In the May 2017 issue of Debt Dialogue, we discussed the recent decision by Judge Martin Glenn of the U.S. Bankruptcy Court for the Southern District of New York with respect to the actual and constructive fraudulent conveyance claims brought by the litigation trust (Trust) established in the bankruptcy case of LyondellBasell Industries AF S.C.A. (LBI). In this issue, we explore the part of Judge Glenn’s opinion that addressed the Trust’s claims against Access Industries, Inc. (Access) for its failure to fund a draw request under a revolving credit facility in the immediate run up to LBI’s Chapter 11 filing.
On July 16, 2007, a merger agreement was signed between Lyondell Chemical Company and Basell AF, with LBI as the resulting company. Despite some negative portents, such as Lyondell missing its EBITDA projections for the third and fourth quarters of 2007, the merger closed on December 20, 2007.1
The next year was a tumultuous one for LBI, with the company being battered by natural disasters, work accidents, and the global economic slump. Given the liquidity crunch that occurred in the run up to the merger, LBI began looking to upsize its existing facilities, but its lenders were reluctant to upsize unless LBI entered into an additional revolving credit facility with Access as lender (Access Revolver). On March 28, 2008, LBI entered into the Access Revolver, which provided for a $750 million unsecured revolving line of credit.
As LBI continued to suffer from liquidity issues, it drew down $300 million on the revolver in October 2008, but immediately repaid the drawn amounts that same month. The company’s liquidity issues continued to worsen, however, and LBI retained bankruptcy counsel, negotiated forbearance agreements in connection with its other indebtedness, and began preparation for a possible Chapter 11 filing. On December 30, 2008, LBI requested a full draw down on the Access Revolver. Aware of LBI’s bankruptcy preparations, including the retention of bankruptcy professionals, Access refused to fund the draw request, citing its belief that a “material adverse change” (a “MAC”) had occurred.2 On January 6, 2009, LBI filed for bankruptcy.
Bankruptcy Preparation Is No MAC
In the aftermath of the bankruptcy, the Trust sued Access, alleging that its refusal to fund the revolver constituted a breach of contract under the Access Revolver. Access responded that its obligation to fund was contingent on the satisfaction of certain conditions, including that a MAC had not occurred.
As a condition precedent to borrowing under the Access Revolver, the credit agreement required, among other things, that LBI represent that it was solvent as of the closing date, and that a MAC had not occurred as of the date of the borrowing date. The relative dates as of which these representations were made proved to be critical in Judge Glenn’s analysis of the Trust’s breach of contract claim.
The MAC provision in the Access Revolver included whether a “a material adverse effect on the business, operations, assets, liabilities (actual or contingent) or financial condition of the Company” had occurred. Access argued that because LBI was preparing for bankruptcy at the time of the borrowing request, the MAC was triggered and therefore LBI could not meet the conditions precedent for a revolver draw.
Judge Glenn rejected this argument and ruled that the fact that the company was heading towards bankruptcy was insufficient by itself to trigger the MAC. He found that reading bankruptcy preparation into the MAC was tantamount to creating a solvency requirement in the MAC and solvency was only a requirement under the Access Revolver as of the closing date, not as of the borrowing request date. Accordingly, Judge Glenn ruled that Access breached the credit agreement by refusing to fund the borrowing request.
Effect of a Damages Waiver Provision
In connection with pretrial motion practice, Judge Gerber (who was previously overseeing the Lyondell case) had upheld the enforceability of a damages waiver provision in the Access Revolver.3 Specifically, the Access Revolver provided as follows:
No [lender] shall have any liability for any special, punitive, indirect or consequential damages related to this Agreement ... or arising out of its activities in connection herewith or therewith.
Access argued that this provision protected it from any claim by the Trust that it breached the Access Revolver in refusing to fund. The Trust argued that the provision was unenforceable, and even if it was enforceable, the waiver did not preclude restitutionary damages.
In addressing the dispute, Judge Gerber found that damage waiver provisions will be upheld under New York law absent disparity among the parties’ bargaining power, or misconduct by the breaching party.4 Finding that neither of these factors was present, Judge Gerber held that the waiver was enforceable, but that the Trust may still be entitled to restitutionary damages.
As such, the breach of contract claim proceeded to trial.
As noted above, following the trial, Judge Glenn (who was now overseeing the case) determined that Access improperly refused LBI’s revolver draw, and thus breached the Access Revolver. Therefore, it was necessary to determine exactly what LBI was entitled to in “restitutionary damages.” In that respect, Judge Glenn found that restitutionary damages “essentially strip the defendant of a wrongful gain, the standard of liability is not the value of the benefit conferred but the amount of the profit wrongfully obtained.” Accordingly, the quantum of damages should be the amount of the commitment fee received by Access in connection with the Access Revolver, which was $12 million. However, because LBI was able to draw down $300 million or 40% of the facility, Judge Glenn reduced the award to 60% of the commitment fee, or $7.2 million.
Companies facing financial distress are under tremendous pressure to preserve every last drop of liquidity in the run up to a bankruptcy filing. To the extent a revolving credit facility is untapped prior to a bankruptcy filing, that potential liquidity source is gone forever. It is therefore not unusual for a distressed company to attempt to max out its revolving credit facilities in an effort to preserve liquidity. By the same token, an alert lender will likely be aware that a bankruptcy filing is in the offing, and will seek to limit its exposure to the company and avoid funding any unfunded commitments.
Depending on the underlying loan documents, it may be difficult for a lender to extricate itself from its commitments to a distressed borrower by relying solely on the contractual provisions tied to the financial well-being of the borrower, such as a MAC clause, a solvency test, or some other financial covenant. Judge Glenn’s decision in Lyondell makes it clear that prognosticating a MAC may be difficult, even where the borrower is clearly on its way to bankruptcy.
Where a credit agreement includes a damages waiver, however, Lyondell suggests another possibility — the efficient breach of a lending commitment. The idea behind efficient breach is that a contract counterparty is able to accurately determine the cost of complying with its contractual obligations and weigh that cost against the cost of breaching the contract. Lyondell suggests that where a lender has not engaged in malicious or self-dealing conduct, and has negotiated a damages waiver with a borrower possessing equal bargaining power, the quantifiable cost of breach may be lower than the uncertain and possibly far higher costs of compliance. Given the prospect of lending substantial sums to an insolvent or near-insolvent borrower, a revolving lender could well conclude that even were its reliance on the MAC to fail, the downside of forfeiting its commitment fee may be more attractive than sending a multimillion-dollar advance out the door to a soon-to-be-bankrupt debtor.