Distressed debt investors face a $1.5 billion disgorgement claim resulting from the accidental release of liens securing the GM term loan facility paid off in 2009.
The Big Picture
In January 2015, the U.S. Court of Appeals for the Second Circuit held that administrative agent JPMC and its counsel had inadvertently released liens securing GM’s $1.5 billion Term Loan facility shortly before the loans were repaid in full as part of the Treasury’s GM bailout.
The decision cleared the way for the Unsecured Creditors’ Committee’s 2009 adversary proceeding to have the payment disgorged, and brought into focus the question of who will ultimately bear responsibility for the now-legendary snafu: the Agent; the law firms responsible for the lien release1; the law firm’s malpractice carriers2; the hundreds of hedge funds and other institutional investors named as defendants in the Committee’s complaint back in 2009 after the error was revealed, who have now been served; or the investors’ transferees.
Whose Due Diligence Is It Anyway?
The GM lien release put a bit of a scare into the distressed secondary loan market, where legal due diligence generally focuses on credit agreement transfer provisions, the ”upstream” chain of title, and key bankruptcy filings, but rarely extends to rechecking the agent’s work in perfecting (and not accidentally releasing) security interests. Reported decisions on agent documentation missteps are few and far between, and whether credit agreement exculpatory provisions are robust enough to shield the agent and its counsel from this Moby Dick of clerical errors remains to be seen, and may take years to determine. Buyside market participants, for whom it is likely uneconomical to have counsel redo the Agent’s due diligence simply to consummate a trade, have begun to take a fresh look at whether oft-ignored enforceability representations in the standard form of Purchase and Sale Agreement sufficiently mitigate the risk of such Agent omissions.3
Winding Road
If disgorgement liability does filter down to the underlying lenders, determining which lenders initially are and ultimately should be on the hook will be no easy task. Heavy trading on the eve of the GM bailout left a significant number of trades unclosed at the time of the payoff, often resulting in record holders of the loans having to remit post-payoff credits in excess of the agreed purchase price to their buyers under so-called “proceeds letters”. Because the payoff occurred not under a confirmed plan of reorganization but under the rubric of the GM Final Cash Collateral Order4, the LSTA’s standard proceeds letter form in effect at the time of these trades was inapplicable5, leading many trading counterparties to negotiate one-off proceeds letters that in some instances may have afforded less robust seller reimbursement protection in the event of a disgorgement.
Takeaway
The scarcity of case law on when bank agents and their counsel can be held liable for clerical errors, the massive liabilities such errors may cause, the absence of routine back-up due diligence on key agent filings, and the inconsistencies among disgorgement provisions used when distressed loans go to proceeds6, can create a stew of uncertainty for prospective purchasers. As long as the period stipulated in the cash collateral order entered in borrower’s Chapter 11 case for the creditors’ committee to challenge the enforceability of the lender’s claims has not yet expired, thoughtful consideration during transfer agreement negotiations of how a lender disgorgement obligation could play out, both for the purchaser and for its potential transferees, is paramount.
Illustration by: Kiki Tikiriki/Illustration Source.
- 1 Above the Law, “Mayer Brown & Simpson Thacher Make Epic Screwup” (January 21, 2015, 3:03 PM), http://abovethelaw.com/2015/01/mayer-brown-simpson-thacher-make-epic-screwup/. ↩
- 2 Law 360, “Simpson Thacher May Be Haunted By $1.5B Loan Gaffe” (January 29, 2015, 7:35 PM), http://www.law360.com/articles/616441/simpson-thacher-may-be-haunted-by-1-5b-loan-gaffe. ↩
- 3 Examples include representations and warranties as to seller’s acts or omissions, and written notice received by seller as to possible impairments of lender rights. But the provisions are tempered by, among other things, requirements that the alleged impairments not apply generally to the entire lending group, and have not been publicly disclosed. See, e.g., LSTA Purchase and Sale Agreement for Distressed Trades – Standard Terms and Conditions (published April 24, 2014), LSTA.ORG, http://www.lsta.org/legal-and-documentation/secondary-trading#secondary-trading (last visited June 25, 2015), §§4.1(h), (w). ↩
- 4 Final Order Under 11 U.S.C. §§105, 361, 362, 363 and Fed. R. Bankr. P. 2002, 4001 and 9014 (I) Authorizing Debtors to Use Cash Collateral and (II) Granting Adequate Protection to Prepetition Revolver Secured Parties, In re General Motors Corporation, Chapter 11 Case No. 09-50026 (REG) (Bankr. S.D.N.Y. June 25, 2009). ↩
- 5 See LSTA Chapter 11 Plan Proceeds Letter Agreement for Post-Effective Date Settlement of Distressed Trades (published April 24, 2014), LSTA.ORG, http://www.lsta.org/legal-and-documentation/secondary-trading#secondary-trading (last visited October 25, 2015), p.1 n.1. ↩
- 6 “Curious Disgorge”, http://www.kieselaw.com/newsletter/curious-disgorge (last visited October 22, 2015). ↩