Lawyers who represent lenders in recovering on defaulted loans are consistently confronted with the lender’s quest to recover the maximum amount at the lowest cost.  Not an unreasonable request.  However, too often the lender’s own form of agreement does not provide assistance in keeping down the costs.

In preparing this article I chose to go beyond the four corners of the judge’s decision and took advantage of electronic filing of documents (PACER) so I could see the promissory note at issue.  I was looking, in particular, to see whether a certain typical clause was included in the form but could not find it.

This case was brought against an individual to recover on two promissory notes.  Simple.

The Court ruled:

at oral argument…. the Defendant conceded that he owed the Plaintiff monies under the two Promissory Notes and that he was in default, as well. The Defendant challenged, however, the amount which Plaintiff claims to be due and owing. The Defendant consented to the entry of summary judgment as to liability but reserved the right to contest the amount of the debt at a hearing on damages. Accordingly, the Motion for Summary Judgment is GRANTED as to liability only.

The Defendant retains the right to challenge the Plaintiff’s proof as to the amount of the judgment sought and to present evidence regarding the same. A hearing to determine the Plaintiff’s damages (the amount of the judgment) shall be held….

Translated?  The bank is granted summary judgment on liability only but still needs to prove the amount owed at a separate evidentiary hearing. 

Could this “extra trial” have been avoided?

It appears (from the decision) that at the hearing on the motion for summary judgment the pro se defendant made a “bald protest” as to the amount claimed by the bank.  For whatever reason, the judge considered that sufficient to put the bank to its burden of proof on the amount owing.

Lenders typically include a clause providing that it will send monthly statements of account which statement shall be deemed to be true and correct unless timely objected to.  Thus, the statement will be deemed to be an account as stated and primary evidence in a contest as to the amount owed. 

A typical clause might read as follows:

Account Stated.  Lender’s books and records showing the account between Lender and Borrower shall be admissible as evidence in any action or proceeding, shall be binding upon the Borrower for the purpose of establishing the items therein set forth and shall constitute prima facie proof thereof.  Lender’s monthly statements setting forth the transactions hereunder rendered to Borrower whether by electronic means or otherwise shall, to the extent to which no written objection is made within thirty (30) days after the end of the month following the month of the statement, be binding upon Borrower and constitute an account stated between Lender and  Borrower and be binding upon Borrower.

A clause such as this shifts the burden of proof on the amount due to the borrower and away from the lender.  Had this clause been included in the note, the bald allegation of a dispute as to the amount would not have prevented the granting of a judgment in an amount certain and would have avoided the necessity of additional proceedings, which likely will include discovery and court appearances, all of which run up the cost of litigation.

Lending money is easy.  Getting it back is not.  That is why we fill up so many pages of a loan agreement.  Plan your divorce before you get married.

TD Bank, N.A. v. Michael C. Culver, 2019 WL 2579232


In November, 2018, I published an article in the ABF Journal entitled Why Are MCAs Doing So Well in the Courts?  First, let’s agree that there are many MCA providers that practice within the scope of what is fair, reasonable and legal.  Those MCA providers tend to view the growing number of unscrupulous MCA providers as being damaging to their growing lending niche.

With few exceptions, MCAs have fared well in the courts.  A very recent decision from the United States District Court for the Eastern District of Pennsylvania may be an indication that things may be changing.

In this case the plaintiff asserted claims for violations of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) and Texas law against Defendants Complete Business Solutions Group, Inc. (CBSG), Prime Time Funding, LLC (PTF), and unnamed John and Jane Does.  Plaintiffs asserted that the Defendants worked together to exploit cash-strapped small businesses by luring them into endless cycles of usurious debt under the guise of false promises of consulting services and debt reduction.

The plaintiff (Fleetwood Services) ultimately received a traditional small business loan that it used to repay Defendants in full, including what Plaintiffs characterize as an undisclosed annualized percentage rate of interest at 114.07%.

