Bankruptcy Archives - The National Law Forum

Temporary Injunctive Relief for Nondebtors in Bankruptcy Court Post-Purdue Pharma

In June, in Harrington v. Purdue Pharma L.P., 144 S. Ct. 2071 (2024), the Supreme Court held that the Bankruptcy Code does not, as part of a bankruptcy plan, allow nondebtors to receive permanent injunctive relief through nonconsensual releases. Less than a month later, two U.S. bankruptcy courts addressed whether Purdue Pharma bars bankruptcy courts from issuing temporary injunctive relief for the protection of nondebtors, and both courts determined that it does not. And just a couple of weeks ago, a third U.S. bankruptcy court reached the same conclusion.

The Supreme Court clearly limited the scope of its Purdue Pharma ruling to the permanent releases before it. In July, the U.S. Bankruptcy Court for the District of Delaware tackled a precise question left unresolved by Purdue Pharma: Can a bankruptcy court issue a preliminary injunction to stay claims against nondebtors? Yes, the court held in Parlement Technologies.

The facts of Parlement Technologies are straightforward. The debtor, Parlement Technologies, and several of its former officers were sued in Nevada state court. While section 362(a) of the Bankruptcy Code automatically stayed the Nevada action against Parlement Technologies, it did not stay claims against the former officers, and Parlement Technologies therefore sought a temporary stay of those claims. Faced with whether it could temporarily stay an action against nondebtors in light of the Supreme Court’s Purdue Pharma ruling, the court concluded: “Purdue Pharma does not preclude the entry of such a preliminary injunction.” In re Parlement Techs., 24-10755 (CTG) (Bankr. D. Del. Jul. 15, 2024).

The court went on to describe the four-factor test for granting a preliminary injunction: (1) likelihood of success on the merits, (2) irreparable injury to plaintiff or movant absent an injunction, (3) harm to defendant or nonmoving party brought about by the injunction, and (4) public interest. In addressing the likelihood of success on the merits, the court considered how Purdue Pharma altered the traditional “success on the merits” calculation. Given the Purdue Pharma holding – that nondebtors may not receive permanent injunctive relief in the form of nonconsensual third-party releases – success on the merits in a temporary stay determination cannot be based on the likelihood that the nondebtors would be entitled to a nonconsensual third-party release. Clearly, that factor would never be met.

Instead, a court should find a likelihood of success on the merits when it concludes that (1) a preliminary injunction is necessary to permit debtors to focus on reorganization, or (2) the parties may ultimately negotiate a plan that includes resolution of the claims against nondebtors. After focusing primarily on the debtor’s failure to meet this first element of the four-factor test – success on the merits – the court declined to issue the preliminary injunction.

The same week that the Parlement Technologies court denied the temporary injunction, the U.S. Bankruptcy Court for the Northern District of Illinois – in Coast to Coast Leasing – granted a preliminary injunction staying state court litigation against nondebtors. Coast To Coast Leasing, LLC v. M&T Equip. Fin. Corp. (In re Coast to Coast Leasing), No. 24-03056 (Bankr. N.D. Ill. Jul. 17, 2024). The Illinois court addressed both the Purdue Pharma and Parlement Technologies decisions, and relied on a three-factor Seventh Circuit test used to determine whether a bankruptcy court may enjoin proceedings in another court: (1) those proceedings defeat or impair its jurisdiction over the case before it, (2) the moving party established likelihood of success on the merits, and (3) public interest.

The Coast to Coast court issued the temporary injunction. The court stressed that unlike Purdue Pharma, where the nondebtors sought to release and enjoin claims, the case before it involved only a temporary injunction (of two weeks). And unlike in Parlement Technologies, there was a likelihood of success on the merits based on both of the above-noted measures set forth in the Parlement Technologies decision ((1) a preliminary injunction is necessary to permit debtors to focus on reorganization, or (2) the parties may ultimately negotiate a plan that includes resolution of the claims against nondebtors).

These two cases point to the conclusion that Purdue Pharma does not preclude bankruptcy courts from temporarily staying claims against nondebtors. On September 13, the U.S. Bankruptcy Court for the Eastern District of Louisiana similarly stated, “under certain circumstances, a bankruptcy court may issue a preliminary injunction that operates to stay actions against nondebtors.” La. Dep’t of Envtl. Quality v. Tidewater Landfill, LLC (In re Tidewater Landfill LLC), No. 20-11646 (Bankr. E.D. La. Sep. 13, 2024). That court cited both Parlement Technologies and a pre-Purdue Pharma Fifth Circuit case, Feld v. Zale Corp. (In Re Zale Corp.), 62 F.3d 746 (5th Cir. 1995), suggesting that preliminary relief should not be treated differently after Purdue Pharma.

That court did not reach the relevant motion, but its clear statement of the law is instructive. Together this trio of cases provides guidance to debtors seeking temporary stays for nondebtors in the wake of Purdue Pharma.

Understanding Post-Bankruptcy Liquidation Trusts

A main goal in bankruptcy is to get in and out as quickly as possible to minimize costs. It is often the case that even though a substantial portion of a debtor’s assets have been liquidated in bankruptcy, some valuable assets will remain that can provide additional sources of recovery to creditors. These assets may include smaller pieces of real estate, accounts receivable, joint venture ownership interests, and claims and causes of action, among others.

In a chapter 11 case, the debtor exits bankruptcy by confirming a plan and having the plan go effective. When a debtor has assets remaining but is otherwise ready to exit the bankruptcy case – for example, because it has closed a sale of a substantial portion of its assets – the plan typically provides for the formation of a liquidation trust on the plan effective date. All remaining assets are transferred to the trust for liquidation, and any proceeds are distributed to creditors, i.e., the trust beneficiaries, in accordance with the plan.

