Summary of Significant Developments Affecting Asset-Based Lending: Part One

The following is the first part of a two-part series covering the judicial developments reported on by CFA's Co-General Counsel, Jonathan N. Helfat and Richard M. Kohn, in The Secured Lender during 2006. Part 2 will appear in the next issue of The Secured Lender. The authors wish to thank David W.

Attachment and Perfection

Madisonville State Bank, N.A. v. Citizens Bank of Texas, N.A., 184 S.W.3d 835 (Tex. App. 2006) (A secured lender's inability to trace proceeds prevented the lender from recovering account funds.)

In a case arising out of a borrower's alleged checkkiting scheme, a secured lender found itself unable to recover over $1,000,000 from its borrower's depository banks when the lender was unable to show that the funds on deposit were proceeds of its collateral.

In Madisonville State Bank, the secured lender, Madisonville State Bank, N.A. ("MSB"), provided an $8,000,000 line of credit to Pate & Pate Enterprises, Inc. ("P&P"). Thereafter, Citizens Bank of Texas, N.A. ("Citizens Bank") filed suit against P&P, alleging that P&P and its affiliates had engaged in a check-kiting scheme involving accounts maintained by P&P at Citizens Bank and Wells Fargo Bank. The check-kiting scheme allegedly resulted in overdrafts at Citizens Bank totaling $8,150,000.

Citizens Bank, after amending its complaint to include Wells Fargo as a defendant, filed an application for prejudgment writ of garnishment against the accounts of P&P at Wells Fargo. Wells Fargo and Citizens Bank subsequently reached an agreement whereby (a) Wells Fargo would apply $167,906 of the funds in P&P's Wells Fargo accounts to the debt owing by P&P to Wells Fargo and (b) $892,333 of the funds in P&P's Wells Fargo accounts would be applied to the debt of P&P owing to Citizens Bank.

MSB intervened in the garnishment action and moved for summary judgment, seeking to recover the $892,333 from Citizens Bank and the $167,906 from Wells Fargo, based upon MSB's allegedly superior security interest in the funds. The trial court denied the motion and MSB appealed.

On appeal, MSB argued that it possessed a security interest in the funds on deposit in P&P's Citizens Bank and Wells Fargo bank accounts. Specifically, MSB argued that the funds deposited into these bank accounts (which funds were subsequently paid to Citizens Bank and Wells Fargo) constituted "proceeds" of P&P's accounts receivable, collateral in which MSB had a perfected security interest. In order to prevail on this argument, MSB had to prove that the funds on deposit in the bank accounts originated from P&P's accounts receivable (i.e., MSB had to "trace" the funds to P&P's accounts receivable). MSB did not have control agreements with either Wells Fargo or Citizens Bank and was therefore not perfected in the deposit accounts P&P maintained at either bank.

In support of its position, MSB presented testimony from P&P's chief executive officer, who testified that the majority of the funds in the Citizens Bank and Wells Fargo accounts most likely came from P&P's accounts receivable. In addition, MSB also produced a summary of deposits placed in the Wells Fargo accounts during the applicable time frame, which showed that deposits totaling $5,305,451.55 were made, with $1,303,118.86 of that amount being derived from P&P's accounts receivable. Nevertheless, the Texas Court of Appeals ruled against MSB and affirmed the ruling of trial court (which denied MSB's motion for summary judgment).

In its opinion, the Texas Court of Appeals stated that the testimony was "at best unequivocal" and did not constitute more than a "scintilla" of evidence proving that the funds in P&P's bank accounts were proceeds of its accounts receivable. According to the Court, not only did the testimony fail to support MSB's claimed right to the funds, but it necessarily established that a large portion of the funds was, contrary to MSB's position, derived from sources other than P&P's receivables.

Madisonville State Bank illustrates just how difficult it can be for a lender to win a tracing argument, especially when the proceeds are held in deposit accounts (i.e., bank accounts). Rather than hoping to claim an interest in a borrower's deposit accounts as proceeds of collateral, lenders should consider taking a security interest in a borrower's deposit accounts as original collateral. By executing a control agreement with its borrower and the borrower's depository bank, the lender can perfect a security interest in a borrower's deposit accounts and thereby hope to avoid having to make a "tracing" argument in the first instance.

NetBank, FSB v. Kipperman (In re Commercial Money Ctr., Inc.), No. SC-05-1238 et al., 2006 Bankr. LEXIS 1845 (B.A.P. 9thCir. Aug. 2,2006) (While a lease is classified under the UCC as chattel paper, the right to receive the payments arising under the lease is classified as a payment intangible.)

Commercial Money Center, Inc. ("CMC") was an originator of commercial equipment leases. CMC would buy the equipment and then lease it to consumer end users. Typically, CMC obtained a surety bond for each lease guaranteeing the payments. CMC would then package the leases into a "lease pool" and assign the payment stream due under the leases, along with the surety bonds, to third-party investors.

During 1999 and 2000, NetBank, FSB ("NetBank") paid CMC more than $47 million for the payment streams associated with seven pools of leases. With respect to each of the pools, CMC assigned to NetBank its rights to payment under the leases and its rights under surety bonds obtained by CMC in respect of the leases. As security for NetBank's receipt of these lease payments, CMC granted to NetBank a security interest in the underlying leases. However, NetBank did not file a financing statement or take actual possession of the leases.

In May 2002, CMC filed a Chapter 11 case. After the bankruptcy case was converted to a Chapter 7, the Chapter 7 trustee commenced an adversary proceeding against NetBank, seeking to avoid NetBank's interest in the lease payment streams. Rejecting NetBank's argument that the transactions between the parties were sales of payment intangibles and, therefore, that NetBank's interest in them was automatically perfected under UCC section 9-309(3) without the need to file a UCC financing statement, the bankruptcy court held that the right to receive payment under a lease is classified under the UCC as chattel paper and that the transactions between the parties were loans. According to the bankruptcy court, NetBank's position, if correct, would allow a party to obtain an automatically perfected interest in the monetary obligation due under a lease without providing any notice, which is contrary to the purpose of Revised Article 9 of the UCC.

NetBank appealed to the United States Bankruptcy Appellate Panel for the Ninth Circuit (the "Panel"). The Panel first had to determine whether the lease payment streams, stripped away from the underlying leases, are classified under the UCC as chattel paper (e.g., leases) or payment intangibles (i.e., general intangibles in which the obligor's primary obligation is the payment of money). Contrary to the bankruptcy court, the Panel held that, although the underlying leases are chattel paper, the lease payments, stripped away from the underlying leases, are payment intangibles.

