Macdonald | Fernandez LLP


221 Sansome Street
San Francisco, CA 94104
Telephone: (415) 362-0449
Facsimile: (415) 394-5544
914 Thirteenth Street
Modesto, CA 95354
Telephone: (209)549-7949
Facsimile: (209) 236-0172

Monday, November 14, 2011

“Me First!” California Appellate Court Rules Two Liens Recorded Simultaneously Have Equal Priority

In First Bank v. East West Bank, 2011 Westlaw 4908756 (Cal.App.), California’s Second District Court of Appeal ruled that two deeds of trust against real property marked “recorded” at exactly the same moment have equal priority, notwithstanding the fact that one was indexed first.

This case arises from a scam in which the borrower, Kyung Ha Chung, obtained two loans from two different banks on the same day, without telling the other what he was doing. Each bank believed it would be in first position. Both banks waited about a week to record their deeds of trust, which were delivered to the recorder’s office on the same day before business hours. When the recorder’s office opened at 8:00 am, both deeds of trust were marked “recorded” as of 8:00 am, although they were indexed approximately 4 hours apart. First Bank’s lien was indexed second, and East West Bank sued for declaratory relief. In the meantime, Chung absconded with the money.

In holding that the liens share equal priority, the court explained that neither lien was the “first duly recorded” pursuant to the recording statute. East West Bank argued that the time of indexing should be used as a “tiebreaker,” but the court found that the statute provides for recording and indexing as separate duties of the recorder, with recording establishing priority, not indexing.

The court’s ruling may be technically incorrect. Specifically, Chung could not have executed both deeds of trust simultaneously (in fact, he probably attended two separate signings). The deed of trust executed earlier in time would prevail under common law, and the recording statute would not invalidate the lien because neither bank was the first to record.

This case provides two practical warnings: First, record as soon as possible. It is not clear why the banks both waited about a week to record, but either one could have avoided losing priority by recording promptly. Second, when multiple deeds of trust are to be executed simultaneously, be sure to provide proper recording instructions.

(Also seen on Insight Into Banking)

Tuesday, May 31, 2011

Be Careful What You Wish For: Automatic Acceleration Upon Bankruptcy Prevented Collection of Prepayment Premium

A Mississippi bankruptcy court has ruled that when a promissory note provides for automatic acceleration triggered by the borrower’s bankruptcy, under New York law oversecured noteholders cannot collect a prepayment premium. In re Premier Entertainment Biloxi, LLC, 445 B.R. 582 (Bankr. S.D.Miss. 2010). The ruling had significant financial consequences for the lenders, and although the impact of the case is unclear, lenders and investment bankers should take steps to avoid a similar result in future transactions.

In 2002, Premier Entertainment Biloxi, LLC and certain related entities undertook to construct the Hard Rock Hotel & Casino Biloxi, the plans for which included a 112-foot guitar sign. To finance construction, the Debtors issued 10.75% first mortgage notes in the principal amount of $160 Million, due on February 1, 2012, with $8.6 Million in interest due February 1 and August 1 each year beginning on August 1, 2004. U.S. Bank served as indenture trustee.

The notes provided for automatic acceleration of the maturity date upon the Debtors’ filing of a voluntary bankruptcy petition. The notes also provided that the Debtors could redeem the notes prior to maturity, but not before the end of the “no-call period” on February 1, 2008, by paying the principal plus a prepayment premium (100% to 105.375% depending on the remaining term). If the Debtors were to take any willful action during the no-call period with the intent of avoiding the prohibition on early redemption, the lenders would be entitled to higher prepayment premiums (106.719% to 110.75% depending on the remaining term).

The hotel and casino were completed on time and a certificate of occupancy as issued on August 26, 2005. Three days later, on August 29, 2005, Hurricane Katrina completely destroyed the resort’s casino, which was built upon two floating barges, and severely damaged other facilities. Thereafter, the Debtors negotiated with the indenture trustee and other parties to reconstruct the resort, this time on concrete piers, using remaining cash and insurance proceeds. However, the lenders eventually lost faith in the project and stopped all construction disbursements.

