Your borrower is in default, but at least you hold a perfected first priority lien in its assets. What could go wrong with that? Plenty. Four recent high-profile bankruptcy cases are gutting the integrity of secured lenders' first lien positions. Herrick is directly involved in three of these cases. Our panel of experts presented an interactive Q&A on how debtors are chipping away at the sanctity of the first lien, and what you can do to protect yourself.
Chrysler: Holders of first liens on Chrysler assets expect the bankruptcy court to summarily dismiss their objections if a sale of the encumbered assets is ordered free and clear of the first liens, and the liens not even to be allowed to attach to proceeds to the full extent of the unpaid debt.
General Growth Properties: "Bankruptcy remote" GGP special purpose subsidiaries filed for bankruptcy despite SPE status. The bankruptcy court then allowed the SPE's to use property "surplus" cash flow (encumbered by property-level perfected first liens) to support the operations of the parent company and cash flow negative affiliates, though neither the parent nor the affiliates were debtors to the first lien lenders.
Yellowstone Mountain Club: A bankruptcy court equitably subordinated a lender's perfected first lien to the claims of unsecured creditors because of the lender's conduct in making the loan, even though the lender was not an insider of the debtor. While this decision is narrowly tailored to the facts of the case--which are not likely present in most loan transactions--first lien lenders can expect borrowers to pursue "Yellowstone" assertions in the future.
Winstar: Carefully crafted, a first lien challenge can benefit other lienors. In Winstar, Herrick recovered a $340 million judgment, affirmed by the Third Circuit, from a creditor that improperly used its dominant position to cause its customer, Winstar, to engage in non-arm's length transactions. The court forced the creditor to repay a $188 million payment received beyond the normal three month voidable preference period and equitably subordinated the creditor's lien on the proceeds of sales of its financed equipment.
What to do? Carefully analyze your situation and options in pursuing first lien holder rights and remedies, and make sure you retain counsel expert in these issues.
Gary Eisenberg, Partner, Herrick, Feinstein LLP
Andrew Gold, Partner, Herrick, Feinstein LLP
Stephen Selbst, Partner, Herrick, Feinstein LLP