Agreeing with the bankruptcy court, the Panel also held that the transactions between NetBank and CMC were loans and not sales. According to the Panel, notwithstanding that the parties may have labeled them as sales, the transactions had more characteristics of loans than sales. In this connection, the Panel relied heavily on the fact that the risk of loss in the transactions remained with CMC.

Under Revised ? 9-309(3) of the UCC, a sale of a payment intangible is perfected when it attaches. Thus, unlike a purchaser of accounts who must file a financing statement against its seller, a purchaser of a payment intangible is not required to file a financing statement in order to have a right to the payment intangible that is enforceable against third parties (including a trustee in bankruptcy). However, because the transactions between NetBank and CMC were found to constitute loans and not sales, NetBank was required to file a financing statement in order to perfect its right to the payment intangibles. While it was undisputed that NetBank had not filed financing statements and did not have actual possession of the leases, the Panel found that there remained material issues of fact and law as to whether NetBank's interests were perfected by constructive possession of the leases (i.e., possession through an agent). Therefore, the Panel remanded the case to the bankruptcy court for a determination as to whether NetBank's interests were perfected by possession through an agent.

Under the holding in Commercial Money Center, an owner of chattel paper could double-finance it by selling off the payment stream to one lender and then grant a security interest in the chattel paper to another lender, who would not necessarily have knowledge of the prior sale.

By contrast, in the case of a loan secured by payment intangibles arising from chattel paper, Commercial Money Center would still require that the secured lender file a financing statement against, or take possession of, the chattel paper in order to perfect its security interest. While the Court did not expressly hold that such filing or possession would also serve to perfect an interest in the payment stream arising under the chattel paper, the Court, citing other case law, suggested that it would.

Commercial Money Center raises questions with potentially significant implications for many commercial transactions and will undoubtedly be the subject of much debate. We will, of course, keep you advised of any new developments and of whether the decision is appealed to the U.S. Court of Appeals for the Ninth Circuit.

Banc of America Strategic Solutions, Inc. v. Cooker Restaurant Corp., No. 05-AP-1126,2006 Ohio App. LEXIS 4507 (Ohio Ct. App. Sept. 5,2006) (State liquor permit was not "property" and therefore not subject to a security interest.)

In 2002, Banc of America made loans to Cooker Restaurant Corporation and took a security interest in certain of Cooker's assets, including, among other things, general intangibles. In 2004, the bank sought to foreclose on its collateral. At the time, Cooker held 16 liquor permits issued by the state of Ohio, which the bank maintained were part of its collateral package.

Shortly after the bank filed its claim, Cooker went into bankruptcy proceedings and a receiver was appointed to liquidate the company. The receiver, Martin Management Services, Inc., opposed the bank's security interest in Cooker's liquor permits on the basis that Ohio law did not allow a liquor permittee to grant a security interest in its permit. The trial court agreed, citing Abraham v. Fioramonte, 107 N.E.2d 321 (1952), in which the court was explicit in its holding that Ohio liquor permits "are personal licenses and are not property which can be mortgaged or seized under execution or court order for the satisfaction of debt."

On an appeal filed by the bank, the Cooker court agreed with the lower court, citing not only Fioramonte and its progeny, but also a 2000 decision in which the same court trying Cooker had observed that Ohio liquor permits "are mere licenses, revocable as therein provided, and create no contract or property right." Continental Sawmill Ltd P'ship v. Italian Oven L.L.C., 2000 Ohio App. LEXIS 4504, (Sept. 29, 2000). The Continental Sawmill court maintained that, because no property right exists, Ohio courts will not enforce the transfer of a liquor permit outside the statutory scheme. The Cooker court acknowledged that Continental Sawmill involved an attempted sale of a liquor permit rather than the grant of a security interest in a liquor permit. The court observed, however, that the underlying principle was the same: Because an interest in an Ohio liquor permit could not be transferred without the approval of the state liquor control board, a transferee of a liquor permit in any unauthorized transaction-whether a sale or a grant of security interest-did not obtain an enforceable property right.

The Cooker court went further to hold that ? 9-408 of the UCC, as enacted in Ohio, did not require a different result. The court agreed that ? 9-408, as a general rule, prohibits laws that would prevent the free creation, attachment, assignment or transfer of a security interest. More instructive according to the court, however, was official comment 3 to ? 9-408, which states that the section applies only where a debtor has a property interest or "rights in the collateral" and is not intended to override other law that determines whether a property interest in the collateral exists and the nature of that interest. The court held that, in the present case, Ohio law has determined that no property right in the liquor permit exists (and, as a result, that a security interest could not be granted in the liquor license).

The decision in Cooker is in line with the case of NJ. Div. of Alcoholic Bev. Control v. United Trust Bank (In re Chris-Don, /?cJ.Nos. 04-2660,04-3670,2005 U.S. Dist. LEXIS 6385 (D.N. J. March 31,2005) (Liquor license not personal property under New Jersey Law and therefore not a general intangible subject to the grant of a security interest.), which was reported in a previous issue of The secured Lender.

Rogan v. Bank One, N.A. (In re Cook), 457 F.3d 561 (6th Cir. 2006) (Recordation of assignment of mortgage not required to perfect assignee's mortgage interest under Kentucky law; recordation of assignment after bankruptcy filing does not violate automatic stay.)

In December of 2000, NCS Mortgage Lending Company loaned Kenneth and Melissa Cook $100,000 for the purchase of a residence in Berea, Kentucky. A promissory note and mortgage were duly executed in connection the loan, and the mortgage was properly recorded in the appropriate County Clerk's office.

NCS subsequently assigned its interest in the note and mortgage in January 2001 to First Greensboro Home Equity, Inc. The assignment was also properly recorded. On the same date, First Greensboro executed an Assignment of Note in blank, which was not recorded until April 2004, reflecting an assignment from First Greensboro to Lehman Brothers Bank.

Lehman Brothers conveyed a large number of mortgage loans to Structured Asset securities Corporation under an ARC Trust Agreement dated October 1,2001. These loans were later transferred to Bank One, N.A., as trustee for the issuance of Amortizing Residential Collateral Trust Mortgage Pass-Through Certificates, and Bank One took possession of the Cooks' original note and mortgage. Though the ARC Trust Agreement required that all mortgages assigned to Bank One be recorded, the assignment of the Cooks' mortgage was not recorded until 2004, after the Cooks had filed for bankruptcy (in 2003).

