Maryland Legal Alert for Financial Services

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Loan Documents May Waive Creditor Bankruptcy Rights

While it is universally recognized that a debtor cannot waive its right to file for bankruptcy, there is little authority concerning whether a creditor can waive its bankruptcy rights in pre-bankruptcy agreements.  The issue was raised in a bankruptcy case in the Northern District of Illinois.  The case involved an unsecured creditor's challenge of the right of certain secured creditors to enforce their rights under Sec. 1111(b)(1)(A) of the Bankruptcy Code.  Under that section, the claim of a non-recourse creditor is treated as though the creditor has recourse.  As a result, if the creditor's collateral value is insufficient to pay the creditor's claim in full, the creditor (unless it elects otherwise) will have an unsecured deficiency claim for the balance.  The objection was based on boilerplate language in one of the loan documents of the secured creditors which provided that "no recourse shall be had … under any law."  The unsecured creditor argued that "any law" included the Bankruptcy Code and thus the secured creditors had waived their right to assert an unsecured deficiency claim in the bankruptcy case.  The Bankruptcy Court overruled the objection and held that the secured creditors had not waived their bankruptcy right.  The court's decision was based on its reading of all of the loan documents, as opposed to the single document on which the objection was based.   While the secured creditors prevailed, what is remarkable about the court's decision is not its reading of the loan documents, but its ruling on the issue of whether a creditor can waive its bankruptcy rights under its loan documents.  As to that issue, the court held that unlike a debtor, a creditor can waive its bankruptcy rights.  The court supported its ruling with citations to decisions which have upheld inter-creditor or subordination agreements in which creditors give up their right to participate in a bankruptcy case in favor of another creditor.  While the court's decision on the waiver issue is questionable, creditors should be careful that their loan documents or credit agreements do not inadvertently include language that could be read to bar them from exercising their rights in bankruptcy.  Please contact  Lawrence Coppel for more information concerning this topic.