The liquidation trust is established and governed by the plan and a liquidation trust agreement. A liquidation trustee is appointed to administer the trust and is granted broad powers to, among other things, liquidate assets, investigate, prosecute, and settle causes of action, object to, resolve, and pay claims, and make distributions to trust beneficiaries.

Trust beneficiaries typically appoint members of a trust advisory or oversight committee who have consultation and approval rights over certain actions proposed to be taken by the liquidation trustee. For example, the trustee may need approval from the oversight committee to resolve claims or causes of action above a certain amount, or to liquidate certain high-value assets.

Who serves as liquidation trustee and how many representatives each trust beneficiary appoints to the oversight committee are typically negotiated in connection with the plan process. The liquidation trustee may have been a professional involved in the bankruptcy, or it may be an outsider with experience serving in such a role. The oversight committee members may be creditors themselves or may be appointed as representatives of the creditors. Trust assets are typically used to compensate the liquidation trustee for its services and reimburse it for its costs and expenses, including for its retained professionals, though oftentimes initial seed funding is also required. Trust oversight committee members may receive modest compensation, which is typically capped, but which may offer an incentive for a creditor or a creditor-appointee to serve.

The role of the trust oversight committee is an important one, as the assets transferred to the trust may provide additional valuable sources of recovery to creditors. Trust beneficiaries are often creditors from different classes under the plan, and therefore may have differing interests and be entitled to different treatment. For example, a secured creditor with a lien on a parcel of real estate may be the sole beneficiary from the sale of such real estate, and therefore has an interest in overseeing how the property is marketed and sold. Even when trust beneficiaries share a right to recover from the same assets, such as from the prosecution of causes of action, they may have differing views or interests as to the potential value of the claims, whether it makes sense to settle them, and overall strategy.

When all assets are liquidated, claims resolved, distributions made, and the estates are otherwise wound down, the trust will be dissolved. Often, this does not occur until years later.

A Primer for Creditors Navigating the Bankruptcy System

Bankruptcy filings affect businesses across America.

The Bankruptcy Code is complex and difficult to navigate. But used properly, it can help creditors to minimize losses when a customer files bankruptcy. This article will guide you on how to stay out of trouble and improve your chances of getting paid by a bankrupt customer.

What Does the Bankruptcy Filing Mean?

The Bankruptcy system serves three basic purposes: It (i) provides a single forum to deal with the assets and liabilities of an insolvent debtor, (ii) provides the honest, but unfortunate, debtor with a “fresh start,” and (iii) if a debtor chooses to reorganize its debts, it provides a process for saving and preserving the going-concern value of a business.

Bankruptcy has different chapters depending on the debtor’s objectives. Chapter 7 is liquidation. A trustee is appointed to take control of and sell the debtor’s property. Typically, the Customer’s assets will be surrendered to those creditors holding security interests sold by the trustee to generate proceeds for distribution to creditors. Individuals or businesses may file Chapter 7, but only individuals can obtain a discharge of their debts.

Chapter 13 is called the “wage-earner” filing, and it’s available to individuals only. In a Chapter 13, the debtor keeps his or her assets and proposes a three to five-year payment plan. Depending on several factors, including the debtor’s income and available assets and whether you are a secured or unsecured creditor, recovery can vary. Similar to Chapter 7, Chapter 13 has a trustee. But his or her role is to be a monitor and conduit for distributing plan payments to creditors.

Chapter 11 bankruptcy is a reorganization proceeding available to businesses and wealthier individuals whose debt levels exceed the less burdensome Chapter 13 requirements. Similar to Chapter 13 cases, the Customer will file a plan of reorganization outlining the Customer’s proposal to modify and repay debts. However, in Chapter 11 cases, creditors generally take a more active role in the proceeding and plan approval process to ensure that their rights are preserved and not adversely affected by the Customer’s proposed plan. Once a plan has been approved by the Bankruptcy Court, payments are made pursuant to its terms.

The Automatic Stay

Immediately upon the Customer’s bankruptcy filing, a substantial impact on a creditor’s ability to exercise its rights is imposed. The “automatic stay” provision of the Bankruptcy Code stops creditors in their tracks from virtually any collection activity against Customer, providing Customer with room to reorganize its debts without the threat of collection actions from their creditors.

Any action to collect the balance of the money the Customer owes or to recover the property now under the protection of the Bankruptcy Court is considered a violation of the stay. Similarly, actions to obtain, perfect, or enforce a lien on property of the bankruptcy estate are prohibited. Further, if the Customer files under Chapter 13 and the debt owed is a “consumer debt” (i.e., a debt incurred for personal, as opposed to business, needs), the “co-debtor stay” prevents actions to collect from individuals jointly liable with Customer on that debt, even if they have not filed their own bankruptcy case.

In light of the automatic stay, proceeding with great caution is of the utmost importance. In the event of willful violations of the automatic stay, the Customer may be awarded sanctions against the creditor, including payment of fines, the Customer’s attorneys’ fees, and/or the creditor losing rights in the bankruptcy case itself. If you receive notice that the Customer is seeking sanctions for your violation of the automatic stay, quickly seek the assistance of knowledgeable legal counsel to minimize your exposure.

Payment Rights and Other Remedies

In certain instances, you may be entitled to “relief” from the automatic stay. If relief is granted by the Bankruptcy Court, creditors may proceed with taking those actions initially prohibited at the outset of the bankruptcy case. For example, a creditor may be able to obtain relief and file suit against a non-filing individual that was once protected by the co-debtor stay, in order to preserve its rights and increase the likelihood of payment on the delinquent account.

