Frandzel Robins Bloom & Csato, L.C. announced today that Shareholders Steven N. Bloom and Michael Gomez have been distinguished by their peers and named to the 2024 Southern California Super Lawyers list.
Annually, Super Lawyers, a lawyer rating service, recognizes no more than five percent of attorneys in each state. This honor highlights lawyers from over 70 practice areas who have demonstrated exceptional professional achievements and garnered substantial peer recognition. The selection process is rigorous and patented, involving a comprehensive statewide lawyer survey, an independent candidate evaluation, and specialized peer reviews within various practice areas.
Steven N. Bloom has been selected as a top-rated attorney in Real Estate for the 12th time. His expertise encompasses real property, warehouse and commercial financings, debt restructurings, and risk management. His transactional work includes asset sales, business arrangement documentation, and credit facilities for banks and financial service providers. He is a past chair of the Financial Institutions Committee of the Business Law Section of the State Bar of California, and a past member of the Legal Affairs Committee of the California Bankers Association.
Michael Gomez has been recognized as a top-rated attorney in Creditor Debtor Rights. His practice focuses on bankruptcy, debtor and creditor rights, commercial and business litigation, debt workout negotiations, and restructuring. He specializes in commercial lending transaction documentation, covering both personal property and real estate-secured credits. Gomez’s diverse client portfolio includes debtors, creditors’ committees, hedge funds, indenture trustees, equipment lessors, receivers, landlords, bankruptcy trustees, judgment creditors, private and institutional lenders. His experience spans out-of-court workouts, federal and state court litigation, and chapters 7, 11, 12, and 13 bankruptcy cases.
Frandzel is a recognized leader offering legal counsel and litigation services to financial institutions and businesses. For over three decades we’ve been providing clients with time-tested results and business insights to help them succeed. We are known for our highly responsive service, lasting client relationships and solutions that work.
“As 2023 draws to a close, Diversity, Equity, Inclusion and Accessibility (DEIA) remains a perennial hot-button topic that companies, no matter what business they’re in, must contend with not only to function on a day-to-day basis but to sustain future growth,” states the publisher. “It is clear that implementing DEIA initiatives is vital for recruiting and retaining talent as well as attracting investors, but many businesses are slow to adopt clear objectives and actionable strategies. More awareness, transparency and effort are needed to drive change and instill a sense of acceptance among the workforce across America.”
Managing Shareholder Hemal Master adds, “We are so proud that Wes has been selected for this honor. This recognition serves as a reminder of the power we possess when we come together to celebrate diversity and embrace our authentic selves.”
King is the first openly gay Partner at the firm, a milestone in the firm’s 40+ year history. As the co-chair of Frandzel’s summer associate program, he is actively engaged in diversifying the firm’s recruitment efforts. Moreover, King is a member of the firm’s DEIA committee where he continues to lead Frandzel’s efforts to promote diversity and inclusion among its attorneys and staff. King’s extensive involvement in the LGBTQ+ community includes his prior leadership as co-president and long-time board member of the LGBTQ+ Lawyers Association of Los Angeles, continuing to mentor local law students.
In his role as a transactional attorney, he specializes in complex financial matters, representing banks, lenders and financial institutions in a range of transactions, including real estate, commercial loans and asset-based credit lines. King adeptly handles restructurings and business disputes, prioritizing client success and minimizing litigation costs. His comprehensive background, including public finance and real estate, brings valuable insight into his clients’ needs.
Frandzel is a recognized leader offering legal counsel and litigation services to financial institutions and businesses. For over three decades we’ve been providing clients with time-tested results and business insights to help them succeed. We are known for our highly responsive service, lasting client relationships and solutions that work.
Frandzel Robins Bloom & Csato, L.C. announced today that Shareholder Brett McClure has been recognized by Lawdragon and included in the 2nd edition of its “500 Leading Litigators in America.”
These lawyers are “the pride of Litigation Nation. What [they] do better than anyone else in the world is litigate. And these are the advisors you want to send into battle,” states the publisher. “We’ve written about and researched lists of lawyers for well over 50 years and noted a transcendence of sorts in the candidates for this guide.” The archetype of a great litigator has, of course, moved with the times and now comes in all shapes, hues, backgrounds and sizes…Today’s litigation battles are small corporate wars that rely on heavily trained and specialized teams comprised of lawyers who are themselves stars.”
Recently recognized as a Litigation and Trial Lawyer “Leader of Influence” by the Los Angeles Business Journal, Brett McClure focuses his practice on resolving the business disputes of his clients, from Fortune 500 companies to start-ups and high net worth individuals. He has served as lead or co-lead trial counsel representing plaintiffs and defendants in state and federal courts, as well as arbitration, across the nation and has also been recognized for his success in litigation matters by The Legal 500.
Frandzel is a recognized leader offering legal counsel and litigation services to financial institutions and businesses. For over three decades we’ve been providing clients with time-tested results and business insights to help them succeed. We are known for our highly responsive service, lasting client relationships and solutions that work.
Frandzel Robins Bloom & Csato, L.C. announced today that Shareholder Brett McClure has been recognized among top lawyers by the Los Angeles Business Journal in its 2023 edition of Leaders of Influence: Litigators & Trial Attorneys.
“There is a special breed of attorney that needs to transcend expert comprehension of the legal system – the litigator,” states the publisher. “Lawyers who go to the proverbial mat to fight for their clients before judges and jury have their own unique sets of skills. In this special section we share profiles of the very best litigators and trial attorneys in the region. These are the trusted advisors you want in your corner in court.”
Managing Shareholder Hemal Master adds, “this recognition is a testament to Brett’s legal prowess and dedication to his clients. We are very proud to have such a meticulous and tenacious lawyer representing our firm.”
McClure focuses his practice on resolving the business disputes of his clients, from Fortune 500 companies to start-ups and high net worth individuals. He has served as lead or co-lead trial counsel representing plaintiffs and defendants in state and federal courts, as well as arbitration, across the nation and has been recognized for his success in litigation matters by The Legal 500.
McClure is skilled in providing insightful and pragmatic advice to avoid disputes and to resolve them if they ripen. He has litigated cases in an array of industries, including real estate, banking, business and consumer technology, entertainment, professional services, manufacturing and insurance industries. Brett’s recent experience covers a broad spectrum of practice areas including real estate disputes, environmental claims, consumer class actions, unfair competition, breach of contract, fraud, employment and trade secrets, personal injury / toxic torts and copyright and trademark disputes.
Frandzel Robins Bloom & Csato, L.C. announced today that Loren Gordon and Albert Moon have been recognized by Los Angeles Times as Commercial Real Estate “Visionaries,” and they are profiled in the annual Commercial Real Estate Magazine.
“In a state of constant recovery and reinvention, the Southern California commercial real estate market has been unpredictable, yet trending toward growth. These uncertainties have not deterred the talented people featured in this list of visionaries,” states the publisher. “These executives, lenders, builders, professional service providers have brought savvy, adaptability and relentless optimism to the commercial real estate world.”
Managing Shareholder Hemal Master adds, “this recognition is a testament to Albert and Loren’s immense dedication to clients. Their legal prowess and commitment to service make them powerhouses in the field of commercial real estate.”
Albert Moon represents private and institutional lenders in various real estate financings, including acquisition, construction, development and refinance of diverse properties. He also assists lenders with loan workouts, loan sales, real property transactions and distressed loan settlements. Mr. Moon recently represented financial institutions in securing loans for commercial properties nationwide, construction financing for a luxury resort and financing for hotels and mixed-use projects. He has also advised on financings for self-storage facilities, single-family home construction, leasehold interests, office space projects and industrial buildings.
Loren Gordon is a “highly accomplished transactional attorney specializing in commercial finance, real estate, and corporate transactions,” states the profile. With nearly two decades of experience, Mr. Gordon has represented banks, regional and community banks, private lenders, developers and entrepreneurs. He has successfully structured, negotiated, and documented billions of dollars in financing. “Gordon also excels in workouts and debt restructuring, aiming to maximize value for his clients and avoid litigation.” He has been recognized as a “Rising Star” by Southern California Super Lawyers Magazine and is a sought-after speaker on commercial lending industry topics.
Frandzel Robins Bloom & Csato, L.C. announced today that Michael Gomez has been recognized as a ‘Legal Visionary’ in Los Angeles Times’ third annual Business of Law Magazine.
“Southern California continues to maintain its status as a center for thought leaders and power brokers in the legal space. With so many superb law firms in the region, to be named as a standout attorney in what is surely one of the most impressive regional fields in the industry is quite an achievement,” states the publisher.
Michael Gomez focuses his practice in the areas of bankruptcy, debtor and creditor rights, commercial litigation, and business litigation; debt workout negotiations, restructuring and documentation of commercial lending transactions, and personal property and real estate-secured credits. He has represented various entities, including debtors, creditors’ committees, hedge funds, indenture trustees, equipment lessors, receivers, landlords, bankruptcy trustees, judgment creditors, private lenders, and institutional lenders in out-of-court workouts, federal and state court litigation, and chapters 7, 11, 12, and 13 bankruptcy cases.
Gomez routinely moderates and speaks at educational presentations before clients and trade groups concerning bankruptcy, enforcing judgments, financing distressed borrowers, and agricultural lending issues. Among his achievements, he has successfully resolved multiple workouts with and without court assistance.
Frandzel is a recognized leader offering legal counsel and litigation services to financial institutions and businesses. For over three decades we’ve been providing clients with time-tested results and business insights to help them succeed. We are known for our highly responsive service, lasting client relationships and solutions that work.
Frandzel Robins Bloom & Csato, L.C. has been recognized in the Los Angeles Times’ list of top law firms in Southern California. The list profiles the 100 leading law firms in Los Angeles County; Frandzel is also ranked as one of the top 25 real estate law firms. These 100 leading law firms employ 6,917 local attorneys and more than 11,000 total local employees. The list is ranked by total number of attorneys in L.A. County offices. To compile the list, B2B Publishing surveyed local, regional and national law firms and asked them to provide information about the number of attorneys and practice groups in their local offices.
Frandzel Robins Bloom & Csato, L.C. announced today that Managing Shareholder Hemal Master has been recognized as a minority leader of influence in a special feature by the Los Angeles Business Journal. According to the publisher, the feature profiles “those standout minority attorneys considered to be particularly impactful on the legal scene while serving as trusted advisors.” Master maintains a robust practice focusing on all aspects of lender representation, including representation of commercial banks, private equity funds, commercial finance companies, hedge funds, factors and other lenders in real estate and commercial loan transactions, commercial and real estate loan workouts, lender liability defense, and exercise and enforcement of all types of lender remedies.
In addition to his experience with the firm, Hemal completed a three-year-long secondment to a major regional bank in which he advised on hundreds of matters involving distressed debt and supervised litigation on matters in 45 different states. Master also previously served as General Counsel of the Western Independent Bankers and on the Event Planning Committee for the Special Assets Management Association. He currently serves on the Legal Affairs Committee of the California Bankers Association. and Master is a graduate of USC and Tulane Law School.
Frandzel is a recognized leader offering legal counsel and litigation services to financial institutions and businesses. For over three decades we’ve been providing clients with time-tested results and business insights to help them succeed. We are known for our highly responsive service, lasting client relationships and solutions that work.
The Truth in Lending Act (TILA) generally prohibits arbitration clauses in home loan transactions. Last year, a class action was filed in state court and later removed to federal court. (Lyons v. PNC Bank, N.A. (D. Md., Jan. 6, 2021) 2021 WL 50918.) The plaintiff alleged that he obtained a Home Equity Line of Credit (HELOC) from PNC Bank’s predecessor-in-interest in 2005. The plaintiff signed a HELOC agreement that did not contain an arbitration clause.
Separately, the plaintiff opened two deposit accounts with the bank, one in 2010 and one in 2016, and for each account, agreed in writing to be bound by the bank’s account agreement and any amendments. The account agreement included a set-off provision and gave the bank a security interest in deposit accounts, and also was amended to add an arbitration clause. The bank later used the set-off provision to make a HELOC payment from each deposit account.
The plaintiff sued the bank, alleging that the withdrawals were unauthorized under TILA. The bank moved to compel arbitration based on the arbitration clause in the account agreement. The issue was the scope of the statutory language that prohibits arbitration clauses in home loan transactions. The bank argued that the prohibition did not apply because the arbitration clause was in the separate account agreement, not the HELOC agreement. The bank also argued that the arbitration clause should control because the plaintiff’s claims arose out of the bank’s set-off payments and the account agreement authorizing them.
The District Court denied arbitration as to the second set-off claim, finding that “[t]o conclude that the Account Agreement’s arbitration clause is not part of the HELOC credit transaction would be to improperly ignore [the bank’s] own intertwining of the Agreement with the HELOC.” (Lyons at *4.) (The Court granted arbitration as to the first set-off, but only on the procedural ground that that account and its related arbitration clause predated the effective date of the TILA restriction.)
The bank appealed to the Fourth Circuit Court of Appeals, and on May 24, 2021, the Consumer Financial Protection Bureau (CFPB) filed an amicus curiae (“friend of the court”) brief, urging the Court to affirm the ruling denying arbitration, because to allow it “would create a broad loophole that would harm consumers” by allowing lenders to evade the TILA restriction by placing arbitration clauses into “related but ostensibly separate agreements.”
The CFPB argued that the TILA restriction by its terms applies not only to home-loan agreements themselves but also to any other contract between the borrower and lender “relating to” the loan, and that “[b]ecause the agreement governing those accounts purported to provide the bank with a means of collecting payment on Mr. Lyons’s home loan, the agreement ‘related to’ that loan – just as much as if the agreement had expressly named the loan.” (Brief for the CFPB as Amicus Curiae, 5/24/21, USCA4th, No. 21-1289, pp. 1, 8-9, 12.)
