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Financial Services FLASHPOINTS July 2020

July 15, 2020Print This Post Print This Post

Michael L. Weissman, Levin Ginsburg, Chicago
312-368-0100 | E-mail Michael L. Weissman

Bank and Borrower Did Not Collude To Injure Another Lender

Under the §9-332 of the Uniform Commercial Code (UCC), 810 ILCS 5/1-101, et seq., a party is liable for colluding with another when there is evidence that the two parties acted pursuant to an agreement or otherwise in concert with each other and the purpose of the concerted action was illegal, fraudulent, or otherwise wrongful toward the injured third party. This standard is based on RESTATEMENT (SECOND) OF TORTS §876 (1979). Applied to NextGear Capital, Inc. v. Bank of Springfield, Case No. 4:18-CV-01086-NCC, 2019 WL 2525753 (Bankr. E.D.Mo. June 19, 2019), the question was whether Bank of Springfield had colluded with its borrower, Gateway Buick GMC, Inc., to injure Gateway’s floor plan lender, NextGear Capital, Inc.

Gateway operated an automotive dealership in Hazelwood, Missouri, selling new Buick and GMC vehicles. Between August 11, 2015, and January 12, 2016, it executed a series of promissory notes totaling $13,625,000 with Bank of Springfield. The notes were secured by a blanket lien on all of Gateway’s real and personal property.

NextGear provided Gateway with floor plan financing pursuant to a demand note and a loan and security agreement dated October 27, 2014. Gateway granted NextGear a blanket lien on its personal property, thereby giving NextGear a senior lien position in Gateway’s accounts receivable and any funds Gateway would receive from General Motors. Gateway received two types of payments from General Motors: (1) vehicle rebates and holdbacks that were proceeds from vehicles floor-planned by NextGear and (2) dealer incentive payments.

With Gateway experiencing financial difficulties, the three parties executed a series of forbearance agreements. On October 1, 2015, NextGear agreed to subordinate its claim to payments Gateway had coming from General Motors, except for the sales proceeds arising from the vehicles NextGear had floor-planned and for which it had not been paid. On May 27, 2016, the parties executed an amended forbearance agreement and on July 10, 2017, yet another amended forbearance agreement. In the last of these agreements, there was a provision prohibiting Gateway from any further borrowing from the bank.

Because NextGear found, as early as May 2016, that Gateway was selling vehicles out of trust and not remitting the sales proceeds to NextGear, it had stationed risk managers at Gateway’s premises to insure that the sales proceeds were delivered to NextGear. The bank was aware of this as well as Gateway’s financial difficulties.

Gateway had bank accounts with several different banking institutions, including Regions Bank. The NextGear loan documents obligated Gateway to deposit vehicle rebates and holdbacks from the sale of vehicles floor-planned by NextGear into the Regions account. NextGear was party to a tripartite control agreement, giving it control over the Regions account.

Gateway directed General Motors to deposit rebate, holdback, and incentive payments into Gateway’s account at Bank of Springfield. Bank of Springfield knew the source of the deposits was General Motors. These deposits were a direct violation of the forbearance agreements, the floor plan financing agreements, and the subordination agreements.

NextGear accused Bank of Springfield of acting purposefully to induce Gateway to deposit monies Gateway received from General Motors with Bank of Springfield and applied to payments due the bank on its Gateway notes. These were monies that were supposed to be placed on deposit at Regions Bank. Despite demands from NextGear, the bank refused to turn over the disputed funds.

The decision arose from a motion to dismiss the case filed by the bank. The bank claimed its conduct fell within the protection of §9-332 of the UCC. The court agreed.

Section 9-332(b) of the UCC states, “a transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.” In the view of the court, the decision hinged on whether the bank was acting in collusion with Gateway when it obtained the General Motors payments.