If it is customary for you to sell goods on credit, and if goods were sold to Customer within 45 days immediately preceding the bankruptcy filing, you may be able to reclaim the goods from the Customer. You may also be entitled to assert an administrative priority claim for the value of any goods sold to Customer in the ordinary course of business during the 20 days immediately preceding the bankruptcy filing. To avail yourself of these options, formalities and procedures must be strictly followed, and quickly, to avoid expiration of your rights.

Some debts may be “non-dischargeable.” In other words, if the creditor can show some exception to the general rule (e.g., debts incurred through fraud, larceny, or embezzlement), the debt will not be discharged, and the Customer will remain responsible to you for repayment at the conclusion of the proceeding. Again, there are strict burdens and time requirements for creditors seeking to have their claims declared non-dischargeable, so creditors should closely monitor those deadlines and discuss with their legal counsel to preserve their rights.

Finally, you can also file a Proof of Claim with the Bankruptcy Court evidencing the debt owed to you by the Customer. Coming as no surprise, this option similarly imposes strict burdens and deadlines on filing requirements. Acting early is advisable, ensuring your claim is recognized, and you are kept abreast of the status of the bankruptcy proceeding. Filing a Proof of Claim does not guaranty repayment but does preserve your right to payment in the case.

Every bankruptcy filing is different, and the underlying facts will impact your rights and influence your overall collection strategy. Proactively seek guidance on proper pre-bankruptcy loss mitigation efforts and understand that all risks of loss cannot be avoided. If a customer does file bankruptcy, act carefully, but quickly to meet deadlines, preserve rights, mitigate losses, and receive payment during the life of the case. The most effective way to do so is by seeking competent legal counsel experienced in navigating the complex and intricate bankruptcy system.

740,000 Reasons to Think Twice Before Putting a Company in Bankruptcy

A recent decision from a bankruptcy court in Delaware provides a cautionary tale about the risks of involuntary bankruptcy.

In the Delaware case, the debtor managed a group of investment funds. The business was all but defunct when several investors, dissatisfied with the debtor’s management, filed an involuntary Chapter 7 petition. They obtained an order for relief from the bankruptcy court, then removed the debtor as manager of the funds and inserted their hand-picked manager. So far, so good.

The debtor, who was not properly served with the involuntary petition and did not give the petition the attention it required, struck back and convinced the bankruptcy court to set aside the order for relief. The debtor then went after the involuntary petitioners for damages. After 8 years of litigation, the Delaware court awarded the debtor $740,000 in damages – all of it attributable to attorneys’ fees and costs.

If you file an involuntary petition and the bankruptcy court dismisses it, then a debtor can recover costs and reasonable attorneys’ fees. The legal fees include the amount necessary to defeat the involuntary filing. In addition, if the court finds that the petition was filed in bad faith, then the court also can enter judgment for all damages proximately caused by the filing and punitive damages. The Delaware court awarded the debtor $75,000 for defeating the involuntary petition.

The debtor also sought a judgment for attorneys’ fees in pursuit of damages for violating the automatic stay. The involuntary petitioners had replaced the debtor as manager without first obtaining leave from the court to do so. The investment fund was barely operating and had little income to support a claim for actual damages. Nevertheless, the Delaware court awarded $665,000 in attorneys’ fees related to litigating the automatic stay violation.

Because the debtor had no “actual” damages from the stay violation, the involuntary petitioners contended that the debtor was not entitled to recovery of attorneys’ fees. The Delaware court pointed out that “actual” damages (e.g., loss of business income) are not a prerequisite to the recovery of attorneys’ fees, much to the chagrin of the defendants. The court held that attorneys’ fees and costs are always “actual damages” in the context of a willful violation of the automatic stay.

The Delaware court also rejected defendants’ argument that the fee amount was “unreasonable” since there was no monetary injury to the business. In other words, the debtor should not have spent so much money on legal fees because it lost on its claim. The court held that defendants’ argument was made “with the benefit of hindsight” – at the end of litigation when the court had ruled, after an evidentiary trial, that debtor suffered no actual injury. The court pointed out that the debtor sought millions in damages for the loss of management’s fees, and even though the court rejected the claim after trial, it was not an unreasonable argument for the debtor to make. The court concluded that “the reasonableness of one’s conduct must be assessed at the time of the conduct and based on the information that was known or knowable at the time.”

The involuntary petitioners likely had sound reasons to want the debtor removed as fund manager. But by pursuing involuntary bankruptcy and losing, they ended up having to stroke a check to the debtor for over $700,000. Talk about adding insult to injury. The upshot is that involuntary bankruptcy is an extreme and risky action that should be a last-resort option undertaken with extreme caution.

Large Corporate Bankruptcy Filings Surged in First Half of 2023

Increase in large corporate bankruptcy filings driven by companies in retail trade, services, and manufacturing.

The increase in large corporate bankruptcies in the first half of 2023 marked a reversal from a gradual decline in filings since the start of 2021, according to a report released today by Cornerstone Research.

The report, Trends in Large Corporate Bankruptcy and Financial Distress—Midyear 2023 Update, found that the number of bankruptcies filed by public and private companies with over $100 million in assets increased during the first half of 2023 to 72 filings, already surpassing the 53 bankruptcy filings in 2022. While the number of bankruptcies increased, the average assets at the time of filing, $780 million, were well below the 2005–2022 average of $2.05 billion and the 2022 average of $1.62 billion.

The surge in large corporate bankruptcy filings in the first half of 2023 is consistent with economic conditions posing heightened bankruptcy risk for highly leveraged companies.

Retail Trade, Services, and Manufacturing saw the most notable increases in bankruptcy filings in the first half of the year, while Mining, Oil, and Gas continued to decline. Manufacturing has already seen nearly twice as many bankruptcies as in the previous year (24 filings in 1H 2023 compared to 13 in 2022) and accounted for 33% of all bankruptcies filed in the first half of 2023.