Stay tuned, as arguments in the appeal have not yet been scheduled.
In re Body Transit, Inc., 2020 WL 4574907 (E.D. Penn. August 7, 2020) was one of the first published bankruptcy decisions involving the intersection between the so-called “1111(b) election” and subchapter V of chapter 11 of the Bankruptcy Code.
This opinion is quite striking.
The Court’s analysis in Body Transit may signal a willingness by bankruptcy courts to interpret words and phrases in generally-applicable chapter 11 code sections differently in “subchapter V” cases under the Small Business Reorganization Act of 2019 (“SBRA”) than in traditional, non-subchapter V cases.
There is a lot to analyze in this opinion, but this blog post will focus on only one aspect of the Body Transit opinion—the Court’s stated use of the “purposes and policies” underlying SBRA to influence its determination of what constitutes “inconsequential value” for purposes of the “inconsequential value exception” to the section 1111(b) election. The Court’s analysis may be a bellwether as to how other courts approach subchapter V cases versus traditional chapter 11 (i.e., non-subchapter V) cases. This case is important, as section 1111(b) elections may, at least anecdotally, become much more useful and prolific in subchapter V cases, given the altered voting structure and the potential for temporarily depressed collateral values (i.e., due to the Covid-19 pandemic and the emergency use authorization of a Covid-19 vaccine in the United States).
But First, A Nutshell Explanation of The 1111(b) Election
The nuances of the so-called “1111(b) election” are complicated enough to give even very experienced bankruptcy practitioners nightmares, and are beyond the scope of this blog post. Generally speaking, under Bankruptcy Code section 1111(b), an undersecured creditor (i.e., a creditor whose claim is only partially “in the money” based on the present fair market value of its collateral) may make the 1111(b) election in a pending chapter 11 case to protect itself against a perceived “temporary undervaluation” of its collateral. When made, the election forces the plan proponent’s plan to treat the undersecured creditor’s entire “nominal” claim as secured at the time of the collateral’s liquidation, despite the fact that the claim is actually undersecured at the time the chapter 11 plan is being considered. The election can be quite useful in the current context as a hedge, if the creditor views its collateral’s value as being temporarily depressed or undervalued (e.g., due to the Covid-19 pandemic).
Absent making the 1111(b) election, an undersecured creditor is entitled to receive (a) the net present value of its collateral on the “in the money” secured portion of its claim, and (b) a pro rata share of distributions under the plan on its “out of the money” unsecured deficiency claim. As noted above, the net present value of the secured portion of the claim is determined by applying the applicable discount rate to the secured portion of the claim. That rate is usually the source of litigation, and courts have adopted various methods for ascribing an appropriate discount rate (e.g., blended rate versus a formula rate of prime plus basis points to account for the time value of money and risk, etc.). When an undersecured creditor makes the 1111(b) election, the creditor’s entitlement to have the “out of the money” portion of its claim treated the same as other unsecured creditors under the plan is waived, and the creditor’s nominal unsecured claim is treated as a non-interest bearing secured lien claim on its collateral if/when the collateral is ever actually liquidated. The election, therefore, reverses one of the principal effects of Bankruptcy Code section 506(a) (a Code section which bifurcates an undersecured creditor’s claim into two claims—a secured claim and an unsecured claim—based on the collateral value).
But again, there are trade-offs to making the election.
Section 1111(b) Election’s Impact on Voting
Bifurcated claims, as impaired claims, are each entitled to vote separately on a proposed plan. Voting is critical in traditional chapter 11 cases because the plan proponent must obtain the favorable vote of an impaired “consenting” class (i.e., a class that votes “yes” to the plan), or else the plan fails—i.e., may not be “crammed-down” over the objection of an impaired objecting class.
When an undersecured creditor’s claim is bifurcated under section 506(a) (and assuming no election has been made), it may vote both of those claims. And, depending on how the deficiency was classified in the proposed plan (and the relative size of the deficiency claim and the number of other creditors in that class), the vote of the unsecured deficiency claim could allow the creditor to effectively block plan confirmation in a traditional chapter 11 case (by swaying the entire class’s vote). But, upon making the election, the secured creditor loses its ability to vote its unsecured deficiency claim. Giving up that “extra” vote of the deficiency claim could be a major concession for a creditor looking to block confirmation of a traditional chapter 11 plan.
However, in subchapter V cases, the favorable vote of an impaired consenting class is not required for cramdown. Indeed, voting in subchapter V cases appears to be more geared toward determining whether the plan being confirmed is “consensual” or “nonconsensual.” See 11 U.S.C. §§ 1181(a), 1191(b). While that determination is critical to subchapter V mechanics, it is not a basis to “block” plan confirmation because a nonconsensual plan may still be confirmed. By contrast, in a traditional chapter 11 case, the failure to obtain an impaired consenting class is an effective “game over” for the plan being proposed. So, making the election (and thus giving up the right to vote) may be less of a concession in a subchapter V context than in a traditional chapter 11 context.
(As an aside, the difference between a consensual and nonconsensual plan may be more dramatic than meets the eye—particularly if the subchapter V debtor is an individual. In particular, because section 1115 does not apply in subchapter V cases, in individual subchapter V cases, property of the estate arguably does not include the debtor’s postpetition assets and earnings. That is, unless the plan is ultimately confirmed as a nonconsensual plan, in which case property of the estate includes such postpetition property. See 11 U.S.C. § 1186(a). It is difficult to know how courts will address this rather bizarre provision in the SBRA, which differs significantly from traditional individual chapter 11 cases. But, case law on this point of law is still developing and no known reported cases exist. And, again, a detailed discussion of this aspect of subchapter V is beyond the scope of this blog post.)
The 1111(b) Election Essentially Waives “Best Interests” Arguments
There’s another drawback—the “best interests of creditors test,” which provides that claims in impaired classes must receive not less than what those claims would have received in a chapter 7 case, does not apply to the claims of creditors who make the election. See, e.g., In re Sunnyslope Housing Ltd. Partnership, 859 F.3d 637 (9th Cir. 2017). So, when an undersecured creditor makes the election, it may lose rights to argue that it would be better off in a chapter 7 case based on a liquidation analysis. Yet another concession….
So, the decision to make the election should not be made lightly.
But, importantly, the value of commercial real estate may be experiencing a temporary downturn, given the recent rolling-out of apparently efficacious Covid-19 vaccines in the United States (and around the World).
And Now, A Brief Synopsis of The “Inconsequential Value Exception” to the 1111(b) Election
Under the so-called “inconsequential value exception” to the 1111(b) election, “A class of claims may not elect the application of paragraph (2) of this subsection if—(i) the interest on account of such claims of the holders of such claims in such property is of inconsequential value. . . .” 11 U.S.C. § 1111(b)(1)(B)(i). Courts have used different approaches in analyzing the “inconsequential value exception” in traditional Chapter 11 cases. Some courts compare the value of the asserted secured interest with the overall value of the collateralized asset to determine whether the lien is of “inconsequential” value. Other courts compare the value of the security interest to the total dollar amount of the underlying secured claim (this was the approach taken by the Body Transit court).
Under this latter approach, if the secured portion of a creditors claim is “inconsequential” in relation to the size of the overall claim, then the creditor may not make the election because the claim would, under non-bankruptcy law—for all intents and purposes—be ostensibly an unsecured claim—the proverbial tail wagging the dog. So, the policy and reasoning goes, the exception to the election should operate to avoid giving creditors greater rights than they would otherwise have under non-bankruptcy law.
But, does the term “inconsequential value” have a different meaning in a traditional chapter 11 as opposed to a subchapter V case? According to Body Transit, the answer is yes.
Body Transit Facts
The debtor in Body Transit (“Debtor”) was a company that owned three fitness clubs, two of which the Debtor closed and allowed to be either sold or foreclosed upon. But, the Debtor sought to reorganize under the SBRA as to the third fitness club, which was subject to First Bank’s (“Bank”) lien. The Debtor filed a plan of reorganization, which it amended after the Bank made an 1111(b) election. The Debtor also filed a motion to value the Bank’s collateral and an objection to the Bank’s election.
The Court valued the property and determined that the secured portion of the creditor’s claim was 8.2% of its total claim. It then found that 8.2% was “inconsequential” and, therefore, came within the inconsequential value exception to the 1111(b) election. As a result, the Court granted the Debtor’s objection to the Bank’s election.
The relevant portion of the Court’s reasoning was as follows:
The key point here is that the “inconsequential value” determination is not a bean counting exercise; the determination cannot be based solely on a mechanical, numerical calculation. Some consideration must be given to the policies underlying both the right to make the § 1111(b) election and the exception to that statutory right. In other words, while “the numbers” provide an important starting point in deciding how much value is “inconsequential,” the court also must consider other relevant circumstances presented in the case and make a holistic determination that takes into account the purpose and policy of the statutory provisions that govern the reorganization case. . . .
To some degree also, the Debtor’s election to reorganize under subchapter V and the purposes and policies underlying the SBRA influence my determination of the level of value that is “inconsequential.”
In re Body Transit, 2020 WL 4574907, *17-18 (E.D. Pa. Aug. 7, 2020).
In other words, the meaning of “inconsequential value” may be different in traditional chapter 11 cases as opposed to subchapter V cases because of, among other things, the purposes and policies underlying the SBRA (which policies and purposes do not apply in non-subchapter V cases). This is a noted departure from the “plain meaning” approach to statutory construction, which has historically pervaded Bankruptcy Code interpretation. See, e.g., In re VP Williams Trans, LLC, Case No. 20-10521 (MEW), 5-9 (Bankr. S.D.N.Y. Sep. 29, 2020) (rejecting Body Transit’s “policies and procedures” analysis and, instead, opting to use a Webster’s Dictionary to define the term “inconsequential” in a subchapter V case).
Some Observations
Section 1111(b) elections may become much more prolific in subchapter V cases. For one thing, subchapter V case do not require an impaired consenting class as a prerequisite to plan confirmation. And, during the Covid-19 pandemic, collateral values (think commercial real estate values) may be temporarily depressed (at least until, hopefully, vaccines may be widely distributed and administered).
The Court in Body Transit imported one aspect of the SBRA’s legislative purpose—i.e., “streamlining” of reorganizations—to influence its interpretation of the meaning of “inconsequential value” for the purposes of determining whether a secured creditor may make an 1111(b) election. That resort to SBRA legislative history basically tipped the scales, resulting in the Court denying the creditor’s section 1111(b) election rights. In short, Body Transit is a “bad case” for secured creditors looking to make an 1111(b) election—especially where they find themselves on the cusp of being out-of-the-money or in a collateral valuation dispute.
But, there are arguments against Body Transit’s approach. In particular, Body Transit’s analysis does not appear to comport with the “plain meaning” approach to Bankruptcy Code interpretation. And, under Body Transit, the phrase “inconsequential value” could mean different things in different chapter 11 cases depending on whether the case is a traditional chapter 11 case, a small business case, or a subchapter V case.
The bottom line is that secured creditors should be aware of the issues posed by Body Transit, and should be prepared to address these issues if their 1111(b) elections are contested based on the “inconsequential value” exception to the 1111(b) election.
With coronavirus cases rising and Washington in partisan gridlock, the likelihood of more aggressive Fed action is rising
As the coronavirus continues to wreak havoc, the US economy faces immense pressure in the near term due to surging Covid-19 cases and the lack of stimulus. Given these significant headwinds, on November 20, 2020, JPMorgan became the first major bank to update its 2021 outlook with negative GDP growth for the first quarter, and growth estimates are expected to continue to be subject to additional downward revisions.
With Washington seemingly unable to address the effects of the coronavirus due to partisan gridlock, the United States Federal Reserve will continue to play an outsize role in the economic recovery. Jerome Powell, the Chairman of the Federal Reserve, indicated in his November 5, 2020 press conference after the last Federal Open Market Committee (FOMC) meeting that current Fed policy was “appropriate,” but “…the accelerating spread of the virus may be changing that assessment…”. On November 5, 2020 the US registered approximately 121,000 new cases of Covid-19. As of November 20, 2020 that number has increased to over 180,000 a day and continues to climb.
Given these concerning trends, the Fed is likely to take more aggressive action to shore up the economy. Moreover, with the United States Treasury Department’s recent request that the Fed wind down several of its emergency lending programs at the end of the year, the Fed has additional impetus to act in the near term.
The central bank has taken unprecedented action since March 2020 to address the Covid-19 crisis. It has already lowered the fed funds rate (the Fed’s main policy tool) to near zero percent. In addition, as part of its quantitative easing program, the Fed has been buying $80 billion of treasury bonds and $40 billion of agency mortgaged-backed securities every month. The Fed has also launched numerous lending programs aimed at market function and lending.
Despite these unprecedented actions, the Fed has a few more options at its disposal that it could announce in the coming months:
Modifications to the Fed’s Existing Quantitative Easing Program. Quantitative easing is essentially when the central bank prints money to purchase government or other bonds on the open market, with the goal of putting pressure on interest rates. Bonds are affected by supply and demand like anything else, so when a large buyer like the Fed creates demand, bond prices rise resulting in a decline in yields. While the current $120 billion a month quantitative easing program is far larger than the $85 billion monthly peak utilized by the Fed during the Great Recession of 2007-2008, the Fed has appeared open to increasing the size of this program.In fact, after the November 5, 2020 FOMC meeting, Chairman Powell acknowledged the committee had “quite a useful discussion” about options for modifying its bond-buying program. Given that long term treasury yields have risen sharply since the election and the announcement of a successful Covid-19 vaccine, from the 0.50% to 0.70% range since the start of the crisis to close to 1.00% today, the Fed is likely to focus any modifications to its quantitative easing program on purchases of longer term bonds, as the Fed’s current program is spread fairly evenly across the yield curve between short and long term debt.
