Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

January 21, 2010, President Obama proposed reforms to the financial system designed to ensure no bank, or financial institution that contains a bank, will own, invest in, or sponsor a hedge fund, private equity fund, or proprietary trading operation for the bank’s own profit. The new reforms, known as the Volcker Rule after former chair of the Federal Reserve Board, Paul Volcker, are intended to prevent banks from engaging in what are now perceived as risky investments.

How the Volcker Rule will be drafted and applied is unclear. At a minimum it seems that banks may have to halt investments that use solely the bank’s capital. Banks may therefore have to divest their proprietary trading desks, although most banks have significantly smaller proprietary trading desks than they did prior to the economic crisis.

What constitutes proprietary trading operations under the Volcker Rule is unknown. For example, do such activities include the practice of facilitating trading for clients and investing alongside clients? Additionally, it is unclear whether only wholly-owned bank funds would be prohibited or any bank involvement in a hedge fund or private equity fund above a certain threshold. One approach, which would be a broad interpretation of the Volcker Rule, would be to prohibit any trading activity that could affect a bank’s balance sheet.

President Obama has pledged to work with Congress to implement the Volcker Rule as part of a comprehensive financial reform bill. The dynamics of the bill should have a direct effect on whether some banks will be willing to cease being a bank holding company in order to keep their trading and investment business.

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On December 3, 2009, the Supreme Court of Ohio decided the case of Mayer et al. v. Medancic et al., in an effort to clarify the calculation of interest on an obligation upon the occurrence of a default. As stated by the Court, “compound interest is not available upon a default on a written instrument absent agreement of the parties or another statutory provision expressly authorizing it.” Accordingly, lenders should ensure that their loan documents clearly state that interest will be compounded not only during the term of the loan, but also after default.

The case involved the calculation of default interest on three promissory notes executed and delivered by the Medancics to the Mayers. All principal and accrued interest on each note was due and payable at maturity and the Medancics failed to make those payments in each case. Although the maturity dates fell in 1995 and 1997, the Mayers did not receive judgment on the notes until May of 2006. The Mayers contended that they were entitled to post-judgment interest at the rates set forth in the notes, compounded annually, but the trial court held that the Mayers were entitled to post-judgment simple interest at the rates set forth in the notes. The Eleventh District Court of Appeals reversed, on the basis of the Supreme Court of Ohio case, State ex rel Bruml v. Brooklyn, which the Eleventh District held provided for “interest upon interest” and, therefore, provided for compound default interest. In doing so, the Eleventh District acknowledged the general rule that compound interest is not available absent a statutory provision or agreement of the parties, but found that the rule applied only to cases decided under Ohio Revised Code 1343.03.

The Supreme Court of Ohio disagreed. The Court evaluated both statutes: Ohio Revised Code 1343.02 and 1343.03. 1343.02 provides that “upon all judgments, decrees, or orders, rendered on any bond, bill, note, or other instrument of writing containing stipulations for the payment of interest in accordance with section 1343.01 of the Revised Code, interest shall be computed until payment is made at the rate specified in such instrument.” 1343.03 sets forth the applicable statutory rate of interest when the instrument does not specify the interest rate. The Court made two crucial findings: (1) it saw no reason to withhold application of the general rule to cases decided under 1343.02, despite its historic application to cases decided under 1343.03, and (2) Bruml v. Brooklyn allowed for only “interest upon interest,” which it distinguished from compound interest. “Bruml merely permits the collection of interest on an amount that is due and payable, but not paid, even if that amount includes previously earned interest.” According to the Court, this meant that Bruml provides for the collection of simple interest on the judgment, whether that judgment amount included unpaid interest or solely principal was irrelevant.