“The surge in large corporate bankruptcy filings in the first half of 2023 is consistent with economic conditions posing heightened bankruptcy risk for highly leveraged companies,” said Matt Osborn, a principal at Cornerstone Research and coauthor of the report. “Along with a general rise in interest rates, credit spreads for highly leveraged corporate issuers compared to investment grade issuers began widening in mid-2022, a shift that generally persisted into the first half of 2023.”

The number of mega bankruptcies, those filed by companies with over $1 billion in reported assets, also increased. In the first half of 2023, the number of mega bankruptcies already matched the full-year total for 2022 of 16 and surpassed the 2005–2022 half-year average of 11. The largest bankruptcy was filed by SVB Financial Group, with $19.68 billion in assets at the time of filing. The largest non-financial-firm bankruptcy filing was by Bed Bath & Beyond Inc., with $4.40 billion in assets at the time of filing. Six mega bankruptcies were filed by companies in the Services industry.

Additional Statistics and Trends

The first half of 2023 saw an average of 12 bankruptcies per month, nearly twice the monthly average between 2005 and 2022 of 6.4.
The average assets at the time of filing among the largest 20 bankruptcies in the first half of 2023 ($32 billion) were 41% lower than that of the 20 largest in 2022 ($3.95 billion).
The most common venues for bankruptcy filings were Delaware and the Southern District of Texas, which accounted for 39% and 32% of all bankruptcy filings in 1H 2023, respectively.
The second half of 2022 saw a large number of corporate bankruptcies involving crypto lending companies, exchanges, and related businesses, with such bankruptcy filings continuing in the first half of 2023.

Click here to read the full report.

Upstream and Affiliate Guaranties in NAV Loans

Guaranties are a common feature in fund finance transactions. Particularly in NAV loans, upstream and affiliate (or “sideways”) guaranties are used. Below we discuss some of the context for the use of these types of guaranties, as well as some of the issues that lenders should consider in relying on them.

Upstream Guaranties

It is not uncommon in NAV loan transactions for the borrower to hold the underwritten assets for the financing (i.e., the fund’s portfolio of investments) through one or more controlled subsidiary holding vehicles (each, a “HoldCo”). Lenders may take a pledge of the management and economic interests in the HoldCos (rather than the underlying investments). In order to get as close to the underlying investments as possible (without taking a pledge), lenders may require that a HoldCo issue a guaranty directly to the lenders (or the administrative agent, on behalf of the lenders), guaranteeing the borrower’s obligations under the NAV loan facility. This “upstream” guaranty provides the lenders a direct claim against the HoldCo for amounts due under the loan, mitigating some of the risk of structural subordination to potential creditors (expected or unexpected) at the level of the HoldCo.[1]

Affiliate Guaranties

It is also common in NAV loan facilities for the borrower’s portfolio of investments to be held by multiple subsidiaries and/or affiliates of the borrower. Each such subsidiary or affiliate may be designated as a guarantor for repayment of the loan. As a result, such entities end up guaranteeing the obligations of their affiliates. The purpose of these affiliate guaranties is the same as the upstream guaranties discussed above – namely, to provide the lenders with a more direct enforcement claim in a default scenario.

Use of Such Guaranties

Motivations for the use of such upstream and affiliate guaranties may include:

a lender’s desire to underwrite a broader portfolio of investments, mitigating concentration risk to the portfolio of a single holding entity;
a lender’s desire to ensure that it is not subordinate to creditors that may arise at the level of the entity that directly owns the investment; or
a borrower’s desire to obtain a higher loan-to-value ratio than the lenders would otherwise provide based on the investments alone.
While upstream and affiliate guaranties can help to address these issues, they may raise nuanced legal issues that should be discussed with counsel in light of the relevant facts and circumstances.

Enforceability Considerations

Guaranties constitute the assumption of the liabilities of another entity and are contingent claims against the guarantor. Under certain insolvency laws, guaranties may be subject to challenge, and payments under guaranties may be subject to avoidance. Upstream or affiliate guaranties may be subject to heightened scrutiny and challenge in a bankruptcy or distress scenario. Below are a few potential issues lenders should bear in mind with respect to upstream and affiliate guaranties.

1. Constructively Fraudulent Transfer Avoidance. Under Bankruptcy Code section 548 and certain state laws, (a) transfers of property (including grants of security interests or liens), or (b) obligations assumed (such as incurring a loan or guaranty obligation) may be avoided as constructively fraudulent if BOTH of the following requirements are satisfied:[2]

(i) the transferor/guarantor does not receive reasonably equivalent value; AND
(ii) the transferor/guarantor is insolvent or undercapitalized or rendered insolvent, undercapitalized or unable to pay its debts because of the transfer or the assumed liability.

A guaranty by a parent of the obligations of a wholly owned and solvent subsidiary, a so-called downstream guaranty, is generally regarded as providing the parent with reasonably equivalent value through an enhancement of the value of its equity ownership of the subsidiary.

Upstream and affiliate guaranties require more scrutiny than guaranties by a borrower parent to determine whether any potential enforceability issues are present.

a. Reasonably Equivalent Value. The determination of value is not formulaic or mechanical, but rather generally determined by the substance of the transaction. Value or benefits from a transfer may be direct (e.g., receipt of loan proceeds) or indirect. But if indirect, they must be “fairly concrete.”

