Midwest Update - Bowling Green Sports Center, Inc.

Bowling Green Sports Center, Inc. v. G.A.G. LLC, Ill. App. (2d) 160656, 77 N.E.3d 728 (2017)

In a dispute between senior and junior lenders, the Illinois Appellate Court (the “Court”) has held that in the event of a breach of an intercreditor agreement for not obtaining a junior lender’s consent prior to a senior lender’s increase of its loan, the junior lender had a superior lien but only to the extent of such increase.

In January 2008, G.A.G. LLC, James P. Gochis and Peter Gochis (collectively , the “Borrower”) entered into (i) a loan agreement (the “Senior Loan Agreement”) with Gold Coast Bank (the “Senior Lender”) and (ii) a loan agreement (the “Junior Loan Agreement”) with Bowling Green Sports Center, Inc. (the “Junior Lender”), in each case, to finance the purchase of a bowling alley in West Chicago. Pursuant to the Senior Loan Agreement, the Senior Lender loaned over $3.4 million to the Borrower (the “Senior Loan” and the Notes evidencing the same, the “Senior Notes”).  Pursuant to the Junior Loan Agreement, the Junior Lender loaned $405,000 to the Borrower (the “Junior Loan”). In connection therewith, the Junior Lender and Senior Lender enter into an intercreditor agreement (the “Intercreditor Agreement”).  The Intercreditor Agreement contained provisions pursuant to which, among other things, (i) the Senior Lender agreed to not amend or modify the Senior Notes or the Senior Loan Agreement or otherwise permit the terms of the Senior Notes or the Senior Loan Agreement to be changed without the prior written consent of the Junior Lender and (ii) the Junior Lender agreed not to sue to recover any money from the Borrower until the Senior Lender was paid in full.  Despite the foregoing provisions, in April 2008, the Senior Lender entered into a modification agreement that increased the amount of the Senior Loan by $51,000 (the “Loan Increase”).  The Junior Lender was not notified of the modification agreement and did not consent to the same. 

After the Borrower failed to timely repay the Junior Lender, in March 2015, the Junior Lender filed a breach of contract claim against the Borrower. Subsequently, in August 2015, the Senior Lender filed a petition to intervene.  Following the grant of the petition to intervene, the Senior Lender filed a motion to dismiss the Junior Lender’s complaint asserting that the Junior Lender’s compliant was barred by the Intercreditor Agreement since the Junior Lender agreed to not sue to recover its debt until the Senior Lender’s indebtedness has been paid in full. Following a hearing, the trial court dismissed the Junior Lender’s complaint with prejudice finding that it was premature until it could show that the Borrower’s obligations to the Senior Lender were paid in full.  The trial court found that, although the Senior Lender breached the Intercreditor Agreement by increasing the amount of the Senior Loan without the Junior Lender’s consent, the Intercreditor Agreement nonetheless prevented the Junior Lender from pursuing its lawsuit.  The Junior Lender then appealed to the Court.  The Court affirmed with modification.

On appeal, the Junior Lender argued that the Intercreditor Agreement was unenforceable due to the Senior Lender’s breach thereof and as such, the Senior Lender forfeited the priority of its lien.  The forfeiture therefore did not require the Junior Lender to have to wait until the Senior Lender was repaid in full to seek repayment of the Junior Loan. In response, the Senior Lender argued that the plain language of the Intercreditor Agreement prohibited the enforcement by the Junior Lender of the Junior Loan Agreement until the Senior Lender was repaid in full.  The Court disagreed with both the Senior Lender and the Junior Lender.  Addressing the issues at hand, the Court noted that although this case is a matter of first impression in Illinois, courts in other states have uniformly held that while a senior lender and a mortgagor can agree to modify terms of an underlying note or mortgage without first notifying or obtaining consent of a junior lender, if the modification (i) is such that the rights of the junior lender will be prejudiced or (ii) impairs the junior lender’s security, then consent is required. Accordingly, any modification without consent of the junior lender will be ineffective as to the junior lender as to the modified terms. In situations where the senior lender’s actions substantially impair the junior lender’s security interest or effectively destroy its equity, a court will wholly divest the senior lender of its priority and elevate the junior lender to a position of superiority.

In applying the above, the Court rejected the Junior Lender’s argument that the Senior Lender’s breach of the Intercreditor Agreement should cause it to forfeit the entire priority of its lien.  The Court noted that (i) the Senior Lender increased its loan by less than 1.5% and (ii) the Loan Increase was not materially significant in the Borrower’s ability to repay the Junior Lender because, at the time the complaint was filed, the Borrower still owed the Senior Lender in excess of $1.9 million. The Court also found that the Senior Lender’s modification of the Senior Loan did not substantially impair the Junior Lender’s security interest and rights as a junior lienholder. The Court reasoned that given the amounts involved, it would not be equitable to subordinate the Senior Lender’s entire lien to the Junior Lender’s lien. Accordingly, the Court held that the Junior Lender’s complaint was premature until the outstanding principal of the Senior Lender’s loan was reduced to the amount of the Loan Increase (i.e. $51,000) and at such time, no further payment should be made to the Senior Lender until the Junior Lender’s loan is paid in full.