The Possibility of Negative Rates. The fed funds rate is a benchmark for other interest rates, so adjusting such rate could lower the cost of mortgages, auto and other loans, while also reducing interest rates on savings accounts. However, the Fed has already reduced the fed funds target rate to near zero percent so the Fed would have to implement negative interest rates to lower rates further. Other central banks around the world, most notably the Bank of Japan and the European Central Bank, have further reduced interest rates to below zero to some success, but to the detriment to their domestic banking industries. Negative rates in the United States would further pressure interest margins at banks, which are already stressed with near zero rates. Given the controversy surrounding negative rates, the Fed has indicated that it is unlikely to pursue negative rates in the future.
Changes to Forward Guidance. The Fed frequently used “forward guidance” as a tool during the Great Recession, whereby the Fed provided future forecasts of its monetary policy to influence market expectations for interest rates. The Fed can keep interest rates low and stimulate the economy by committing to continue its quantitative easing program, or keeping interest rates at a certain level through a certain date. It is highly likely that the Fed will utilize such tool in the future, and may even indicate that it will allow higher inflation than its usual 2% target until the economy regains its footing. Given that the Fed traditionally raises interest rates to fight inflation, this could have a significant stimulative effect on the economy.
Yield Curve Control. In addition to the tools described above, the Fed could use another policy tool called “yield curve control” where the Fed commits to buying whatever amount of bonds are necessary to cap long term interest rates. This was done during World War II but has not been utilized by the Fed since 1951. Yield curve control has been used recently by the Bank of Japan and the Reserve Bank of Australia, so it is possible that the Fed will utilize such a program if the economy continues to deteriorate.
Monetizing the Debt. This is a form of quantitative easing by which the Fed buys debt directly from the government. While similar to quantitative easing, monetizing the debt allows the government to directly finance itself with printed dollars. This policy would be subject to intense debate, as many economics argue that monetizing the debt would potentially create runaway inflation in the economy. The Bank of England has recently agreed to do this to reduce the supply of government bonds in the marketplace, thereby reducing interest rates, but this is highly unlikely to happen in the United States given the political controversy surrounding the idea.
While Chairman Powell has repeatedly emphasized the importance of the fiscal response to handling the Covid-19 crisis, the Fed has shown its willingness and ability to act in times of crisis. Given the current political environment and recent rise in cases, the likelihood of Fed action in the coming weeks is high.
By Wesley King Associate at Frandzel Robins Bloom & Csato, L.C.
The Coronavirus Aid, Relief, and Economic Security (or “CARES”) Act includes a Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). The PPP was intended to provide unsecured loans on favorable terms to small businesses to pay their employees and other enumerated expenses during the COVID-19 crisis. The PPP provides that the loans are forgivable if used as specified in the Act. One of the requirements of the program is that applicant borrowers, when applying for a loan, must certify “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations” of the applicant.
The PPP has recently come under scrutiny after reports that some large public companies, including national restaurant chains, obtained loans in excess of $10 million. In response, the SBA issued guidance in April indicating that it is unlikely that a public company with substantial market value and access to capital markets would be able to make the required certification in good faith, and that it should be prepared to demonstrate to the SBA, upon request, the basis for its certification.
Some believed that the April guidance could have the effect of discouraging smaller employers who were otherwise eligible from applying for loans. Earlier this month, in light of the program’s original intent and in order to provide assurance to smaller employers, the SBA issued additional guidance which creates a safe-harbor from certification review for borrowers that received less than $2 million. This safe harbor provides that any such borrower “will be deemed to have made the required certification concerning the necessity of the loan request in good faith.”
According to the SBA, this safe harbor is appropriate “because borrowers with loans below this threshold are generally less likely to have had access to adequate sources of liquidity in the current economic environment than borrowers that obtained larger loans.” The SBA further determined that given the large volume of PPP loans, “this approach will enable SBA to conserve its finite audit resources and focus its reviews on larger loans, where the compliance effort may yield higher returns.”
As the landscape of business and other services continue to evolve from physical brick and mortar stores to online websites, courts across the country have been seeing an increase in the number of cases regarding website accessibility under the Americans with Disabilities Act (the “ADA”) and comparable state laws. A typical lawsuit alleges that a defendant’s website is not properly designed and coded causing accessibility barriers that makes it difficult or impossible for some people with disabilities, such as the visually impaired, to access or use. Between January 1, 2019 and June 30, 2019, more than 5,500 ADA lawsuits were filed in federal court, representing a double digit increase from the same time period in 2018. If this pace continues, the number of federal ADA lawsuits filed in 2019 will top 11,000. California continues to top the list of federal ADA lawsuits with more than 2,400 filed in the first six months in California. And many more me be filed due to a recent California Supreme Court decision expanding standing for website accessibility claims.
Previously, courts required a plaintiff asserting a website discrimination claim to demonstrate a nexus between the “discriminatory” website and that person’s full access to a connected physical location. However, the California Supreme Court’s recent decision in White v. Square, Inc., 7 Cal. 5th 1019 (August, 2019), which was decided under California’s Unruh Civil Rights Act (California Civil Code § 51) (the “Unruh Act”), as opposed to the ADA, demonstrates the shift that is occurring among courts and the need for business’s to reevaluate their online presence to ensure their websites are accessible to persons with disabilities.
Enacted in 1959, the Unruh Act guarantees all persons full and equal access to “all business of every kind whatsoever.” Expanding on the Unruh Act, the Supreme Court in White ruled that any person who visits a business’s website with the intent to use its services and encounters terms or conditions that exclude the person from full and equal access to its services has standing to sue under the Unruh Act, with no further requirement that the person enter into an agreement or transaction with the business. While the decision concerned discriminatory terms of service by the business as opposed to the subject website having an accessibility barrier due to, for example, improper coding, the ruling suggests that any individual has standing to bring a lawsuit under the Unruh Act based only on that person’s intent to access the website to use or purchase the business’s services or products. In fact, the language of the opinion suggests much broader implications, namely, that visually impaired individuals who visit ADA non-compliant websites may have standing to sue under the Unruh Act, even if the individual takes no action to actually use the services offered on the website.
So how can a business try and insulate itself from these claims? There is no legislation or case law affirmatively specifying what exactly makes a website compliant. Most companies have adopted the Web Content Accessibility Guidelines (“WCAG”) 2.0. in updating their websites in order to demonstrate that their websites provide sufficient accommodations to allow visually impaired individuals to participate equally in their websites’ products and services. WCAG is a series of guidelines for improved website accessibility produced by the World Wide Web Consortium (“W3C”). While not an all-inclusive list of remedies for issues facing web users with disabilities, the WCAG is an internationally adopted and recognized standard. In fact, many federal and state agencies have adopted the WCAG standard and incorporated them into their online websites.
Due the ever changing nature of website accessibility lawsuits, including the recent decision of the California Supreme Court in White, businesses must be diligent in the continued review and monitoring of their online presence and websites in order to keep up with the emerging technology of website accessibility.
In early September, 2019, the California legislature passed AB 1482, which would enact a statewide rent-control law and other eviction protections for renters. AB 1482 is part of the State’s efforts to reduce the cost of housing and protect California renters who have been adversely affected by rising rents and gentrification. The law is expected to be signed by Governor Newsom before the end of October, and the law will go into effect on January 1, 2020 and expire in 2030, unless extended by lawmakers.
What does AB 1482 do?
As currently contemplated, AB 1482 will institute state-wide rent control where landlords will be restricted from raising rents by more than 5 percent per year plus the local rate of inflation, with 10 percent being the maximum amount of the increase.
In addition to the rent control provisions, AB 1482 will also require that landlords show “just cause,” such as a failure to pay rent or some other default under the lease, before evicting tenants from a unit that such tenant has resided in for over one year. Moreover, landlords must provide the tenant an opportunity to “cure” the missed payment or default. If a landlord wants to evict a tenant without the aforementioned “just cause,” such as to convert a rental property to condominiums or make other renovations, the landlord will have to pay the evicted tenant a relocation assistance of one month’s rent.
AB 1482 only applies to units that are (i) not already covered by a rent control ordinance, and (ii) greater than 15 years old, which will get adjusted with every passing year (eg: units built in 2006 would be covered in 2021, units built in 2007 would be covered in 2022, and so on). For example, in a city like Los Angeles where the local rent control ordinance only applies to buildings constructed before 1978, as of January 1, 2020, rental units built from 1978 to 2005 would be covered by AB 1482. Moreover, single family home rentals are exempt unless such rentals are owned by an institutional investor.
How will AB 1482 affect the housing market?
According to a study by UC Berkeley’s Terner Center for Housing Innovation, which studied 10 communities throughout the state – Chula Vista, Fresno, Long Beach, Los Angeles, Oakland, San Francisco, San Rafael, Stockton, Vallejo, and West Sacramento – found that a majority of the rent increases over the last several years would have been permitted under AB 1482. However, the study did note several communities, such as Fruitvale/West Oakland, the Mission in San Francisco, and Boyle Heights in Los Angeles, that had exorbitant rent hikes over the period studied. Existing tenants in those areas would have been substantially benefited by the law, with an estimated 32 percent of the units in such areas being covered by the law.
Economists generally view rent control laws as having a detrimental affect on the cost of housing over the long term. While California suffers from an acute shortage of housing, there is little evidence that rent control laws actually increase the supply or affordability of housing. In fact, the opposite may be true – rent control laws deter the supply of new housing as the construction for new homes becomes less profitable. Moreover, landlords are often discouraged from investing in their existing properties as they see less return on their investment, and renters stay put as the disparity between their controlled rent and the market increases over time. These factors create distortions in the housing market.
While economists point to the construction of new units as the primary solution to the shortage of housing in California, such construction is unlikely to happen fast enough to address the current crisis in the State. Accordingly, as recognized by the Berkeley Haas Institute for a Fair and Inclusive Society, rent control is the only way for government to enact immediate solutions to respond to the housing crisis.
By Wesley King Associate at Frandzel Robins Bloom & Csato, L.C.
Gone are the days of “basic security.” What used to be optional is now standard: two factor authentication, complex passwords, clean desk policies, data encryption at rest and in transit, mobile device management and up-to-the-minute patching. Clients expect these items to already be in place and are further expanding their expectations. They expect sophisticated and secure systems to keep their information safe. This obviously makes your IT professional’s job much harder. Additionally, attorneys expect instant performance and near 100% up time.
Achieving the delicate balance between accessibility and security is a challenge. Meanwhile, clients continue focusing attention on documentation, planning and training. The frequency of client-initiated audits has increased dramatically over the last five years. In 2013, Frandzel received its first audit; it was one page long and consisted of seven questions. In 2018, the firm received five audits. All were greater than one hundred pages in length. The longest one included over seven hundred questions. All of the inquiries seek documented information security policies, incident response plans and business continuity plans. Vulnerability scans of networks are required on a monthly basis, with classification and inventory controls put in place immediately. Clients seek annual security awareness and phishing defense training for all staff. The most consistent change is a requirement that the firm conduct substantial employee background checks for every new hire.
Information Security Policies
Developing one security policy for all clients is far simpler than answering every question individually. This practice also provides the firm and its third party vendors with guidelines to adhere to. These policies become a firm’s bible to follow with regards to information technology security. They include general information on security management standards, classification and controls, information users, guidelines for personnel and physical
security.
a. Information Security Policies – These identify (1) the firm’s Information Security Manager (“ISM”), the person responsible for your information technology, (2) how to manage sensitive information and (3) who can access what in your firm.
b. Classification and Control – This describes the fundamentals of information security, including a description of the information you maintain and how is it classified (i.e., private, sensitive, restricted or confidential).
c. Information Users – In most cases, the human factor is a firm’s greatest risk. Password standards, workstation security and automatic screen protection, end of day log off requirements, unusual behavior detection, mobile device protection, good judgment policy and most importantly, training all come into play.
d. Physical Security – Having physical controls in place helps staff follow standards with regards to securing visitors and physical rooms. Educating staff regarding visitor policies, such as keeping a log with the visitor’s name, date, purpose of visit and physically keeping all server rooms locked, also aid in security. These are standard requirements and commonly considered basic controls today.
Incident Response Plan
This documents your organization’s formal response plan in preparation for a breach.
Requirements in this area vary widely. Clients frequently dictate policy inclusions such as
maximum notification times, specific contacts, and general best practices. Regardless of whether
client requirements exist, general best practices include developing these procedures today. It is
common for these policies to include some or all of the following:
a. Names of your incident response team and key clients and the numbers you need
to call if an incident occurs;
b. The name of your key resources needed to maintain or resume operations;
c. Procedures for various incidents;
d. Inventory of all hardware;
e. Inventory of all software;
f. Inventory of connectivity vendors;
g. Inventory of critical IT documents;
h. Location of data;
i. Location of passwords; and
j. Inventory of vital business records.
Business Continuity Plans
A growing best practice is to combine both business continuity and incident response plans into a single document. They are of equal importance and tend to contain similar information. Whether it’s a breach, fire, earthquake, etc., you will need to follow documented plans of action equally. The primary focus is to ensure operability of technology resources without interruption to minimize loss of revenue. Properly documented and tested plans will enable your firm to remain standing.
Vulnerability Scans
Our firm has been executing vulnerability scans for several years. After executing the initial scan we realized how critically important these scans were. Numerous open ports, default passwords, and service accounts that historically didn’t matter provided opportunities for access, hacking, and even email relays. Once the openings were identified, we realized what was open, the process of making refinements was effective and permanent. Future scans identified minimal vulnerabilities and risks, which were created due to modifications and improvements in the environment. As our system continues to mature, security risks diminish and confidence both internally and with the firm’s clients improved.
