Prudential Insurance Company of America v. WestLB AG, 961 N.Y.S. 2d 360 (2012)
A group of lenders participated in a syndicated loan. When the borrowers filed for bankruptcy, the lenders were forced to buy certain of the collateral by way of a credit bid. Some of the lenders agreed to provide exit financing in exchange for enhanced rights to the proceeds of the collateral granted by the administrative and collateral agent with the consent of a majority of the lenders. Upon the sale of the collateral, however, the minority of lenders, who did not participate in the grant of the enhanced rights to the exit lenders, complained that the enhanced rights were in contravention of the credit agreement that provided for pro rata distributions to all lenders. The court agreed and, on summary judgment, held the exit lenders liable for conversion of the minority lender’s pro rata share and, but for an exculpation clause creating a triable issue, would have also held the administrative and collateral agent liable for breach of contract.
Prudential Insurance Company of America, Natixis, New York Branch, and Metropolitan Life Insurance Company, the plaintiffs here, were part of a group of 16 lenders that extended loans totaling $262 million to certain borrowers, secured by three ethanol plants. Under the Credit Agreement, WestLB AG was appointed administrative and collateral agent and is the defendant here along with certain other lenders. The Credit Agreement provides for pro rata distribution to the lenders of all payments received with respect to the loan, including repayments consisting of proceeds of collateral sales.
Following the borrowers’ bankruptcy filing, certain lenders and WestLB formed a steering committee to develop a strategy to sell the collateral, i.e., the three ethanol plants. First, certain lenders and WestLB extended DIP financing to the borrowers to fund their working capital needs pending the sale. Second, certain lenders and WestLB committed to extend exit financing to fund working capital needs in the event not all of the plants sold to a third party and the lenders were forced to obtain the collateral through use of a credit bid. While WestLB afforded all of the lenders the opportunity to commit to the exit facility in exchange for enhanced post-sale rights, none of the plaintiffs agreed to participate in the facility. Finally, WestLB, with the consent and guidance of certain lenders, directed the section 363 sale of the ethanol plants.
Only one plant sold to a third party at the auction, for $55 million, and the lenders became the owners of the remaining plants pursuant to a credit bid. The proceeds of the sold plant repaid the DIP financing and then were distributed pro rata to the lenders pursuant to the Credit Agreement. After the sale, the plaintiffs sought to participate in the exit facility but were turned down by the lenders who had agreed to participate pre-sale.
The lenders’ ownership of the two remaining plants was to be governed by an operating agreement drafted by WestLB that sought to create a management and ownership structure that rewarded the exit lenders through "participation enhancements" at the expense of the non-participating lenders (including the plaintiffs). The operating agreement generally excluded the non-exit lenders from voting and management, reduced their pro rata distributions by providing the exit lenders with priority in distributions and liquidation preferences, and diluted their pro rata distributions by providing for an increased distribution to the exit lenders beyond what they would have received under the Credit Agreement.
When the remaining two plants were eventually sold for $200 million and the proceeds were going to be distributed to the lenders pursuant to the operating agreement, rather than pro rata pursuant to the Credit Agreement, the plaintiffs sued WestLB and the other exit lenders for breach of contract, conversion, and declaratory judgment, and obtained a temporary restraining order.
The plaintiffs argued that the Credit Agreement mandated pro rata distribution of the sale proceeds to the lenders. Thus, any distribution of proceeds on a non-ratable basis pursuant to the operating agreement constituted a breach of the Credit Agreement.
WestLB and the exit lenders did not deny that the distribution of sale proceeds pursuant to the operating agreement resulted in the exit lenders obtaining more than they would have had the proceeds been distributed pro rata pursuant to the Credit Agreement. They argued, however, that, but for the participation enhancements, there would have been no exit facility to fund working capital prior to the sale, and, as a result, the plants would have been sold for much less and all of the lenders would have received less.
WestLB further argued that it was authorized under the Credit Agreement to pursue the strategy it chose, as "necessary and desirable" to "protect or realize upon" the lenders’ interest in the collateral. In other words, WestLB argued that the plaintiffs had consented in the Credit Agreement to be dragged along by the majority of the lenders during exactly this kind of process.
The court began with the Credit Agreement, noting that it provided "in no uncertain terms" that all collateral proceeds must be distributed to the lenders on a pro rata basis. The court rejected WestLB’s contention that it was permitted to pursue the conveyance of the collateral to the lenders under the terms of the operating agreement because "Required Lenders" (a majority of the lenders) approved the participation enhancements granted to the exit lenders. The court found that the Credit Agreement did not grant unfettered discretion to WestLB and specifically required the unanimous consent of all lenders to modify their contractual rights in connection with the sale of all or substantially all of the collateral. Thus, the court held that there was no legal justification for the differential treatment of lenders vis-à-vis their rights in the collateral without their consent.
The court granted summary judgment against the exit lenders for conversion by reason of their accepting sale proceeds in complete disregard of the pro rata distribution rights of the lenders and, but for an exculpation clause in the Credit Agreement that created a triable issue, would have granted summary judgment against WestLB for breach of contract.
The court’s decision certainly dis-incentivizes pre-bankruptcy lenders from making exit loan facilities that, under the circumstances, may be critically needed and not obtainable from any other source. The court appears to be asking such lenders to take all the risk but not receive any awards, ignoring the new role they’re playing and focusing only on their pre-bankruptcy status. Furthermore, the court’s decision puts administrative and collateral agents in an untenable position where, to avoid any liability, they may need to both (i) act swiftly to preserve collateral value and (ii) obtain the unanimous consent of all lenders. On the other hand, the court is clearly attempting to ensure that a majority of lenders aren’t permitted to run roughshod over a minority of lenders in contravention of or in a manner inconsistent with their rights. In any event, the decision highlights the importance of carefully considering intercreditor issues at the outset of a loan.