The Cooks filed for bankruptcy on April 25,2003. Bank One filed a proof of claim against the Cooks, claiming to be owed $99,371 plus interest on the note secured by the mortgage. However, the Cooks' bankruptcy trustee objected to the Bank One proof of claim, asserting that Bank One did not have a perfected security interest and, therefore, that Rogan's interest as judicial lien creditor was superior to Bank One's unperfected interest. Bank One responded by filing an amended proof of claim showing the owner of the security interest as "Bank One National Association, as Trustee for ARC 2001-BC6 Trust" and submitting evidence of the chain of assignments.

The trustee then filed an adversary proceeding in the Bankruptcy Court, seeking a determination that his interest as trustee in the Cooks' property was superior to all other creditors. The trustee obtained a default judgment confirming the priority of his interest over the respective interests of NCS, First Greensboro and Lehman Brothers, but Bank One continued to assert its interest in the property. Counsel for Bank One filed an affidavit stating, inter alia, that counsel was in possession of the original Cook note.

The Bankruptcy Court held that, because Bank One's counsel was in possession of the original note (considered by the court to be bearer paper because it was endorsed in blank), Bank One was a holder entitled to enforce the note. seeRogan, 2006 U.S. App. LEXIS 20377 at *6. The Bankruptcy Court further held that the assignment of the promissory note to Lehman Brothers and later to Bank One - neither of which were recorded until after the Cooks filed for bankruptcy - did not violate the automatic stay because the transfers were assignments of the creditors' property and did not involve property of the estate. see id.

The decision of the Bankruptcy Court was affirmed by the District Court, which held that Bank One's possession of the note endowed Bank One with a perfected interest in the Cooks' property, and that Bank One did not violate the automatic stay by recording its interest after the bankruptcy filing. see id.

On appeal, the trustee continued to assert that Bank One did not have a perfected security interest, and therefore that his interest as a judicial lien creditor was superior to the bank's. Because a debtor's property rights are created and defined by state law, the Sixth Circuit looked to Kentucky law. It held that under Kentucky law, when First Greensboro assigned its interest by means of a blank endorsement, the interest became payable to the bearer and could be negotiated by transfer of possession alone. see id. at *10. The affidavit presented by Bank One's counsel was sufficient evidence to affirm the Bankruptcy Court's finding that Bank One possessed the note. Kentucky law also provides that, if a purchaser of an instrument gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of a secured party, that purchaser has priority over a security interest in the instrument which is perfected by a method other than possession. See id. at * 10-11. The ARC Trust Agreement demonstrated that Bank One purchased the note and mortgage for value.

The Sixth Circuit further held that Bank One was not required to record its interest because the recording of the original mortgage to NCS constituted constructive notice that a mortgage lien existed against the Cooks' property. See id. at * 13. Bank One's failure to record the assignment of mortgage "did not affect the perfection of the lien as against the mortgagors and those claiming through them" and therefore had no effect on its ability to enforce the mortgage against the trustee. Id.

Lastly, the Sixth Circuit rejected the trustee's argument that Bank One's recordation of the mortgage assignment after the bankruptcy filing violated the automatic stay, concluding that Bank One did not transfer or attempt to perfect legal title to the Cooks' property. Instead, said the Court, Bank One recorded its equitable interest in the property, which did not belong to the Cooks and therefore was not property of the estate. see id. at *16.

Interestingly, though, the Rogan court based its perfection decision on applicable state law, U.C.C. ? 9-308(d) could have provided the same result. Under ? 9-308(d), perfection of a security interest in collateral also perfects a security interest in the supporting obligation for the collateral. The Rogan court does not reference ? 9-308(d), nor does it reference the Sixth Circuit's earlier decision in Peoples Bank of Polk County v. McDonald (In re Maryville Savings & Loan Corp.), 743 F.2d 413 (6th Cir. 1984). Rogan stands as an implicit overruling of the Maryville case, which in essence bifurcated a mortgage loan by holding that Article 9 applied to a security interest in promissory notes but did not apply to a security interest in the related deeds of trust. See Maryville, 743 F.2d at 416-17. The Maryville decision was expressly rejected by the drafters of Revised Article 9. see U.C.C. ? 9-109(b), Official Comment 7.

Pankratz Implement Co. v. Citizens Nat'1 Bank, 130 P.3d 57 (Kan. 2006) (Affirming lower court decision holding that a financing statement is seriously misleading despite the exclusion of only one letter from the debtor's name.)

In November 2004, the Court of Appeals of Kansas held that even a minor misspelling of a debtor's name on a financing statement may render the financing statement "seriously misleading" and thus ineffective. On appeal, the Supreme Court of Kansas affirmed. The ruling makes it clear that even a minor misspelling in a name may render a financing statement seriously misleading and thus, ineffective for purposes of perfecting a security interest.

Host America Corp. v. Coastline Fin., Inc., No. 2:06-CV-5,2006 U.S. Dist. Lexis 35727 (D. Utah May 30, 2006), certificate of appealability denied, 2006 U.S. Dist. LEXIS 46251 (D. Utah July 6,2006) (Even a small error in punctuation when recording a debtor's name in a financing statement can render the financing statement "seriously misleading" under revised Article 9.)

In a decision of interest to all secured lenders, the United States District Court for the District of Utah recently determined that a financing statement was "seriously misleading" under Utah's revised Article 9 because three periods (i.e., punctuation marks) were omitted from the debtor's name as reported on a financing statement.

K. W. M. Electronics Corporation ("KWM"), a manufacturer and assembler of electronic goods, leased space for its corporate facilities from Coastline Financial, Inc. ("Coastline"). In May 2003, KWM granted Burton Sack a security interest in certain of KWM's collateral. A few days later, Sack filed a financing statement which identified KWM as "K W M Electronics Corporation." Host America Corporation ("Host America") subsequently acquired the debt and security interest held by Sack.

In the summer of 2004, after KWM failed to pay rent to Coastline, Coastline initiated an unlawful detainer action against KWM in the Third District Court for the State of Utah. Under applicable Utah law, lessors are granted a lien (for unpaid rent) on all nonexempt property of the lessee which is brought or kept on the leased premises. In accordance with Utah law, Coastline obtained a writ of attachment and a default judgment against KWM in November 2004. In this connection, the lessor's lien in favor of Coastline attached to the goods identified as collateral in Sack's financing statement.