Classification and Inventory Controls
What do you have, where is it located and how is it classified? Prior to inventorying documents, one must understand what is in one’s possession. Some of our firm’s clients are classifying documents when they send them to us with designations such as Restricted, Confidential, Internal and Public. Because of client turnover, mergers, etc., clients are inquiring more frequently as to what client data is contained within our system. Developing a reference of contents that identifies contents will ease in your ability to respond. Collaborating with information technology professionals, managing attorneys, and internal practice groups will help accelerate this process. Clients are increasing the frequency with which they are making these requests; getting in front of them early will help your firm prepare for the inevitable.
Security Awareness Training
Security Awareness Training seems the most basic of items, but is one of the most difficult to adhere to. End users frequently believe that “it won’t happen to me”, “I’m tech savvy”, or “I can spot a scam a mile away”. This risk involves human awareness and training, and it likely provides the most risk and vulnerability within your firm’s environment. Clients are well aware of publicized security breaches, and are beginning to mandate that law firms require annual security training for all staff. Best practices suggest utilizing an external party that is fully equipped, knows the industry, and is current with ongoing and increasing scams. Utilizing an expert will help maintain an interested audience for a longer period. Preventing breaches by investing in training will result in a tremendous return on investment.
Phishing Defense Training
Conducting a random click sampling via emails distributed to a firm’s end users has the potential to create the most eye opening of events. A test email is pushed out randomly after everyone has been through Security Awareness Training. The intent is not to trap or blame employees; quite the opposite, it is to be utilized as a training tool to help them naturally identify and avoid future scams. Clients have not yet begun to demand this type of training. Regardless, we are doing this in an effort to better educate and prepare our attorneys and staff.
Preparing for Ongoing Security Challenges
Client requirements for law firms around security policies, procedures, and preparation will remain steadfast. We anticipate them continuing to escalate over time. By staying on top of ongoing audit requests, performing scans, and training employees, our firm is in a strong position. We utilize our experience and investment as a marketing tool to garner new business. While some attempt has been to minimize client requirements, embracing change and protecting your firm’s information security investment is not only wise, it may even impress your clients and garner the firm more business.
Collateral descriptions in Uniform Commercial Code (“UCC”) financing statements have been the genesis of numerous conflicts between creditors. The purpose of a financing statement is to give notice to subsequent creditors of a prior security interest in personal property . In order to achieve these objectives the financing statement must accurately describe the collateral. However, a subsequent creditor may be required to do more than simply review active UCC-1 financing statements to determine whether a given debtor has already encumbered its personal property assets, and ambiguities may only serve to impose additional duties of inquiry on the subsequent creditor.
This was the subject of a dispute recently decided in the United States Bankruptcy Court for the Western District of Missouri in In re: 8760 Service Group, LLC (In re 8760 Service Group, LLC, 65 Bankr. Ct. Dec. (CRR) 170, (Bankr. W.D. Mo. 2018)).
In In re: 8760 Service Group, LLC, the debtor, 8760 Service Group, LLC (“Debtor”), operated a custom industrial construction and fabrication business with its office located at 1803 W. Main Street, Sedalia, Missouri. (“Main Street Property”). The creditor, Bancorpsouth Bank (“BCS”) , made a number of loans to Debtor and Pelham Property, LLC (“Pelham”), a single purpose entity formed to own the real property located at 5105 Pelham Drive, Sedalia, Missouri (“Pelham Property”), from which Debtor operated its fabrication facility. Debtor was the only member of Pelham. To secure these loans, Pelham executed and recorded a deed of trust and fixture filing on the Pelham Property in favor of BCS, and Debtor granted BCS a personal property security interest in collateral described in BCS’s UCC-1 financing statement as “all accounts receivable, inventory, equipment, and all business assets located at [the Main Street Property]”. Subsequently, a blast booth was installed in the building located at the Pelham Property. It was funded by proceeds from Pelham’s construction loan from BCS. However, the construction contract and the invoices for the blast booth’s construction were in the name of Debtor.
Subsequently, Hudson Insurance Company (“Hudson”) provided payment and performance bonds for the account of the Debtor. To secure Debtor’s repayment obligations to Hudson in connection with the bonds, Debtor granted security interests to Hudson in substantially all of Debtor’s property. Hudson filed a UCC-1 financing statement with respect to Debtor’s inventory, equipment and accounts.
The Debtor and Pelham subsequently filed Bankruptcy, and a dispute arose between BCS and Hudson as to the existence and priority of their respective and competing security interests in the inventory and equipment of the Debtor, including the blast booth located on the Pelham Property.
BCS contended that the collateral description in its UCC-1 financing statement filed against the Debtor could reasonably be interpreted two ways: (1) that the address restricts all described collateral to only that which is located on the Main Street Property, OR (2) that the commas separating out the various types of collateral, and addition of the second “all” (i.e., “and all business assets located at…”(emphasis added)) serve to limit the effect of the reference to a specific property address only to the business assets of the Debtor, and that BCS’s security interests in “…all accounts receivable, inventory, equipment…” mean precisely that; all accounts receivable, inventory, equipment, wherever they may be located, including equipment (i.e., the blast booth) located on the Pelham Property. BCS went further in asserting that since there were two reasonable interpretations then its financing statements were not seriously misleading and triggered a duty to further investigate the extent of BCS’s security interest. The Court agreed with BCS. The Court reiterated that it views the validity of a financing statement in terms of whether “it provides notice that a person may have a security interest in the collateral claimed.” Further, the Court noted that the UCC recognizes further inquiry may be necessary and that therefore, errors or omissions in the description of the collateral do not render financing statements ineffective unless they are seriously misleading. Based upon that reasoning, the Court held that Hudson’s claim in the Debtor’s equipment (including the blast booth) was subordinate to BCS’s.
This case should serve to remind creditors that if the collateral description in a pre-existing UCC-1 financing statement is ambiguous or subject to multiple interpretations, it is incumbent upon the subsequent creditor to reach out to the existing creditor(s) to clarify and/or confirm the nature and extent of any pre-existing liens on the collateral.
The law is often complex and convoluted. But in some cases, the law is remarkably simple and straightforward. In Black Sky Capital, LLC v. Cobb, decided on May 6, 2019, the California Supreme Court opted for simplicity and followed a straightforward interpretation of California’s anti-deficiency statute, California Code of Civil Procedure section 580d, to provide relief to a creditor who, holding two deeds of trust secured by the same property, foreclosed on the senior deed of trust and, in a separate action, sought to recover a money judgment as to the amount still due and owing on the junior deed of trust, which was extinguished due to the creditor’s foreclosure. The Supreme Court’s intervention resolved a deep conflict amongst the California Courts of Appeal.
Facts and Background
In August 2005, Citizens Business Bank (the “Bank”) extended a loan to Michael and Kathleen Cobb (the “Cobbs”) in the amount of $10,299,250.00 (the “Senior Loan”), which was evidenced by a promissory note and a deed of trust (the “Senior Deed of Trust”) secured by commercial property located in Rancho Cucamonga, California (the “Property”). More than two years later, in September 2007, the Bank extended a second loan to the Cobbs in the amount of $1,500,000.00 (the “Junior Loan”), which was evidenced by a promissory note and a deed of trust (the “Junior Deed of Trust”) secured by the Property. Subsequently, the Bank sold both notes and assigned the Senior Deed of Trust and the Junior Deed of Trust to Black Sky Capital, LLC (“Black Sky”) in January 2014.
The Cobbs defaulted on the Senior Loan, and on June 10, 2014, Black Sky sent a notice of default and election to sell the Property under the Senior Deed of Trust (the “Senior NOD”). After failing to cure the defaults that gave rise to the Senior NOD, Black Sky foreclosed the Senior Deed of Trust and acquired the Property at a trustee’s sale for the sum of $7,500,000.00 on October 28, 2014. As a result of the foreclosure of the Senior Deed of Trust, the Junior Deed of Trust was extinguished.
One week after completing the foreclosure of the Senior Deed of Trust, Black Sky brought suit against the Cobbs in San Bernardino County Superior Court to collect the amounts due and owing under the Junior Note. In resolving the case, the trial court’s focus was on California Code of Civil Procedure section 580d(a) (“Section 580d”), which states, in relevant part, as follows:
“[N]o deficiency shall be owed or collected, and no deficiency judgment shall be rendered for a deficiency on a note secured by a deed of trust or mortgage on real property or an estate for years therein executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.”
The trial court ruled in favor of the Cobbs, holding, based on prior Court of Appeal precedent from 1992, that Section 580d precludes a deficiency judgment for a junior lienholder who was also the foreclosing senior lienholder. Specifically, the trial court relied upon the so-called “Simon rule,” which originated from the Court of Appeal case Simon v. Superior Court (1992) 4 Cal.App.4th 63, which found that this situation—creditor forecloses on senior deed of trust, but still holds junior note—comes within California law’s prohibition against collecting a “deficiency judgment” against the borrower. California’s anti-deficiency statutes provide, among other things, that a creditor holding a note secured by a deed of trust or mortgage on real property may not collect a “deficiency judgment” (i.e., the difference between the amount owed to that creditor less the fair market value of the real property) if the real property is sold at foreclosure for less than the full amount of the debt.
On appeal by Black Sky, the Court of Appeal reversed the trial court’s decision. Reviewing Supreme Court precedent in this area from 1963, the appellate court concluded that Section 580d does not preclude a deficiency judgment for a nonselling junior lienholder who also holds the senior lien. As noted by the Court of Appeal, the Supreme Court had ruled, in Roseleaf Corp. v. Chierighino (1963) 59 Cal.2d 35, that where a creditor foreclosed a senior deed of trust by a borrower, Section 580d did not prevent a different creditor from seeking a money judgment against the same borrower. The Court of Appeal did not find a reason, under the circumstances presented in the Cobbs’ matter, to distinguish between junior liens held by the same creditor and a different creditor under the Roseleaf Corp. decision. By doing so, the Court of Appeal declined to follow the Simon rule and three other Court of Appeal decisions that adopted the Simon rule.
Supreme Court Ruling
In order to resolve a conflict amongst the Courts of Appeal on the issue, the Supreme Court agreed to weigh in and heard oral arguments in February 2019. Three months later, the Court unanimously concluded that Black Sky was not barred from pursuing a money judgment against the Cobbs as to the Junior Loan. In analyzing the text of Section 580d, the Supreme Court stated that the plain language of the statute compelled the result: “The plain language of the statute bars a deficiency judgment ‘when the trustee has sold the property ‘under power of sale contained in the…deed of trust.’” (Slip Op. at 9; emphasis in original). The definite article (i.e., the word “the”) in the phrase “the…deed of trust” makes clear that the statute is referring to the deed of trust under which the power of sale has been exercised, and not another deed of trust. Thus, Section 580d did not bar Black Sky from seeking to collect against the Cobbs with respect to the debt due and owing on the Junior Loan: “Because no sale occurred under the deed of trust securing the junior note in this case, section 580d does not bar a deficiency judgment on the junior note.” (Slip Op. at 12). The holding in Black Sky thus represents a significant change in California law as to the scope of Section 580d.
The Supreme Court’s decision also makes practical sense. Were Section 580d to be interpreted as barring deficiency judgments under these circumstances, lenders would be disinclined to extend additional credit to borrowers secured by the same property. Borrowers would then be forced to turn to other creditors, but the extension of credit on a second position lien by a different creditor normally costs borrowers more due to the additional risks being assumed by the junior lender.
The Court’s analysis did come with an important caveat: “Where there is evidence of gamesmanship by the holder of the senior and junior liens on the same property, a substantial question would arise whether the two liens held by the same creditor should – in substance, if not form – be treated as a single lien within the meaning of section 580d.” (Slip Op. at 10-11). For example, Section 580d may be applicable in a scenario where a creditor extended multiple loans days apart and secured by the same property, were the loans a part of the same transaction. However, that was not the case before the Court, as the two loans held by Black Sky were made more than two years apart involving separate transactions.
The Supreme Court’s decision in Black Sky Capital, LLC, v. Cobb puts to rest an issue that has vexed trial courts and the California Courts of Appeal for years, as its simple and straightforward decision provides benefits to both lenders and borrowers.
Feel free to contact us at (323) 852-1000 if you have any questions concerning these types of issues.
As the third and final article in our series on blockchain technology, we will discuss how the burgeoning technology will affect the financial industry.
To review, blockchain in general can be described as a decentralized, shared, public ledger that is maintained by a network of computers that verify and record transactions into the same decentralized, shared, and public ledger. No single user controls the ledger – it is maintained by all of its participates, in the cloud, or by a network of designated computers that collectively keep the ledger up to date and verify its transactions. As such, blockchain creates irrefutable records of transactions, creating trust between counterparties and eliminating the need for clearing houses or middlemen in transaction.
As mentioned in our prior article, modern banks and other financial institutions face the biggest and most sweeping changes as blockchain is implemented across the industry. According to a 2018 report from the accounting firm KPMG, the implementation of blockchain in the financial industry will have numerous major benefits, such as increasing efficiency, reducing loss and fraud, improvement to client/customer experience, and will result in a higher availability of capital. Also as previously discussed, per a 2017 study conducted by Gartner, Inc., it is estimated that the business value-add of blockchain will likely exceed $3.1 trillion by 2030, most of which will accrue in the financial or financial-adjacent industries.
As a financial professional, banker, or even a consumer of financial services, you may be asking yourself, “what do these changes look like?” While “increasing efficiency” may sound esoteric, using a universal and automatically verified ledger for financial transactions within a given entity or marketplace will clearly streamline accounting and auditing systems. Moreover, a universal and irrefutable ledger provided by the implementation of blockchain in a given system has the potential to drastically reduce loss and fraud. However, as we will illustrate, the most exciting implementation of blockchain is coming in the form of new and innovative financial products.
