WGLO BREAKOUT SESSION - Opinion Issues Relating to the Difference between Amendments and Novations. Bash v Textron Financial Corporation (In re Fair Finance Company) 834 F.3d 651 (6 th Cir. 2016) Does your Amendment and Restatement result in a Novation? Larry Safran & Elizabeth Orelup A. Summary of Facts (Bad facts make bad law) To finance its operations, both prior to and subsequent to the entering into of the credit agreement, debtor, Fair Finance Company, had a practice of selling unsecured investment certificates called V Notes to unsophisticated investors in NE Ohio. Originally having a 6 month term, after an LBO the principal amount of V Notes issued increased substantially and the new notes had a longer maturity. Post-LBO proceeds were used to fund insider loans. 2002 In order to finance the LBO of the debtor, acquisition co Fair Holdings Inc. (FHI) and, immediately after the acquisition, debtor Fair Finance Company (collectively with Holdings, the Borrowers ), enter into Loan and Servicing Agreement (2002 L&SA) with two lenders, Textron Financial Corporation and United Bank. The 2002 L&SA included a blanket lien security interest 2004 Borrowers and Textron entered into a First Amended & Restated Loan and Servicing Agreement (2004 L&SA). The terms of the 2004 L&SA included: Recitals that the parties intended to amend and restate the original agreement to reduce the amount and modify certain terms and conditions of the lending. A fairly standard merger/integration clause stating that the 2004 L&SA was intended by the Borrowers and the Lender to be the final, complete and exclusive expression of the agreement between them and that the Agreement supersedes any and all prior oral or written agreements relating to the subject matter hereof. A new grant of a security interest and new promissory notes and new guarantees. A new interest rate, new fee schedule, new covenants, new events of default and new conditions precedent. The requirement that the Borrowers give Textron 50% of the amount required to obtain United Bank s release from the 2002 1
L&SA as well as all accrued interest, fees and expenses owing under the 2002 L&SA. New UCC financing statements were not filed but the existing financing statements were amended purporting to evidence the continuation of the 2002 security interest. 2007 Borrowers secure alternative asset sale financing and repays Textron and discharges the 2004 L&SA and related security interests. 2009 FBI raids debtor s headquarters and various principals indicted for wire fraud, securities fraud, etc. Fair Finance Company files for bankruptcy shortly thereafter. B. Summary of Proceedings Bankruptcy Trustee and other creditors move to set aside 2007 payments to Textron on, among other grounds, fraudulent conveyance. There was evidence that Borrowers were running a Ponzi scheme as early as 2003 which is why United insisted on getting out. Intimation that Textron knew of fraud at time of 2004 L&SA and that Textron entered into 10 amendments to 2004 L&SA to waive covenants and received substantial consideration for doing so. Trustee brings claims against Textron for aiding and abetting as well as actual and constructive fraudulent transfer. Textron moves to dismiss claims and bankruptcy court denies motion. On appeal, the district court overrules the bankruptcy court and holds that as a matter of law the 2004 L&SA was not a novation and therefore neither the 2004 L&SA nor the payments made thereunder constituted transfers for purposes of the Trustee s fraudulent transfer claims since Textron already had a pre-existing security interest. Sixth Circuit analyzing Ohio s Uniform Fraudulent Transfer Act first holds any constructive fraudulent transfer claims (i.e. a transfer made without receiving reasonably equivalent value ) were time barred. However, any claims as to actual fraudulent transfer (i.e. with the actual intent to hinder, delay or defraud any creditor of the debtor ) were not timed barred. Trustee argues that under Ohio law the 2004 L&SA constituted a novation and therefore the transfers pursuant to it can be set aside as an actual fraudulent conveyance. The Sixth Circuit looked at the elements of intent, knowledge and consent to determine if there had been a novation of the 2002 L&SA. The court found support for a novation in the text of the 2004 L&SA, where several provisions evidenced the intent of the parties for the 2004 L&SA to extinguish and wholly 2