Host America (as assignee of Sack) then brought suit against Coastline, claiming that the security interest Host America acquired from Sack had priority over any landlord's lien in favor of Coastline. In support of its position, Host America argued that its security interest was perfected (by Sack) in 2003, well before Coastline attempted to foreclose on its landlord's lien.

Resolution of the priority dispute turned on whether the financing statement filed by Sack (and assigned to Host America) was "seriously misleading" under section 70A9a-506(3) of the Utah Uniform Commercial Code, which section is, in all relevant respects, identical to Section 9506(c) of the Official Uniform Commercial Code. Under both the Utah UCC and the Official UCC, the financing statement filed by Sack (and assigned to Host America) would be deemed seriously misleading (and therefore ineffective) unless a search under KWM's correct name, using the filing office's standard search logic, would have revealed Sack's financing statement.

The financing statement filed by Sack omitted three periods from KWM's correct name, identifying KWM as "K W M Electronics Corporation" instead of "K. W. M. Electronics Corporation." Although only three periods were omitted from Sack's financing statement, a search under KWM's correct name, using the Utah filing office's standard search logic, would not reveal Sack's financing statement. Thus, the Court held that Sack's financing statement was seriously misleading and was therefore ineffective to perfect the security interest which was assigned to Host America. Moreover, as Coastline perfected its lessor's lien before Host America took steps to remedy the defective financing statement, the Court found that Coastline's lien had priority over Host America's security interest.

Host America is yet another expensive reminder that even a small error in punctuation when recording a debtor's name in a financing statement can cause a lender to lose its grip on the debtor's collateral. As the Court noted, strict limitations on a filing office's standard search logic do not excuse a creditor's failure to comply with the debtor identification requirements of revised Article 9. To avoid situations like Host America, lenders should make sure to include the correct name of a debtor, as reported on the debtor's certificate of incorporation, when preparing a financing statement.

Duesterhaus Fertilizer, Inc. v. Capital Crossing Bank (In re Duesterhaus Fertilizer, Inc.), 347 B.R. 646(Bankr. C.D. Ill. 2006) (An "in lieu" financing statement must contain a description of the collateral in order to comply with the requirements of Revised Article 9 of the UCC).

In 1994 and 1995, Duesterhaus Fertilizer, Inc. obtained loans from the United States Small Business Administration ("SBA"). As part of the loan transactions, Duesterhaus executed security agreements in favor of the SBA, pursuant to which Duesterhaus pledged its inventory, accounts receivable and other personal property to secure its indebtedness to the SBA. At the time the loans were made, the SBA properly filed UCC-1 financing statements in Illinois (which was the correct jurisdiction for the SBA to file under Old Article 9 of the UCC).

In 1999, the SBA assigned its security interests (in Duesterhaus' inventory, receivables and other personal property) to Capital Crossing Bank ("CCB"). As the original financing statements (filed by SBA and assigned to CCB) would lapse five years after the date originally filed, CCB properly filed continuation statements, thereby continuing the effectiveness of the earlier filings.

In 2002, in accordance with the requirements of Revised Article 9, CCB filed an initial financing statement in lieu of a continuation statement, or an "in lieu" financing statement, with the Iowa Secretary of State (which was the correct jurisdiction for CCB to file under Revised Article 9). Pursuant to Revised Article 9, an "in lieu" financing statement is necessary when a filing under Old Article 9 was in the correct jurisdiction, but that jurisdiction is no longer the correct place for filing under Revised Article 9. In such a circumstance, the old financing statement can be continued only by filing an initial financing statement in lieu of a continuation statement in the proper jurisdiction for filing under Revised Article 9.

The "in lieu" financing statement filed in Iowa (the "new" jurisdiction) by CCB referenced both the original financing statements and the 1999 continuation statements. However, it did include a description of the collateral.

In October 2005, Duesterhaus filed a Chapter 11 case. Shortly after the case was filed, Duesterhaus commenced an adversary proceeding against CCB, alleging that CCB's "in lieu" financing statement was defective because it did not include a description of the collateral.

CCB moved for summary judgment, arguing that its "in lieu" financing statement was sufficient because it referenced the prior Illinois financing statements (filed in the "old jurisdiction), which did contain descriptions of the collateral. However, the United States Bankruptcy Court for the Central District of Illinois disagreed and denied CCB's motion for summary judgment.

In its decision, the Court noted that under Revised Article 9 of the UCC, an "in lieu" financing statement must satisfy the requirements for an "initial" financing statement. In this connection, pursuant to Revised Article 9 of the UCC, an initial financing statement is sufficient only if, among other things, it indicates the collateral covered by the financing statement. As the "in lieu" financing statement filed by CCB did not describe the collateral, the Court held that CCB's "in lieu" financing statement was defective and therefore denied CCB's summary judgment motion.

While the holding of Duesterhaus should not come as a big surprise, the scope of this problem makes the case significant as throughout the transition to Revised Article 9, some filers omitted the collateral description from their "in lieu" financing statements. In light of Duesterhaus, secured lenders should review their "in lieu" filings to confirm that the filings comply with all of the requirements of Revised Article 9, including that they contain a description of the collateral. Although the transition to Revised Article 9 has proceeded to a point where it is too late (except in a few jurisdictions) to amend the "in lieu" statements, the lender could still file a new UCC-I. Although the lender would lose the priority of the defective "in lieu" statement, it would at least have a valid financing statement on file.

Priority

United States v. Crestmark Bank (In re Spearing Tool & Mfg. Co.), 412 F.3d 653 (6th Cir. 2005), cert. denied, 2006 U.S. LEXIS 5700 (U.S. Oct. 2, 2006) (Notice of federal tax lien need not meet the precise identification requirement found in Revised Article 9 of the Uniform Commercial Code.)

In June 2005, the United States Court of Appeals for the Sixth Circuit ruled that the identification requirement found in Revised Article 9 of the Uniform Commercial Code, which requires that a financing statement use the exact legal name of a debtor, does not apply to the filing of federal tax liens. According to the Sixth Circuit, requiring the government to identify a taxpayer with absolute precision would unduly burden the government's tax collection efforts.

As noted by the CFA in the amicus brief it filed in support of Crestmark's position, subjecting the government to the same filing requirements as commercial lenders would merely require the government to follow the same simple, logical rules as commercial lenders. However, The Supreme Court of the United States denied Crestmark's petition for a writ of certiorari, October 2, 2006.

Frazier Nuts, Inc. v. American AG Credit, 141 Cal. App. 4th 1263 (Cal. Ct. App. 2006) (California almond growers have a statutory lien on proceeds of processor's sale of almonds that primes secured lender's blanket lien.)