Lawyers, computer programmers and financial professionals all over the world are in the process of developing “smart contracts” that imbed traditional financial products with blockchain technology. These “smart contracts” not only take advantage of the security features provided by blockchain, they provide an opportunity to connect and digitalize every aspect of financial services and transactions. Upon the full realization of blockchain technology, data will be shared across disparate services and technology, from bank accounts to mortgages to smart appliances to regulatory registries, which will all continuously record and cross-check into their own respective universal blockchain ledger. Imagine:
A mortgage that connects to the blockchain ledger at local the County Recorder’s Office that will automatically notify the lender if an impermissible lien is placed on the property.
A smart car that will drive itself to a repo lot as soon as there is a 30-day delinquency in the blockchain ledger that records the payments on the loan used to purchase the vehicle.
A bond that connects automatically to a company’s blockchain ledger and converts to equity upon certain financial performance metrics, which then in turn can automatically pay a dividend based on the number of widgets sold in a given quarter.
A contract for life insurance that will reduce your monthly payment when your smart watch records exercise activity (or increase your payment when it connects to your bank account and sees one too many fast-food stops).
The beauty of these financial products is that they involve no middlemen and no back-office support, as such transactions will be automatic and seamless. The possible innovations are only limited by the imaginations of creative and tech-savvy lawyers who can marry finance with the complicated technical and legal aspects of implementation.
Fortunately for the banking and financial industry, and the individuals who consume their services, these changes are not going to occur overnight. Given the recent implosion of what is now being referred to as the “Bitcoin bubble,” the notoriously conservative financial industry is likely taking a second look at some of its blockchain initiatives. Moreover, new blockchain dependent financial innovations will have to be proven safe, fair, and reliable to staid regulators.
However, like in all major industry shifts, there eventually will be winners and losers. Just as the internet took traditional retail by storm, slow-moving incumbents will likely suffer relative to their peers who benefited from early adoption of blockchain technology.
By Wesley King Associate at Frandzel Robins Bloom & Csato, L.C.
As part two of our three part series on blockchain technology, we will provide an overview of the many different applications of blockchain and how it will change a variety of industries. As discussed in our first article, blockchain technology moves far beyond its implementation in Bitcoin digital currency and has the potential to remove middlemen, reduce transaction costs, and make the analysis of data more efficient across a wide variety of industries and applications.
Entertainment and Intellectual Property
Blockchain technology has the potential to revolutionize the way artists get paid and intellectual property is enforced in the entertainment industry. The consumption of media, from television shows to video games and music, can be embedded with blockchain technology so content creators are paid, advertisers have accurate consumption information, and piracy is eliminated. Entertainment executives, along with several artists, such as Imogen Heap, which recently released the first song with blockchain technology built-in, imagine a blockchain system where digital rights are centrally maintained, where creative works can be stored, and consumption tracked. The building blocks for such a system already exists as more and more entertainment is consumed digitally, and artist societies such as ASCAP, SACEM, and PRS have recently begun blockchain initiatives to improve data accuracy for creative rightsholders.
Energy
Blockchain technology has the potential to further upend energy markets, as smaller, green energy projects, such as roof-mounted solar panels or small wind farms, aim to use blockchain sell energy to their neighbors without going through a middleman-power company. Companies such as Electron in the United Kingdom and Power Ledger in Australia are working to implement peer-to-peer energy trading markets, underpinned with blockchain technology, where individuals can buy and sell centricity within “microgrids,” or specific geographic regions. This development could be revolutionary as large, capital intensive electric utilities the world-over are already suffering from the democratization of energy generation through home solar installations. Allowing the efficient tracking of consumption, and efficient transfer of energy on a peer-to-peer level could completely change the way electricity is generated and consumed.
Retail and Inventory Tracking
Walmart and other large retailers are working to deploy blockchain to manage their international procurement inventory operations. Blockchain can be used to create a centralized digital ledger to track a product from the moment its manufactured overseas, to its shipping, warehousing, stocking on a store shelf, and ultimate sale. Such a system has the potential to reduce costs for cross-border transactions, and could eliminate the use of letters of credit and other trade financing instruments. Moreover, just-in-time manufacturing will only be made more efficient, as manufacturers will have access to troves of new data about the transfer of goods through supply channels.
Maintenance Schedules of Automobiles, Other Machinery
Blockchain technology may eventually be embedded in every automobile or other large piece of machinery that is ever manufactured to track maintenance schedules and performance. For example, proponents of the technology envision an era where automobile maintenance is tracked in a centralized ledger, and each automobile automatically updates the blockchain upon every oil change, part replacement, or error code that is generated. Automobile manufacturers will be able to track in real time the performance of their products, finance companies will be able to verify if their collateral is being appropriately maintained, and buyers of used automobiles will be able to know with 100% certainty the history of the vehicle they are buying.
Luxury Goods and Collectibles
As global counterfeiting runs rampant, luxury goods companies are beginning to explore using blockchain technology to reassure customers they are getting the real thing (while protecting companies’ valuable brand equity). Purveyors of luxury goods are establishing centralized ledgers to track the manufacture, sale and ownership of luxury goods. Companies are exploring different ways that blockchain could be embedded in items, such as a Gucci purse or a piece of fine art, that would allow someone to verify its authenticity. Such transparency could invigorate secondary markets for such goods, as buyer will be able to trust the authenticity of otherwise questionable goods they are purchasing.
Finance and Lending
As you can see, there are an endless number of ways blockchain can be implemented across a vast number of industries. Despite the potentially disruptive applications discussed above, the finance industry faces the biggest revolution as a result of the implementation of blockchain technology. As we will discuss more in depth in our part three of this series of articles, the financial industry, from borrowing money to raising capital, and any legal documentation relating to the same, will be irreversibly impacted by blockchain technology.
By Wesley King Associate at Frandzel Robins Bloom & Csato, L.C.
In Bankruptcy, Are Both the Prevailing Party and the Oversecured Creditor Entitle to Attorneys’ Fees When the Oversecured Creditor Loses the Action on a Contract?
In a case that should grab every commercial lenders’ attention, a bankruptcy court in the Central District of California in Altadena Lincoln Crossing LLC, 2018 Westlaw 3244502 (Bankr. C.D. Cal. 2018) disallowed an over $10 million default interest component to the bank’s proofs of claim, finding that the default interest was an unenforceable penalty under California’s liquidated damages statute, California Civil Code section 1671(b), which provides that “a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” The Court found that there was no evidence demonstrating that the parties negotiated or even discussed the issue of default interest before or at the time the contracts were made. As a result, the Court disallowed the entire $10 million default interest component as being categorically unenforceable under California law.
The gravity of the Altadena default interest analysis has been discussed by numerous commentators, including Loyola Law School’s Professor Dan Schechter.
But, this article analyzes a different issue raised by the Altadena case: whether an oversecured creditor is entitled to attorneys’ fees and costs when it loses a claim objection and the debtor is declared the prevailing party on the contract under state law. In Altadena, the bankruptcy court appears to have disallowed the bank’s attorneys’ fees and costs related to its defense of the debtor’s claim objections, finding that the debtor was the prevailing party on the contract because it prevailed on its claim objections. But, the categorical disallowance of the bank’s attorneys’ fees based on a state law fee-shifting statute is not an obvious result, given that the bank was an oversecured creditor. As analyzed below, courts have taken different approaches to this situation.
Background
In Altadena, the debtor, Altadena (“Debtor”), filed claim objections to two proofs of claim filed by East West Bank (“Bank”), an oversecured creditor. The Bank’s first claim included a default interest component of over $10 million and the second claim included a default interest component of over $175,000. The court found that there was no evidence that the parties’ agreed-upon 5% default interest provision was the product of the parties’ pre-contractual efforts to estimate a fair average compensation for the foreseeable loss that the Bank might suffer in the event of default. As a result, the court disallowed these default interest components, finding them to be unenforceable penalties under California Civil Code section 1671(b).
The court also found that the Debtor was the “prevailing party” on the claim objections, finding that because the Debtor was the “prevailing party” on the claim objections, the Bank should exclude its fees and costs incurred in connection with the claim objection litigation. Altadena, 2018 WL 3244502 at *12 (“[The Bank] shall file and serve one or more declarations setting forth its calculation of the attorneys’ fees and costs that it is entitled to recover as part of its secured claims, which declarations shall include as attachments copies of time records reflecting the relevant services. As the Debtor is the prevailing party with regard to the Objections, these calculations should not include fees or costs incurred in connection with litigation of the Objections. . . .”).
Thoughts
Altadena is interesting because under state law, the bank would not be entitled to attorneys’ fees since it was not the “prevailing party on the contract,” but under bankruptcy law, it was entitled to recover its “reasonable” attorneys’ fees as an oversecured creditor under section 506(b) of the Bankruptcy Code.
Although not expressly analyzed in the opinion, the court’s “prevailing party” reference may have been a reference to California Civil Code section 1717(a), which provides a reciprocal right to attorneys’ fees to the “prevailing party on the contract.” But, generally, oversecured creditors are entitled to “reasonable fees, costs, or charges” under section 506(b) of the Bankruptcy Code.
Other courts confronted with this situation have found that the oversecured creditor is entitled to attorneys’ fees and costs, subject to a federal reasonableness analysis, which is not limited by state law “prevailing party” or fee-shifting analysis. See In re Hoopai, 581 F.3d 1090 (9th Cir. 2009) (analyzing pre-2005 BAPCPA version of section 506(b) and finding that an oversecured creditor was entitled to post-petition / pre-confirmation attorneys’ fees which could not be limited by state law despite the fact that the debtor was the prevailing party under Hawaii fee-shifting statute); In re McGaw Property Management, Inc., 133 B.R. 227 (Bankr. C.D. Cal. 1991) (awarding oversecured creditor attorneys’ fees under section 506(b), but also awarding debtor attorneys’ fees under California Civil Code section 1717(a) as the debtor was the prevailing on the contract, i.e., the claim objection at issue).
A federal “reasonableness analysis” looks very different than the all-or-nothing “prevailing party” analysis under state law. See In re Le Marquis Associates, 81 B.R. 576, 578 (9th Cir. BAP 1987) (“Reasonableness embodies a range of human conduct. The key determinant is whether the creditor incurred expenses and fees that fall within the scope of the fees provision in the agreement, and took the kinds of actions that similarly situated creditors might reasonably conclude should be taken, or whether such actions and fees were so clearly outside the range as to be deemed unreasonable. The bankruptcy court should inquire whether, considering all relevant factors including duplication, the creditor reasonably believed that the services employed were necessary to protect his interests in the debtor’s property.”) (citations omitted).
It is not clear whether these issues were raised at the bankruptcy court level in the Altadena case, and from the decision itself, it appears that this argument was not raised. But, unless all of the Bank’s attorneys’ fees incurred in defense of the Debtors’ claim objections were beyond the pale, the Bank’s section 506(b) entitlement means the Bank may have been entitled to recovery of at least some of its fees insofar as those fees were determined to be reasonable under federal law.
Commercial lenders concerned about the enforceability of default interest and attorneys’ fees and costs should contact attorneys at Frandzel Robins Bloom & Csato, L.C. to discuss these complex issues, which are important at the formation the lending relationship through bankruptcy and beyond.
On January 1, 2019, the most significant and game-altering changes in decades to the Official Rules of Golf will take effect.
Implemented after a multi-year vetting and commenting process jointly overseen by both of golf’s supreme governing authorities–the United States Golf Association and the Royal & Ancient Golf Club of St. Andrews–golf’s worldwide unified “New Rules” are intended to streamline and speed up play for the recreational golfer, while making rulings in formal competitions more intuitive, more user-friendly, and less “gotcha,” than were prior versions of the Rules.
Resources:
(A)The USGA Rules 2019 APP: Every golfer with a an Android or iOS smartphone should immediately go to their App Store and download the USGA RULES OF GOLF – 2019 APP. It is FREE. The App has three separate segments: (i) the “Players Edition,” which provides a laypersons detail (with very helpful illustrations) of the new rules that should prove sufficient in virtually all casual golf rounds and most competitive ones, (ii) the “Full Rules,” which provides the actual text of the new rules as jointly drafted and agreed upon by the USGA and the R&A, and (iii) the “Official Guide,” which is designed for use in tournament conditions by Tournament Rules Officials/Committees, and includes, among other things, recommended Committee Procedures, and the formal Rules Interpretations (i.e. what was known previously as the “Rules Decisions”).
(B) www.USGA.org: Every golfer should bookmark the USGA’s website on their home computer. A click on the “Playing,” and “Rules” dropdown menus will direct you to a 2019 Rules Education menu that gives direct access to the formal text of the New Rules, the Rules Interpretations, and very helpful series of short videos providing visual guidance to golfers as how to proceed under the New Rules in a variety of common situations golfers face on the course in a typical round. Twenty-five minutes spent online watching this series of videos is time well-spent for any golfer who wants to make sure he or she is playing our great game as it is intended to be played.
(C) www.SCGA.org: Golfers in Southern California will be able find additional helpful information about the New Rules by visiting the website of the Southern California Golf Association at www.scga.org. Rumor has it that beginning in late 2019, the SCGA’s Rules personnel will be rolling out an entire new series of its popular (and humorous) “Rules Crew” videos dedicated to providing practical interpretations of the New Rules as they impact Southern California golfers.
Highlights
A full discussion of all the 2019 changes to the Rules of Golf would turn this blog-post into a decent sized book. A few highlighted 2019 changes include:
(A) Knee Height Drops: Any time a ball is to be dropped by a player under the New Rules, the player no longer extends his or her arm at shoulder height to drop the ball. Under the new rules, all drops are from approximately the height of the player’s knee.
