This post was also written by Bart Cicuto.
A recent decision out of the U.S. District Court for the Western District of Washington will be of interest to both lenders and borrowers of loans that are expected to be traded. In Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Limited, hedge funds found themselves excluded from the definition of “Eligible Assignee” under a loan agreement when the Court narrowly interpreted the meaning of “financial institutions” to exclude a distress debt fund. The Court equated “financial institutions” with “entities that make loans” rather than any entity that manages money, such as a hedge fund, ultimately resulting in the fund’s inability to vote for a Reorganization Plan.
In April 2008, Meridian Sunrise Village, LLC (“Meridian“) borrowed $75 million from U.S. Bank to construct a shopping center. Unlike the common LSTA or LMA provisions, the negotiated loan agreement restricted assignments to “Eligible Assignees,” defined as “any commercial bank, insurance company, financial institution or institutional lender.” Meridian specifically sought to limit who was an “Eligible Assignee” because of its prior negative experiences and to avoid predatory investors in the future. U.S. Bank subsequently assigned portions of the loan to Bank of America, Citizens Business Bank, and Guaranty Bank and Trust.
In early 2012, the lenders declared a non-monetary default under the loan agreement. While not charging Meridian default interest, U.S. Bank requested that Meridian waive the “Eligible Assignee” limitations to allow for a sale of the loan. Meridian refused the request.
In January 2013, U.S. Bank notified Meridian of its intent to charge the default interest rate, which Meridian could not afford to pay, so Meridian filed for Chapter 11 protection. After the bankruptcy filing, Bank of America transferred its interest to NB Distressed Debt Limited Fund, who subsequently assigned one-half of its interest to two other hedge funds (collectively, the “Funds“). The Funds were in the business of acquiring distressed debt, and, according to Meridian, were exactly the types of lenders intended to be prohibited by the “Eligible Assignee” provision. Meridian immediately objected to the transfer of debt, and argued that the Funds should be precluded from exercising “Eligible Assignee” rights, including voting on its proposed Reorganization Plan. The Bankruptcy Court granted an injunction on the Reorganization vote and the Funds appealed; their primary argument centered on, what they believed to be, the “broad, [and] even limitless” definition of “financial institution” in the loan agreement. The Court disagreed.
The Dispute over Language
The Funds contended that “financial institutions” should be interpreted broadly, based on its dictionary definition, and should include all entities that handle and invest funds. The Court found this definition to be overly broad, and if interpreted as such, would have “no limiting effect at all”, allowing free assignment to virtually any entity with a remote connection to money management, including a “pawnbroker”.
Furthermore, the Court interpreted “financial institutions” in such a way that harmonized with “commercial bank”, “insurance company” and “institutional lender”—the other types of “Eligible Assignees,” reasoning that for the other defined terms to maintain their meaning, “financial institution” must be interpreted to mean an “entity that makes loans.”
Lastly, in applying Washington law, the Court looked to the parties’ actions, and considered extrinsic evidence in determining whether they truly intended to exclude the Funds. The Court found that U.S. Bank’s prior negotiations to eliminate the “Eligible Assignee” requirement showed an understanding by U.S. Bank and the Lenders that the provision was indeed intended to limit transfers to “distressed asset hedge funds who candidly admit they seek to ‘obtain outright control’ of assets.”
While the Court’s holdings in this case are fact-specific and rely on Washington, as opposed to Delaware or New York law, they nonetheless serve as a cautionary tale for parties negotiating loan documents. For lenders, this case offers an important reminder to carefully draft assignment provisions to anticipate any future need to assign its interest in the loan. Furthermore, a court may look beyond the four corners of a contract in interpreting the terms of a loan agreement that were fully negotiated—including, the “Eligible Assignee” definition in this case—and consider both to the history of the negotiations and also to the parties’ conduct, even at late stages, when interpreting the such terms. Finally, this case may also encourage borrowers to become more pro-active in scrutinizing a lender’s assignment of its loans if the borrower feels that the assignment is beyond the scope of assignments permitted under the loan agreement.