LOANS AND LIENS AND. . .WHAT CAN GO WRONG HERE? PROTECTING A LENDER’S COLLATERAL POSITION UNDER THE UCC – ONCE AGAIN THE DEVIL IS IN THE DETAILS

 

The lender gets loan documents signed by the borrower and gets collateral to secure the debt – that is, a lien on the borrower’s property. It sounds easy and familiar. So what can go wrong here? The progression of cases interpreting the Uniform Commercial Code (UCC) provides insight into the mistakes, large and small, that can create unexpected exposure for lenders and surprise defenses for borrowers. Earlier this year two new cases shed additional light on this question. This article takes up the first of these.

Situation – A Lien on an LLC

The case involved an LLC membership interest offered as collateral for a commercial loan. 11 East 36 th, LLC (“36 LLC”) was the sole member of Morgan Lofts, LLC (“Lofts LLC”), which owned numerous units in a building. Both entities along with a third entity (the Borrower in this situation) were controlled by common family interests. As security for a loan to Borrower, the controlling family agreed to have 36 LLC pledge its sole membership interest in Lofts LLC.

When the transaction was documented, the pledge agreement granted a lien in favor of the lender in the Lofts LLC membership interest held by 36 LLC. The UCC-1, however, described the collateral as specific units in the building that were owned by Lofts LLC.

Bankruptcies were subsequently filed by 36 LLC and Lofts LLC and the lender’s security interest was challenged. The court held that the lender was unsecured as its UCC collateral description incorrectly described the collateral as the real estate owned by Lofts LLC and not the membership interest of 36 LLC in Lofts LLC. Although the lender had its security interest correctly described in the loan papers, it did not really matter because the UCC-1 had it all wrong. The court explained that 36 LLC had no interest at all in the real estate units owned by Lofts LLC; rather, its lien was on the membership interest and it never perfected that security interest. Accordingly, the lender was a mere unsecured creditor in the bankruptcy. In re 11 East 36 th, LLC, 2016 WL 1117588 (S.D.N.Y. March 21, 2016). The takeaway? A security interest in an LLC membership interest is very different than a security interest in the assets actually held by that LLC. The lesson is clear: make sure you accurately describe the collateral in the UCC-1 to properly perfect your interest in that collateral.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

The Loan Commitment or Term Sheet – Have You Thought Through Everything That You Are Agreeing To?

By: Serge Filatov

With interest rates still at historically low rates, many people here in Silicon Valley and San Jose are taking out inexpensive debt to finance their business and real estate needs . The first step in obtaining commercial debt is obtaining a loan commitment or term sheet from a lender. Loan commitments set forth the basic economic terms of the loan and include items like:

  • loan amount;
  • maturity date;
  • interest rate;
  • payment terms; and
  • security that the lender will take (if any).

While the items listed above are certainly important, many people often only focus on these “major” items and do not worry about the other details of the loan. Unfortunately, those “less important” details are often the major cause of future headaches for the unwary borrower.

When reviewing a term sheet or loan commitment, and before entering into an agreement with a lender, a potential borrower should consider the other common restrictions or requirements often imposed by lenders, which may include:

  • Financial covenants, including debt service coverage ratios;
  • Entity structure requirements;
  • Loan fees;
  • Prepayment fees and restrictions;
  • Reporting requirements;
  • Reserves for taxes, insurance premiums, capital expenditures, or other future costs and expenses;
  • Guarantees; and
  • Affirmative and negative covenants.

While the list above is by no means exhaustive, it is representative of the type of items that a borrower should consider when reviewing a loan commitment or term sheet. It is important to know about all that you are agreeing to – even the details. In many loan agreements, if you breach any part of the loan agreement, you will be in default of the loan and the lender could potentially accelerate all of the amounts owed under the loan. Will you be in the financial position to pay back the loan in full when the lender demands payment? Don’t put your business or property at risk by not thinking through the details of the loan.

Alternatively, if you are a lender, it can be advantageous to include the points above (and perhaps others, depending on the transaction) to minimize later negotiations with the borrower and ensure you do not invest more time in working on a transaction that will not get to closing because the parties are unable to agree on important final terms.

A term sheet or commitment letter can also be construed as a binding agreement in some instances, and the parties must use care to avoid this – assuming they do not want the term sheet or commitment letter to represent an actual, binding agreement.

If you are interested in avoiding problems later, it may be wise to have an attorney help you navigate the potential pitfalls of a term sheet, commitment letter and debt package and provide you with the best possible outcome for success.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Creatively Covering Customers’ Catastrophes: Cover THIS!

By: Robert Hawn

As a San Jose corporate lawyer, many of our clients make their money through software licenses. As part of their deals, a number of risks have to be allocated. As explained in my blog posted on May 18 [ Creatively Covering Customers Catastrophes: The Exciting World of IP Infringement Indemnification ], one major risk is that our client’s customer may get sued for infringement due to the software they have received from our client. To allocate this risk, a process called indemnification is used. Indemnification means that if the customer is sued, the licensor will defend the customer and, if an infringement occurs, agree to cover the customer for any damages. Software licensors will often, but not always, indemnify their customers from this risk.

One issue is what types of intellectual property the indemnification will cover.

Before we dive in, let’s discuss some background. Generally, intellectual property is thought of as falling into four major categories: patents, trademarks, copyrights, and trade secrets. There are others, but we’ll ignore them for now. Each form of intellectual property covers certain items. Although it is a gross overgeneralization, you can think of patents as covering inventions and their improvements, trademarks as symbols of the source of a good or service, copyrights as a creative work, e.g., music, a book, or software, and a trade secret as something that is subject to reasonable efforts to be kept secret and has some economic value.

Typically, an infringement clause will cover all intellectual property, and a clause is often added which says this. Licensors will often, however, attempt to limit the intellectual property to specific categories. The blanket indemnification that is often provided may be unnecessary under certain circumstances. One area concerns territory. For example, if the key technology that is being licensed, whether directly or by incorporation into licensed software, is protected by a patent, and the license limits use to the United States, then there probably isn’t much need to protect the customers from patents granted in other countries. It’s a good idea, where license rights are constrained, particularly to geographic areas, to match the indemnification obligation to those areas.

Another way indemnification can be limited is by corresponding the item licensed with the appropriate intellectual property right. This occurs most often with trademarks. Remember, trademarks are words or symbols that tell the consumer the source of a product or service. If a customer is merely licensing technology that they are going to distribute under their own name, there’s really no reason for that customer to be protected from an infringement claim against the licensor’s trademark, because the customer isn’t going to be using it. On the other hand, if the customer is licensed to use the trademark, such as in a franchise agreement, and the customer is motivated to enter into the deal because of the strength of the mark, you can bet that an infringement indemnification concerning the licensor’s (or franchisor’s) mark will be a key part of the agreement.

A third limitation occurs when an item licensed is composed of intellectual property that comes from third parties. This is very common these days when licensing software, because software often includes “open source” software that is free to developers and free to distribute, but often disclaims any obligations regarding any commitments regarding intellectual property. When this occurs, a licensor will often attempt to exclude any coverage for such software that has been licensed by the licensor and incorporated into its products. This often makes for a very spirited discussion!

In my next blog on the exciting world of intellectual property infringement indemnification, we’ll talk about some of the approaches that can be used if an infringement is expected to, or actually does, occur.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.