Plaintiffs in this case are almond growers who used Central Valley Processing, Inc. to process and sell their almonds. Beginning in April 2000, Central Valley established a revolving line of credit with American AG Credit, which was secured by the personal property of Central Valley, including all of Central Valley's inventory, accounts receivable, and equipment. Central Valley ultimately defaulted on the line of credit by failing to pay the outstanding balance by the November 1, 2002 maturity date. A few months later, on February 21, 2003, Central Valley filed a Chapter 11 case (which was subsequently converted to Chapter 7). Both before it defaulted on the line of credit and during the period between default and filing for bankruptcy, Central Valley made periodic payments to American under the credit facility. After the Chapter 11 was commenced, the bankruptcy court also ordered Central Valley to pay certain amounts to American in respect of the facility.

Various almond growers sued American in the Superior Court of Merced County, California, for intentional interference with economic relations, money had and received, conversion, unjust enrichment, and unfair business practice in violation of Section 17200 of the Business and Processions Code of California. American filed a motion to dismiss all five causes of action, which the Superior Court sustained with respect to conversion and unfair business practices claims. American then filed a motion for summary judgment with respect to the intentional interference with economic relations, money had and received, and unjust enrichment claims, which the Court granted, reasoning, in part, that the growers' statutory lien did not include accounts receivable or sale proceeds arising out of the sale of the almonds by Central Valley. The growers then appealed to California's Fifth District Court of Appeal.

In their appeal, the growers asserted that, among other things, they had a statutory lien on the proceeds of the almond sales under the "producer's lien statute" of California's Food and Agricultural Code (Cal. Agric. Code ?? 55631-55653). American countered that the growers had no such statutory lien on the proceeds and, even if the grower's did have a lien, the lender's security interest was superior.

As a threshold matter, the Court of Appeals considered whether the growers had any right in the proceeds of the almond sales. The Court concluded that the growers did have a right to, and a producer's lien on, the proceeds of the almonds sales under the Food and Agricultural Code, focusing on the last sentence of ? 55638, which creates an obligation on the part of processors to pay the proceeds of sales of farm products to producers (but does not explicitly create a right in favor of producers to receive such proceeds), and reads in part:

...this section shall not prohibit the sale of any farm product or processed form of the product to which such a lien has attached, so long as the total proceeds of the sale are used to satisfy obligations to producers which are secured by a lien established pursuant to this chapter.

141 Cal. App. 4th at 1271-72 (emphasis in original).

Reaching a different conclusion than the bankruptcy court in In re Sargent Walnut Ranches, Inc., 219 B.R. 880 (Bankr. E.D. Cal. 1998), which held that California's Food and Agricultural Code did not give producers a lien on proceeds, the Court of Appeal concluded that "...the meaning of the last sentence of section 55638 is clear. Processors have a legal duty to use the proceeds from the sale of farm products subject to a producer's lien to pay the producer, and the producer has the right to be paid with those proceeds." 141 Cal. App. 4th at 1277.

In reaching this conclusion, the Court of Appeals also considered the legislative history of the relevant sections to the Food and Agricultural Code, concluding that the legislative intent when drafting the statute was to make sure that producers would be paid for their products. The court noted:

Consistent with this objective, the legislative history identifies only one use for proceeds generated by the sale of farm product subject to a producer's lien - the payment of producers who hold the lien. In contrast, [American] has cited and we have located no legislative materials that state or imply that proceeds (such as cash or accounts receivable) generated by the sale of farm products subject to a producer's lien are part of the collateral available to lenders with security interests.

141 Cal. App. 4th at 1274.

The Court of Appeals next turned to whether the growers' lien was superior to American's lien. The Court concluded that, under ? 5563 of the Food and Agricultural Code, a producer's lien has priority over all other liens (except for certain employee wage claim and warehouseman liens), and that this outcome promoted the purpose of the statute. The Court briefly addressed American's contention that recognizing the priority of a producer's lien would harm agricultural lending. According to the Court, American's argument assumed that lenders primarily consider farm product inventory when lending to processors, an argument which, said the Court, American had provided no evidence to support. The Court of Appeals went on to say that,

to the extent that some financial institutions may have lent to processors in reliance on the theory that inventory subject to a producer's lien would generate proceeds and that those proceeds would be subject to their prior security interests, they chose a risky course. First, this course is not one contemplated in the legislative history that discussed the collateral available to banks that lend to processors...Second, a bank that relies on proceeds from inventory subject to a producer's lien is betting that (1) the producers will not enforce their lien on the product itself before it is sold and generates proceeds and (2) the processor will violate the directive in section 55638 that the proceeds are to be used to pay producers.

141 Cal. App. 4th at 1281 (emphasis in original).

Thus, the Court of Appeals overturned the superior court's ruling, ordering it to vacate its orders sustaining the motion to dismiss and granting summary judgment, and further ordering it to grant summary adjudication with respect to the growers' claim for intentional interference with economic relations.

Frazier Nuts is a reminder of how important it is to search for, and carefully consider, any local laws that grant priority to third parties with respect to specific types of property. In this connection, lenders should consider the possibility that such laws could be broadly construed to extend to related collateral not explicitly covered by the law itself.

In re Globe Building Materials, Inc., 463 F.3d 631 (7th Cir. 2006) (Statutory lien in favor of debtor's Wisconsin-based employees may be avoided by bankruptcy trustee.)

Globe Building Materials, Inc. was a manufacturer, seller and distributor of residential roofing materials. Globe's primary assets consisted of three manufacturing plants, including one plant located and operated in Wisconsin, machinery, equipment, inventory and receivables.

In early 2001, Globe filed for relief under Chapter 11 of the Bankruptcy Code, but the case was soon converted to Chapter 7, and a trustee was appointed. Several months after the case was filed, the State of Wisconsin's Department of Workforce Development (the "State") filed a lien against all of Globe's real and personal property located in Wisconsin under the Wisconsin wage lien law, Wis. Stat. 109.09(2). As discussed in previous issues of The secured Lender, under this law, the State has a lien on a business's real and personal property located in Wisconsin to secure all unpaid employee wages and benefits, including any monies to which employees might be entitled by the failure of a business to give proper notice of a "mass layoff' or "business closing" under Wisconsin law. According to amendments to the statute effective in 2003, this wage lien has priority over the lien of a "commercial lending institution" on the assets of the employer, that originates prior to the wage lien, to the extent of unpaid wages of $3,000 (or less) earned by each employee within the six months preceding (a) the date on which the employee files the wage claim or brings an action under the applicable Wisconsin statute or (b) the date on which the State receives the wage claim, as applicable. The wage claims that receive the benefit of the lien in favor of the State, and are subject to the $3,000 per employee limitation, include not only earned wages but also claims for vacation pay, health care reimbursements, deferred compensation and expenses, and any wage penalties due as a result of an employer's failure to give proper 60-day notice prior to a mass layoff or business closing when applicable.

