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

On November 30, 2011, the Supreme Court of Ohio accepted KeyBank's appeal from the judgment in JNT Properties, LLC v. KeyBank, Nat'l Assoc., decided by the Eighth District Court of Appeals in Cuyahoga County, Ohio on June 30, 2011. As our July 2011 blog post, available here, explained, this case hinged on whether KeyBank's use of the "365/360 method" of interest calculation, resulting in an effective interest rate of 9.05% per annum, breached a promissory note pursuant to which JNT Properties had agreed to repay principal together with interest at the rate of 8.93% per annum. The Eighth District Court found that the "365/360 method" used in the case "cannot be read as clearly evidencing an intent of the parties to alter the ordinary meaning of the term 'per annum,' or as creating an 'annual interest rate' other than the stated rate of 8.93 percent."   2011-Ohio-3260, at ¶ 21 (internal quotations omitted). Concluding that genuine issues of material fact remained, the Eighth District Court reversed the trial court's grant of summary judgment in favor of KeyBank.

Since we last reported, KeyBank filed a Notice of Appeal of the case and Memorandum of Jurisdiction with the Supreme Court of Ohio on August 15, 2011. On the same date, the American Bankers Association and the Ohio Bankers League filed a Jurisdictional Memorandum of Amici Curae in support of KeyBank, arguing that the case is one of great public interest and could impact thousands of commercial loan transactions in Ohio. On November 30, 2011, in an entry by Chief Justice Maureen O'Connor, the Supreme Court of Ohio accepted the appeal.

The Supreme Court of Ohio's resolution of this case may prove to be significant, as the decision as it stands creates uncertainty and may possibly render unenforceable the "365/360 method" commonly used in loan documents. Lenders should seek professional guidance on crafting "365/360 method" interest calculation language to ensure they receive their expected yield and avoid costly and unnecessary litigation.

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On June 30, 2011, the Eighth District Court of Appeals in Cuyahoga County, Ohio decided the case of JNT Properties, LLC v. KeyBank, Nat'l Assoc., which dealt with the calculation of interest on a commercial loan by what is known as the "365/360 method." The court held that KeyBank's interest calculation method for the loan was unintelligible because although a provision toward the top of the note contained a stated annual interest rate of a certain percentage, that provision was contradicted by another term in the note relating to calculation of interest.  Accordingly, lenders using the common "365/360 method" should ensure that their loan documents clearly and intelligibly describe the calculation of interest.

The case originated when JNT Properties filed a class action against KeyBank, alleging breach of contract based on KeyBank's use of the "365/360 method" for the calculation of interest. The promissory note in question stated that the "Initial Interest Rate" was 8.93%, but then elsewhere in the document stated as follows:

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Secured lenders must prepare to conduct more due diligence than ever before when lending to motor carriers. As a result of the March 3, 2011 Sixth Circuit decision In re: Arctic Express Inc., owner-operators (independent drivers) may have enforceable "hidden" liens on certain assets of motor carriers that would require restitution, not only from the motor carriers but from the motor carriers’ secured lenders as well.

Arctic Express Inc. (Arctic) and its affiliated leasing company D&A Associates Ltd. (D&A) were sued in a class action filed by the Owner Operator Independent Drivers Association, Inc. (OOIDA). Each independent driver entered into two agreements with Arctic and D&A: an independent contractor agreement, and a lease agreement. Under these agreements, the independent drivers were entitled to compensation as a percentage of revenue generated from the associated transportation and were required to make equipment rental payments. Also, the agreements permitted Arctic to deduct a fee of nine cents per mile from the compensation paid to the independent drivers to be kept in a "maintenance escrow fund," for purposes of repair and maintenance to the leased equipment. If the fund balance exceeded maintenance expenses, the net was to be paid to the independent driver upon the expiration of the agreements.

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The Foreign Account Tax Compliance Act (FATCA) [Sections 1471-1474 of the Internal Revenue Code] was enacted to prevent U.S. taxpayers from evading U.S. tax obligations by parking funds in foreign accounts or with foreign investors. FATCA requires each U.S. entity to withhold 30% of certain payments made after 2012 to foreign investors or foreign lenders unless such foreign entities satisfy certain new disclosure and reporting requirements. 