In each of the above scenarios, we are assuming that the upstream or affiliate guarantor would not use the proceeds of any loans and, consequently, would not be added to the loan facility as a borrower. However, other indirect but tangible benefits or value to the guarantor should be identified, e.g., favorable loan terms or amendments, use of the NAV facility proceeds that may indirectly but materially benefit the guarantor, maintenance of the entire fund group of entities that benefits the guarantor, etc.

b. Financial Condition of Guarantor. The financial condition of the transferor/guarantor is evaluated at the time of the incurrence of the guaranty. The evaluation is made from the debtor/guarantor – in what condition was the guarantor left after giving effect to the transfer or assumption of the obligation. Diligence regarding a guarantor’s financial condition may demonstrate that such guarantor is sufficiently creditworthy to undertake the guaranty and remain solvent and able to conduct its respective businesses. Representations from the guarantor may be sought to confirm its financial condition.

c. Potential Mitigants. In addition to performing diligence with respect to the above points, lenders and their counsel will often include contractual provisions to mitigate the possibility that a guaranty may be found to constitute a fraudulent transfer. Savings clauses, limited recourse guaranties, and net worth guaranties are all tools that can be used to address the issues noted above. The scope and appropriateness of such provisions is beyond the scope of this article and should be discussed with external deal and restructuring counsel.

2. Preference Challenge. Under Bankruptcy Code section 547, a transfer made by a debtor to a creditor, on account of an antecedent debt, that is made while the debtor was insolvent and within 90 days before the bankruptcy case has been commenced may be subject to avoidance as a preferential transfer. Certain defenses may apply to a potential preferential transfer, including the simultaneous exchange of “new value” by the creditor. However, note that any pre-bankruptcy transfers of value, like payments under a guaranty, may be subject to scrutiny and potential challenge by the guarantor/debtor or a bankruptcy trustee.

Guaranties can be an important element in structuring NAV loan transactions to achieve the terms desired by the parties and to provide necessary protections for the lenders, but consideration needs to be given to the legal issues, such as the ones mentioned here, that their inclusion can present.

[1] Lenders will typically also require the HoldCo to pledge its accounts to which proceeds of the underlying investments are paid, allowing lenders to foreclose on such cash at the HoldCo level, without the need for such cash to first be distributed up to the borrower.

[2] Note that the precise language of certain state fraudulent transfer laws may differ, but conceptually, most state statutes require a showing of (i) insufficient or unreasonably small consideration in exchange for the transfer or liability incurred, and (ii) the transferor/debtor being insolvent at the time of the transfer, or becoming insolvent or subject to financial distress as a result of the transfer.

Navigating the Business Landscape After Silicon Valley Bank and Signature Bank

NOTE: The information contained in the following alert is up-to-date as of March 15, 2023. News and events are evolving, so check the websites for the FDIC and the applicable banks for updates and announcements.

Start-up, emerging, middle market and other companies and their founders, executives, and investors, are facing heightened demands in the wake of recent developments involving Silicon Valley Bank (SVB) and Signature Bank. You can navigate the situation and be well-positioned for continued growth and success by considering the suggestions below.

We banked with Silicon Valley Bank or Signature Bank. How can we get our funds?

All funds, including those above Federal Deposit Insurance Corporation (FDIC) insurance limits, were transferred to Silicon Valley Bridge Bank, N.A. and Signature Bridge Bank, N.A., respectively, and depositors have full access to their money beginning March 13, 2023
You may continue to use the same online banking access, checks and/or ATM/debit cards to access your funds

What are the applicable FDIC insurance limits generally?

The FDIC exercised its authority under the systemic risk exception to cover uninsured deposits at Silicon Valley Bank and Signature Bank, but has not otherwise modified the FDIC insurance thresholds
Deposits are insured up to at least $250,000 per depositor, per FDIC-insured bank, per ownership category
Legal entities with independent operations are generally entitled to $250,000 in FDIC-insurance per FDIC-insured bank
Bank customers do not need to purchase deposit insurance; it is automatic for any deposit account opened at an FDIC-insured bank
Funds swept into money market funds on an overnight basis are not treated as deposits of the bank, are not subject to FDIC insurance, and the FDIC will honor the banks obligation to convert the money market funds back into cash the next day
Banks may also offer a multibank sweep vehicle, often via IntraFi’s ICS or CDARS program, which allows balances in excess of the $250,000 amount to be transferred to other banks to take advantage of each bank’s $250,000 FDIC insurance limit
FDIC Link to Are My Deposit Accounts Insured by the FDIC
FDIC’s Electronic Deposit Insurance Estimator

We have venture debt or another form of loan from Silicon Valley Bank or Signature Bank. Do we need to continue to make payments? Are the terms of the facility or any security interest modified? Can we continue to draw on a line of credit? Is a letter of credit issued by one of those banks still valid?

Payment obligations continue, and the terms of any arrangements are unchanged
The FDIC can repudiate contracts under certain circumstances, and so it may not honor advances or letters of credit
The FDIC’s general policy is that its role as receiver generally precludes continuing the lending operations of a failed bank
The FDIC will consider advancing funds if it determines that the advance is in the best interest of the receivership
Upon receiving a funding request, the FDIC may: make all or a portion of the requested loan advance, undertake discussions to reach a mutually satisfactory agreement to restructure the loan, or exercise its statutory right as receiver to repudiate its funding obligations with respect to the loan
Accordingly, letter of credit counterparties may not view Silicon Valley Bank-issued or Signature Bank-issued letters of credit as creditworthy in the current circumstances, and it may be beneficial to take proactive steps to make alternate arrangements where possible
However, Silicon Valley Bridge Bank has indicated that it will honor all commitments to advance under existing credit agreements
As receiver, the FDIC is looking to maximize recovery and will likely sell the assets of the banks in receivership, either individually or collectively to a successor institution.

What about any warrants issued to such institutions?

