The Fifth Circuit Court of Appeals recently upheld a lower court ruling permitting a lender to change management pursuant to a negotiated agreement notwithstanding the debtor’s allegation that it was only under duress that it permitted the lender to do so.
As noted by the Fifth Circuit,
[U]sing leverage is what negotiation is all about. And difficult economic circumstances do not alone give rise to duress. If they did, then many loans would be voidable.
Lockwood v. Wells Fargo NA, No. 20-42324 at 3 (5th Cir. Aug. 16, 2021).
Lockwood v. Wells Fargo NA – Background
Here, the facts are typical to all workouts. An individual owned several companies and guaranteed $90 million of secured bank debt. As the company finances deteriorated, to avoid acceleration of the debt, the individual acknowledged that the debts were valid, binding, and enforceable. He also agreed there were no valid defenses and waived all setoffs, claims, and counterclaims. Finally, the individual agreed to hire a chief restructuring officer. He agreed to these same waivers in consideration for second forbearance.
Ultimately, the lender declared the loans in default and accelerated the debt. As expected, the companies sued the lender seeking more than $1.5 billion in damages for negligence, fraud in the inducement, conversion, and a host of other business torts. The district court dismissed the owner’s claims on summary judgment based on the waivers.
Examination by the Fifth Circuit
The Fifth Circuit first addressed the fraudulent inducement claim, which was based on the lender’s insistence on control being turned over to the Chief Restructuring Officer (CRO). Yet, as pointed out by the court, the owner knew about this demand before agreeing to the forbearance and thus ratified his personal guaranty.
The owner then claimed that because of economic duress, i.e., based on the leverage the bank had on him, he was compelled to sign the guaranty and forbearance agreement. The Fifth Circuit shot this claim down by stating,
But using leverage is what negotiation is all about. And difficult economic circumstances do not alone give rise to duress. See Dicker Ctr., 631 S.W.2d at 186. If they did, then many loans would be voidable. People and businesses often need loans because they are facing financial challenges. Borrowers who seek to modify their loan agreements after failing to make payments are even more likely to be feeling the squeeze. Opportunities to modify—and potentially stave off financial disaster—would be few and far between if a borrower could later void the modification because of the economic pressure that prompted it in the first place.
Id., at 7 (citation omitted).
The Fifth Circuit then laid out the three (3) elements in proving up duress:
“(1) a threat to do something a party has no legal right to do, (2) an illegal exaction or some fraud or deception, and (3) an imminent restraint that destroys the victim’s free agency and leaves him without a present means of protection.”
Id., at 7- 8, citing Wright v. Sydow, 173 S.W.3d 534, 544 (Tex. App.—Houston [14th Dist.] 2004, pet. denied).
Thus, in the absence of bad faith, and not being aware of any defense barring a lender from seeking a change of management as a condition for a forbearance or loan modification, the Fifth Circuit affirmed the lower court ruling.
So, at the end of the day, when undergoing a workout with a lender who holds all the cards, a borrower needs to decide whether to throw in the towel or agree to lender demands no matter how aggressive such demands may be. Presumably, with the owner being on the hook per his personal guaranty, the owner presumably had no choice, but this does not equate to duress.
One side note, this author wonders if it would have made a difference if the companies had sued the CRO for professional negligence and perhaps breach of fiduciary duty.