District Judge James D. Zagel of the United States District Court for the Northern District of Illinois on Nov. 9, 2007, ordered a Chapter 11 debtor-in-possession ("DIP") to "immediately" pay its so-called "commitment" and "DIP Facility Funding" fees. ("Loan Fees"). Arlington LF, LLC, v. Arlington Hospitality, Inc., 2007 WL 3334499 (N.D. Ill. 11/9/07). Reversing the bankruptcy court, the district court held that the DIP was not excused from paying the fees despite the lender's earlier refusal to advance further funds on its $6 million revolving loan agreement ("Revolver"). Id. at 5.
The Interim DIP Financing Order
The lender had negotiated the DIP facility with its borrower on the eve of bankruptcy, evidencing that agreement with only a term sheet providing for, among other things, a $6 million Revolver. Instead of a loan agreement, the parties relied on an interim financing order that had been approved by the bankruptcy court during the first few days of the reorganization case, over the objection of certain creditors. Among other things, the order recited that the terms of the proposed financing were "more favorable" than any other alternative financing; and that the parties had "negotiated in good faith and at arm's length." Id. at 7. Moreover, the court found that the terms of the proposed financing were not only "fair and reasonable," but also "enforceable according to their terms." Id.
Loan Fees Payable Immediately
Attached to the interim order was a budget listing authorized disbursements. In the event of any conflict between the order and the earlier term sheet, the order stressed that its terms controlled. Id. at *2. Most important, the order provided that the DIP was required to pay "immediately" the $310,000 of Loan Fees. Id. Other expenses incurred by the lenders, such as legal fees, would, in contrast, be payable "upon invoice." Id.
Loan Fees Not Payable From Loan Proceeds
The term sheet preceding the interim order provided that the loan proceeds could be used to pay all fees and expenses. Id. This language, however, was not contained in the interim financing order. On the contrary, the budget attached to the interim order expressly provided that the Loan Fees were to be paid with separate funds, but not drawn from the Revolver loan proceeds. Id. Significantly, the interim order provided that the DIP would be in default if it failed to pay the Loan Fees. Id.
The DIP's Default
When the DIP failed to pay the Loan Fees immediately, the lender became unwilling to continue its relationship. It told the DIP's investment banker and the creditors' committee that it would make no further loans, and that the DIP should find another lender. Id. at *2–*3. When the DIP failed to pay other expenses that the lender had invoiced, the lender called a default. Id. at *3.
The DIP eventually sold all of its assets, and used the proceeds to pay the entire principal balance on the DIP loan plus non-default interest. It refused to pay default interest and the Loan Fees. Id. Lender's Motion for Payment The lender moved in the bankruptcy court, seeking default interest and the Loan Fees. The bankruptcy court denied the motion. Id.
Bankruptcy Court Reasoning: Lender Breached First
The parties agreed that the terms of the interim order controlled. Id. at n. 2. Nevertheless, citing the lender's earlier communications with the debtor's investment banker and the creditors' committee about ending the lending relationship, the bankruptcy court held that the lender had anticipatorily breached its loan agreement. Id. As a result, reasoned the bankruptcy court, no Loan Fees were ever due the lender until it had sent an invoice to the DIP, weeks after the lender had purportedly breached its agreement. Id. at *4. The lender appealed.
District Court Reversal: DIP Breached First
According to the district court, the DIP had breached the agreement first by failing to pay the Loan Fees. Id. at *3. It could not thus claim that it had been excused from paying because of the lender's actions. Id. at *5.
The Loan Fees here were due "immediately" on the making of the loan. Id. Because the DIP failed to pay those fees, it had breached the terms of the interim order. Id. at *3. Disagreeing with the bankruptcy court, the district court held that the lender did not need to send the DIP an invoice for the Loan Fees that were "payable immediately" under the terms of the interim order. Id. at *4. Other types of expenses, under the terms of the interim order, however, had to be invoiced separately (e.g. the lender's legal fees). Id.
When a plaintiff in a contract action claims an anticipatory breach by the other party, reasoned the district court, it must show that it is able and willing to perform its part of the contract in a timely manner. Id. at *5. A party in default—the DIP here—thus cannot complain of the other party's anticipatory repudiation. Id. Because of the DIP's prior default here, it could not "claim that Lender anticipatorily breached and withhold performance" (refuse to pay the Loan Fees plus default interest). Id.
- Parties Typically Draft Court Orders. The court recognized that "in all likelihood…the parties supplied the pre-drafted" interim order to the bankruptcy court for its "signature." Id. at *4, n.3. As experienced lenders know, an order like the one here is often the operative agreement governing each party's obligations. And note that it was careful drafting by lender's counsel that carried the day: It showed what fees were due, when those fees were due and the controlling nature of the order over any earlier documents (e.g., the term sheet).
- The Financing Budget Is Critical. Again, experienced lenders know that the budget attached to any DIP Financing or cash collateral order is critically important. Here, it showed that loan proceeds could not be used to pay the Loan Fees, a key fact leading to the district court's reversal.
- Growing Judicial Respect For Bargained For Agreements. In a series of recent alerts— "Supreme Court Allows Unsecured Lender to Recover Contractual Legal Fees," (March 2007); "Court Insulates Lender's Collateral From Professional Fee Surcharge," (July, 2007); and "Oversecured Lender's Contractual Prepayment Penalty Enforceable As Unsecured Claim Against Solvent Debtor," (November, 2007), we have noted a growing judicial respect for clearly drafted, negotiated loan agreements. Unfortunately, appeals are often necessary to arrive at the right result