Article courtesy of Kevin P. Braun of Morgan, Lewis & Bockius LLP
United States Bankruptcy Court for the District of Massachusetts holds that under the standard for equitable subordination, the Debtors’ allegations that the Lender’s aggressive actions to advance the Lender’s acquisition of the Debtors’ properties harmed the Debtors and their other creditors were sufficient to state a claim for plausible relief.
In re NESV Ice, LLC, No. 21-11226-CJP, 2022 WL 586136 (Bankr. D. Mass. Feb. 25, 2022)
In June 2016, HarborOne Bank (the “Original Lender”), the predecessor in interest of SHS ACK, LLC (the “Lender”), made loans to NESV Ice, LLC (the “Borrower”) and other companies (collectively, the “Debtors”), which included a construction loan to the Borrower. The construction loan required that the Borrower deposit $200,000 with the Original Lender in an escrow account if the Borrower failed to obtain a specified lease required by the loan agreement. The Borrower failed to obtain the lease and subsequently failed to make the required deposit, resulting in a “nonmonetary default” under the loan agreement, which would constitute an “Event of Default” if not cured within thirty days of the Original Lender’s “notice of such failure.” In April 2019, the Original Lender sent a notice to the Borrower of such default, which asserted the right to demand payment of default interest but did not demand payment at such time and which reserved the right to demand payment of default interest at a later date. In December 2020, the Original Lender then sent another notice to the Borrower demanding payment of default interest. The Original Lender subsequently assigned the loans to the Lender.
The Debtors commenced bankruptcy proceedings. As part of the bankruptcy proceedings, the Debtors claimed that payment of the default interest was unenforceable, and the Lender moved the Court to dismiss the Debtors’ claim. The Court denied the Lender’s motion to dismiss because of the parties’ fundamental disagreement as to the facts and held that unless the Debtors plead more specific facts in an amended complaint, the Debtors’ claim that the default interest was a penalty or usurious will be dismissed. The Debtors also claimed that the Debtors’ transfers of certain assets to the Lender constituted fraudulent transfers due to inadequate consideration received in exchange for the Debtors’ grant of additional collateral. The Court concluded that the “adequacy of non-monetary consideration is question of fact” but held that unless the Debtors can plead more specific facts in an amended complaint, the Debtors’ fraudulent transfer claim will be dismissed.
Additionally, the Debtors sought equitable subordination of the debt owed by the Debtors to the Lender, alleging that the Lender “acquired the [l]oans for the purpose of obtaining the properties of the Debtors and instructed [the Original Lender] to demand payment of default interest to which it was not entitled as a means to forward its acquisition strategy and leverage the Debtors.” The Lender moved the Court to dismiss the Debtors’ claim of equitable subordination. The Court explained that when determining whether a claim should be equitably subordinated, the following test applies: (i) the claimant is found to have engaged in inequitable conduct, (ii) the claimant’s misconduct either resulted in injury to creditors of the debtor or gave the claimant an unfair advantage, and (iii) equitable subordination of the claim does not conflict with federal bankruptcy law.
Accordingly, the Court held that under the test for equitable subordination, the Debtors’ allegations sufficed to state a claim for plausible relief. The Debtors alleged that the Lender’s hostile actions caused customers and vendors to stop paying or extending credit to the Debtors, which resulted in a significant revenue loss for the Debtors and conferred an unfair advantage on the Lender. The Debtors further alleged that the Lender’s actions caused injury to the Debtors and their other creditors by compelling the Debtors to commence bankruptcy proceedings, and thereby incur extensive administrative expenses that will harm the Debtors’ unsecured creditors, and by adversely affecting the Debtors’ operations and potential beneficial business transactions. Therefore, based on the sufficient heft of the Debtors’ allegations, the Court denied the Lender’s motion to dismiss the Debtors’ claim for equitable subordination.