Vol 6 (2009) - Issue 5

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In re Fedders North America, Inc., 405 B.R. 527 (Bankr. D. Del. 2009)

Should a lender be held liable for ‘improvident lending’ to a company that borrows funds and soon thereafter files a chapter 11 petition for bankruptcy? This was the question before Judge Linehan Shannon of the Bankruptcy Court for the District of Delaware (the ‘Court’) in Official Committee of Unsecured Creditors v Goldman Sachs Credit Partners L.P. (In re Fedders North America, Inc.), 405 B.R. 527 (Bankr. D. Del. 2009).

Fedders North America, Inc. (‘Fedders’) was founded in 1896 and was successfully operating business as of 1988. In the early 1990s, however, Fedders’ leadership changed, and the company began to pursue growth and expansion strategies. These new strategies required the incurrence of substantial debt, including a USD 75 million secured revolving credit facility with Wachovia Bank (‘Wachovia’). Unfortunately for Fedders, the new business strategies were unsuccessful, and Fedders defaulted on its facility with Wachovia. Consequently, Wachovia began limiting its exposure to Fedders’ financial distress by restricting further disbursements under the facility.

Fedders, confronted with a severe liquidity crisis and an inability to prepare inventory for the upcoming 2007 summer selling season, sought new funding, which resulted in two facilities aggregating to USD 90 million total (the ‘Facilities’). Bank of America, N.A. as administrative agent, collateral agent, and lender, and General Electric Credit Corporation, as documentation agent and lender, entered into a USD 50 million revolving credit facility with Fedders. Goldman Sachs Credit Partners, L.P., as administrative agent, collateral agent, and lender, entered into a USD 40 million term facility with Fedders (lenders under the Facilities, ‘the Lenders’). These two credit lines were entered on 20 March 2007, and used to pay off Wachovia and provide working capital to Fedders. However, this cash infusion was insufficient to make Fedders fiscally sound, and Fedders filed for bankruptcy protection on 22 August 2007. Upon filing, Fedders proceed to sell assets through 363 sales and ultimately filed a plan of liquidation, which was confirmed on 22 August 2008.

The Official Committee of Unsecured Creditors (the ‘Committee’) sought and was granted derivative standing to pursue certain causes of action upon confirmation of the plan. Specifically, the Committee brought fourteen causes of actions against individual defendants on Fedders’ board of directors and the Lenders. The Court reviewed each cause of action against the standard employed with motions to dismiss, dismissing ten of the causes of action in their entirety and allowing four others to continue in full or in part.

One cause of action was directed solely at the Lenders and alleged that the Lenders were guilty of ‘improvident lending’ under state law and had closed on the Facilities despite Fedders’ shrinking sales figures. The Committee also alleged that the Lenders obtained liens on most of Fedders’ assets, collected origination and placement fees from the Facilities, and required Fedders to pay the Lenders’ legal and professional fees with full knowledge that defaults under the Facilities were inevitable.

When evaluating the propriety of the ‘improvident lending’ cause of action, the Court first determined that the applicable state law was either Delaware or New Jersey. The Court then reviewed both states’ laws and noted that neither has previously recognised ‘improvident lending’ as a cause of action. The Court then considered whether the Supreme Courts of Delaware or New Jersey would recognise such a cause of action and concluded they would not.

As to its reasoning, the Court noted that it previously predicted, in Rosener v Majestic Management, Inc. (In re OODC, LLC), 321 B.R. 128 (Bankr. D. Del. 2005), that the Delaware Supreme Court would recognise a cause of auction for ‘improvident lending.’ However, that decision relied upon three cases from states other than Delaware and New Jersey, and the present Court easily distinguished the facts of this matter from those set forth in the three cases, which involved negligent misrepresentation, faulty loan application processing, and complicity in fraud.