Ultimately, this decision takes a middle position between that urged by the Mayers and that urged by the Medancics. Because the payment at maturity on each note included both principal and accrued interest, the default interest would be on that entire missed payment amount, but would be simple interest instead of compounded annually. Still, the decision is a costly one for the Mayers who lost compound interest over a nearly ten year period. This case should serve as a warning to all lenders in Ohio. Even if the instrument fully describes the accrual and calculation of interest during the term of the obligation, it must also do so for the period following a default.

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Porter Wright is deeply honored to be ranked among the 30 elite firms in the country when it comes to client service.  In a national survey of in-house counsel at Fortune 1000 companies conducted byThe BTI Consulting Group (BTI), Porter Wright ranked 22 out of 505 core firms named by in-house counsel.

Porter Wright was honored as a “Leader of the Best” when it comes to advising clients on business issues. According to the report, “Porter Wright differentiates itself with clients by translating legalese into business speak — a key method to prove your commitment to help clients.” The report also cites specific comments from corporate counsel about Porter Wright’s commitment to client service, specifically, “They know our business and us. They have skilled people in a number of areas critical to our business.”

Based out of Boston, BTI is the leading provider of strategic market research to law firms and professional services firms. BTI’s analysis draws on candid feedback from 240 corporate counsel at Fortune 1000 companies to determine which law firms among 505 core firms nationally top the charts in client service. Corporate counsel ranked Porter Wright among the best in the country in 14 areas:

1. Anticipates the Client’s Needs
2. Breadth of Services
3. Brings Together National Resources
4. Commitment to Help
5. Deals with Unexpected Changes
6. Helps Advise on Business Issues
7. International Capability
8. Keeps Clients Informed
9. Legal Skills
10. Meets Scope and Budget
11. Provides Value for the Dollar
12. Quality Products
13. Understands the Client’s Business
14. Unprompted Communication

For more information about this survey, visit www.bticlientservicesateam.com.

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In November the House Financial Services Committee passed an amendment to the proposed Investor Protection Act, H.R. 3817, that would exempt non-accelerated filers from providing auditor attestation of internal control over financial reporting. Public holding companies for some community banks may be affected. If passed, the bill as amended would provide significant relief for smaller reporting companies which are, generally speaking, companies with a public float of less than $75 million.

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Under the Gramm-Leach-Bliley Act (“GLB”), financial institutions are required to disclose their information-sharing practices to their customers and also to notify them of their right to opt out of certain practices. As amended by the Financial Services Regulatory Relief Act of 2006, GLB also requires that certain regulatory agencies develop a model privacy notice form. This form will assist consumers in comparing the different information and privacy practices of financial institutions by providing an inclusive form that is consistent across all institutions.

On November 17, 2009, the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Federal Trade Commission, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Securities and Exchange Commission jointly issued a final model privacy notice form under GLB. The final model privacy notice form comes in two versions: (1) a version containing opt-out language in a section titled “To limit our sharing,” and (2) a version without opt-out language.

By using the appropriate final model privacy notice form, financial institutions can comply with the GLB notice and disclosure requirements. Under the final rule promulgated by the regulatory agencies, use of the model form functions as a “safe harbor” such that any financial institution correctly using the appropriate model form will satisfy the notice and disclosure requirements.

While the model form provides a safe harbor, financial institutions can continue to use their own notice form so long as it complies with the final rule. If a financial institution elects to use the model form, that institution must determine whether or not their information-sharing practices necessitate the use of the opt-out model form. Accordingly, financial institutions should seek the advice of privacy personnel and legal counsel to determine if switching to the model form is the right decision for their business and, if so, which version applies.

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The Sixth Circuit Court of Appeals recently addressed the effect of mergers and internal corporate restructuring on intellectual property licenses in a decision that has implications in drafting and interpreting license agreements as well as in advising entities who are considering whether to restructure or merge a corporate entity. 

In Cincom Systems, Inc. v. Novelis Corp., 6th Cir. No. 07-4142, 2009 WL 3048436 (6th Cir., Sept. 25, 2009), the Court considered whether an internal corporate merger resulted in an improper transfer of a copyright license. It determined that an internal merger may result in a transfer and that the transfer is improper unless it is expressly authorized by the licensor.