Warrants issued to a bank in receivership should remain valid and outstanding with no change impacting the cap table
As receiver, the FDIC is looking to maximize recovery and will likely sell the assets of the banks in receivership, either individually or collectively to a successor institution.

Can we leave our current bank or at least diversify our deposits across financial institutions?

Examine banking relationships and review loan agreements and lines of credit for restrictions and covenants that may require you to maintain primary banking relationship or certain deposit accounts (e.g., your receivables) at the lender
Look into ICS or CDARS programs at network banks, which provide FDIC insurance coverage for certain business deposits of $250,000 or more
New bank relationships require “Know Your Customer” processing, which requires lead time that could be even more protracted in the current climate
An international company considering cash repatriation will want to consider tax implications

Payroll is coming due. Can we delay payments to employees? What should our company do if it is tight on cash?

Labor and wage payment laws and regulations impose requirements on when employers must pay employees

Under the Federal Fair Labor Standards Act, employers must pay non-exempt employees for hours worked and exempt employees for their regularly weekly rate of pay on regularly scheduled pay days for the covered pay period
Where state law imposes higher standards regarding unpaid wages, minimum wage, and other wage payment obligations, consider furloughs or changes for future wages to avoid violations
Failure to pay wages when due can subject U.S. employers to, among other things, fines and liquidated damages including double or treble damages, attorney fees (for litigation) and individual personal civil and, in some cases, criminal liability on owners and executives
Employers remain obligated to deduct and remit payroll taxes from wages even when under stress caused by the insolvency of its bank
If company has employees or independent contractors outside the United States, consult local lawyer(s)

Assess payroll, legal and contractual requirements and alternatives

Identify other available funds to ensure that payroll requirements can be met and, if not, explore alternative sources of funding
Request company owners, senior executives and board to consider pay cuts
Consider measures ranging from furloughs of nonexempt employees to pay cuts and/or reductions in hours in compliance with labor and employment laws, and clearly communicate changes to employees
Consider use of retention/stay bonuses
If an employee decides to leave or a decision is made to let an employee go, consider separation agreement issues and limits on use of non-compete, non-solicitation, non-disclosure, non-disparagement and appropriate release terms in specific context, including in light of existing employee agreements
Confirm and comply with prior employee documentation, including employment agreements, offer letters, employee handbooks and policies, IP assignment terms, confidentiality terms, and option or other equity terms
Consider governance and contractual requirements with respect to changes in compensation, bonus plans, etc.
Take control and communicate with employees as appropriate, to manage the situation and help allay fears and risk of departures and to enhance productivity

What are our options for payments owed to lenders, landlords, suppliers, vendors and other creditors?

Consider contacting creditors to negotiate short-term credit and payment extensions in light of cash flow needs and credit risk issues
Consider drawing existing and available lines of credit to shore up working capital position
Consider strategically stretching out payments to certain other non-critical trade creditors
Consider reaching out to investors for short-term liquidity or equity infusions

How can we identify and secure alternative sources of funding?

Focus on maintaining current payments to lifeblood sources
Consider reaching out to investors for short-term liquidity or equity infusions
Consider straight loan or promissory note if the company is in a position to pay a fixed sum or interest, and evaluate valuation, dilution and cap table impacts if considering SAFE, convertible note, warrant, preferred or other equity
Consider governance issues including necessary board and investor approvals, creditor consents, intercreditor and tax issues
Consider selling non-core assets

How do we obtain a line of credit in this environment?

New bank relationships require “Know Your Customer” processing, which require lead time that could be even more protracted in the current climate
New lines of credit require lead time for underwriting, credit approval and documentation and, if you have other debt facilities in place already, potential consent from existing lenders
Consider expanding existing banking relationships to shorten potential lead times,

What else should we take into account if we are considering bridge financing or other funding from our investors?

In addition to above, consider SAFE, convertible note or a preferred stock round and extending any repayment terms
Obtain interested party transaction approvals and addition to typical governance requirements such as board and investor approvals

What are my company’s reporting or disclosure obligations? What information should we share internally?

Your obligations depend in part on whether the company is public or private, accounting standards, securities laws, exchange rules, state corporate law, and your governance documents
For a private company, managing the situation through open and informal communications with stakeholders may provide insight and useful information for financial and operational issues and reporting to the Board
A public company affected by a bank shutdown or experiencing a liquidity challenge may have SEC disclosure obligations, and communications with stakeholders will be governed by securities laws

What should I keep in mind about board decision-making

Maintain acute awareness of the possibility of self-dealing or even the appearance of self-dealing, and obtain appropriate approvals for any insider transactions, such as disinterested director or stockholder approval

We are focused on conserving and managing cash. What should we be doing?

Engage or hire experienced financial and accounting advisors (whether an outside consulting or other firm, or a fractional or full-time experienced finance employee or independent contractor)
Track financial position and obligations closely, with an eye on foot faults that could arise in the near, medium, and long-term horizon
Challenge assumptions: long-term risks might suddenly become near-term ones.
Focus on liquidity issues (cash position, cash flow and burn rate) and forecast for several months to meet obligations to creditors, considering limits on access to significant deposits or credit lines if a banking partner has closed and potential changes in the credit market more broadly
Assess availability of alternative funding sources
Update financial statements, plans and projections and underlying assumptions, and consult with board, advisors and key investors about appropriate adjustments
Consult with advisors and partners on appropriate cash management, financial institution diversification and risk management strategies for your situation

How do we know if our business insurance is the right kind and amount to cover the risks our company and its directors and officers may face?

Determine whether losses from a bank closure are covered by business interruption or other insurance
Review current D&O insurance coverage, including the applicable limits and periods of coverage

Our company’s insurance premium payment is coming due. Can we delay or defer payment if we are tight on cash?

