A lender may be surprised to learn that, where a participant acquires an interest in some, but not all, of its loans, the lead/participant relationship can affect the parties' rights even regarding loans in which the participant does not own an interest. In these situations, a careful reading of the participation agreement will govern the parties' rights and duties. A recent Illinois federal case, in which the lead lender achieved a pre-answer dismissal of only some of a participant's claims, amply illustrates this important point.
The lead provided a borrower with: (1) a $32 million general line of credit, in which the participant acquired a 40% interest, and (2) a separate trade line of credit, in which the participant acquired no interest, and which had a $2.5 million cap on so-called "packing loans." The trade line of credit was crosscollateralized with the general line of credit.
The lender increased the packing loans above $2.5 million without consulting with the participant. The lender also delayed, for approximately 60 days, declaring a default on the general line of credit. After it declared a default, the lender set-off amounts in the borrower's bank account in connection with the trade line of credit, without sharing any of the funds with the participant. The participant sued the lender, and the lender moved to dismiss the lawsuit.
The Court's Position
The participant argued that the lender violated the participation agreement by not seeking the participant's consent to modify the loan documents. The Court rejected this argument because specific provisions in the participation agreement expressly stated that the participant would have no right to make any decisions or take any actions concerning the trade line of credit. The agreement also provided that the lender would have sole and absolute discretion to take actions regarding the trade line of credit without owing any duties to the participant.
At the same time, however, the court refused to dismiss the participant's claim that the lender wrongfully delayed declaring a default so it could apply collateral to reduce the packing loans in which the participant had no interest, rather than to reduce a loan in which the participant owned an interest. A provision in the participation agreement stated that money paid to the lender after declaration of a default had to be applied according to certain set-off procedures. Without deciding the issue at the pleading stage of the case, the court held that the lender may have breached the participation agreement if it delayed declaring a default to avoid triggering that provision. Thus, the court decided that the participant had at least stated what could be a valid breach of contract claim, and the lawsuit could proceed.
When drafting participation agreements, a lender and its participants must carefully delineate their respective rights and duties regarding pre- and post-default events. In addition, before deciding whether to act or forbear when a default occurs, a lender must remember that a participation agreement affecting one loan may affect its freedom of action concerning a borrower even as to loans in which the participant owns no interest.
Copyright ©2004 Herrick, Feinstein LLP. Lender's Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.