Cincom Systems granted Alcan a software license, which was “non-transferable” without Cincom’s prior written approval. Alcan, a wholly-owned subsidiary of a Canadian corporation, later created a separate corporation, Alcan Texas, and the two subsidiaries merged. The surviving corporation, Alcan Texas, simultaneously merged into itself and its three subsidiaries. After several name changes, the corporation became Novelis. None of the entities ever sought or received Cincom’s approval to continue to use the software license. In the resulting copyright infringement action, the district court granted summary judgment to Cincom, finding that the merger with Alcan Texas was an improper transfer of the software license under the Sixth Circuit’s decision in PPG Industries, Inc. v. Guardian Industries, Corp., 597 F.2d 1090 (6th Cir. 1979) (the “PPG” decision). The court awarded Cincom $460,000 in damages for the infringement.

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It seems safe to assume that no lender would extend high-dollar credit without first having a deep knowledge of the party accepting the funds.   Certainly, such deep knowledge would include the precise legal name of that borrower. Nevertheless, recent cases continue to demonstrate the prevalence of filing UCC-1 financing statements that may be deemed “seriously misleading” as to the name of the debtor and, therefore, ineffective to fix the secured creditor’s place in the chain of priority. All of this means that secured creditors should be cautious when preparing and filing UCC-1 financing statements, or else watch their claims in bankruptcy move further down the chain of priority. But, is there such a thing as being too cautious?

Revised Article 9 of the Uniform Commercial Code, specifically 9-503(a)(1), states that a financing statement sufficiently provides the name of the debtor “if the debtor is a registered organization, only if the financing statement provides the name of the debtor indicated on the public record of the debtor’s jurisdiction of organization which shows the debtor to have been organized[.]” Instead of leaving it at that, however, 9-506 discusses the effect of errors or omissions in a filed financing statement. In short, 9-506(a) provides that errors or omissions are of no consequence unless they render the financing statement “seriously misleading,” and 9-506(c) provides that if a search in the filing office using the filing office’s standard search logic would disclose the financing statement, then it is not “seriously misleading,” even if it fails to provide the precise name of the debtor as required under 9-503(a).

 Most filing offices use search logic that eliminates certain common words or abbreviations (such as “inc.,” “co.,” “Company,” and so forth). And, any other words are included in the search in a way that allows additional words to create problems. A recent example appears in the Nebraska bankruptcy case of EDM Corporation. In that case, the first-filing lender used the debtor name of “EDM Corporation d/b/a EDM Equipment.” The later-filing lender searched the debtor’s exact legal name of “EDM Corporation.” The filing office search logic eliminates the word “Corporation” and does a search only for the name “EDM.” Because of the filing office’s search logic, that search revealed only filings for “EDM” with no other words included in the filing. That search failed to disclose the first-filing lender’s financing statement because only a search for “EDM,” “d/b/a,” and “Equipment” would have revealed that filing. Thus, the first-filing lender had failed to file the exact public record name of the debtor (as required by 9-503(a)(1)) and the search logic failed to reveal that erroneous financing statement (as an available cure under 9-506(c)), so the first-filing lender lost its first priority lien position because its financing statement was “seriously misleading” under the law.

The result of the EDM Corporation case seems harsh—the first-filing lender was trying to be extra cautious by using a belt-and-suspenders, cover-all-the-bases approach. This harshness is tempered only by the fact that the result preserves the purpose of Revised Article 9: to put the burden of proper notice on the filing party, not the searching party. If the law and/or the search logic were the opposite, the later-filing lender would have to review every filing containing the word “EDM,” when only “EDM Corporation” is the precise name of the debtor. This may be a small task to expect when it involves the name “EDM,” but it could be an arduous task if the name were “Smith.”

