). Later, the Obligor enters bankruptcy and a trustee (the “Trustee”) is appointed. The Trustee asserts various avoidance actions against the Lender, alleging that the Obligor previously paid money to the Lender actually owed by other affiliates, the Obligor did not receive value for the loans, the Obligor preferred the Lender over other creditors, and other claims. The Trustee and the Lender litigate for three years. The Trustee loses. And the Lender has spent $350,000 in attorneys’ fees.
The Problem: There are enough funds in the bankruptcy estate to pay secured claims in full, including the Lender. But the problem is the Lender’s loan documents, and the nature of an avoidance action. Here, the Lender’s documents required the Obligor to pay all fees and costs of collection. And all costs and fees incurred by the Lender to enforce the loan. And all costs, expenses, and fees to enforce the Lender’s collateral and lien rights. Indeed, one loan document stated that enforcement costs included fees and legal expenses in bankruptcy proceedings. Unfortunately, a Trustee’s suit to recover past payments to the Lender, and the Lender’s efforts to protect prior payments, isn’t really “collection.” Nor is it “enforcement,” as the Lender is trying to keep what it has, instead of an effort by the Lender to get what it doesn’t. And although the Trustee’s avoidance suit took place in a “bankruptcy proceeding,” the Trustee’s suit was not part of the Lender’s “enforcement” of its rights (and the word “enforcement” modified all subsequent phrasing in the loan documents). As such, the Bankruptcy Court struggled with whether the Lender was entitled to add its $350,000 in attorneys’ fees to its claim amount, despite the Lender’s defeat of the Trustee’s avoidance action.
The Ruling: After surveying the case law, including the many cases where attorneys’ fees provisions were not sufficiently broad, the Court ruled in the Lender’s favor. But it was only due to California case law, which (for the most part) does not narrowly construe fee clauses in contracts. And the ruling was despite another Ninth Circuit ruling that a preference suit challenging the creation of a security agreement was not an action regarding the “enforcement” of the security agreement – in that case, the Lender won the suit, but got $0 added to its claim for fees or costs. Indeed, the impartial reader may think the Mac-Go Court was struggling to find a way to rule in the Lender’s favor, despite other cases holding that “enforcement” and “collection” have nothing to do with fighting off an effort to claw back what a lender or other creditor has already received.
The Solution: Revise your form note and security agreement. Make sure the attorneys’ fees provision covers fighting off efforts to reclaim or avoid prior payments. Your authors suggest a provision such as the below; the bolded language may be an unusual thing to add at the start of a lending relationship, but could indeed be helpful on the back end, when debtors or trustees try their worst:
Borrower agrees to pay, upon demand, all of Lender’s costs and expenses, including Lenders’ reasonable attorneys’ fees, legal expenses, court costs, and any other costs of any type or kind incurred by Lender: (i) to enforce this Agreement, (ii) to collect any amounts owed to Lender, (iii) in any bankruptcy, insolvency, assignment for the benefit of creditors, receivership, or other similar proceeding relating to Borrower or its assets, (iv) in any actual or threatened suit, action, proceeding, or adversary proceeding (including all appeals) by, against, or in any way involving Lender and Borrower, or in any way arising from this Agreement or Lender’s dealings with Borrower, and (v) to retain any payments or transfers of any kind made to Lender by or on account of this Agreement, including the granting of liens, collateral rights, security interests, or payment protection of any type. Lender may hire or pay someone else to enforce this Agreement or protect Lender’s rights under this Agreement, the costs of which are included in the amounts set forth above and are part of Lender’s right to payment by Borrower.
 See 11 U.S.C. § 506(b).
 See, e.g., 11 U.S.C. § 547(b), 548(a)(1).
 In re Mac-Go Corp., Case No. 14-44181, Memorandum Decision at Docket No. 235 (Bankr. N.D. Cal. March 20, 2015).
 Id. at p. 1; see also Poonja v. First National Bank (In re Mac-Go-Corp.), Adv. Proc. No. 14-04148, Order on Summary Judgment at Docket No. 80 (Bankr. N.D. Cal. May 23, 2014).
 In re Mac-Go, Docket No. 235, at pp. 2-3.
 Id. at pp. 6-8.
 Id. at p. 11 (citing Williams v. Official Unsecured Creditors’ Comm. (In re Connolly), 238 B.R. 475 (9th Cir. B.A.P. 1999)).
 Revised drafting may be needed if the applicable state law allows the recovery of a set percentage of the loan as “reasonable attorneys’ fees.” See, e.g., O.C.G.A. § 13-1-11(a)(2) (providing that “reasonable attorneys’ fees” in a note automatically means 15% of the first $500 owed and 10% of the amount owed that is greater than $500). But even in that situation, you should make sure the events giving rise to a fee claim include a trustee’s or debtor’s subsequent avoidance action, and not just the more generic “enforcement” or “collection.”