(B) Dropping Areas Simplified: When under the Rules a ball is to be dropped, either within one club length (relief from immovable obstruction, abnormal ground condition, or when taking stroke and distance relief) or two club lengths (unplayable lie, relief from lateral hazard) of a fixed point, the “Dropping Area” is now the appropriate “wedge of pie” measured from the fixed point in which the Ball must be BOTH dropped (from knee height) AND come to rest. The prior rule that a dropped ball was permitted to roll two club-lengths from where the ball first hit the ground has been eliminated.
(C) Penalty Areas Simplified: Water Hazards (marked yellow) and Lateral Water Hazards (marked red) have been redefined as “Penalty Areas” (marked either yellow or red), and a player’s options have been simplified. First, a ball found in a Penalty Area may be played as it lies in the Penalty Area. Unlike before, the Player is now permitted to remove loose impediments from around a ball found in a Penalty Area as long as the ball does not move in the process, and the player is permitted (i) toground his or her club in the Penalty Area, and/or (ii) take practice swings insidee the Penalty Area, as long as the player’s lie and intended line are not improved. Second, with a penalty of one stroke, a player may still take either “stroke and distance” or “line of sight” relief from the Penalty Area by dropping a ball within one club-length from the appropriate relief spot. Third, in a Red Penalty Area, the player has an additional option, with a one stroke penalty, of dropping a ball within two club lengths no closer to the hole of the last point the player’s ball crossed the margin of the Red Penalty Area. A fourth option previously available for lateral hazard relief under the prior rules permitting a drop on the “opposite margin of the hazard equidistant from the point of entry” has been eliminated.
(D) Ball Deemed Lost if not Found Within 3 Minutes: Under the New Rules, a player’s ball is deemed lost if not found within 3 minutes of when the player or the player’s caddie first begins to search for it. The prior rules gave the player a 5 minute search time to find his or her ball. To speed up play, players are encouraged to play a Provisional Ball before going to start the search for their original ball.
(E) No Penalty If Ball Accidentally Moved: If a player, a player’s caddie, or anyone else accidentally moves a ball in play while searching for it, there is no longer any penalty associated with the accidental movement. The Player must replace the Ball and restore its lie before playing the next shot. Further, if a player’s ball is accidentally moved for any reason on the putting green, it is to be replaced with no penalty. If a ball on a putting green moves after it has been marked and lifted (even if it has been replaced and the mark removed and/or if the movement was caused by the wind or other natural causes), the ball is to be replaced where it had been marked and played from the spot where previously marked with no penalty. If a ball on a putting green moves due to wind or other natural causes before it has first been marked or lifted, the ball is to be played from the new spot without penalty as if the ball had come to rest on that new spot originally.
(F) Additional Option for Ball Unplayable in Bunker. The one stroke penalty options of stroke and distance, and line of sight within in the bunker, provided under the former rules for taking relief from an unplayable ball coming to rest in a Bunker have been retained. The New Rules, have added an additional relief option which permits the player to extend the line of sight relief option beyond and behind the margin of the Bunker, except that the penalty associated with this new method of relief is two strokes, instead of one.
(G) Flagsticks: Players may, at any time, have the flagstick attended, removed, or left in the hole—even if their stroke is taken with the ball on the putting green. This will likely speed up play significantly as players—particularly on long putts (and on very short ones)–will not have to wait to have the flagstick attended before taking their first putt. *Note, PGA Tour Player Bryson DeChambeau was recently quoted as saying it is his intention in 2019 to never have the flagstick removed for any full shot or putt, because he believes the flagstick will never “hurt” a good shot or putt, and hitting the flagstick can only help shorten shots or putts that are hit with too much pace and would not go in anyway.
(H) Miscellaneous additional changes. Unless the conditions of competition expressly prohibit them, standard distance measuring devices are permitted. The embedded ball rule now covers the entire golf course, except Penalty Areas and Bunkers. An unintentional “double-hit” of any shot (putt or swing) no longer triggers a one-shot penalty. If a ball in play accidentally strikes or is interfered with by a player, a player’s caddie, an opponent, any of their equipment or any other person or person’s equipment, there is no penalty, it is considered a “rub of the green,” and the ball is played wherever it comes to rest.
As noted at the outset, there are many significant changes to the Rules of Golf that automatically go into effect on January 1, 2019. Due to space limitations, a number of these changes could not be discussed here. I strongly recommend that any casual golfer interested insuring their golf rounds are scored correctly, and every competitive golfer, both (i) download the free USGA Rules App to their smartphone (and read it), and (ii) spend about twenty-five minutes at the www.USGA.org website watching the series of videos designed by the USGA to provide players with an overview of the New Rules. I’m certain most players will find it a useful and productive use of their time, and should make their rounds of golf in 2019 (and beyond) that much more enjoyable.
On September 30, 2018, California Governor Jerry Brown signed into law Senate Bill 1235 (SB 1235). SB 1235, which overwhelmingly passed the State Legislature and Senate on August 31, 2018, mandates that certain “providers” of “commercial financing” provide a list of disclosures to a class of “recipients”. Subject to exceptions, a “provider” is any person who provides commercial financing to a recipient. “Commercial financing” encompasses a broad array of extensions of commercial credit, such as (a) loans in a principal amount of $5,000.00 or more for which the proceeds are primarily used for commercial purposes, (b) accounts receivable transactions (including factoring), and (c) asset based lending. A “recipient” is defined as a person who is presented with a specific commercial financing offer by a provider that does not exceed $500,000.00.
The new law will not come into effect until after the California Department of Business Oversight has adopted final regulations to implement it. Given that the next California election is in November 2018, it is unlikely that any regulations will be implemented until after the next Commissioner of the Department of Business Oversight is sworn into office, so the earliest possible effective date would be January 7, 2019.
Subject to exceptions and other provisions, the law will require the following disclosures by providers of commercial financing to recipients, which the recipients will need to acknowledge in writing:
The total amount of funds provided;
The total dollar cost of the financing;
The term or estimated term;
The method, frequency and amount of payments;
A description of prepayment policies; and
The total cost of the financing expressed as an annualized rate.
The law will sunset on January 1, 2024. However, except for the provisions regarding the total cost of the financing expressed as an annualized rate, the remainder of the law will automatically become operative again on January 1, 2024.
The new law does not apply to (i) a provider that is a depository institution, such as a traditional bank, (ii) a provider that is a lender regulated under the federal Farm Credit Act, (iii) a commercial financing transaction secured by real property, (iv) certain dealers covered under the California Vehicle Code, and (v) any person who makes no more than one commercial financing transaction in California in a 12-month period, or any person who makes five or fewer commercial financing transactions in as 12-month period that are incidental to the business of the person relying upon the exemption.
While SB 1235 will not be effective until the regulations are implemented by the Department of Business Oversight, once the regulations are issued, it will be imperative for any providers of commercial financing to recipients to comply with the statute and the regulations once they go into effect.
Earlier this year, the California Supreme Court issued a unanimous ruling regarding the test to be used in determining whether a worker is an “employee” or an “independent contractor” in the context of the California Wage Orders. The Court in Dynamex Operations West, Inc. v. Superior Court established a test which heavily favors workers being classified as employees.
Dynamex, a nationwide courier and delivery service, previously classified its California drivers as employees and then later, in an effort to cut its costs, converted those same drivers to independent contractors. One of those converted drivers filed a class action alleging several wage and hour claims, based on the misclassification of its workers, under the California’s Wage Orders. The California Supreme Court granted review to review and determine the appropriate test for determining the classification of workers in California for the Wage Orders. The Court’s decision in Dynamex and the stringent requirements that must now be satisfied to classify a worker as an independent contractor (known as the ABC Test), greatly changed the landscape in worker classification in California under the Wage Orders.
The ABC Test begins with the presumption that a worker is an independent contractor. The test deplaces the burden on the hiring company to demonstrate that the worker is in fact an independent contractor. In order to establish independent contractor classification, the hiring company must demonstrate that the worker meets each part of the following three prong test:
(A) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact (i.e., in practice); and
(B) that the worker performs work that is outside the usual course of the hiring entity’s business; and
(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
In the context of prong A, the Dynamex Court discussed the case of Great N. Constr., Inc. v. Dept. of Labor, stating that the construction company “established that [the] worker who specialized in historic reconstruction was sufficiently free of the company’s control to satisfy part A of the ABC test, where [the] worker set his own schedule, worked without supervision, purchased all materials he used on his own business credit card, and has declined an offer of employment proffered by the company because he wanted control over his own activities.”
Prong B of the ABC Test, that a worker performs work that is outside the usual course of the hiring entity’s business, will be perhaps the most difficult prong for employers to satisfy. The Court provided several examples of the application of this prong. First, the Court stated that when a retail store hires a plumber to perform repairs in the bathroom on its premises, the services of that plumber are not part of the retail store’s usual course of business and the store would not reasonably be seen as having permitted that plumber to provide services to it as an employee. As another example, the Court discussed a seamstress hired by a clothing company to make dresses from the cloth and patterns provided by the hiring company, which would then be sold by the hiring company. Unlike the plumber example, the seamstress duties do not satisfy prong B of the ABC Test because the seamstress is performing work that is part of the hiring company’s usual business operation.
Prong C requires that the hiring company demonstrate that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. The Court held that the term “independent contractor” refers to individuals who make the decision to go into business for him or herself, and take steps to advertise and promote the independent business. Evidence in support of this prong may include the worker’s own business licenses, business incorporation, advertisements, and offerings to provide those services to the public at large or to other companies.
The hiring company bears the burden to prove that a worker is an independent contractor for the purpose of the Wage Orders, and the hiring company’s failure to prove any one of the three prongs of the ABC Test will lead to the classification of the worker as an employee.
While the ABC Test arguably provides clearer guidelines for the classification of workers pursuant to the Wage Orders, companies may find that the workers they currently classify as independent contractors cannot satisfy each prong of the ABC Test. Dynamex has the potential to effect any company that relies on independent contractors, and businesses that do utilize independent contractors should immediately reassess those classifications to make sure they are in line with each of the three prongs as to workers who are non-exempt employees. Misclassification of workers may lead to penalties, including payment of back payroll taxes, subject to interest and a penalty on unpaid taxes, criminal penalties for failure to withhold and pay payroll taxes, Labor Code section 226.8 penalties for willful misclassification (between $5,000 to $25,000 for each violation), as well as penalties by the IRS.
Fintech (FINancial TECHnology), the moniker for startups that aim to provide financial services by making use of modern technology, is big business. There are now close to thirty private financial technology startups with valuations at or above $1 billion, according to Bloomberg News. A certain percentage of these fintech firms are focused on competing with traditional banks in the lending market. These online lending companies promise a new approach to consumer finance, one that leverages ever-evolving technological advances to more conveniently serve their customer base.
Fintech’s talk of disruption in the banking world has certainly encouraged investments. In 2015 alone, more than $3 billion in capital went to lending startups. However, these hefty investments have not always yielded profitable results. A prime example is LendingClub, which also happens to also be one of the most prominent online lenders. LendingClub originates credit card refinancing and other loans which are then sold to investors, and once had a market value of $10 billion. However, LendingClub has reported losses for the majority of its twelve year history, and its shares are down 77% from their IPO price.
LendingClub’s troubles range from lack of profitability to poor loan performance and legal troubles. On April 25, 2018, the Federal Trade Commission (“FTC”) accused LendingClub of deceiving borrowers about fees and removing money from their bank accounts without authorization. Specifically, the FTC alleges that LendingClub often charges borrowers more than $1,000 in origination fees, despite advertising that its loans carry no hidden fees, and of automatically withdrawing monthly loan payments from borrowers’ bank accounts even after their loan was paid off. The FTC action isn’t the first legal hurdle faced by LendingClub. Earlier this year, the company settled a $125 million shareholder lawsuit stemming from the ouster of CEO Renaud Laplanche.
LendingClub isn’t the only fintech firm that has struggled to deliver on its promises to investors. For example, LendUp has also paid fines and refunds for illegal fees and poor customer practices. The trouble seems to be that as these companies attempt to scale up, they struggle with aspects of the industry that banks have already mastered, such as complying with and navigating the complex landscape of financial regulations, the repercussions of prioritizing customer convenience over risk management, and difficulties in obtaining customers (who tend to be more risk-averse when it comes to financial products, as opposed to other technology-driven markets, such as social media or ride sharing).
However, a new wave of fintech firms appear to be redefining and reviving the online lending space. Perhaps the most prominent of these companies is GreenSky Inc. (“GreenSky”), which facilitates loans for home improvement projects through a smartphone app. Greensky had a tremendously successful IPO in late May of this year, reaping $874 million through sales of 38 million shares (which was higher than its original expectation to sell 34 million shares).
What makes GreenSky unique in this space is that it partners with other companies to both find customers and fund its loans. GreenSky operates a lending platform that enables retailers, health-care providers and home contractors to offer loans to their customers. For example, Home Depot customers have the option of financing their renovation projects using a GreenSky loan. Unlike LendingClub, it does not make loans directly. A network of partner banks, including Fifth Third Bancorp., SunTrust Banks, Inc. and Regions Financial Corporation, fund the loans and hold them on their balance sheets. Perhaps due in part to these strong partnerships, GreenSky also differs from LendingClub in that it has a record of profitability (its net income rose 11% in 2017 to $139 million).
Another fintech firm, PeerStreet, a startup that operates a marketplace for “fix and flip” real estate loans, raised $29.5 million in Series B financing in April of this year. PeerStreet vets loans from lenders that back real-estate investors or entrepreneurs rehabbing single-family houses for resale or rental income. PeerStreet characterizes itself as “a platform for lenders who make loans to sell their loans to a secondary market so they can get liquidity to make more loans.”
