LIBOR SET FOR ELIMINATION IN 2021; ILLINOIS FEDERAL COURT HOLDS THAT ILLINOIS STATUTE REQUIRING NO “BAD FAITH DENIAL OF COVERAGE” DOES NOT APPLY TO TITLE INSURERS; AND DELAWARE SUPREME COURT REJECTS PRESUMPTION THAT DEAL PRICE IS BEST ESTIMATE OF FAIR VALUE
A. LIBOR ELIMINATION
On July 27, 2017, British regulators announce that the London Interbank Offered Rate (LIBOR), the interest rate tied to trillions of dollars in loans, interest rate swaps and other financial products, will be eliminated by the end of 2021. U.S. and international regulators are developing replacement benchmark rates and are expected to outline implementation plans later this year. Lenders should take the following steps:
- Staff responsible for loan administration and compliance should track regulatory guidance concerning new benchmark rates.
- Lenders and swap providers should evaluate non-LIBOR indexes for new loans maturing after 2021.
- For new LIBOR-based loans or swaps maturing prior to 2021, consider identifying other reference rates for use as a substitute index.
- Loan documents for new LIBOR-based loans should specify an alternative index or expressly permit the lender to select a comparable reference rate when LIBOR is eliminated. Procedures for implementing a new index for LIBOR-based loans should be clearly stated.
- Loan documentation for existing LIBOR-based loans should be reviewed to determine the lender’s ability to select an alternative index when LIBOR is eliminated. If the documents fail to expressly state an alternative, an amendment may be necessary.
In anticipation of the elimination of LIBOR, the U.S. Federal Reserve established the Alternative Reference Rates Committee (ARRC) to select a replacement index for U.S. Dollar LIBOR. ARRC, comprised of a group of large domestic banks and regulators, voted to use a benchmark based on short-term loans backed by Treasury securities, known as repurchase agreements or “repo” trades. ARRC is expected to announce a transition plan for the new rate later this year.
B. “BAD FAITH DENIAL OF COVERAGE” DOES NOT APPLY TO TITLE INSURER
In a case between a lender and its title insurer, the U.S. District Court for the Northern District of Illinois recently held that a title insurer may exclude coverage under the exception for defects “created, suffered, assumed, or agreed to by the insured claimant” without intentional or wrongful conduct by the insured-lender. The court also held that the Illinois statute for bad faith denial of coverage by insurers did not apply to title insurers. Bank of America, N.A. v. Chicago Title Insurance Company, Case No. 17 C 0407, (N.D. Ill. May 18, 2017).
In 2007, a developer sought to build a shopping center in Yorkville, Illinois. Bank of America provided construction financing by way of a construction loan agreement secured by a construction mortgage, security agreement, assignment of rights and leases and fixture filing on the property. As part of the project, the developer sold land to an anchor tenant pursuant to a real property purchase agreement (“purchase agreement”). In that purchase agreement, the developer agreed to reimburse the anchor tenant for a portion of a special tax imposed on the property by Yorkville. The purchase agreement also provided lien rights to the anchor tenant should the developer fail to timely pay the reimbursement, and stated that the developer’s obligation shall be a covenant running with the land and binding on the developer’s successors and assigns. The developer and anchor tenant also entered into a “development agreement,” which referenced the above provisions of the purchase agreement and also provided similar lien rights subordinate to the lien of any first mortgage.
On May 24, 2007, the purchase agreement, development agreement, and the mortgage were recorded in that order with the Kendall County Recorder. Also on May 24, 2007, Chicago Title issued to Bank of America the title insurance policy at issue. The developer defaulted under the construction loan agreement and the bank sued for foreclosure in Illinois state court. The Illinois Appellate Court held that the bank’s mortgage had priority over any lien of the tenant, but concluded that the tenant’s tax reimbursement and lien rights were covenants that ran with the land binding on the bank and its successors, and were not extinguished as a result of the foreclosure, because the bank had actual knowledge of the tax reimbursement and lien rights before the bank recorded the mortgage, and because the mortgage was recorded after the memorandum of agreement and memorandum of development agreement.
Bank of America then brought suit against Chicago Title in federal district court, claiming that as a result of the appellate court ruling, it sold the property for $1,780,000 less than what it would have sold for absent the tax obligation. As a result, Bank of America sought indemnity from Chicago Title based on the title insurance policy. Chicago Title, which represented the bank in the state court action against the tenant, had denied coverage and refused to indemnify the bank, arguing that the bank’s loss is excluded from the policy based on exclusion 3(a) in the policy for “defects, liens, encumbrances, adverse claims or other matters (a) created, suffered, assumed, or agreed to by the insured claimant.”