On January 6, 2006, the indenture trustee gave notice of certain defaults, which did not trigger automatic acceleration. Subsequently, a controlling stake in the Debtors was purchased by a new equity group, which made several offers to purchase the notes up to 101% of principal, far below the 105.375% required as of the expiration of the no-call period. At the time, the market price of the notes ranged from 105% to 106%.

The indenture trustee rejected the offers, and the Debtors commenced chapter 11 cases on September 19, 2006. The Debtors filed a reorganization plan providing for payment of the notes at par value plus accrued interest from new financing. Although the noteholders rejected the plan, all other classes of creditors voted in favor of the plan and it was “crammed down” over the noteholders’ objections. The plan was confirmed in June, 2007, and the resort opened to much fanfare just a few days later.

Thereafter, a trial was held on the noteholders’ entitlement to the contractual prepayment premiums that were denied under the plan. The bankruptcy court ruled in favor of the Debtors, holding that: “The reason [automatic acceleration] clauses exist is to allow lenders to accelerate the debt without first having to petition the bankruptcy court to lift the automatic stay.” In exchange for this advantage, the court held that the noteholders gave up their expectation of a prepayment premium: “The [noteholders] chose to forego any prepayment premium in favor of an immediate right to collect their entire debt after a bankruptcy event of default.”

The court’s rationale is dubious in that it is unlikely the noteholders actually preferred to exchange the significant economic benefits of the prepayment premium for the relatively minor procedural advantage of avoiding a motion for relief from the automatic stay. Moreover, there is authority questioning whether an automatic acceleration clause is barred by the “ipso facto” provisions of the Bankruptcy Code and is invalid in any case. See In re Crystal Properties, Ltd., L.P., 268 F.3d 743 (9th Cir. 2001). In other words, the court read a very bad bargain into the terms of the notes.

If the court’s holding were to become the rule, it would give rise to difficulties in determining the present value of corporate bonds and disrupt the corporate bond market. In fact, in this case the market priced the bonds significantly higher before the commencement of the case, and bondholders would have been better off selling out. This underscores the fact that the court’s ruling sharply reduced the real value of the notes.

It is unclear what impact this opinion will have, and investment banking counsel should take steps to reduce the risk of a similar result for their clients. Specifically, this result might be avoided by specifying that the prepayment premiums apply notwithstanding acceleration of the maturity date. In fact, the court commented that: “Contractual acceleration provisions are only limited in what they can do by the parties’ imaginations – in the absence of fraudulent, exploitative, overreaching, or unconscionable conduct.” Alternatively, lenders that are likely to be significantly oversecured should consider whether automatic acceleration upon bankruptcy confers any real advantage.

(Also seen on Insight Into Banking)

Thursday, March 10, 2011

Barrister's Club Crystal Ball (March 26, 2011)

Your are cordially invited to the Barrister’s Club Crystal Ball, which is a charity fundraiser benefitting the San Francisco Bar Association’s youth, diversity and school-to-college programs. This semi-formal event will take place at the San Francisco War Memorial’s Green Room (401 Van Ness Avenue at McAllister Street) on Saturday, March 26, 2011, at 7:00 pm. All are welcome to mingle and dance with our local attorneys, bid at the silent auction, and enjoy drinks and gourmet snacks. The price per ticket is $75, and you can register here. We would love to see you there! - Reno Fernandez

Wednesday, February 16, 2011

Borders Files Chapter 11

Mega book retailer Borders Group, Inc. commenced a chapter 11 bankruptcy case today in the United States Bankruptcy Court for the Southern District of New York (Case No. 11-10614).  The company disclosed $1.29 billion in debt and $1.27 billion in assets.  Borders owes $41.1 million to Penguin Group , $36.9 million to Hachette Book Group and $33.8 million to Simon & Schuster, all of which are book publishers.  Prior to filing, Borders secured $505 million in financing from GE Capital and other sources to assist in the reorganization.