The recent success of GreenSky and PeerStreet demonstrate the new reality of online lending: fintech’s long-term success may depend on developing partnerships with the very industry it has set out to disrupt. Fintech’s expansion does not need to come at the expense of traditional banks, and by learning from and working with each other, both online and traditional lenders can help spur the evolution of the finance marketplace.
Discharged debts detrimentally drain the national economy. A bankruptcy discharge allows the debtor to be relieved from paying off his or her debts. Discharges are granted to the vast majority of debtors who file bankruptcy. The purpose of Chapter 7 bankruptcy is to give a “fresh start” to debtors who have fallen on hard times. Bankruptcy doctrine provides that an “honest but unfortunate debtor” may obtain a discharge by filing bankruptcy. But, not surprisingly, some debtors are less-than-honest. What happens when a debtor is less-than-honest with his creditors in obtaining money, services, or other extensions of credit? In these cases, the Bankruptcy Code provides certain exceptions to the discharge. Those exceptions are contained in section 523 of the Bankruptcy Code.
One type of debt which a creditor may seek to except from discharge is a debt for “money, property, services or an extension, renewal, or refinancing of credit, to the extent obtained by false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.” 11 U.S.C. § 523(a)(2)(A) (emphasis added). Note that a debtor may not discharge a debt arising from a written statement respecting the debtor’s financial condition (the typical example being a false financial statement). 11 U.S.C. § 523(a)(2)(B). These two Code sections are mutually exclusive. In other words, if the claim of false pretenses, false representations or actual fraud arises from a “statement respecting the debtor’s financial condition,” then the debt is discharged, unless the statement is in writing.
But, what does the phrase “a statement respecting the debtor’s financial condition” mean?
On June 4, 2018, the United States Supreme Court unanimously held, in the case of Lamar, Archer & Cofrin, LLP v. Appling, that a statement about a single asset can be a “statement respecting the debtor’s financial condition” within the ambit of Section 523(a)(2)(A) and (a)(2)(B), and that if that statement is not in writing, then the debt associated with that statement is not rendered non-dischargeable, even if the statement was a misrepresentation.
The case involves a debtor (Appling) who allegedly promised to pay his lawyers’ (the Atlanta-based firm of Lamar, Archer & Corfin, LLP) legal bill with an anticipated tax refund of approximately $100,000.
But, when Appling received his tax refund, it was only about $60,000, and he promptly spent it on his own business expenses and did not pay the Lamar firm anything. In fact, the debtor later met with the firm and told them that he had not yet received the refund. The firm contends that, based on this statement, they agreed to continue to represent the debtor and complete pending litigation involving the debtor. The final invoice to the debtor was about $55,000. After not receiving payment, the firm sued Appling for this debt and obtained an approximate $100,000 judgment. Shortly thereafter, Appling filed Chapter 7 bankruptcy in the Middle District of Georgia.
The firm continued to pursue the debtor in bankruptcy, filing an adversary complaint against the debtor in the bankruptcy case, alleging that their debt should be excepted from the debtor’s discharge. The firm alleged that the debtor made fraudulent statements to them, which were non-dischargeable under section 523(a)(2)(A).
One of the debtor’s defenses was that the debt should be discharged because the debtor’s statement to the firm (that he would remit his tax refund to them, which the debtor never did) was an oral “statement concerning the debtor’s financial condition” under section 523(a)(2)(A). If the debtor’s argument were correct, then the debt could not be rendered non-dischargeable under section 523(a)(2)(A).
But, the bankruptcy court disagreed with the debtor’s argument and found in favor of the law firm. The debtor appealed to the district court, but the district court agreed with the bankruptcy court, finding that “statements respecting the debtor’s financial condition involve the debtor’s net worth, overall financial health, or equation of assets and liabilities. A statement pertaining to a single asset is not a statement of financial condition.”
Undeterred, the debtor further appealed to the Eleventh Circuit who reversed and remanded the matter, finding that he phrase “statement respecting the debtor’s financial condition” was broad enough to encompass the debtor’s statement concerning his tax refund. The Eleventh Circuit pointed out that this very same cryptic phrase occurs in both sections 523(a)(2)(A) and (a)(2)(B), and that as a matter of statutory construction, the same phrase must have the same meaning in both sections. This observation is important because although a narrow reading of the phrase would mean that the debtor’s statements were excepted from discharge under section 523(a)(2)(A), that same narrow interpretation would also narrow the scope of section 523(a)(2)(B), which prevents a debtor from discharging false written statements “respecting the debtor’s or an insider’s financial condition.” In other words, the circuit court observed that:
[I]f the phrase has a broad meaning, more false oral statements will have the effect of exempting a debt incurred as the result of a misrepresentation, from the exception to discharge (meaning that such debts will be discharged), than if we construe the phrase narrowly. But fewer false written statements will result in excusing a debt for a fraudulently obtained asset, service, or loan. And since it seems likely that, at least in arm’s length transactions, most significant debts are obtained as the result of written representations about finances, as opposed to oral ones, a broader interpretation of the phrase is less likely to benefit dishonest debtors than a narrow construction of it.
The Supreme Court granted cert to resolve the circuit split concerning whether a statement about a single asset constitutes a “statement respecting the debtor’s financial condition.”
The Supreme Court affirmed the Eleventh Circuit, rejecting the law firm’s argument that a “statement respecting the debtor’s financial condition” should be limited to statements concerning the debtor’s overall financial status. The Court reasoned that Congress could have written this Code section more narrowly, but did not. The Court further found that the term “respecting” entails a direct relationship to, or impact on, the debtor’s financial condition, and that a statement respecting a single asset may have such a relationship with the debtor’s overall financial condition. Finally, the Court found the law firm’s interpretation to lead to absurd results: for example, under the law firm’s interpretation, a misrepresentation about a single asset made on a balance sheet would be non-dischargeable, but the same statement made outside of a financial statement (e.g., in a list of some, but not all, of the debtor’s assets and liabilities) would not be non-dischargeable. The Court rejected this interpretation because it created distinctions that were “incoherent.”
The opinion and its central holding was unanimous, but three justices declined to join the final portion of the opinion which discussed practices related to providers of consumer finance.
Freddie Fraudster[1] wholly owns and operates Loser LLC, an operating business with significant cash flow. Unbeknownst to anyone, over the span of several years Freddie diverts more than $8 million in funds from Loser LLC’s business operations into a “secret” bank account he maintains at a separate Bank in the name of Loser LLC, but over which Freddie at all times holds exclusive discretion and control. Freddie uses the secret account as his personal piggy-bank, paying on going personal expenses such as: regular monthly mortgage payments to his Bank on his personal residence, utility and homeowner association payments regarding that same residence, funding a personal horseracing hobby, and hiring Sally Trueblood, a salt of the earth interior designer to whom Freddie paid approximately $230,000 over time—using checks from the “secret” Loser LLC account–as payment for legitimate interior design services provided by Sally in remodeling a building owned by Freddie personally. It was stipulated that Sally was referred to Freddie by another of her clients and did not know Freddie previously, that she had provided her design services to Freddie based a truly arms’ length transaction, that the value of the services she provided were consistent with the amounts paid, and that she had otherwise acted at all times in good faith with respect to Freddie and the services she provided to him without knowing anything about Freddie’s unrelated fraudulent activities.
As one might expect, Loser LLC suffered significant losses and filed for Chapter 7 Bankruptcy protection. Freddie went into hiding somewhere outside the country. A Chapter 7 Trustee was appointed to recover and liquidate Loser LLC’s assets for the benefit of its creditors, and Freddie’s scheme of diverting Loser LLC’s funds into the secret bank account for Freddie’s personal benefit, was uncovered. The Trustee then “sued the checkbook” for the secret account, filing more than 100 fraudulent transfer suits against virtually every recipient of any payment out of the “secret” account under Bankruptcy Code section 548(a)(1)(B), alleging that each recipient was strictly liable for the return of all payments from the secret account because they were the initial recipient of a constructive voidable transfer for which Loser LLC received no benefit or consideration.
Because Ms. Trueblood was obviously an “innocent” recipient of payments made via checks written on Freddie’s “secret” Loser LLC checking account, the parties chose to use the Trustee’s lawsuit against Ms. Trueblood as a “test case” to obtain a ruling on an affirmative defense that would be asserted by virtually each of the 100 “checkbook” defendants sued by the Trustee. Section 550(b) of the Bankruptcy Code provides that an otherwise avoidable fraudulent transfer may only be recovered from an “initial” transferee or the recipient of the benefits of the transfer, and cannot be recovered from a “mediate or subsequent” transferee if the subsequent transferee “takes for value, . . . in good faith, and without knowledge of the avoidability of the transfer avoided.
The Bankruptcy Court initially ruled in Ms. Trueblood’ s favor, holding that Freddie’s diversion of Loser LLC funds into the “secret” bank account over which he held “exclusive control,” was sufficient to render Freddie as the “initial” transferee of the diverted funds referenced in Section 550(b), thereby rendering Ms. Trueblood an innocent “subsequent” transferee entitled to avail herself of Section 550(b)’s good faith defense. On appeal, the US District Court initially, and the US Ninth Circuit Court of Appeals ultimately, disagreed, and ruled that the appropriate inquiry was to focus on who, at the time of the challenged transfer, had “dominion” over the funds being transferred, and defined such “dominion” as (essentially), “whether the recipient of funds has legal title to them.”
Following this logic, the Ninth Circuit reasoned that notwithstanding that Freddie’s “diversion” of Loser LLC’s operating revenues into a secret account over which he exercised exclusive control, because the “secret” account was at all times maintained in the name of Loser LLC (and not Freddie or another unrelated entity), Loser LLC all times retained “dominion” over the funds at issue, and Loser LLC could not, under any circumstances, be considered the “initial transferee” of its own funds for the purposes of Section 550(b). This led the Court to the inevitable conclusion that Ms. Trueblood (and virtually all of the other100+ “checkbook” defendants), was therefore (i) ineligible to assert the Section 550(b) good faith defense, and (ii) was strictly liable to the Chapter 7 Trustee for the return of all the payments she received from the secret account because the services she provided did not benefit Loser LLC.
The bottom-line lesson from this case is that form over substance matters in the Ninth Circuit. Because Freddie diverted Loser LLC’s operating funds into a “secret account” that remained in the name of Loser LLC, everyone who received a check written on the secret account for Freddie’s personal expenses was strictly liable for, and had no defense to, an avoidable transfer claim by Loser LLC’s Chapter 7 Trustee. Had Ms. Trueblood (or any of the other recipients) insisted on having Freddie pay her with a personal check or in cash—even if the initial origins of the funds used to cover any such payment was the very same “secret” Loser LLC account–Ms. Trueblood and those in her position would then have been deemed a “subsequent transferee” of the diverted funds entitled to the good faith defense of Section 550(b).
After issuing its ruling, the Ninth Circuit remanded the Trueblood case back to the Bankruptcy Court after striking Ms. Trueblood’s Section 550(b) good faith defense. The Bankruptcy Court then applied the Ninth Circuit’s logic in each of the other 100(+) avoidable transfer actions filed against every recipient of a payment from the secret account. Recoveries on this theory included recovery of payments made out of the secret account to, among other things, Las Vegas Casinos for Freddie’s personal gambling debts, monthly mortgage payments made on Freddie’s home loan, monthly utility payments and homeowner association dues paid regarding Freddie’s residence, payments made to the seller of real property to Freddie through an escrow agent, and other similar payments made by Freddie directly from the “secret” Loser LLC account for personal expenses. In each instance, had the recipient of any such payment insisted that Freddie make the payment with a personal check or cash, they would have been entitled to assert the Section 550(b) good faith defense, resulting in a limitation on the Chapter 7 Trustee’s recourse on those transactions solely to Freddie or to those who were involved in (or at least aware of) his diversion of funds.
Practical Suggestions:
If a Borrower or customer is permitted to set up automatic monthly mortgage (or other) payments electronically, the Banker/Creditor should verify and make sure that the automatic payments are actually being made by the Borrower or Customer who owes the payment.
To the extent possible, particularly when working with a small business owner, real estate developer or other entrepreneur who regularly conducts business through the use multiple entities and/or multiple bank accounts, make an effort to “match” the source of payments received, or to be received, to bank accounts or other funding sources to a party obligated for the loan. It should particularly be viewed as a red flag if checks are received from an unknown or seemingly unrelated small business entity who is not an obligor or guarantor of the obligation being repaid.
Whenever a loan pay off, or property purchase resulting in a loan payoff, is taking place through a third-party escrow, endeavor to include instructions to escrow in the payoff demand that escrow is to determine, verify and advise you prior to closing as to the source of the funds being used to pay off the loan and/or purchase the property through said escrow. To the extent that the source of funding cannot be sufficiently tied to the beneficiary of the transaction, consult with legal counsel to determine whether there are unnecessary “form over substance” avoidable transfer risks in the transaction that can be minimized prior to escrow’s close.
[1] This article is drawn from the US Ninth Circuit Court of Appeals decision rendered on October 2, 2017 in: Henry v. Official Comm. Of Unsecured Creditors of Walldesign, Inc. (In re Walldesign, Inc.), 872 F.3d 954 (9th Cir. 2017). The names have been changed to protect the (not so) innocent.
The U.S. Court of Appeals for the Ninth Circuit sharply expanded the scope of liability for factors dealing with fresh produce distributors. In doing so, the Ninth Circuit distinguished its 17 year-old precedent, Boulder Fruit Express & Heger Organic Farm Sales vs. Transp. Factoring, Inc., 251 F.3d 1268 (9th Cir. 2001) (“Boulder Fruit“).