Failure to comply with FATCA will subject the U.S. entity to penalties and fines. Domestic lenders and domestic borrowers alike should ensure that foreign entities are FATCA compliant by adding language to the parties' credit agreement that obligates each existing and future foreign entity to provide tax documents, certificates and other tax information upon demand. An example of such language follows:

Promptly upon receipt of written request, each Foreign Lender shall deliver to the Borrower and the Agent any information, document, or certificate, properly completed and in a manner prescribed by law or satisfactory to the Borrower or the Agent, as the case may be, in order to permit the Borrower or the Agent to make a payment under this Agreement or the Loan Documents without any withholding on account of any tax otherwise required to be withheld under FATCA, and each Foreign Lender shall strictly comply with any disclosure or information reporting requirements (including entering into an agreement with the Internal Revenue Service) that are required to secure an exemption from any United States withholding taxes.

Depending on whether you are a domestic lender or domestic borrower, FATCA raises other issues you may want to consider with your legal advisor.

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That is the question addressed in Amcan Holdings, Inc. v. Canadian Imperial Bank of Commerce, 894 N.Y.S.2d 47 (N.Y. App. Div. 1^st Dep’t Feb. 4, 2010).

Amcan Holdings, Inc. (“Amcan”), certain of Amcan’s affiliates (together with Amcan, collectively, “Borrower”), and Canadian Imperial Bank of Commerce (“Lender”) negotiated, executed and delivered a certain “Summary of Terms and Conditions” (the “Term Sheet”). The Term Sheet contained a variety of agreed upon terms and conditions, including the principal amounts of the revolving and term facilities, interest and amortization schedules, maturity dates, fees, the collateral to secure the debt, and a proposed closing date. 

After discovering that Borrower was subject to a preliminary injunction that prohibited Borrower from pledging to Lender certain equity interests, Lender lost interest in the proposed financing arrangement. Six years later, Borrower initiated a breach of contract action against Lender. Borrower’s position was that the Term Sheet was a binding commitment to lend.

The New York appellate court disagreed. The court stated that the fundamental issue to be determined in these cases is whether the parties intended to be bound by the agreed upon terms and conditions set forth in the preliminary agreement (i.e., the Term Sheet). To support its conclusion that the Term Sheet was not binding, the court noted that the Term Sheet clearly states “the credit facilities will only be established upon completion of definitive loan documentation, which would contain not only the terms and conditions in those documents but also such other terms and conditions as [Lender] may reasonably require. Although the [Term Sheet] was detailed in its terms, it was clearly dependent on a future definitive agreement, including a credit agreement. At no point did the parties explicitly state that they intended to be bound by the [Term Sheet] pending the final Credit Agreement, nor did they waive the finalization of such agreement.”    

Based upon this case, a prudent lender should make it clear within the term sheet which provisions, if any, are binding upon the parties. Additionally, the term sheet should indicate that the proposed credit facilities shall not be established, and lender shall not be committed to lend, unless and until the parties execute and deliver definitive loan documentation.

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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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In this challenging economy, intellectual property rights are increasingly valuable assets. As sales and profits struggle, companies are taking more steps to promote their brands and preserve their intellectual property rights in hopes of improving their position in the marketplace upon recovery. Likewise, many companies find themselves leveraging the value of their intellectual property and the strength of their exclusive rights as collateral on much-needed loans.

When taking intellectual property assets as collateral, lenders should be aware of issues specific to perfecting security interests in patents, trademarks, copyrights, and domain names.  The Official Comments to Uniform Commercial Code § 9-102 include intellectual property within the definition of “general intangibles.” Generally, a lender’s security in general intangibles is perfected by the filing of a UCC-1 financing statement in the state where the borrower’s principal place of business is located.  It should be noted, however, that UCC § 9-311 provides an exception when the intellectual property rights are governed by federal statutes, regulations, or treaties. In such a case, the proscribed federal procedures take precedence.

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