replace the 2002 L&SA. In particular, the court focused on the merger integration clause and the new granting clauses among other things. The court also found supporting circumstantial evidence, such as the timing of the entering into the 2004 L&SA, which occurred at the maturity of the 2002 L&SA. Additionally, new terms in the 2004 L&SA all signified the intent of the parties to extinguish the 2002 L&SA. The court discussed and distinguished the TOUSA case that the district court relied upon because the agreement at issue there included express language that the prior security interest continued in full force. When all the facts were examined together, Sixth Circuit found there existed an ambiguity as to whether the parties intended the 2004 L&SA to extinguish the 2002 L&SA and remanded to the district court for further proceedings. Further, the court stated that the trustee demonstrated with sufficient evidence that the security interest granted by the Borrowers pursuant to the 2004 ARL&SA, along with all payments made by the Borrowers in accordance with the 2004 ARL&SA, amounted to fraudulent transfers under the Ohio UFTA because each transaction was undertaken in an effort to perpetuate a Ponzi scheme that inevitably collapsed and left hundreds of unsophisticated Ohio investors holding the bag. B. Summary of New York law on Novation Under New York law, the essential elements of a novation are: (1) a previous valid obligation; (2) an agreement of the parties to a new contract; (3) extinguishment of the previous obligation; and (4) a valid new contract. Atlantic Mutual Ins. Co. v Balfour MacLaine Int l Ltd., 85 F. 3d 68, 82-83 (2d Cir. 1996); Wasserstrom v. Interstate Litho Corp., 114 A.D.2d 952, 495 N.Y.S.2d 217, 219 (App. Div. 1985). "New York courts have set a stringent standard for novation." Wang v. Chen, 1992 U.S. Dist. LEXIS 299, *15, 1992 WL 7840, *6 (S.D.N.Y. Jan. 10, 1992), Citibank, N.A. v. Benedict, 2000 U.S. Dist. LEXIS 3815, 97 Civ. 9541, 2000 WL 322785 at *8 (S.D.N.Y. Mar. 28, 2000). To satisfy the second and third elements set out above, all parties must have clearly expressed their intention that a subsequent agreement superseded or substituted for an old agreement. Flaum v. Birnbaum, 120 A.D.2d 183, 508 N.Y.S.2d 115, 120 (App. Div. 1986) (quoting Northville Indus. Cor p v. Fort Neck Oil Terminals Corp., 100 A.D.2d 865, 474 N.Y.S.2d 122, 125 (App. Div. 1984)). The key element of a novation is that the parties unequivocally intended to extinguish and discharge the prior obligation. See, e.g., Citibank, N.A. v. Benedict, 2000 U.S. Dist. LEXIS 3815, 2000 WL 322785 at *8-9. "Not only must the intention to effect a novation be clearly shown, but a novation must never be presumed." Wang v. Chen, 1992 U.S. Dist. LEXIS 299, 89 Civ. 8319, 1992 WL 7840 at *6 3
(S.D.N.Y. Jan. 10, 1992) quoting Beck v. Manufacturers Hanover Trust Co., 125 Misc. 2d 771, 481 N.Y.S.2d 211, 218 (S. Ct. 1984) (citations omitted). "To establish a novation, there must be a clear and definite intention on the part of all the concerned parties that such is the purpose of the agreement." Yahaya v. Hua, 1989 U.S. Dist. LEXIS 14115, 87 Civ. 7309, 1989 WL 214481 at *4 (S.D.N.Y. Nov. 28, 1989). C. Changes to Opinion Practice as a result of the Case If your firm previously gave lien affirmation opinions (e.g. opinions that the creation and/or perfection of the security interest has not been adversely affected by the amendment) in connection with amendments or amendments and restatements of credit documents, do you still do so? Does your firm give "lien affirmation" opinions in connection with amendments or amendments and restatements of credit documents? Has or should the case change your firm's policy on such opinions? Does your firm require that no novation language be included for opinions with respect to amendments and restatements? Same question for amendments? Does the case change your view as to whether a new granting clause in the amendment or amendment and restatement is advisable? Does the case change your view on whether to include merger or integration clauses in the amendment or amendment and restatement? Would the case have turned out differently if decided under the law of New York or your state rather than Ohio? 4
Suggested insert to amended and restated security agreement Section. Amended and Restated Agreement. This Agreement amends and restates the Security Agreement dated as of, 20 (as amended, supplemented or otherwise modified prior to the date hereof, the Original Security Agreement ) in full but shall not constitute a novation thereof nor impair the liens and security interests created thereunder it being the intent of the parties hereto that obligations under the Original Security Agreement shall remain in full force and effect as amended hereby and to the fullest extent permitted by applicable law this Agreement shall not adversely affect the liens and security interests created under the Original Security Agreement or the priority thereof. All references in any other [Loan Document] to the Original Security Agreement shall, or on after the date hereof, be deemed to be references to this Agreement. 5