Banking Agencies Pause Phase-In of Certain Basel III Capital Rules
On November 21, 2017, the OCC, FDIC and FRB adopted a final rule that will pause the phase-in of Basel III capital rules relating to mortgage servicing assets, certain deferred tax assets, investments in capital of unconsolidated financial institutions and minority interests, which were scheduled to take effect on January 1, 2018. The rule applies only to non-advanced approaches institutions (i.e., institutions with less than $250 billion in consolidated assets and foreign bank subsidiaries with less than $10 billion in assets) and is intended to maintain the status quo while the agencies finalize a broader rule-making process to simplify the treatment of these capital components. Until that process has been completed, these institutions will continue to apply the risk weight and deduction treatment that was applicable during 2017. Please contact Andrew Bulgin with questions about this topic.
Does Lender Owe a Duty to Ensure Co-Signer's E-Signature is Valid?
The U.S. District Court for the District of Maryland recently granted a motion to dismiss filed on behalf of a student loan lender.
The plaintiff, a parent of the student loan borrower, alleged that his child added his e-signature as co-signer on seven student loan agreements without his knowledge or consent. The plaintiff asserted the defendant/lender had a duty to confirm that he indeed intended to be a co-signer and the defendant was negligent in not doing so. The court determined the facts in the complaint did not support plaintiff’s claim.
The court analyzed the facts presented based on Maryland law governing negligence, which requires proof of four elements: duty, breach, causation and damages. Regarding the element of duty, an intimate nexus (for example, a contract between the parties) is required when, as in this case, the harm is purely economic. The court cited as a well-established legal rule in Maryland that a lender does not owe a duty to a non-customer with whom it has no direct relationship absent special circumstances. The plaintiff argued there was a sufficient nexus. He stated that based on prior relationships between himself and the lender, the lender should have known his contact information (e-mail and telephone number) contained in the suspect loans was incorrect.
The plaintiff also argued that the lender owed him a duty because the lender had no safeguards to protect him from being fraudulently named as a co-signer. The court reasoned that prior contractual relationships do not establish a duty regarding future activities. Further, new or different contact information, such as an e-mail address or telephone number, is not facially suspect.
Regarding safeguards, the court recognized that lenders do not owe an indeterminate duty to protect non-customers from fraud. Thus, the court granted the motion to dismiss filed on behalf of the lender.
This decision is of particular interest to lenders that rely on e-signatures, who face greater risks because these are not normally face-to-face transactions.
For any questions, please contact Christopher Rahl.
Liability for Unpaid Employee Withholdings - Even with Lender Lock-Box Arrangement
Earlier this year, the U.S. Court of Appeals for the Sixth Circuit issued an opinion in which it affirmed a lower court’s determination that a business owner was liable for failing to remit trust-fund taxes that were to have been withheld from employee wages notwithstanding the fact that the business was operating under a lock-box arrangement with its lender.
Pursuant to the terms of the loan agreement, the lender exercised its right to control the business’s financial activities. The owner asked the court to hold that the lock-box arrangement and the lender’s resulting control over payments to third parties absolved him of any responsibility for remitting the taxes to the IRS.
The court rejected that argument because, among other things, the business had voluntarily entered into the loan agreement and, thus, the lock-box arrangement, the owner continued to exercise significant control over the payment of the business’s creditors after the lock-box arrangement went into effect and the owner knew that the taxes were due and could not show that the lender rejected a request to pay those taxes. Please contact Andrew Bulgin with questions about this topic.
Factors of Medicaid Receivables Left with Unsecured Claims
A factoring arrangement occurs when a debtor sells its receivables to a third party for an agreed upon discounted amount. Under the typical agreement, the debtor must pay the factor the entire amount of the receivable in daily, weekly or monthly installments.
In a recent Texas bankruptcy case, the debtor, a home healthcare agency, entered into agreements with two factors prior to bankruptcy under which certain Medicaid receivables were sold to the factors. When the debtor filed for bankruptcy under Chapter 11, it owed one factor approximately $222,000 and the other $31,000. Both factors filed proofs of claim in the bankruptcy case, asserting a security interest in the debtor’s accounts, including deposit accounts.
The debtor objected to both claims on the basis that the transactions were disguised loans that were usurious, and that the factors’ claims were unsecured because federal law prohibits Medicaid receivables from being assigned.
The bankruptcy court overruled the first objection after concluding that the transactions were true sales, not loans, and that the sales were not subject to the applicable state usury statute.
However, the second objection was sustained. In doing so, the court based its decision on its reading of 42 U.S.C. §1396a(a)(32), which prohibits Medicaid payments from being made to anyone other than the provider of the service for which the payment was made. Although the anti-assignment law contains exceptions, the court held that none of the exceptions applied to the subject factoring transactions. Accordingly, the court ruled that the factors’ claims were unsecured.