The court said there was an insufficient allegation of collusion and ruled as follows: “ ‘[A] junior secured creditor is under no obligation to identify and segregate cash proceeds for the benefit of the senior secured creditor.’ . . . This is the case even if the junior secured creditor knew of the senior secured party’s interest. . . . The collusion standard in Article 9 does not impose a duty on a transferee of funds to identify and segregate the funds absent a contractual obligation to do so. . . . As long as [Bank of Springfield] acts rightfully, it cannot be responsible for Gateway’s potentially wrongful actions.” [Citations omitted.] 2019 WL 2525753 at *4.

For a decision reaching the opposite conclusion on this issue of collusion, see Banner Bank v. First Community Bank, 854 F.Supp.2d 846 (D.Mont. 2012).

License Cancellation Trumps UCC

In GLH Communications, Inc. v. Federal Communications Commission, 930 F.3d 449 (D.C.Cir. 2019), the contest was between the Federal Communications Commission as lender and a licensee-borrower whose license was cancelled when it defaulted on payments due under an installment payment program.

GLH was a cellular telephone company that acquired a number of radio spectrum licenses from Leap Wireless International, another cellular telephone company. Leap had purchased them from the FCC under an installment payment program. The installment payment program was instituted to enable small businesses to participate in spectrum auction sales by reducing the upfront cost of a license.

But the installment payment program came with an important caveat: it was subject to the condition that the licensee must fully and timely perform all of its payment obligations under the installment plan. If it missed a payment (and didn’t make it up during two quarter-long grace periods), the law provided that “[the licensee] shall be in default, its license shall automatically cancel, and it will be subject to debt collection procedures.” 930 F.3d at 455.

Some of the licenses GLH acquired from Leap had been purchased by Leap under the installment payment program. As part of the deal, GLH assumed the obligation to make the remaining installment payments due on those licenses. Concurrently, Leap agreed to pay GLH the amounts necessary to make the installment payments each quarter.

At first, the arrangement worked. But ultimately, Leap failed to make a payment in January 2003, which lead to GLH failing to make an installment payment due to the FCC on January 31, 2003. GLH had until July 31, 2003, to cure the payment delinquency. It didn’t. Instead, it requested a waiver for two years during which it would “try to satisfy its obligations.” 930 F.3d at 452. The FCC declined the request.

While GLH was appealing the denial, the FCC once again auctioned the spectrum covered by the cancelled licenses to new purchasers. On appeal to the court, GLH argued, inter alia, that the Uniform Commercial Code governed its relationship with the FCC, which meant that it was entitled to the proceeds of the new auction of the licenses to the extent the sale proceeds exceeded its debt to the Commission.

Even assuming, arguendo, that UCC principles should apply to the extent they did not conflict with federal interest or policies, the court said, “we cannot accept GLH’s argument that the UCC governs the Commission’s actions in this case.” 930 F.3d at 456. The court declared that Article 9 of the UCC sets forth a secured creditor’s lien enforcement remedies, which meant that it would only apply if the FCC’s cancellation of the licenses was “a lien-enforcement remedy under the UCC.” Id.

But, said the court, the FCC is not only a creditor but also a regulator. Its authority to cancel the licenses was predicated on its regulatory posture, not any remedy it reserved in the installment payment documentation GLH assumed. In the view of the court, “Because the FCC’s license cancellation is not a UCC lien-enforcement remedy, the UCC’s requirements are simply inapplicable to the cancellation.” 930 F.3d at 457. And for the final nail in the coffin: “[O]nce the licenses were cancelled pursuant to the Commission’s regulatory authority, GLH had no claim under the UCC to the proceeds of the reauction of the underlying spectrum.” Id.

What’s the point? Lenders considering FCC or other regulatory authority-granted licenses as collateral should investigate thoroughly the extent of the regulatory remedies available to the issuing agencies.

With a swift stroke of the pen declaring a license cancelled, the lender’s collateral can evaporate.

For more information about financial services, see COMMERCIAL AND INDUSTRIAL LOAN DOCUMENTATION (IICLE 2018). Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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