Borders cited reduced customer spending and lack of liquidity among the reasons for filing chapter 11.  Borders President Mike Edwards said the company "does not have the capital resources it needs to be a viable competitor and which are essential for it to move forward with its business strategy to reposition itself successfully for the long term."  Borders plans to close approximately 200 of its 642 stores, 35 of which are in California, and lay off about 6,000 of its 19,000 employees.  Copies of the bankruptcy petition and first day motions can be found here. - Reno Fernandez

Wednesday, February 2, 2011

Lockyer Rejects State Bankruptcy for California

We previously posted a short article on a Republican proposal to allow states to file bankruptcy.  Bill Lockyer, California's state treasurer, has rejected the idea, arguing that bankruptcy is for individuals, companies and municipalities that cannot raise their revenue, whereas states are entitled to raise taxes.  Sacramento Bee columnist Dan Walters has commented that California's $20 billion deficit is only 1% of its economic output. - Reno Fernandez

Tuesday, January 25, 2011

Republicans Propose Allowing States to File Bankruptcy

Newt Gingrich and Texas Senator John Cornyn are advocating allowing states, such as California and New York, to file bankruptcy.  At present, only cities and other municipal entities can file bankruptcy under chapter 9 of the Bankruptcy Code.  Allowing a state to utilize some form of bankruptcy protection would likely shift losses from taxpayers to public sector union employees and pension plans.  In fact, Newt Gingrich's proposal would prohibit any tax increases as part of a reorganization.  In addition to public employees, bondholders are likely to take a loss in a state bankruptcy, and adding a chapter of the Bankruptcy Code for states will certainly upset the government bond market.  Nevertheless, University of Pennsylvanie law professor David. A. Skeel argues that state bankruptcy will make it easier for states to negotiate with unions and that the alternative of a federal bailout is unattractive.  Skeel also notes that, although the bond market will be unhappy, California bondholders are already accounting for a potential default. - Reno Fernandez

Friday, January 21, 2011

Justice Kagan's First Opinion Tightens Automobile Ownership Cost Determination Under the Means Test

In her first opinion on the United States Supreme Court, Justice Elena Kagan reports the Justices' 8-1 ruling that a consumer debtor cannot deduct the IRS standard automobile ownership costs from his or her disposable monthly income under the means test if the automobile is free and clear.  In Ransom v . FIA Card Services, N.A., 11 C.D.O.S. 459 (U.S. Supr. Ct. No. 09–907 January 11, 2011), Justice Kagan explained that the means test, which is used for determining eligibility for chapter 7 and is related to the calculation of plan payments under chapter 13, includes deductions from disposable monthly income for vehicle “Ownership Costs” and vehicle “Operating Costs” pursuant to certain IRS standards.  The Ownership Costs include only loan or lease payments, and they are deemed to be $471 per month based on national automobile financing data.  Operating Costs, on the other hand, can include the expenses of driving and maintaining a vehicle.

In Ransom, the chapter 13 debtor claimed the full Ownership Cost as well as Opweating Costs of $388 per month for a car that the debtor owned free and clear.  A creditor, namely FIA Card Services, objected to the claim of Ownership Costs and argued that the payments to creditors proposed in the plan should be increased in light of the resulting higher disposable monthly income.  The bankruptcy court agreed and denied confirmation of the plan.  The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed.

The Supreme Court focused on the language of 11 U.S.C. § 707(b)(2)(A)(ii)(I), which provides that:  “The debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides.”  Specifically, the Justices ruled that the term "applicable" means that the debtor must have actually incurred the expense.  In other words, the Ownership Costs do not apply if there are in fact no loan or lease payments.  The opinion further notes that the Ownership Costs do not include the expenses of driving or maintaining an automobile, which are covered by the separate Operating Costs deduction.

The Justices did not discuss the debtor's policy argument or alternative interpretation of the term "applicable."  These may be similar to the arguments advanced in a recent Credit Slips article.  The article argues that:  "[W]e also can think of the 'ownership expense' as the cost of saving up to replace an existing car. In addition, if we deny an ownership expense to a debtor who owns a car free and clear, we create an incentive to buy a new car on credit just before filing bankruptcy so that there is an actual out-of-pocket 'ownership expense' the debtor can deduct." 