The federal district court allowed Chicago Title to proceed with this affirmative defense and counterclaim, which alleged that the bank was aware: (1) of the documents creating the tax encumbrance; (2) that the documents provided for the encumbrance to run with the land; and (3) the documents that created the encumbrance were intended to be and were recorded prior to the bank’s mortgage. Because the tax encumbrance was recorded before the mortgage, the court held that the foreclosure could not extinguish it. The court also held that the exclusion could be applied without intentional or wrongful conduct by the bank to create the encumbrance. By agreeing to the order of recordation, the court found that the bank implicitly agreed that the encumbrance for tax reimbursements would survive a foreclosure.
The bank had also claimed that the title insurer acted in bad faith in denying coverage, but the court dismissed this claim, reasoning that Section 155 of the Illinois Insurance Code, which provides a cause of action against insurers for bad faith denial of coverage, did not apply because the Insurance Code specifically exempted title insurance companies. See 215 ILCS 5/451. In addition, Illinois law does not provide an independent tort claim for breach of the covenant of good faith and fair dealing. To succeed, the bank must also allege a tort independent from a breach of the policy, such as fraud, but because no such independent tort claim was stated, the bad faith claim was dismissed.
This case is a reminder to lenders and borrowers that a court will hold them to the terms and conditions of the documents to be recorded in connection with the mortgage, especially if the parties can be charged with knowledge of them, and that the priority of their recording is important in determining the priority of the competing liens created by them.
C. DELAWARE SUPREME COURT REJECTS PRESUMPTION THAT DEAL PRICE IS BEST ESTIMATE OF FAIR VALUE
In DFC Global Corp. v. Muirfield Value Partners, L.P., the Delaware Supreme Court declined to adopt a presumption that in an arm’s length merger, the deal price is the best estimate of fair value for purposes of an appraisal rights proceeding. The Delaware Supreme Court found the Chancery Court erred by not giving appropriate weight to the price paid by a private equity buyer because a sponsor focuses on achieving certain internal rates of return and on reaching a deal within its financing constraints.
DFC was a publicly traded payday lending firm purchased by a private equity firm, and had experienced regulatory uncertainty in its industry. The DCF board hired a financial advisor to explore a sale. Initially, the advisor contacted six private equity sponsors, all of whom declined to proceed. The financial advisor then contacted 35 more private equity sponsors and three strategic buyers. Financial projections were provided to prospective purchasers were lowered throughout the process, with Lone Star eventually agreeing to acquire DFC for $9.50 per share.
In determining fair value, the Court of Chancery gave equal weight to the deal price, a comparable companies analysis and a discounted cash flows analysis in determining fair value at $10.21 per share, without explanation as to its rationale for such weighting.
The Delaware Supreme Court reversed and remanded the case back to the Chancery Court for it to reassess the weighting of the various factors potentially relevant to fair value, noting that the sale value resulting from a robust market check “will often be the most reliable evidence of fair value and that second-guessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous.” However, the Delaware Supreme Court declined to go so far as to adopt a presumption that the deal price was the best estimate of fair value because it would be contrary to the Delaware appraisal statute, which required the court to consider “all relevant factors.” It would also be contrary to controlling precedent, as established in Golden Telecom, Inc. v. Glob. GT LP and elsewhere. The Supreme Court also rejected the Chancery Court’s finding that the deal price was unreliable because Lone Star, a private equity firm, required a specific rate of return on its transaction with DFC. The Supreme Court found that was illogical because any rational purchaser of a business should have a targeted rate of return that justifies taking on the substantial risks and costs of buying a business. That a buyer focuses on hitting its internal rate of return has no rational connection to whether the price it pays as a result of a competitive process is a fair one. Here, the Delaware Supreme Court cited objective factors supporting the fairness of the price paid, such as no conflicts of interest, the failure of other potential bidders to pursue DFC, the unwillingness of lenders to lend to potential buyers, a credit rating agency putting DFC’s long-term debt on negative credit watch, and DFC’s failure to meet its own projections.
Steven A. Migala is a partner at Lavelle Law and possess over 20 years of providing excellent representation to banks, businesses and individuals in a variety of matters. He can be contacted at (847) 705-7555 and firstname.lastname@example.org.