In Boulder Fruit, the Court held that “factoring agreements do not, per se, violate PACA [the Perishable Agricultural Commodities Act],” and that a “commercially reasonable sale of accounts for fair value is entirely consistent with the trustee’s primary duty under PACA . . . to maintain trust assets so that they are freely available to satisfy outstanding obligations to sellers of perishable commodities.” Id. at 1271. An en banc panel of the Circuit Court expressly overturned Boulder Fruit in S & H Packing & Sales Co., Inc. v. Tanimura Distrib., Inc. (“Tanimura“) to the extent it disagreed with its Tanimura decision.
Tanimura presents the typical story of a struggling produce distributor. Tanimura Distributing, Inc. (“Tanimura”) purchased perishable commodities from produce growers. As such, Tanimura became a trustee for the growers’ produce and any accounts receivable arising from the sale of the produce under PACA. Tanimura sold the produce on credit to third parties and sold the resulting accounts receivable to AgriCap Financial Corporation (“AgriCap”). When Tanimura could not repay its growers, they sued Tanimura.
Tanimura responded by filing for chapter 7 bankruptcy protection. The growers then added AgriCap to their action against Tanimura, contending it received trust property in breach of the PACA trust. Despite prevailing before the lower court and a prior panel of the Ninth Circuit, an en banc panel of the Ninth Circuit vacated its earlier ruling.
The Ninth Circuit concluded that in determining if a factor is liable for a breach of the PACA trust, courts must first conduct an inquiry as to whether the sale of the accounts receivable is a “true sale” and then determine if the sale was “commercially reasonable.” If the sale was not a “true sale,” then it is a lending transaction and the factor may be liable. The factor may nonetheless still be liable if the sale is not determined to be commercially reasonable, i.e., whether the sale was a fair deal.
To determine if there was a “true sale,” courts must now rely upon a transfer-of-risk test and not upon the labels contained in the factoring agreement. Under the transfer-of-risk test, courts will be focused on whether the factor actually purchased the accounts receivable and bears the risk of non-performance by the account debtors. In particular, courts will be looking at the following factors: (1) whether the factor may recover a deficiency against its assignor if the accounts sold are insufficient to repay the factor for its purchase; (2) the effect on the assigned accounts if the assignor were to repay the debt owed to its factor from its other assets; (3) whether the assignor has a right to recover on any of the accounts assigned; and (4) whether the assignment reduces the assignor’s obligation to the factor.
The transfer-of-risk test is a factual determination and will lead to further litigation for factors. No longer may factors as easily dispose of claims that they received PACA trust assets in breach of the trust because the PACA creditors may inquire into the nature of the factoring arrangement to challenge the sales of the accounts as being “true sales.”
Following the financial crisis of 2007 and 2008 significant reforms were called for in the London Interbank Offered Rate (ICE LIBOR or “LIBOR”). These reforms were spurred by three issues: regulator’s fears over having a single rate with no credible alternative or back-up rates; allegedly inaccurate or manipulated individual panel bank submissions scandals; and the implication that senior United Kingdom regulators asked banks to alter their reporting to project financial strength. These proved to be more than the United Kingdom could stand, and thus Libor was transferred from the control of the bank market association to a regulated independent operator. This change opened the door to two major challenges: other rates that are proposed to supplant traditional LIBOR and how to deal with those changes in LIBOR regulation, especially in the context of extant loans.
For United States lenders there are two main choices going forward. U.S. banks can either elect to stay with the reformed LIBOR rate operator, or switch to the U.S. organized Secured Overnight Funding Rate (“SOFR”). The SOFR is a rate that is a secured overnight Treasuries repo rate (i.e., the interest rate paid on overnight loans collateralized by US government debt; collateral that is high-quality, liquid, and accepted as collateral by the majority of intermediaries in the repo market). One of the most glaring omissions in the calculation of the SOFR is that, unlike LIBOR, it does not take into account bank credit risk, thus the resulting rate is frequently significantly lower than the corresponding LIBOR rate for the same period. The New York Fed anticipates publishing this rate beginning April 3, 2018.
The greatest complications of any of the new rate is in how it affects outstanding loans and obligation of lending institutions that are already pegged to the LIBOR rate.
If the LIBOR reforms prove adequate and are widely accepted by the market, then there are should be no necessary changes to existing contracts. The main issue for banks would be in ensuring that they insert some language into new credit agreements to adequately address specifically that they will be applying the LIBOR rate as its calculation methodology may change from time to time.
If the LIBOR reforms are deemed inadequate by the market and backup or replacement rates become relevant, then there are a number of issues that arise and must be addressed. The largest and most glaring issue is how to address contracts that do not adequately provide for a transition to a rate other than LIBOR. These can be addressed in four main ways:
Option 1: An overriding law is passed, which statutorily forces conversion. The main risk to this option is that not all jurisdictions possess the legislative power to implement this option.
Option 2: Parties agree to amend the existing contract to provide for transition to the new rates. The main risk with this option that the SOFR is new and will likely require fine-tuning to address any kinks in the calculation of a fair and representative rate, thus any amendment will likely need to involve flexibility for the change rate without the need for amendment every time.
Option 3: Just wait for maturity. Lenders could just wait until obligations mature and thus rely on the changes of the reformed LIBOR rate. This option will likely be adequate for short term contracts, but will become increasingly problematic and risky with contracts that extend beyond the transition date.
Option 4: Refinancing. The Lenders could always refinance debt instruments that are subject to LIBOR thus bringing them into immediate compliance. The risks associated with this method are in the fees and costs associated with such refinancing (i.e., for Borrowers, the refinanced debt may be more expensive than their existing debt, may give rise to prepayment penalties, or may trigger debt modification regulations)
Regardless of how the market addresses the changing interest rates the change itself can be detrimental to banks portfolios of existing credit obligations. To combat this, banks will need to be proactive in identifying outstanding credit instruments which will be affected by the changes in LIBOR and how they internally wish to address each outstanding credit individually.
On May 11, 2016, FinCen (the Financial Crimes Enforcement network of the U. S. Treasury Department) issued a final rule regarding enhanced customer due diligence (“CDD”) requirements that amends regulations under the Bank Secrecy Act. While the rule has been in effect for almost 2 years, compliance is mandatory by May 11, 2018. While Customer Identification Program (“CIP”) procedures have been around for quite some time, this new CDD rule requires additional layers of inquiry, diligence and collection of data with respect to “legal entity customers” who open new accounts or receive extensions of credit.
The CDD rule adds a “fifth pillar” to the “four pillars” of an effective anti-money laundering program. The first four pillars consist of the following, at a minimum, to be performed by a bank:
A system of internal controls to assure ongoing compliance;
Independent testing for compliance, to be performed by the bank or third parties;
Designation of individual(s) responsible for monitoring and coordinating day-to-day compliance; and
Training for appropriate personnel.
The fifth pillar adds a new layer of complexity, as follows:
Appropriate risk-based procedures for conducting ongoing customer due diligence, to include (but not be limited to):
Understanding the nature and purpose of customer relationships for the purposes of developing a customer risk profile, and
Ongoing monitoring to identify and report suspicious transactions and on a risk basis, and to maintain and update customer information, with customer information to include information about the “beneficial ownership” of “legal entity customers”.
What is a “legal entity customer“?
Legal entity customers include corporations, LLCs, partnerships, business trusts and any other entity created by a filing with a state office. This term does not include natural persons, sole proprietorships, unincorporated associations, trusts (other than those created by a state filing) and various regulated entities such as banks, insurance companies, registered investment adviser, etc.
Banks are now required to identify the “beneficial owners” of each legal entity customer and collect and collect the following information with respect to each beneficial owner: name, address, date of birth, Social Security number (or similar numbers for non US persons).
What is beneficial ownership?
Beneficial ownership for purposes of the CDD rule consists of 2 prongs:
Ownership Prong: Any individual who, directly or indirectly, owns 25% or more of the legal entity customer. Entities such as non-profit or public benefit corporations are not subject to the ownership prong.
Responsibility Prong: Any individual who has “significant responsibility to control, manage, or direct the entity”. The following are given as examples: CEO, CFO, COO, managing member, general partner, president, vice president, treasurer or any other person who regularly performs similar functions.
As an example, if the legal entity has 4 owners who each own 25%, there are 4 beneficial owners and the required information must be collected from each of the four. If no one person owns 25% or more, no information has to be collected from such owners but one person must always be identified under the responsibility prong.
Practical Notes:
Forms: The collection of the required information be done by following and filling out the form suggested by FinCen (found at 82 Federal Register 45184 (published 9-28-17) or obtaining the required information from the individual who will certify the accuracy of the information provided.
Originals v. copies. Since the beneficial owner(s) may not be in your office when the account is opened, a bank may use photocopies of identification.
Reliance on customer: You may rely on the certification of the information furnished by the customer, so long as the bank has “no knowledge of facts that would reasonably call into question the reliability of the information.”
Not retroactive: The CDD rule is not retroactive, but new accounts opened by existing customers after May 11, 2018 are subject to the new CDD rule and the obligation to update customer information is “event based”, which means that if the bank learns something about a customer that is relevant to reevaluating or reassessing the risk posed by that customer, then the beneficial ownership information should be updated.
Record Retention: As a general rule, the records must be kept for 5 years.
Rely on other banks? You may rely on information from other banks, but similar to the CIP, an bank may rely on such information if (i) the reliance is reasonable under the circumstances, (ii) the bank supplying the information must be subject to AML requirements and be regulated by federal functional regulator and (iii) must enter into a contract requiring it to annually certify that it has an AML program and that it will perform the specified beneficial ownership diligence.
Relief on the Horizon? Congress is considering a bill, the Counter Terrorism and Illicit Finance Act, which would, among other things, require legal entities to submit beneficial ownership information to FinCen to create a national directory of beneficial owners. Having such a directory would eliminate some of the back office detective work and potentially create a safe harbor for relying on the published information.
Assembly Bill 1088 (“AB 1088”), signed by Governor Jerry Brown on October 14, 2017, took effect on January 1, 2018, and added a section to California’s Fair Employment and Housing Act (“FEHA”) restricting an employer’s ability to make hiring and personnel decisions based on the applicants criminal history or conviction record.
AB 1088, applicable to government and private employers with five or more employees, makes it unlawful for employers to include any questions about an applicant’s conviction history before extending a conditional offer of employment (which includes oral questions during an interview)[1]. Employers are also prohibited from considering, distributing, or disseminating information about any of the following when conducting a criminal history background check in connection with any application for employments: (i) an arrest that did not result in a conviction, subject to the exceptions in Labor Code §§ 432.7(a)(1) and (f); (ii) referral to or participation in a pretrial or post trial diversion program; and (iii) convictions that have been dismissed, expunged, sealed, or otherwise vacated pursuant to law.
Pursuant to AB 1088, an employer can consider an applicant’s criminal history after the employer has made a conditional offer of employment, however, an employer cannot deny the applicant a position based on the applicant’s conviction history until the employer performs an in depth “individual assessment” considering all the specified circumstances and information. To that effect, AB 1088 set forth specific steps the employer must take in performing this individual assessment. Specifically, the employer must determine whether the conviction history has a “direct and adverse relationship” with the specific job duties and, in doing so, must consider (i) the nature and gravity of the offense, (ii) the time that has elapsed since the offense or the completion of the sentence, and (iii) the nature of the job sought.
Once this individualized assessment is completed, the employer must then notify the applicant, in writing, of the preliminary decision to disqualify the applicant for the position due to the applicant’s criminal history. AB 1088 mandates that this written notification (i) identify the disqualifying conviction(s) that is the bases for the preliminary decision to rescind the conditional employment offer, (ii) provide a copy of the conviction history report, if any, (iii) explain the applicants right to respond and challenge the accuracy of the conviction history and/or provide evidence of mitigating circumstances or rehabilitation, and (iv) provide a deadline of no less than five business days after providing the notice for the applicant to respond.
Once this notice is provided pursuant to AB 1088, the employer cannot make any final determinations until the expiration of the response window provided in the written notice (i.e., no less than five business days). If the applicant timely notifies the employer, in writing, that they would like to challenge the conviction history and is taking steps to gather all necessary evidence to support their challenge, the employer must provide the applicant with an additional five business days to respond to the notice. The employer must also consider any additional evidence or documents the applicant provides the employer in challenging the disqualification before making a final determination or decision.
If the employer ultimately decides to deny the applicant the position after reviewing any mitigating or other evidence submitted by the applicant in challenging the disqualification, the employer must again notify the applicant in writing of their final decision. Pursuant to AB 1088, this notice must notify the applicant of (i) the final decision or determination, (ii) the employers procedure for challenging the decision or to request a reconsideration (if any), and (iii) the right to file a complaint with the Department of Fair Employment and Housing. This notice may again provide the applicant with an explanation or justification for making the final decision, however, this is not a requirement under AB 1088. If the applicant files a lawsuit or civil action against a potential employer for a violation of AB 1088, the applicant may sue for the full range of damages available under FEHA, including compensatory damages and attorney’s fees and costs.
In order to comply with the new restrictions set forth in AB 1088, California employers (with five or more employees) should review their written employment applications and their oral interview questions to determine whether or not they seek an applicant’s criminal history, and if they do, revise to remove all such questions. Employers who intend to use criminal background checks or conviction reports after a conditional offer of employment should also revise or create written preliminary decision and final decision notices that are in compliance with the requirements of AB 1088. Finally, those employees utilizing the service of recruiters or “head-hunters” should ensure that they are also readily familiar with the provisions and restrictions of AB 1088 to confirm that they are also in compliance with those requirements.
[1] AB 1088 does not apply to (i) a position for which a state or local agency is otherwise required by law to conduct a criminal background check; (ii) a position within a criminal justice agency, as defined in section 13101 of the Penal Code; (iii) a position as a Farm Labor Contractor, as defined in section 1685 of the Labor Code; and (iv) a position where an employer or agent thereof is required by any state, federal, or local law to conduct criminal background checks for employment purposes.