In February 2002, the bankruptcy court approved the trustee's sale of Globe's Wisconsin manufacturing facility, the proceeds of which were paid to the trustee. After the State, relying on Wis. Stat. 109.09, claimed a first-ranking lien on the net sale proceeds, the trustee brought an adversary proceeding seeking to set aside the State's claim. The trustee brought this proceeding under ? 545(2) of the Bankruptcy Code, which allows a bankruptcy trustee to avoid statutory liens that are not perfected or enforceable against a bonafide purchaser at the time of the filing of the underlying bankruptcy case, whether or not such a person exists.

The bankruptcy court granted summary judgment to the trustee. After the federal district court affirmed the bankruptcy court's ruling, the State appealed to the United States Court of Appeals for the Seventh Circuit. The Court of Appeals focused its attention on the interpretation of, and interplay among, three separate statutory sections ?? 545(2) and 546 of the Bankruptcy Code and the Wisconsin wage lien law.

At the outset of its analysis, the Court summarily rejected the State's argument that the absence of an actual bonafide purchaser on the date of the filing was somehow relevant to the case. As noted above, ? 545(2) permits the trustee to avoid a statutory lien that is not perfected or enforceable against a bonafide purchaser at the time of the commencement of the underlying bankruptcy case "whether or not such a purchaser exists." 11 U.S.C. ? 545(2).

The Court then turned to the State's argument that the trustee's avoidance powers under ? 545(2) were irrelevant as a result of ? 546(b)(1)(a) of the Bankruptcy Code, which provides that the power of a bankruptcy trustee to avoid statutory liens is "subject to any generally applicable law that... permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection." 11 U.S.C. ? 546(b)(1)(a). Basing its argument on the Seventh Circuit's previous decision in In re AR Accessories Group, Inc., 345 F.3d 454 (7th Cir. 2003), the State asserted that the Wisconsin wage lien statute qualifies as a "generally applicable law" under ? 546(b)(1)(a), and, therefore, that the trustee was precluded from exercising its avoidance power under ? 545(2). However, the Court in Globe made it clear that AR Accessories merely held that a Wisconsin wage lien was not void ab initia when it was created after the debtor's bankruptcy case had commenced. Globe did not, said the Court, address the question of whether a Wisconsin wage lien could be avoided by the trustee under ? 545(2). As to that issue, the Court in Globe implicitly concluded that the Wisconsin wage lien statute qualifies as a "generally applicable law" under ? 546(b)(1)(A), yet held that the trustee had the power to avoid a Wisconsin wage lien under ? 545(2) because the Wisconsin wage lien law did not expressly provide by its terms that the lien had priority over a bonaftde purchaser of property-the very status accorded a bankruptcy trustee under ? 545(2). On the contrary, the Wisconsin law provided that it primed "debts, judgments, decrees, liens or mortgages against the employer, except a lien of a financial institution ... that originates before the [wage] lien," but did not mention bona fide purchasers. The Court volunteered, however, that, if the Wisconsin legislature desires its wage lien statute to take precedence over a bankruptcy trustee's rights under ? 545(2), it need only add "bona fide purchaser" to the list of rights that the statute primes.

It should be noted that ? 545(2) has been amended, applicable to cases commenced on or after October 17, 2005, to reduce the powers of the bankruptcy trustee with respect to federal, state or local tax sales.

Intellectual Property

N.C.P. Marketing Group, Inc. v. Billy Blanks (In re N.C.P. Marketing Group, Inc.), 337 B.R. 230 (D. Nev. 2005) (Because a nonexclusive trademark license is personal and non-assignable, a debtor-in-possession may not assume it without the consent of the licensor.)

Lenders increasingly find themselves making loans to borrowers whose businesses are dependent on a few, or even one, license from an intellectual property owner. Indeed, these days much of the value of a business (and the lender's collateral) may reside in a single intellectual property license. For example, some businesses are dependent on a trademark license from a trademark owner in order to advertise and sell a particular product that is critically important to its business. In such situations, the ability of the borrower/licensee to continue using the trademark after it files a Chapter 11 case is likely to be the difference between being able to reorganize the company and being forced to liquidate it. Determining whether a debtor-in-possession can assume a trademark license without the consent of the licensor is an important issue for both the borrower/licensee and a lender whose collateral includes the trademark license rights.

There are currently two different tests employed by courts to determine whether a debtor-in-possession can assume an intellectual property license: the "actual test" and the "hypothetical" test. Under the "actual test," employed by the First Circuit, see Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489,493 ( 1 st Cir. 1997), the debtor-in-possession is treated functionally like the original licensee. Accordingly, if applicable intellectual property law prevents assignments to a third party who is not the original licensee, then a debtor-in-possession will only be prevented from assuming the license without the consent of the licensor if the debtor-in-possession actually intends to assume the license and then assign it to another third party. Thus, the debtor-in-possession will be permitted to assume the license so long as it does not actually intend to assign it subsequently.

Under the "hypothetical test" (currently used by the Fourth, Third, Ninth and Eleventh Circuits), if applicable intellectual property law prevents assignments to a third party who is not the original licensee, then assumption by the debtor-in-possession is not allowed without the consent of the licensor, even if the debtor-in-possession has no intention of assigning the license to a third party after assuming. Functionally, under this test the debtor-in-possession is treated as if it were a new third party, and the law of assumption in bankruptcy tracks the law of assignments regardless of whether or not the debtor-in-possession later plans to assign the license to another party. In effect, the debtor-in-possession is treated as if it hypothetically intended to assign the lease to a third party, even if it merely wished to use the license in its own business.