The defendants brought a motion to dismiss the complaint.  In its decision denying the motion, the Court described the relationship between the parties as follows:

The relationship between Plaintiffs and CBSG was governed by the terms of the “Factoring Agreement,” which … obligated CBSG to provide Fleetwood Services with $370,000 (the Purchase Price) allegedly in exchange for $547,000 worth of Fleetwood Services accounts receivables (the Receipts Purchased Amount)…. However, allegedly unlike a traditional factoring agreement, the fair market value of the accounts receivable (i.e., the Receipts Purchased Amount) was unilaterally dictated by CBSG and based upon the creditworthiness of Fleetwood Services—not the creditworthiness of the customers who were to pay the accounts receivable or any appraisal of the actual value of Fleetwood Services’ accounts receivable…. The Factoring Agreement obligated Fleetwood Services to repay the Receipts Purchased Amount in 110 daily installments of $5,000.25, which were effectuated by electronic automated clearing house debits from Fleetwood Services’ Texas-based bank accounts. These daily payments were, like the Receipts Purchased Amount, also divorced from Fleetwood Services’ actual accounts receivable because the Factoring Agreement made “any and all receivables from any customer in any amount based on any sale subject to Defendant CBSG for payment of the daily fixed debit.

The Factoring Agreement also provided for (1) a declaration that the money provided by CBSG to Fleetwood Services “is not intended to be, nor shall it be construed as a loan”; (2) CBSG’s promise to refund Fleetwood Services any amount greater than the maximum lawful interest rate, in the event “a court determines that [CBSG] has charged or received interest” under the Agreement; and (3) a Pennsylvania choice of law provision.

Along with the Factoring Agreement, the Defendants also required Fleetwood Services to ensure repayment by granting CBSG security interests in “all accounts, chattel paper, documents, equipment, general intangibles, instruments and inventory…now or hereafter owned or acquired by [Fleetwood Services] and (b) all proceeds, as that term is defined in Article 9 of the UCC”, and obligating the owners to personally guarantee that Fleetwood Services paid CBSG the Receipts Purchased Amount ($547,000).

The Court stated:

Before the Court can address the Defendants’ arguments, it must first characterize the Factoring Agreement. If the Factoring Agreement is in substance a factoring agreement, i.e., a purchase of accounts receivable below their face value, then there can be no usury….If the Factoring Agreement functions as a loan, however, the Court must …determine whether it is subject to the usury laws of Pennsylvania or Texas, as the Agreement calls for the application of Pennsylvania law but the Plaintiffs assert Texas law applies…

The Court went on to rule (only for the purposes of the motion to dismiss) that the Factoring Agreement was not a “true factoring agreement” and, thus, was a “loan” subject to the usury laws of Texas which has a rather harsh usury law.

What glares out the most from this decision is the Court’s characterization of the MCA industry:

CBSG and PTF are engaged in the merchant cash advance industry, which is the merchant-to-merchant equivalent of consumer pay-day lendingan industry allegedly notorious for its predatory practices and extremely high interest rates.

Whether this case will spark closer scrutiny of providers of merchant cash advances is yet to be seen.  Those MCA providers that offer “true sale” factoring and/or rates that are reasonable based upon the credit risk being taken and below any usury limit will have nothing to fear and will likely benefit from those less scrupulous providers being punished for their greed.

Fleetwood Services, LLC v Complete Business Solutions Group, Inc. doing business as Par Funding, 2019 WL 1558087 (April 10, 2019, EDPA)


From time to time a lender may find itself holding funds that are not its property and to which multiple parties claim an interest. The lender does not want to be accused of exercising control over those funds (conversion), but does not want to take the risk of delivering the funds to the wrong person and remaining at risk of having to pay the “wronged” party. That is the purpose of an interpleader action – to implead (deposit the funds into court for a determination of who is entitled to them. Interpleaders may be used to dispose of funds (defensive) or to recover funds. For example, imagine you have placed account debtors on notice and the “bad guy” borrower is disputing your entitlement to the funds and pressuring the account debtor to pay him. You can bring the interpleader action to force the account debtor to deposit the funds in court.

An interesting interpleader case recently came down from the California Court of Appeal involving proceeds from the award winning Broadway musical, Million Dollar Quartet (MDQ). The question in this interpleader action was which adverse claimant was entitled to the impleaded funds: a judgment creditor with a properly recorded judgment lien, or an assignee who did not file a financing statement with respect to distributions irrevocably assigned to it by the judgment debtor before the judgment lien was recorded.