 Regardless of its harshness, the EDM Corporation case and others like it clearly show that secured creditors must carefully check and review the debtor’s name prior to filing. And even more, secured creditors could avoid most problems by simply running a search on the debtor’s precise legal name after filing their UCC-1 financing statement. If doing so fails to reveal their recent filing, then that secured creditor knows there is a problem with their financing statement. Although running a post-filing search takes additional time and money, learning of the problem at that point is far better than learning of the problem once the debtor enters bankruptcy.

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Receiverships have gained in popularity in foreclosure cases and in other types of litigation in recent years. Orders appointing receivers and setting forth the receiver’s duties frequently include a provision allowing the receiver to market and sell real estate. However, the question of whether a receiver legally has the ability to convey title to real estate, free and clear of liens and encumbrances, appears to have been answered in the negative, at least by one appellate district in Ohio.

In 2008, the Eighth District Court of Appeals handed down its decision in the matter of Ohio Director of Transp. v. Eastlake Land Dev. Co., 177 Ohio App.3d 379, 2008-Ohio-3013, 894 N.E.2d 1255. In what appears to be a classic example of bad facts making bad law, the appellate court reversed the lower court’s approval of a receiver’s sale of real property free and clear of liens. In Eastlake, which was not a foreclosure, the court-appointed receiver sought authority to sell a parcel of real estate for the sum of $250,000, an amount which he stated he “believed” was a commercially reasonable price for the property. In connection with the motion, the receiver presented no evidence of his marketing and sale efforts, nor did he present any evidence regarding the value of the property. Notably, the receiver’s motion did not state that he intended to sell the property free and clear of AFF’s liens. The senior lienholder, American First Federal, Inc. (“AFF”) intervened in the case and filed an objection to the receiver’s motion to sell the property for less than what was owed to AFF. 

On January 20, 2007, the court issued two, inconsistent orders related to the receiver’s motion. In the first, the court set the receiver’s motion for hearing on February 13, 2007. In the second, the court “inexplicably” granted the receiver’s motion to sell, without vacating the order setting the hearing.   In its approval of the motion, the trial court specifically authorized the receiver’s sale free and clear of AFF’s liens. On February 2, 2007, (presumably unaware of the court’s 1/20/07 granting of the sale motion) AFF filed its objection to the receiver’s motion and in that objection (1) submitted a credit bid of $251,000 and (2) offered evidence to the court that the property in question was worth at least $600,000.

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 Ohio and federal courts continue to recognize an effective but seldom used preemption defense under the National Bank Act (“NBA”). This legal defense, available only to national banking associations, can be asserted against certain employment claims brought by terminated bank officers. 

Specifically, the NBA grants national banks the power: To elect or appoint directors, and by its board of directors to appoint ... officers, define their duties, require bonds of them and fix the penalty thereof, dismiss such officers or any of them at pleasure, and appoint others to fill their places.

Courts continue to hold that the NBA’s “at-pleasure” provision preempts state-law tort and contract wrongful discharge claims brought by terminated bank officers. For instance, recently in Schweikert v. Bank of America, Case No. 06-2137 (4^th Cir. April 1, 2008), Bank of America terminated Schweikert, a senior vice president in private banking, for failing to cooperate with the bank’s and the FBI’s investigation of a client for whom Schweikert had arranged several loans. Schweikert sued the bank for wrongful and abusive discharge under Maryland law. The trial court held the NBA’s “at-pleasure” provision preempted the claims and dismissed the complaint. The federal Court of Appeals for the 4^th Circuit upheld the trial court’s application of the NBA’s “at-pleasure” provision. In so ruling, the 4^th Circuit cited with approval the 9^th Circuit’s nearly twenty-year-old ruling in Mackey v. Peoria National Bank, 867 F.2d 520, 525-26 (9^th Cir. 1989), where the 9^th Circuit held that the NBA’s “at-pleasure” provision preempts a terminated bank officer’s state tort and contract claims.

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