Insurance premiums should be paid when due, as failing to pay an insurance premium could cause the policy to lapse leaving it without coverage
Consider contacting the insurance company to clarify any grace period or adjust any deductible
Consult with an insurance broker and the board to evaluate whether there is a more affordable option. Review governance terms to see whether changes to insurance may require investor approval

Article By Lori Anne Czepiel, Robert Klingler, James W. Bartling, Mitch Boyarsky, Jason L. Watkins, Paul Z. Rothstein, Joe Daniels, Jackson Hwu, Neil Grayson, Benjamin Barnhill, J. Brennan Ryan, Dowse Bradwell Rustin IV, Richard Levin, and Craig Nazarro of Nelson Mullins.

For more financial and banking legal news, click here to visit the National Law Review.

The Silicon Valley Bank Failure: Implications on Commercial Leasing

This past Friday, March 10, 2023, the Federal Deposit Insurance Corp. (FDIC) announced its takeover of the failed Silicon Valley Bank (“SVB”) after a run on the bank late last week caused the largest-scale U.S. bank failure since Washington Mutual in the 2008 financial crisis. Two days later, New York regulators shuttered Signature Bank (“Signature”). The federal government has made it clear that, while FDIC will guaranty all deposits, including uninsured ones, bailouts of these banks will not occur. The failures of SVB and Signature are likely to have widespread ramifications across many industry sectors, including commercial leasing.

How will the bank failures impact landlords in the commercial leasing sector?

SVB was a very common issuer of tenant letter of credit security deposits. A letter of credit security deposit is the issuing bank’s contractual obligation to pay the landlord beneficiary the amount that such landlord’s tenant is in default.
Landlords holding tenant letters of credit issued by SVB or Signature as security deposits will be directly impacted by the bank failures. Any undrawn standby letters of credit issued by SVB, Signature or any other bank under FDIC receivership may be repudiated by the FDIC, making any such letter of credit worthless. Any affected landlord will want to act promptly to provide proper protection of their interests under any applicable lease.

How can landlords protect their interests under such leases?

Any landlord holding a letter of credit security deposit should identify the issuing bank.
In any lease where the security deposit is a letter of credit issued by SVB or Signature, the landlord should carefully review the terms of the lease regarding the security deposit and the landlord’s approval rights over the issuing bank, but in any event require the tenant to provide it with a letter of credit issued by a different financial institution.
All landlords should review the terms their lease agreements relating to landlord approval rights over issuing banks, draw procedures and requirements and the process for replacing a letter of credit.
In the event the lease agreement in question does not provide landlord with adequate approval rights over the issuing bank, clear draw procedures and stringent replacement requirements, the landlord should consider amending the lease agreement to so require.

Article By Jeff Bates and Blake Young of Winstead

For more finance and banking legal news, click here to visit the National Law Review.

Information for Borrowers with Loans from Silicon Valley Bank or Signature Bank

This alert provides information for borrowers with loans from Silicon Valley Bank (“SVB”) or Signature Bank (“Signature”) based on information available from the FDIC and our clients’ experiences over the last few days. We have also included information regarding the FDIC’s general policies and procedures when selling and administering loans of failed banks. We will update this alert as additional information becomes available.

Borrowers with loans from SVB or Signature continue to wait for information from the FDIC, and the new bridge banks it formed, with respect to their loans, including any information regarding the sale of their loans, new bank contact information and updates to borrowing procedures and payoff logistics. At present, we understand that the bridge banks are attempting to operate in the same manner with respect to their borrowers (and depositors) that SVB and Signature operated prior to their failures, including through use of the existing relationship managers/bank contacts and online platforms and consistent borrowing and payment mechanics.

Systemic Risk Exception

As widely reported, on Sunday, March 12, the Federal Reserve, the FDIC and the Treasury Secretary announced a systemic risk exception and created Silicon Valley Bridge Bank, N.A. and Signature Bridge Bank, N.A. (together, the “Bridge Banks”). The systemic risk exception is an attempt to avoid a widespread bank run and to ensure that all of SVB and Signature Bank’s depositors would be made whole after the failures of the two banks. The systemic risk exception is an exception to federal law that otherwise would require the FDIC to resolve a bank failure at the lowest cost to the Government’s deposit insurance fund. See Crisis and Response: An FDIC History, 2008-2013, p. 36. Otherwise, the FDIC would not have been in a position to backstop uninsured deposits beyond the $250,000 insured limit per depositor per ownership category. For more information about FDIC deposit insurance limits please see our prior alert: SVB Receivership – What You Need to Know.

Prior to Sunday, the only uses of the systemic risk exception occurred in 2008 and 2009. Id., pp. 35-36. The systemic risk exception has never before been used to create bridge banks at which loans at failed institutions would then be sold or administered by the FDIC.

Sale of SVB and Signature Loans

The general expectation after a bank failure is that the failed bank’s loans will be sold to a new lender as expeditiously as possible. The FDIC conducted an auction for the assets of SVB (including its loan portfolio) on Sunday, March 12. The Wall Street Journal reported on Monday, March 13 that, while none of the largest U.S. Banks bid on SVB at the initial auction, there was at least one offer which was declined by the FDIC. The WSJ is also reporting that regulators are planning to hold another auction of SVB’s assets. We also anticipate an auction of Signature’s assets. The timing of these auctions remains unclear.

In the event that either or both of these auctions produce buyers of the Bridge Banks’ respective assets in bulk, those buyers will become the lenders under the failed banks’ loans. In that case, the applicable successor lender will advise its new borrowers of their new bank contacts and provide relevant loan administration information including loan payment procedures.