Justice Scalia filed a dissenting opinion, arguing that the term "applicable" does not do as much work as the majority thinks.  "A House of Lords opinion holds, for example, that in the phrase ‘in addition to and not in derogation of ’ the last part adds nothing but emphasis.  Davies v. Powell Duffryn Associated Collieries , Ltd. , [1942] A. C. 601, 607."  Specifically, Justice Scalia argues that the phrase simply makes the IRS tables applicable to the means test.  The tables have entries for "one car" and "two cars," but not "no car."  In other words, the first two entries are applicable of the debtor has a car, and the last is applicable if the debtor has no car, regardless of whether there are any loan or lease payments.

In an interesting twist, the Credit Slips article criticized the Office of the US Trustee for having published guidelines on the means test that stated, without qualification, that the Ownership Costs could not be deducted if the automobile is free and clear; in other words, the US Trustee decided the Ransom case before the Supreme Court did.

By Reno F.R. Fernandez III

Tuesday, January 11, 2011

Anchor Blue Files Chapter 11

Today, Anchor Blue Holding Corp. and Anchor Blue, Inc. commenced a chapter 11 bankruptcy case in Delaware.  Anchor Blue is a clothing retailer known for its denim wear.  The company is based in Corona, California, and operates 117 stores and employs approximately 1446 employees in Arizona, California, Colorado, New Mexico, Oregon, Texas, Utah and Washington. - Reno Fernandez

Monday, January 10, 2011

Event Update: Alternative Strategies in Assisting Distressed Companies

On Thursday, January 13, 2010, John Seeley of Acrius Capital will be giving a talk entitled "Alternative Strategies in Assisting Distressed Companies" to the Barrister's Club Business, Commercial and Bankruptcy Section.  We look forward to getting the inside scoop on turnaround financing and other issues.  The program is from 12:00 to 1:00 pm, and all are welcome.  For more information and to sign up, click here.  - Reno Fernandez

Wednesday, January 5, 2011

Buyer (and Lender) Beware! Court Rules Bank May Have Acted as Financial Advisor and Wrongfully Refused to Fund All Phases of Condominium Project

In Errico vs. Pacific Capital Bank, N.A., ___ F.Supp.2d ___, 2010 Westlaw 4699394 (N.D. Cal.), William and Loretta Errico allege that in 2005 they applied for three loans to finance and develop a single parcel of real property they had owned for about 25 years.  The loan was obtained through Niraj Maharaj, a vice president of Pacific Capital Bank, with whom the Errico's had previously done business.  The bank orally agreed to finance at least 75% of the appraised value of the project.

Subsequently, Maharaj advised the Errico's that, due to a declining market, they should construct the project in phases, which would result in delayed financing.  The Errico's agreed that the financing would be staggered in three separate loans for three phases:  (1) construction of 140 condominium units; (2) construction of a commercial plaza; and (3) construction of off-site improvements (typically roads and utility trenches).  Simultaneously, the bank assured the Errico's that it would provide the promised minimum financing for the entire project.  However, as of approximately August, 2007, the bank secretly determined not to fund the condominium phase.

After the other two phases were funded, the bank advised the Errico's that the condominium construction costs should be reduced and that the units should be initially leased as apartments, and the Errico's agreed.  Thereafter, the bank approved certain expenditures for the condominium phase, additional appraisals were obtained and additional information was provided to the bank.  The prevailing economic crisis intervened, and in July, 2009, the bank informed the Errico's that it would not fund the condominium project.

The bank moved to dismiss the complaint, and the court ruled that the allegations of fraud and promissory estoppel were sufficient to state a cause of action.  Specifically, the court ruled that the allegations could support findings that the bank orally promised to finance the entire project, and that the bank acted as financial adviser to the Errico's, who reasonably relied upon the promise.

The ruling that the bank might have acted as a financial adviser may be subject to criticism because no fiduciary relationship arises in a loan transaction absent special circumstances.  Perlas v. GMAC Mortgage, LLC, 187 Cal.App.4th 429, 436 (2010).  Whether the facts of this case give rise to a fiduciary duty is likely to be an issue at trial and possibly on appeal.  In any case, this case is a reminder to both borrowers and lenders against going too far on a handshake.

By Reno F.R. Fernandez III