The appellate court determined that the answer depended on whether under California’s Uniform Commercial Code the assignment created a security interest that had to be perfected (but was not) by the filing of a financing statement. The court then determined that the trial court was correct in holding that although the assignment created a security interest, the judgment creditor was entitled to the impleaded funds because its recorded judgment lien had priority over the unperfected security interest.

The interpleader action followed a prior action brought by Cleopatra Records as an investor in the development of the MDQ musical which prior action ultimately resulted in a judgment in favor of Cleopatra. Prior to the entry of the judgment, the author of the musical (one of the judgment debtors) assigned part of his interest in future distributions from the production of the musical to the law firm that represented the defendants in the lawsuit. The trial court in the interpleader action ruled that the assignment constituted a “security interest” that was subject to (UCC) perfection by the filing of a financing statement inasmuch as the transaction did not involve real property and because the assignment was of a percentage of the interest in future distributions that would revert to the debtor once the debt to the law firm was paid.

The law firm argued that the transfer was an absolute assignment. However the court dismissed that claim because the assignment reverted back once the firm’s fees had been paid and because the assignment was not for the full amount of the asset.

The appellate court held that because the law firm did not file a financing statement, Cleopatra’s judgment lien had “priority in time of filing or perfection”of the unperfected assignment to the law firm.

Two worthwhile takeaways from this case:

  1. Although there are other legal theories the law firm might have pursued the lesson from this case is clear: When in doubt file. A prophylactic filing could have saved this law firm the trouble and aggravation it put itself through.
  2. When holding funds in which you do not have an interest and which are subject to multiple claims, implead the funds by bringing an interpleader action. The court awarded MDQ its attorneys fees and costs, which the court directed were to be deducted from the impleaded funds. Thus, there was no loss for doing the right thing and at the same time demonstrated MDQ’s clean hands in not retaining possession of the funds.

MDQ, LLC et al. v Gilbert, Kelly, Crowley & Jennett LLP, Court of Appeal, Second District, Division 8, California. 2019 WL 948726.


The issue of liquidated damages often confronts lenders seeking to recover for their losses when a borrower defaults or chooses to exit a facility prior to its contracted maturity date.  Liquidated damages provisions are enforceable, but only at an amount that is reasonable in light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss in such circumstances.

Courts have considered the reasonableness and applicability of these provisions in various contexts and in all kinds of courts.  A very recent decision from the Bankruptcy Court for the Southern District of New York is one of interest to readers of this publication.  The case involves the lease of several aircraft to a commercial airline.

Lessor purchased seven aircraft that were then leased to a commercial airline.  Shortly after the airline filed its Chapter 11 it rejected the seven aircraft leases and surrendered them back to the Lessor.  The Lessor filed a proof of claim for its rejection damages which proof of claim included liquidated damages as provided for in the leases.  The debtor airline filed objections to the proof of claim and, on February 14, 2019 (Valentine’s Day), the Court issued its decision on the motion for summary judgment deciding the issues.

Because this involved a leasing transaction Article 2A of the UCC came into play.  Even so, the controlling section of Article 2A is consistent with general law on the topic of liquidated damages.  Section 504 of Article 2A provides:

Damages payable by either party for default, or any other act or omission, including indemnity for loss or diminution of anticipated tax benefits or loss or damage to lessor’s residual interest, may be liquidated in the lease agreement but only at an amount or by a formula that is reasonable in light of the then anticipated harm caused by the default or other act or omission.

The Court characterized the liquidated damages provision as follows:

The Lessee then has the choice of liquidated damages as measured in three different ways which make reference to various calculations of rent and stipulated loss value:

(i) Stipulated loss value minus present value of the fair market rental value for the remainder of the Amended Lease term;

(ii) Stipulated loss value minus the fair market sales value of the Aircraft; or

(iii) Difference between present value of rent reserved for the remainder of the Amended Lease term and the fair market rental value for the remainder of the term

The UCC, however, does not define reasonableness and as you would expect, the parties disagreed leaving it to the Court to decide.

