By Aaron B. Chapin, Associate, Financial Services Group, Reed Smith
In the case, Official Committee of Unsecured Creditors v. Credit Suisse (In re Champion Enterprises, Inc.), No. 09-14014, Adv. No. 10-50514, 2010 WL 3522132 (Bankr. D. Del. Sept. 1, 2010), the unsecured creditors’ committee brought multiple claims against debtors’ lenders based on conduct relating to certain prepetition lending agreements, including equitable subordination, equitable subrogation, unjust enrichment, equitable estoppel, breach of contract, fraudulent transfer and preference. On the defendants’ motion to dismiss, the court dismissed all claims against all defendants except for the breach of contract action against Credit Suisse.
Prior to the sale of its business, the debtors, Champion Enterprises and its affiliates, made pre-fabricated housing and modular buildings. In 2005, the operating entity, Champion Home Builders Co. (Champion OpCo), obtained a senior secured credit facility from what the court referred to as the “lending group.” The lending group consisted of Credit Suisse, MAK Capital Fund, L.P. (MAK), and approximately 100 other lenders that participated in the credit agreement. As part of this credit facility, the holding company, Champion Enterprises, (Champion HoldCo), issued certain notes, which became due in 2009 (the 2009 notes). The prepetition credit facility was secured by all of the assets of Champion OpCo.
In 2007, the debtors’ business began to suffer. To stay afloat, the debtors renegotiated the credit agreement with the lending group, amending the credit agreement and giving certain concessions to avoid defaults. One such concession included Champion HoldCo’s issuance of new unsecured notes to third parties, the proceeds of which were used to pay down the 2009 notes. This benefited the lending group, because after the 2009 secured notes were paid off, the lending group would alone have a priority security interest in Champion OpCo’s assets.
In addition, in early 2009 lenders started to assign certain debt obligations of the debtors. The credit agreement provided that the lenders could assign certain obligations to an “eligible assignee,” which was a defined term under the agreement. The lenders needed the consent of the debtors, unless a default had occurred. Notwithstanding that a default had not occurred, Bank of America assigned approximalty $1 million in term loans and $1 million in synthetic deposits to MAK (the MAK Assignment).
In the end, the various concessions and amendment made to the credit facility proved insufficient to save the debtors’ business, and on November 15, 2009, the debtors filed petitions for relief under Chapter 11 of the Bankruptcy Code. At the time, $147 million remained outstanding in the credit facility.
The unsecured creditors committee, which consisted mostly of the purchasers of Champion HoldCo’s 2007 unsecured notes, brought an adversary proceeding against the lending group for various forms of equitable relief and breach of contract, based on alleged prepetition misconduct on the part of the lenders.
Of 13 counts in the complaint, the bankruptcy court allowed only one count, breach of contract relating to the MAK Assignment, to survive the motion to dismiss. In short, the court found that the committee sufficiently pled that an agreement existed and that Credit Suisse, as plan administrator, breached that agreement by allowing the MAK Assignment to occur without the debtors’ consent. The court was skeptical that the committee would be able to prove damages resulting from this alleged breach, but would allow the committee to proceed to discovery on the issue.
The court, however, was not so kind to the committee on the equitable claims, which the court dismissed with varying degrees of analysis. The three claims given the most analysis, equitable subordination, equitable subrogation and constructive fraudulent transfer, are discussed here.
To equitably subordinate the lending groups’ claims to those of the unsecured creditors, the committee needed to show 1.) inequitable conduct, 2.) resulting in injury to creditors or unfair advantage to the claimant and 3.) an outcome that is not otherwise inconsistent with the bankruptcy code. In addition, the committee would have a lesser burden of proving inequitable conduct if it could demonstrate that the lending group was an insider of the debtors, which it attempted to do by arguing that the lending group exercised a high level of control over the debtors due to the credit agreement.
The court, however, rejected this argument, holding that the lending group were traditional lenders, nothing more. While the complaint did allege that lending group had access to and monitored the debtors’ financials, exerted influence in negotiating amendments to the credit agreement, and received certain concessions, none of this was sufficient to show insider status. The court also noted that there was nothing unique about these lenders that would have made the debtors’ economic survival dependant upon them, such as might be the case if the debtors were depended on inventory purchases from a certain vendor.
In addressing the elements of the equitable subordination claim, the court found insufficient probability of inequitable conduct. The committee had alleged that the lending group acted inequitably in requiring certain concessions when amending the credit agreement. The court, however, rejected this theory, stating: “Although the lending group may have forcefully negotiated, the fact that one party to a contract has more leverage does not indicate that the dealings are not at arm’s length. Moreover, use of that leverage does not provide a basis for the court to find inequitable conduct.”
In addition, the court found that the prospectus issued in connection with the 2007 unsecured notes clearly stated that the notes would be used to pay off the 2009 notes. The purchasers of the unsecured notes could not, then, complain that the notes were used for their stated purpose, even if that purpose benefited the secured creditors. Finally, the court noted that the breach of contract claim relating to the MAK Assignment was not enough to show inequitable conduct.
Moving on to equitable subrogation, which allows one who has satisfied the debt of another to succeed to the position and rights of the satisfied creditor in certain circumstances, the committee argued that because the noteholders paid off the 2009 notes, in essence, they should be able to take the place of the 2009 secured noteholders. The court disagreed. To prevail on an equitable subrogation claim, the committee would need to show: 1.) that the payment was made by the subrogee to protect his or her own interest, 2.) the subrogee was not a volunteer, 3.) the subrogee was not primarily liable for the satisfied debt, 4.) the subrogee paid the entire debt and 5.) subrogation will not work injustice on others.
In reviewing these elements, the court held that the committee’s claim failed at the motion to dismiss stage for at least two reasons. First, the noteholders did not directly pay off the 2009 notes, and the committee could not cite any case law to support the theory that the debtors’ were acting as a mere conduit to facilitate the transaction. And second, the plaintiffs could be considered “volunteers” in that the prospectus explained exactly how the unsecure notes would be used.
As for the fraudulent transfer claim, the committee argued that the debtors did not receive reasonably equivalent value in return for granting new security interests to the lending group as part of the amendments to the credit agreement because the lenders were undersecured and the transfers did not reduce the amount of the outstanding liens. The court, however, held that value of the collateral securing the debt and the determination of whether the lenders were undersecured are irrelevant, because the rights of secured creditors are always limited to the amount of the debt. The additional security interest did not enable lenders to receive anything more than what they have loaned and the debtors’ liabilities are not increased as a result of the collateralization.
Secured lenders will find this case useful, both in its holdings and its analysis, when faced with similar complaints from creditors’ committees or Chapter 7 trustees. For instance, this case succinctly reaffirms the principle that the use of leverage in negotiations does not amount to inequitable conduct. In addition, insiders do not normally include third-party lenders with contractual relationships with the debtor, and this case finds no exception to that general principle even where the lenders’ conduct in monitoring the debtors’ financial and aggressively negotiating with the debtors could be said to have affected or influenced the debtors’ conduct.
Aaron B. Chapin is an associate in the Financial Services Group, practicing in the area of Financial Services Litigation at Reed Smith’s Chicago Office. Chapin joined the firm in 2008. Chapin earned his J.D. cum laude from the University of Minnesota Law School in 2006 and his B.A. from Drake University in 2002.