In a recent case, the District Court for the District of Nevada decided what it described as "an issue of first impression in the [Ninth] circuit": whether a debtor-inpossession in a Chapter 11 case may assume a nonexclusive trademark license without the consent of the licensor. Because this court is in the Ninth Circuit, which uses the "hypothetical test," the essential question that the court addressed was what underlying trademark law says about the assignability of nonexclusive trademark licenses. N.C.P. Marketing Group involved an agreement between Billy Blanks and Gayle Blanks, the creators and owners of the trademark TAE BO? and N.C.P. Marketing Group, Inc. ("NCP"), as the licensee. The agreement granted NCP the right to advertise and sell products containing the Blanks' TAE BO trademark. Soon after entering into this agreement, the parties became involved in a dispute about their respective obligations. Consequently, the parties entered into a Settlement Agreement, confirming the Blanks' ownership of the TAE BO mark, and a License Agreement, detailing how NCP was to use the Blanks' mark in marketing and selling products. However, not long after entering the Settlement Agreement and the License Agreement, NCP materially breached both agreements by not paying the Blanks the required amount of royalties. Accordingly, the Blanks initiated an arbitration proceeding, in which the arbitrator ordered NCP to pay the Blanks $2.1 million in royalties.

Rather than pay the royalties, NCP filed for Chapter 11 bankruptcy protection. As part of the bankruptcy case, NCP attempted to assume the trademark licensing agreement so it could either continue operating its business or assign the license to a third party in exchange for cash. The Blanks responded that, under applicable law, any rights that NCP had in the TAE BO trademark were non-assumable and, therefore, NCP could not subsequently assign rights in the TAE BO mark to any other party. The Blanks also made clear that they did not consent to NCP's assumption of the license. Moreover, they argued that if, under applicable trademark law, a licensor could reject performance from a third party (i.e., reject the assignment of the trademark license to another party who was a stranger to the original license agreement signed by the licensor), then under Ninth Circuit law, a debtor-in-possession cannot assume a trademark license without the licensor's consent, even if the debtor-in-possession does not later intend to assign the licensee to a third party. The bankruptcy court agreed with the Blanks.

On appeal to the district court, NCP argued that it did not need the Blanks' consent because, under applicable trademark law, the Blanks were not excused from accepting performance from a party other than the original licensee. NCP also argued that the Blanks had consented to assignment of the license in the Settlement Agreement and License Agreement. However, the district court agreed with the bankruptcy court, holding that the trademark license could not be assumed by a Chapter 11 debtor-in-possession without consent of the licensor, and that the licensor had in fact not consented. The district court held that the Settlement Agreement and License Agreement contained time limits for licensing third parties, which had expired. Because any third-party license signed by NCP outside of the time limits prescribed in the agreements would not be valid, the district court held that any consent that might have been manifested by the agreements had expired. Accordingly, the district court held that the Blanks had not consented to the assignment of the trademark license and, therefore, NCP could not assume the license.

By ruling in favor of the Blanks, the district court followed the general trend that started with the Ninth Circuit's decision in in re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir. 1999). Catapult dealt with patent law, where consent of the licensor is generally required for assignment of certain patent licenses (also true under copyright law), and held that applicable patent law made exclusive patent licenses personal and non-assignable and, therefore, non-assumable by a debtor-in-possession without the consent of the licensor. In N.C.P. Marketing Group, however, NCP claimed that trademarks were fundamentally different from patents and copyrights because "trademark law was designed to protect the consumer from deception and confusion and not the interests of the trademark holder." 337 B.R. at 235. The district court, while not denying that protection of the public was an object of trademark law, noted that another object of trademark law was to preserve a trademark holder's good will in its "business name and products." Id. at 236. Because a trademark owner/licensor has a duty to control the quality of goods sold under a mark, the trademark owner/licensor has an interest in the party to whom a trademark is assigned. Accordingly, the district court held that "trademark rights are personal to the assignee and not freely assignable to a third party." Id. Therefore, employing the "hypothetical test" used in the Ninth Circuit, NCP could not even assume the nonexclusive trademark license and bring it into its Chapter 11 bankruptcy estate without the consent of the Blanks.

Given the holding in the N.C.P. Marketing Group case, lenders must consider that, if a borrower who is the licensee under an important nonexclusive trademark license fails to obtain consent from the licensor for the assignment of the license before the lender extends credit to the borrower, the lender runs the risk that the borrower will lose its license rights when a Chapter 11 is filed, a result that could have dire consequences for the lender by making reorganization impossible. The only other option for a debtor/licensee who has not obtained such up-front consent from a licensor to assume a non-exclusive trademark license is to file a Chapter 11 case in a jurisdiction that employs the "actual test" rather than the "hypothetical test."

In re Exide Tech., Inc.,340 B.R. 22 (Bankr. D. Del. 06) (Bankruptcy rejection power terminates demark license agreement.)

In today's complex business world, a sophisticated lender must not only be concerned with its borrower's possible insolvency, but that of entities with whom its borrower contracts. One risk is that such a third party might file bankruptcy and seek to reject an important executory contract with the borrower under ? 365(a) of the Bankruptcy Code. That's precisely what happened in Exide.

In 1991, Exide Technologies, Inc., in connection with the sale of its battery business to EnerSys, Inc. for $135 million, granted to EnerSys a perpetual, exclusive, royaltyfree license to use the trademark "Exide" in connection with batteries that EnerSys produced. In 2000, the agreement was amended to permit Exide to manufacture batteries, at which time Exide unsuccessfully sought to reacquire exclusive use of the trademark. Exide commenced a Chapter 11 case in 2002. In 2003, it filed a motion to reject the executory portions of the 1991 sale agreement, including the trademark license (a strategy that EnerSys characterized as Exide's attempt to "steal back" its trademark). After extensive and acrimonious litigation, the bankruptcy court granted the motion to reject in March 2006.

One of the reasons compelling the commencement of a bankruptcy case is the unique power under ? 365 to assume or reject an executory contract or unexpired lease. When a contracting party becomes a debtor, ? 365 affords it the best of all worlds. If a contract is beneficial to the estate, ? 365 permits its assumption. Conversely, if the contract is unfavorable, ? 365 permits its rejection with the claim arising therefrom (absent security) only being a general unsecured claim in the case. The rejection power also has a practical effect. The mere threat of rejection may cause the counterparty to renegotiate the adverse terms of the contract to the end that it is assumed, as amended.

In determining whether a contact is executory, and thereby subject to rejection, courts employ the rule formulated by the late Professor Vern Countryman in 1973. Under this test, a contract is executory:

under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing performance of the other.

While not adopted by the Bankruptcy Code, the Countryman definition was used in the legislative history to Code ? 365 to illustrate an executory contract. In formulating the test, Professor Countryman emphasized that it was to protect the nondebtor party from having to perform a contract without the assurance that the estate will perform its reciprocal obligations.