Prior to Article 2A’s enactment, liquidated damages clauses in leases were governed by the common law. The common law provided that to be enforceable a liquidated damages clause must specify a liquidated amount which is reasonable in light of the anticipated probable harm, and that actual damages must be difficult to ascertain as of the time the parties entered into the contract.

Courts have upheld liquidated damage provisions so long as the amount liquidated bears a reasonable proportion to the probable loss and the amount of the actual loss is incapable or difficult of precise estimation.  If, however, the amount liquidated is plainly disproportionate to the probable loss, the provision will be deemed an unenforceable penalty

Under the Common Law a three part test was applied to consider reasonableness:

  1. Reasonableness must be judged at the time of contract formation;
  2. Due consideration must be given to the nature of the contract and the attendant circumstances; and
  3. The liquidated damages clause cannot be a penalty.

It is interesting to note that the Official Comments to Article 2A discuss eliminating the second and third prongs to this test.  Notwithstanding, the court turned to the common law for guidance as well as how other courts in similar situations treated liquidated damages since the enactment of Article 2A.

Courts have identified certain formulations as inherently unreasonable. For example, static liquidation values (“SLVs”) (i.e., where the SLV does not decline over the course of the lease term and thus fails to recognize depreciation and the payment of rent over time) have been repeatedly rejected.

The Court was clearly concerned with the propriety of the liquidated damages provision, saying:

At the center of the parties’ dispute is the fact that the liquidated damages provisions here allow for the unconditional transfer of residual value risk, or market risk, only upon default, without a cognizable connection to any anticipated harm caused by the default itself. …the question is “whether the parties in a true finance lease transaction can allocate risk so that the financing is treated as a debt obligation until the end date of the Leases, and then at the end of the term the Lessor Parties becoming the true economic owners.” …. Applying the applicable legal principles above to the SLVs in the Amended Leases, the Court concludes that the parties may not allocate risk where—as here—doing so violates the reasonableness requirement of Article 2A, Section 504.

The Court found that this approach transferred all market risk, or residual value, including any risk of idiosyncratic depreciation or damage to a particular aircraft. This provision granted Lessor the ability to retake possession of the aircraft and recover not just a dollar value equal to scheduled rental payments, but also any deficit in the value of the aircraft that fell short of Lessor’s desired total gross return. The SLVs were calculated to achieve a four percent margin above the original purchase price regardless of where default may have left the parties.  The Court noted:

The unreasonableness of the liquidated damages clauses here per Article 2A is confirmed by a comparison of the SLVs with the dollar value of the Debtors’ remaining rent obligations. Using the rent obligations set forth in the [o]riginal [l]eases, the numbers show a stark difference between the rent obligations that remain unpaid here—near the end of the lease term—as compared with the corresponding SLVs.

The Court itemized damage calculations that appeared to be out of line with the actual loss incurred by the Lessor.  One example showed an SLV of $ 6,358,502.68 on March 23, 2019, the last month of the lease term, when only $ 115,626.08 remained in basic rent obligations.

The Court concluded that the liquidated damages clauses operated as a penalty contrary to the spirit of a traditional liquidated damages provision and dismissed the Lessor’s claims.

Bank and ABL early termination provisions typically provide for a declining percentage of the maximum loan amount.  Those provisions consistently are upheld as being reasonable.  The takeaway from this decision, however, is be cautious in your liquidated damages provisions so as to assure that you obtain the benefit of your bargain and not imposing a penalty.

In Re: Republic Airways Holdings Inc.,  2019 WL 630336, (Bankr. NY 2019)


A New Year’s Eve (yes, December 31) decision came down from the Court of Appeals of Texas that is worthy of your consideration and a few minutes of your time.  The case concerns whether the secured creditor waived its priority rights to collateral by failing to declare a default or take an affirmative action to foreclose on collateral prior to the judgment-lien-creditor foreclosing on the same collateral through garnishment.