The bankruptcy court’s decision is not surprising since most factors and lenders are aware of the federal laws requiring that Medicare and Medicaid payments be made only to the provider. Apparently, the factors did not structure their transactions in a way that would minimize the effect of such laws.
One common arrangement structured by factors and lenders for Medicare and Medicaid receivables is to require their seller or borrower to set up two accounts. The first account is for the purpose of receiving Medicare and Medicaid payments. The second would be a concentration account controlled by the factor or lender into which the Medicare or Medicaid payments made to the first account would be automatically transferred by the depository bank. Although the factor or lender may be barred in enforcing their rights to the first account, applicable case law and federal regulations hold that the factor or lender is not barred from debiting the second account since the second account is not the direct recipient of the payments.
For any questions, please contact Christopher Rahl.
Bitcoin Derivatives Are Here
On December 1, 2017, the Commodity Futures Trading Commission (CFTC) announced that it is permitting the listing of bitcoin derivatives contracts on three United States commodities exchanges. The Chicago Mercantile Exchange (CME) and the CBOE Futures Exchange (CBOE) will begin listing bitcoin futures contracts in December 2017, while the Cantor Exchange plans to list bitcoin binary options beginning in the first half of 2018.
The three exchanges were approved under the CFTC’s self-certification process after several months of negotiation over controls to address the potentially high volatility in bitcoin prices.
For example, CME’s notification letter states that it will implement trading cooling-off periods at prices that hit 7% and 13% above or below the most recent daily settlement price and will halt daily trading at prices that exceed 20%.
The exchanges can use settlement prices based on the trading prices of widely used bitcoin exchanges. For example, CME will clear through its clearinghouse, CME Clearport, at a settlement price that is a composite of the trading prices of Bitstamp, GDAX, itBit and Kraken, which together represent approximately 35% of global U.S. dollar bitcoin trading.
One hope for bitcoin derivatives is that they will help dampen price swings in the commodity. In 2017 alone, the value of bitcoin has increased from $900 to currently more than $11,000. For more information concerning bitcoin and how it can impact your business, please contact Ned T. Himmelrich, and for questions concerning securities offerings, please contact Michele Walsh.
Post-Petition Interest Owed to a Fully Secured Creditor May Be Disallowed on Equitable Grounds
In an unprecedented published decision, the U.S. Court of Appeals for the Fourth Circuit upheld a Bankruptcy Court decision that tolled (disallowed) post-petition interest due to an over secured creditor for a period of 266 days due solely to delay caused by the court’s schedule and actions taken by the creditor to protect its rights.
The facts of the case were relatively straightforward.
The creditor held a lien to secure a note on several tracts of land owned by the debtor. After the note went into default, the debtor filed a Chapter 11 case.
During the case, the debtor proposed to satisfy the creditor’s $13 million claim by conveying to the creditor certain tracts of land plus cash equal to the difference between the value of the land being conveyed and the amount owed to the creditor.
The creditor rejected the plan and the Bankruptcy Court was required to conduct lengthy valuation hearings to determine the value of the land being conveyed. It was necessary for the court to do so to decide whether the plan could be “crammed down” on the creditor under the Bankruptcy Code because it was being given the “indubitable equivalent” of its claim.
The Bankruptcy Court confirmed the plan and the creditor appealed.
On appeal, the Fourth Circuit decided several issues, including whether a partial “dirt-for-debt” plan could meet the indubitable equivalent standard of the Bankruptcy Code and whether the Bankruptcy Court properly disallowed a portion of the post-petition interest due on the creditor’s secured claim.
The court held for the debtor on both issues. Its decision on the disallowance of post-petition interest due to delays in the case was particularly remarkable due to the absence of any direct authority supporting such a decision. Section 506 (b) of the Bankruptcy Code provides that a secured creditor whose collateral is greater than the amount of its claim “shall be allowed” post-petition interest up to the value of the collateral. Despite the clear mandate of Section 506(b), the Fourth Circuit held that “equitable defenses” could be applied to a creditor’s right to receive post-petition interest.
The court then found that delay caused by the Bankruptcy Court’s schedule or proceedings filed by the creditor were sufficient equitable reasons for the Bankruptcy Court to disallow a portion of the post-petition interest due to the secured creditor. Notably, the Fourth Circuit did not suggest that the creditor’s actions were taken in bad faith. Based on the facts set forth in the decision, all of the creditor’s actions were taken in response to a controversial Chapter 11 plan proposed by the debtor.
Even if the court is correct that the mandate of Section 506(b) can be disregarded in view of the equities of the case (a debatable proposition), it is difficult to understand why a secured creditor should be required to pay for the delay caused by a Bankruptcy Court’s calendar or proceedings filed by the creditor in good faith to protect its rights.
For any questions, please contact Christopher Rahl.