By comparison, Professor Countryman noted that, if the only unperformed contractual obligation was for the debtor to pay money to a creditor, the creditor held a claim under Code ? 101(5). Conversely, if the only remaining obligation was for a third party to pay money to the debtor, the right to payment was simply property of the estate under ? 541.

Under the prior Bankruptcy Act, many courts permitted the rejection of an executory contract only if it was onerous to the estate. American Brake Shoe & Foundry Co. v. New YorkR. Co., 278 F. 842,843 (D.N.Y. 1922).

Under that rule, a contract that generated a profit could not be rejected, although a new contract would generate a greater profit. Professor Countryman reminded the bench and bar that the test used by the Supreme Court was the business judgment rule. Group of Institutional Investors v. Chicago, Milwaukee, St. Paul, and Pacific R. Co., 318 U.S. 523, 550 (1943). As interpreted in numerous decisions, the Court asked to reject a contract must determine whether a reasonable business person would make a similar decision under similar circumstances. The test requires a review of both how the estate came to its decision to reject and the effect that decision will have on the estate and the Chapter 11 process. see Lawrence P. King, Collier on Bankruptcy, ? 1108.07[2] (15th ed. revised 2003).

There are cases that temper the business judgment rule. For example, there must be some benefit to the estate (general creditors) from the rejection. Matter of Minges, 602 F.2d 38 (2d Cir. 1979 (Act case); In re Federated Department Stores, Inc., 131 B.R. 808, 812 (S.D. Ohio 1991). The absence of creditors or the ability to satisfy claims without resort to the rejection power have barred its use. Shell oil Co. v. Waldron, 785 F.2d 936 (1 lth Cir. 1986). The most liberal defense is that rejection will not be permitted, if doing so will cause substantial harm to the counterparty with no proportionate benefit to the estate. Sundial Asphalt Co. v. V.P.C. Investors Corp., 147 B.R.72 (E.D.N.Y. 1992). Most decisions reject this balancing test.

Much of the opinion in Exide is devoted to an analysis of whether the license agreement at issue was an executory contract. The Court found that it was, based upon the existence of ongoing material obligations. The Court went on to find that the decision to reject the license agreement satisfied the business judgment rule, and then fashioned a two-year transition period in which EnerSys had to get its affairs in order before the license terminated. While the tone of the decision indicates a proreorganization bias, the 1991 agreement did provide for a transition period in the event of the license's termination. Whether termination was contemplated because of Exide's bankruptcy is another question, perhaps answered by the rule that bankruptcy law is superimposed upon every contract. An even more basic question turns the clock back to the 1991 negotiations. Why did EnerSys not purchase the trademark and license Exide to use it in nonbattery operations? It appears that EnerSys missed the boat in 1991 by not following the "stitch in time" rule.

Exide illustrates the dramatic effect that the rejection of an executory contract under ? 365 of the Bankruptcy Code can have on the nondebtor party to the contract and how easy it is to achieve rejection under the business judgment rule. The decision also serves as a reminder that the Bankruptcy Code does not define trademarks as intellectual property in ? 101(35)(A). Accordingly, the licensee of a rejected trademark license may not elect to continue to use the trademark as permitted by Code ? 365(n) with respect to the defined types of intellectual property.

The significance of the Exide case is not whether it was correctly decided. Its importance is that it serves as a reminder of the rejection power, that bankruptcy courts are likely to construe that power liberally, especially in a Chapter 11 case, and the enormous consequences that can befall the nondebtor party, and its lenders, from a rejection.

Interest and Fees

In re Adelphia Communications Corp., etaL,

342 B.R. 142 (Bankr. S.D.N. Y. 2006) (Lenders were not entitled to retroactive adjustments of grid interest based on recomputation of financial ratio.)

Prior to the petition date, Adelphia Communications Corporation and its subsidiaries (the "Debtors") entered into credit agreements with seven lenders. Each credit agreement provided for "grid pricing interest," whereby the non-default rate of interest was specified as the sum of a floating Base Rate and an Applicable Margin. Based upon a data grid, the Applicable Margin increased as a function of the borrower's reported Leverage Ratio, which in turn was based on compliance certificates and related financial information that the borrower was required to submit to the lenders.

The lenders contended that the Debtors provided inaccurate compliance certificates and financial information, thereby triggering a default under the credit agreements and allowing the recomputation of the Applicable Margin. Such a recomputation would have resulted in an increase of the lenders' claims from $ 187 million to $300 million, in addition to the approximately $1.5 billion in preand post-petition interest that the lenders had already received throughout the pendency of the Debtors' cases.

The Court first considered the lenders' argument that they were contractually entitled to the incremental interest, which should be recoverable as a secured claim under ? 506 of the Bankruptcy Code. In doing so, the Court looked to the unambiguous language of several sections of the credit agreements. The Court found that section 9 ("Covenants") merely set forth promises to be performed and did not include any remedies for failing to satisfy those promises. Similarly, the Court determined that sections 3 ("Terms of Payment"), 10 ("Default"), and 11 ("Rights and Remedies") did not "provide for alternate computations of the 'Applicable Margin' under the credit agreement, retroactively or otherwise." The Court found that the lenders could have drafted the credit agreements to include, as an additional remedy, the recomputation of the Applicable Margin, but that they failed to do so. Accordingly, the Court ruled that "under these credit agreements, the interest rate is not automatically and retroactively adjusted in the event reported financial information turns out to have been false; that is not one of the contractual remedies that any of the bank lenders bargained for."

The Court noted that the credit agreements contained a provision for default interest that would have given the lenders even more interest than the recomputed interest, but that the lenders had waived the right to receive such interest in connection with the negotiation of the DIP financing facility. Id. at 4.

The Court also considered the lenders' argument that they were entitled to the incremental interest as a matter of tort law. In rejecting this argument, the Court noted that Section 506(b), which "provides holders of oversecured claims interest on such claim, and any reasonable fees, costs or charges provided for under the agreement under which such claim arose," did not apply, as tort claims do not give rise to secured claims. The Court concluded that "[w]hile most or all of the bank lenders did indeed retain remedies against Adelphia in tort, these tort remedies do not include expectancy damages, and, at such time as the bank lenders are fully repaid the principal on their loans, they will have no claims in tort."

Based on this decision, lenders would be welladvised to consider including in their credit agreements a specific provision allowing them to recompute interest retroactively based upon corrected financial information.