In October, 2011, Legacy Bank entered into a secured revolving line of credit facility with Canyon Drilling Company. In December, 2012, two trade creditors obtained judgments against Canyon and soon thereafter filed a writ of garnishment. Upon learning of the garnishment, Legacy appeared and intervened asserting that it held a properly perfected security interest in the garnishees’ accounts due and owing to Canyon and that its interests were superior to those of the judgment creditors.

Legacy subsequently provided a formal notice of default to Canyon on July 19, 2013. Despite Canyon’s default, Legacy continued to advance funds to Canyon hoping for a successful turnaround. However, Legacy ultimately exercised its foreclosure rights against Canyon after the note became due in April, 2014.

At trial the judgment creditors argued that Legacy waived its security interest by (1) allowing Canyon to remain in default for several years without making demand, accelerating the debt, liquidating collateral, or otherwise enforcing its security interest; (2) not demanding payment until a year after the judgment creditors obtained their judgment and more than six months after Canyon filed the writ of garnishment; and (3) making a “nominal, halfhearted demand on Canyon solely to save face” before loaning Canyon more than $2 million in additional funds. In advancing this argument the judgment creditors asserted that they are not bound by the terms of the contracts executed by Legacy and Canyon to define the terms by which Legacy could waive its security interest. Instead they asserted that they were entitled to establish a waiver under equitable principles.

The jury agreed and awarded judgment in favor of the judgment creditors.  Legacy appealed.

This was a case of first impression in Texas and accordingly, the Texas Court of Appeals turned to a recent decision from Oregon in a similar situation.  The Oregon Court, also lacking precedent in its state, turned to a group of decisions from the Northern District of Illinois.

The Texas Court stated:

The Oregon court determined that, taken together, the cases from the Northern District of Illinois impose three preconditions on a secured creditor attempting to enforce its interest in garnished collateral funds under the waiver theory: (1) a default has to occur; (2) the secured party must declare a default; and (3) the secured party must take an “affirmative step” to exercise its rights (such as acceleration). **** If any of the preconditions remain unsatisfied as of the time the lien creditor garnishes funds, “the secured party is deemed to have constructively waived its priority vis-à-vis the lien creditor, and, thus, cannot trace and recapture its collateral from the garnishor.” ****. [This] waiver theory has been characterized as a “use-it-or-lose-it” approach. *** [T]his characterization of the waiver approach is accurate.

Conversely, under the trace and recapture approach, “before and until a secured party declares default and acts on its right to collateral, a garnishor is entitled to take the collateral; however, in doing so, the garnishor takes traceable collateral subject to the secured party’s interest.” ***. “Thus, unlike the waiver approach, the secured party maintains its security interest, despite a period of inaction after default and before a judgment creditor takes the funds.” *** In other words, a security interest under the trace and recapture approach is not lost if it is not used.

The Court also looked to the UCC for guidance noting that the official comments to Section 9-610 expressly support the trace and recapture approach.  Comment No. 5 to Section 9-610 provides that “the disposition by a junior [creditor does] not cut off a senior’s security interest.” Rather, “[t]he holder of a senior security interest is entitled, by virtue of its priority, to take possession of collateral from the junior secured party and conduct its own disposition.”

The Court reversed the trial court concluding:

Legacy’s security interest in the collateral could not be waived under equitable principles or by operation of law by not being enforced prior to the garnishment. Instead, the UCC affords Legacy the opportunity to trace and recapture its prior perfected security interest in the garnished funds even though it did not exercise those rights prior to the garnishment. That is not to say that it was impossible for Legacy to waive its security interest because, under Texas law, waiver is a valid defense to an action to enforce a security interest

OK.  So do we think that this is a win for the good guys or did they just dodge the bullet?

The concern I have with this case arises out of Legacy’s continued advances – some $2 million over a period of several years – following the judgment creditors obtaining their judgments and having commenced enforcement proceedings.  Although this conduct may now be sanctioned in Texas, we cannot suggest that secured lenders be cavalier in their secured position when confronted with the execution of a judgment against their borrowers-debtors.

Legacy Bank, v. Fab Tech Drilling Equipment, Inc. and Impulse Electric, Ltd., 2018 WL 6928971 (Texas, 2018)