Every now and then the name of the parties in a case just sort of jumps out and grabs you. A recent decision out of Nevada involved a guaranty given by The Mafia Collection (“Mafia”) for certain loans made to Murder, Inc., LLC (“Murder”).  Murder defaulted on the loans and the secured creditors sought to foreclose on the collateral pledged by Mafia comprising some 1500 mob related artifacts.

While the foreclosure case was pending, Mafia acquired some of the secured notes that it had guaranteed. Mafia then filed a counterclaim/third-party claim against the collateral agent for the lenders, Andrew DeMaio, alleging unjust enrichment and breach of fiduciary duty. The lower court ruled in favor of the collateral agent and the secured creditors and awarded attorney fees and costs as allegedly provided for in the parties’ secured notes and security agreement.

On appeal to the Nevada Supreme Court, Mafia raised several issues, one of which dealt with whether the district court erred by dismissing as nonassignable Mafia’s claim for breach of fiduciary duty. A claim for breach of fiduciary duty is similar in nature to a claim arising under fraud as opposed to a breach of contract type of claim. In many states, including Nevada, a claim for fraud is not assignable to third parties, it is deemed to be “personal” to the defrauded party.

The court found that the district court erred by dismissing Mafia’s claim because there was a disputed issue of material fact as to the basis of Mafia’s claim, namely, whether the collateral agent allegedly breached his fiduciary duty to Mafia in its personal capacity, as a guarantor and/or a creditor (after it acquired the secured loans), or whether he allegedly breached his fiduciary duty to the selling noteholders, who in turn attempted to assign their claim to Mafia by virtue of the loan assignments. The former claim would be permissible; the latter would not.

Mafia’s strategy of purchasing notes at a discount is a traditional method used by guarantors to reduce their potential liability. Interestingly, the secured creditors argued that Mafia’s purchase of the notes was an attempt to hinder the ability of the remaining creditors to collect on the notes. The court found that “there is nothing nefarious about a guarantor acquiring a secured party’s note… and that there was ample support for the proposition that a party who pledges collateral is entitled to protect themselves by purchasing the lien.”

The complicating factor for the remaining secured creditors was that the security agreement was in favor of multiple parties, one of whom now has a different financial interest in the collateral. The case did not contain any excerpts from the actual loan documentation but it would not be unusual for such documents to contain provisions where certain percentages of the note holders may be required to approve certain courses of action and to that extent the administration of the loan would be similar to that presented in a loan participation arrangement or a syndicated loan where decisions are approved by the “required lenders.”

There are several ways of addressing this type of issue. The FDIC dealt with it during the financial crisis by simply forbidding borrowers and guarantors from being able to bid on note sales it conducted after troubled banks were placed into receivership.  A common method used in bank loan participations is to build a right of first refusal into the loan participation documents so that a selling creditor must first offer to sell its interest in the loan to one of the existing lenders.

The takeaway for lenders is that this sort of issue needs to be dealt with on the front end of the transaction. Whatever united front a bank group presents at the outset of a credit relationship quickly begins to degenerate once the loan becomes troubled and lenders start heading for a quick exit.

The Mafia Collection v. Demaio, 2015 WL 3936836 (Nev 2015)(June 24, 2915)