Creditors’ Rights and Bankruptcy

"Comfortably Numb": Five Pink Floyd Songs relating to Creditors' Rights Issues

By
Ronn Steen

First, let me state this disclaimer:  Each of the following songs by Pink Floyd are copyright-protected.  As a result, to avoid infringement on any marks or protected works, no artwork or song links are included. Sorry, you'll have to dust off your LP's, CD's or digitally stored music library to listen to these songs.Second, you are undoubtedly wondering how in the world the music of Pink Floyd relates to Creditors' Rights issues.  Actually, they don't. I just wanted to grab your attention.  Now that I have it, here are five things issues that you should be wary of when preparing or drafting loan documents in Tennessee.  It is very easy to become "comfortably numb" to these issues over time since much of the financial process becomes rote.

"Us and Them"

(The Dark Side of the Moon 1973):  UCC and Real Estate Title Searches.   It is essential to spend some time and money on the front-end of any transaction to see what other creditors have claimed a security interest in the debtor's personal and/or real property.  When it comes to priority of a creditor's lien, it is truly an "us versus them" situation.  Depending upon the type of collateral to be pledged, knowing up front what is already pledged to other creditors is crucial.  For example, are you taking an interest in inventory?  If so, will the money advanced be used to purchase the inventory thereby providing a purchase money security interest?  Knowing if there is already a lien on inventory is essential since a creditor is required to give advance notice to other secured creditors of the anticipated purchase money security interest on inventory in order to preserve the purchase money priority in both the inventory and its proceeds.  Similarly, knowing where to search and file the UCC is crucial.  Exceptions for perfection notwithstanding, filing should be in the state where the debtor was created (if an entity) or the state of residence (if an individual).  Filing in the wrong place results in a zero sum for the creditor; relegating the creditor to "unsecured."  Searching the title on real estate is crucial to understanding whether there are other lien holders, zoning and/or use restrictions, and if the chain of title is correct.  As the saying goes, "an ounce of prevention is worth a pound of cure."

"Wish You Were Here"

(Wish You Were Here 1975)  Guarantors, Changes in Terms, and Reaffirmations of Guaranty Obligations.  One of the problems creditors seem to overlook deals with guarantors.  Most commercial loans are accompanied by personal guaranties obligating others for the performance of the debtor.  Failing to properly secure guarantors' responsibility if a default occurs can leave many creditors "wishing the guarantors were here" for recovery purposes.  Here are some issues to consider/avoid.  Recently, many guarantors/debtors have started utilizing the provisions of the Equal Credit Opportunity Act ("ECOA") as a defense to guarantor lawsuits.  This is most noticeably present where you have a spouse or other entity/individual included as a guarantor where there appears to be a "tenuous-at-best" relationship between the company and the guarantor.  In order to avoid this issue, a creditor should properly document at the outset of the loan the prospective guarantor's involvement with the debtor (e.g., is s/he an officer, shareholder or member of the debtor?) or that the prospective guarantor's assets are a sufficient/necessary consideration for inducing the creditor to make the loan (e.g., does the prospective guarantor's individual net worth surpass the other, related guarantor or debtor such that if default occurs that the prospective guarantor's assets will ensure that recovery is possible?).  Oftentimes creditors and debtors will alter the terms of the loan transaction.  When this occurs, it is important to obtain all guarantors' consent and reaffirmation of the changes.  Simply having the guarantors co-sign the "change in terms" agreement is sufficient to avoid an argument later on that the guarantors did not consent to changing the terms and thus such changes nullified the guaranty agreement(s) because the guarantors' exposure was increased without consent.  Preferably, a creditor should incorporate a "Guarantor Consent, Reaffirmation, and Waiver" section or stand-alone document into the change in terms (including when such change in terms is the result of a forbearance agreement).  By so doing, all doubt as to the guarantors' consent to the newly changed terms is removed.

"Money"

(Dark Side of the Moon 1973): Payment of Indebtedness Tax and Inclusion of Maximum Principal Indebtedness Statement. Cha-Ching. Everyone wants their share of "Money" especially in a loan transaction.  Tennessee requires both payment of the indebtedness tax based upon the amount of principal loaned to the debtor and a statement of the "maximum principal indebtedness" on security instruments such as deeds of trust, assignment of rents and leases, and UCC statements.    A creditor only has to pay the tax once on the principal amount loaned but if mixed collateral secures the loan, i.e., real estate and personal property, but still must include the "maximum principal indebtedness" statement on all security instruments, and, for all security instruments following the payment of the tax, should reference the security instrument where the tax was paid.  Additionally, creditors should also note that if the loan amount is increased during the life of the loan, then the creditor must pay the additional increase in the principal amount loaned.

"Run Like Hell"

(The Wall 1979): Remedies and Waivers.  When a deal goes bad, debtors and guarantors usually "Run Like Hell" from their obligations taking a scatter-gun approach to any and all defenses.  Creditors should always include waivers of defenses in the loan documents including waivers of presentment, notice, impairment of collateral, and waivers of any and all defenses to the Note or the obligations.  It is also important to provide for recovery of attorneys' fees incurred by the creditor for whatever reason including defense of the note or defense of any claims brought against creditor or debtor affecting or potentially affecting the obligation, for costs of collection including an award for post-judgment fees incurred or to be incurred by creditor in recovering on any award or judgment, and for any actions taken to protect the creditor's interest or position in or to the obligation including bankruptcy.  Casting this broad net provides for the potential to recover for any out-of-pocket fees incurred by the creditor when outside counsel is needed.  One other oft omitted provision should be that the debtor holds all collateral pledged, and the proceeds thereof, in trust for the benefit of the creditor.  There are various ways to achieve this, but it should be included as it gives the creditor a valuable weapon in its arsenal if the debtor defaults.

"Goodbye Blue Sky"

(The Wall 1979): Forum Selection, Jury Waiver, and Personal Jurisdiction Statements.  Once a deal goes bad, it's "Goodbye Blue Sky" for the parties.  Oftentimes litigation results, and including provisions on where and how a case is to be tried can help shelter the creditor from the impending storm.  At the outset of the deal, and including any changes or amendments during the deal's life, the parties can agree on where any disputes will be heard.  A creditor would be wise to select a forum and venue convenient to it.  These could include arbitration or a specific geographic area (e.g., any court of general jurisdiction in Davidson County, Tennessee, whether state or federal).  While now commonplace, occasionally creditors will forget to include a jury trial waiver in the loan documents.  Inclusion of a jury trial waiver can  be a tremendous cost-saving device.  Such waivers are enforceable, and can prevent distasteful results from jury nullifications.These are only a few pointers for creditors to consider.  For more information on these and others, please do hesitate to contact me! Now go and enjoy some Pink Floyd!!

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