If either or both of the auctions fail to produce a buyer for all of the bank’s assets, a bank’s loan portfolio may be split up and sold piecemeal. In this event it may take longer before borrowers know the identity of their new lender. If some or all of the loans are not purchased, they will continue to be administered by the respective Bridge Banks or the FDIC. As noted above, the intent of the FDIC is to continue to operate the Bridge Banks pending substantial completion of the sale process.

Borrowing Under an SVB or Signature Line of Credit

In general, when the FDIC is appointed receiver, it immediately begins analyzing loans that require special attention, such as unfunded and partially funded lines of credit, and construction and development loans. Typically speaking, the role of receiver generally precludes the FDIC from continuing the lending operations of a failed bank; however, the FDIC will consider advancing funds if it determines an advance is in the best interest of the receivership, such as to protect or enhance collateral, or to ensure maximum recovery to the receivership. See A Borrowers Guide to an FDIC Insured Bank Failure.

When the FDIC is operating as receiver, its general procedures provide that if a borrower submits a request for additional funding, the FDIC will conduct a thorough analysis to determine the best course of action for the receivership. The FDIC uses information contained in the failed bank’s loan files to the extent available and considered reliable. Because the files of failed banks are often incomplete or poorly documented, the FDIC may require additional financial information to perform its analysis and make decisions.

In the current circumstances, with the Bridge Banks operating under the systemic risk exception, these general FDIC rules appear to have been relaxed, at least for the time being and our clients are reporting that borrowing (and deposit) operations are generally functioning in the ordinary course. We have not yet heard from any clients that additional information has been required in connection with advances from the Bridge Banks.

SVB Contact Information

The FDIC is currently directing SVB borrowers with questions about drawing on lines of credit to contact their existing relationship manager/bank representative at SVB. SVB also has a call center at 800-774-7390 open from 5:00 AM to 5:30 PM (Pacific) with representatives that can assist borrowers.

Signature Contact Information

The FDIC is currently directing Signature borrowers with questions about drawing on lines of credit to contact their existing relationship manager/bank representative at Signature Bank. Signature Bank also has a 24-hour call center at 866-744-5463 with representatives that can assist borrowers.

On Monday, March 13, our clients had mixed results contacting their existing bank relationship managers and drawing on lines of credit. Some clients requested online draws but have not been successful as a result of system malfunctions (and we heard the same reports with respect to some attempts to access and move deposits). On the other hand, we heard reports from our clients that automatic draws and account sweeps have continued to function (and many borrowers successfully accessed their accounts). Today (March 14), clients appear to be having more success in accessing their lines of credit. We will continue to gather information about borrowers’ ability to access their lines as it becomes available.

Loan Payoff/Lien Release Information

Many clients have inquired about the mechanics for arranging a loan payoff/refinancing of their SVB loan or Signature loan. In the event that the loan is sold, the borrower can coordinate payoff with the new lender that purchased the loan. In the meantime, borrowers should reach out to their relationship managers or otherwise contact the bank using the means provided above to arrange any payoff and/or lien release. Further information regarding lien releases may also be found on the FDIC lien release website. In the event that borrowers’ loans are not sold quickly by the FDIC to a new lender, we expect that those borrowers will be strongly encouraged by the FDIC to arrange for a refinancing. See A Borrowers Guide to an FDIC Insured Bank Failure.

Continue Performing Obligations under Loan Documents

Notwithstanding the failures of SVB and Signature, their borrowers should continue to abide by their loan documents, including submitting payments as required by their loan documents at the same addresses and complying with all other covenants and agreements. Borrowers will be advised by the FDIC, the Bridge Banks or a subsequent purchaser of their loan if there are any updates to payment mechanics or bank contact information.

Article By Timothy John Carter, Jonathan C. Hayden, Trevor Hoffmann, Muryum Khalid, Kevin Renna, Douglas B. Rosner, Andrew Rothstein, Jesse Rubinstein, and Jesse Scott of Goulston & Storrs.

Click here for more financial legal news from the National Law Review.

2023 Goulston & Storrs PC.

Silicon Valley Bank Fails After Run on Deposits

“The Federal Deposit Insurance Corporation took control of the bank’s assets on Friday. The failure raised concerns that other banks could face problems, too.”

Read the New York Times article (Free Subscription Required)

In light of the news this morning that Silicon Valley Bank (SVB) has been closed by the California Department of Financial Protection, which appointed the Federal Deposit Insurance Corporation as SVB’s receiver, it’s fair to ask if this is the beginning of a trend among regional banks or an isolated incident. SVB, while unique in the banking industry, since it would lend against illiquid (pre-IPO) securities, mainly issued by ventured-backed companies, faced challenges in a rising interest rate environment that are not unique and which, many similarly situated regional banks, are still facing.

As the Federal Reserve considers whether to raise interest rates by 0.25% or 0.5%, in order to combat inflation, a key factor in their analysis will be the impact these interest rate hikes have on regional banks and their portfolios. Regional banks, unlike their Fortune 100, multi-national counterparts, derive their value from vast portfolios of bonds, which are very sensitive to interest rate hikes (as interest rates rise, the value of these bonds fall). For instance, the S&P Regional Banks Select Industry Index is down 3.69% today, 19.92% month-to-date, and 13.02% year-to-date.

Therefore, in the coming days, it will be crucial to watch both the Federal Reserve’s Federal Open Market Committee meeting on March 21-22 and whether SVB’s collapse signals a contagion among the regional bank sector. SVB’s closure is the biggest bank collapse since the financial crisis and many start-up/early-stage companies will be very interested to see if it is the last or the first of many.

Article By Aaron H. Jacoby and Justin A. Goldberg of ArentFox Schiff LLP

For more financial and legal news, click here to visit the National Law Review.

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