Recently, the U.S. Court of Appeals for the Sixth Circuit issued an opinion in the Chapter 7 bankruptcy case Bash v. Textron Financial Corporation (In re Fair Finance Company), which has important effect on a number of legal issues, including whether a trustee in bankruptcy can bring a conspiracy claim on behalf of a bankrupt entity that participates in a fraud (creating a split with the Second Circuit) and whether, for the purpose of a fraudulent conveyance, the statute of limitations runs from the time of the transfer or the time when the fraud occurred or could reasonably have been discovered. However, the blockbuster in the case is that the Court held that an amended and restated loan agreement, which contains language commonly used by many banks, may actually have been a novation of the original agreement resulting in the loss of the lender’s security interest. This Advisory summarizes only that aspect of the holding which considered the question of whether the amended and restated loan agreement constituted a novation.

On January 7, 2002, Textron Financial Corporation and United Bank entered into a Loan and Security Agreement with Fair Finance Company (the “Debtor”) and its parent, Fair Holdings, Inc. (“FHI”) (the “2002 Agreement”). The 2002 Agreement created a revolving credit facility secured by the assets of the Debtor and FHI. To perfect the security interest, the lenders filed a UCC Financing Statement with the Ohio Secretary of State. In 2004, the Debtor, FHI and Textron entered into a “First Amended and Restated Loan and Security Agreement” (the “2004 Agreement”). The 2004 Agreement removed United Bank as a party and, as stated, evidenced the parties’ “desire to amend and restate the Original Agreement.” Bash v. Textron Fin. Corp. (In re Fair Fin. Co.), No. 15-3854, 2016 U.S. App. LEXIS 15432, at *37 (6th Cir. Aug. 23, 2016). The 2004 Agreement contained a “Grant of Security Interest” under which “the Debtor and FHI ‘assign[ed] [Textron] a continuing security interest and lien upon’” their assets. Id. at *18. The 2004 Agreement went on to state that “[i]t is Borrowers’ express intention that this Agreement and the continuing security interest granted hereby, in addition to covering all present obligations of Borrowers to Lender and its Affiliates…shall extend to all future obligations of the Borrowers to Lender intended as replacements or substitutions for the Obligations.…” Id.

The “final provisions [of the 2004 Agreement] provided that it 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 all prior oral or written agreements related to the subject matter hereof.’” Id. at *20.

Textron did not file a UCC financing statement in connection with the execution of the 2004 Agreement, but in 2006 it filed a UCC amendment “purporting to evidence the continuation of the security interest established on January 8, 2002….” Id. at *20-21.

In the District Court, the Trustee argued that the 2004 Agreement constituted a novation of the 2002 Agreement, but the Court found it to be merely a refinancing. The Circuit Court, however, disagreed, holding that the Trustee had put forth enough evidence at this stage in the proceedings to support his contention that the parties intended a novation to create a justiciable issue. Id. at *42.

The Court cited four provisions in the text of the 2004 Agreement in support of its holding:

37. “Paragraph 39 expressly sets forth the parties’ desire to [have that agreement] ‘supersede[ ] any and all prior oral or written agreements relating to the subject matter thereof.’” at *37.

38. Another paragraph provides that it “constitutes the entire agreement of Borrowers and Lender relative to the subject matter hereof.”

39. “[T]he Debtor and FHI agreed to ‘grant, pledge, convey and assign’ a new security interest in and lien upon their property to Textron ‘to secure the prompt and full payment and complete performance of all obligations of Borrowers to Lender under [the 2004 Agreement].’”

40. The parties agreed that the 2004 Agreement “was the product of ‘valuable consideration, the receipt and sufficiency of which are hereby acknowledged.’” at 39.

Reading these four provisions together, the Court held that they “support a finding that the parties demonstrated their intent to ‘extinguish[] their obligations under the prior agreement’ and be bound anew under the terms of [the 2004 Agreement].” Id.

The Court also found evidence that the parties may have intended a novation by reason of the following circumstances:

  1. The 2004 Agreement was entered into on the date the 2002 Agreement expired;
  2. New promissory notes and guarantees were issued;
  3. New financial terms were agreed; and
  4. United Bank ceased to be a lender.

Id. at *39-40.

The Circuit Court noted that the only authority relied on by the District Court for rejecting the Trustee’s claim that the 2004 Agreement was a novation was the Official Committee of Unsecured Creditors of Tousa, Inc. v. Citicorp North America, Inc. (In re TOUSA Inc.), No. 09-60589, 20011 WL 1627129 (S.D. Florida. Mar. 4, 2011). The Court distinguished this case because in In re TOUSA Inc. the Florida district court “…relied heavily on [the agreement’s] explicit statement that ‘it was the ‘intent of the parties…that the security interests and [l]iens granted in the [c]ollateral under and pursuant to the [o]riginal [s]ecurity [a]greement shall continue in full force and effect.’” But the Court found that “[no] such language exists in the 2004 [Agreement]…and that renders decision of the issue as a matter of law especially challenging.” Id. at *41-42.

The key takeaway from In re Fair Finance Company is that parties to loan agreements must be clear in their intent and expressly state in any amended and restated agreements that the security interest will continue in full force and effect in order to avoid a court finding that the amended agreement and restated constitutes a novation.

Thus, in light of the Court’s decision, we recommend that clients consider including in all future amended and restated loan agreements language to the following effect:

“This [reference amending and restating agreement] is not intended to, and does not, novate [reference existing agreement] and [reference borrower(s)] reaffirms that the existing security interest created by the [reference existing agreement or other appropriate document] is and remains in full force and effect.”

Of course, the precise language should be reviewed with counsel.