Breaking Up Is Hard to Do: Can a DIP Lender Say “So Long” to Its Debtor-Borrower by Phone Call and Email?

Contributed by Elisa Lemmer
There is a famous Sex and the City episode from Season 6 where the show’s protagonist, Carrie Bradshaw, ponders the indignity of being “dumped” by her boyfriend, Berger, through a Post-It note on which he stated concisely, “I’m sorry. I can’t. Don’t hate me.”  Most would agree that this is not a particularly classy way to break up.  But as Carrie might ask rhetorically in a question tapped out on her laptop, “Is it legally binding?”  In a reality imitates television moment, a DIP lender broke up with its borrower-debtor in a similarly impersonal way, informing third parties on a phone call and in an email that it would not make a DIP loan and leaving the debtor scrambling for financing.  The Seventh Circuit’s verdict on this break-up by proxy, as Carrie might put it: Not cool!
In Arlington LF, LLC v. Arlington Hospitality, Inc., Case No. 09-3560, 2011 WL 727981 (7th Cir. Mar. 3, 2011), the Seventh Circuit Court of Appeals recently held that DIP Lender Arlington LF, LLC (LF), anticipatorily repudiated its DIP loan when it stated in a phone call and email to third parties that it no longer would be willing to fund the debtor’s DIP loan.  As a result of its breach, the DIP lender was not entitled to collect certain fees that already were due and payable by the debtor.
Prior to filing its chapter 11 bankruptcy case, the soon-to-be debtor Arlington negotiated a term sheet for a DIP loan with its lender pursuant to which the DIP lender agreed to lend $11 million split among a revolving loan, a “Term Loan A” and a “Term Loan B.”  In connection with the DIP loan, Arlington was required to pay certain fees, including a commitment fee and funding fee that, pursuant to the interim order approving the loan, were payable “immediately.”  The interim order, however, also contained a notice provision that required the DIP Lender, LF, to give the borrower notice of any default along with three business days to cure the default.  As a result of the notice provision, the borrower technically could not be considered in breach of the interim order until it had been given notice and an opportunity to cure.
Shortly after the bankruptcy court entered the interim order, Arlington drew over $3.5 million of the revolver and used it to pay its prepetition lender.  Arlington, however, did not pay the commitment fee and funding fee that were due “immediately” under the terms of the interim order, and LF did not ask Arlington for the fees.  Over the next few weeks, the relationship between Arlington and LF hit the rocks.  Though the two had been negotiating a potential asset purchase by LF, the negotiations went nowhere, and LF began to have doubts about the lending relationship.  In fact, the court noted in a footnote that LF had only agreed to be Arlington’s postpetition lender because it wanted to bid for Arlington’s assets in bankruptcy.  Once LF fell out of love with Arlington’s assets, it no longer wanted to continue as its DIP lender either.  As the bankruptcy court observed, “LF had had enough of Arlington.  It wanted out.”
LF’s doubts eventually were communicated over the phone to Arlington’s investment banker by LF’s general counsel where he stated that LF was not willing “to fund any more money under the DIP.”  Arlington’s investment banker, in turn relayed this information to Arlington.  Nearly one week after the phone conversation, LF again stated that it did not intend to make any further DIP loans to Arlington, but this time the statement was communicated by email to counsel for Arlington’s creditors’ committee.  LF’s counsel wrote unequivocally, “We are not willing to proceed further with the DIP loan; in other words, we will make no further loans to the Debtors….We think the Debtor should find a new DIP Lender to pay out our loan and fund the options that expire at the end of this month.”
It was only after LF sent the email to counsel for the creditors’ committee that it invoiced Arlington for the unpaid funding fee and commitment fee.  Arlington did not pay the fees, and LF then sent Arlington a notice of default providing for the three-day window to cure, as required in the interim order.
Shortly thereafter, Arlington sold its assets to a third party and used the proceeds of the sale to repay LF the principal owed on the revolver.  But Arlington did not pay the fees at issue, contending that LF had “double-crossed” it and breached the DIP loan, when it refused to make any further loans to Arlington.  Not surprisingly, LF fought back, filing a motion with the bankruptcy court for payment of the fees plus default interest.
In what can only be described as the bankruptcy- and district court procedural equivalent of the dating lives of Carrie, Miranda, Charlotte and Samantha, LF’s motion was ruled on by the bankruptcy court (in Arlington’s favor), appealed to the district court, remanded to the bankruptcy court, ruled on (again) by the bankruptcy court (this time in LF’s favor), appealed back to the district court (by both parties – as LF believed it should have been awarded more fees than it received), remanded again to the bankruptcy court (with instructions to enter a judgment in favor of Arlington) and, ultimately, appealed to the Seventh Circuit.
Notwithstanding the convoluted procedural factual and procedural history, the issue before the Seventh Circuit was relatively simple:  who breached first?  If LF breached first (by committing an anticipatory breach through the statements it made on the phone and by email), then it would not be entitled to collect the fees at issue.  By contrast, if Arlington breached first (when it didn’t pay the fees that were “immediately” due under the interim order), then LF was entitled to collect the fees and default interest sought.  The Seventh Circuit found that although Arlington failed to pay the “immediately” due and payable fees under the interim order, by the time LF invoked the notice procedures required by the interim order, LF had already breached the loan agreement.
LF argued that its statements about future loans simply meant that it did not want to make additional loans in the future – not that it would not lend under the DIP loan at issue.  But the court did not find this position credible.  LF also argued that the statements at issue (made through a phone call and an email) were made to third parties – not to the debtor directly.  But the court found that the debtor’s investment banker was the debtor’s agent and as such, a statement made to it qualified as a statement made to the debtor as its principal.  The court also noted that LF “had to know that comments made to the creditor committee would make their way to Arlington.”  In any event, the court reasoned that LF’s repudiation took place when it advised Arlington’s investment banker by phone that it no longer wished to fund the DIP loan, and the subsequent email to counsel for the creditors’ committee corroborated LF’s true intentions.  Finding, additionally, that LF had not retracted its repudiation of the DIP loan, the Seventh Circuit concluded that, once LF breached the DIP loan, Arlington was free from its obligations to pay the unpaid commitment fee and funding fee.  Much like Berger was forced to endure Carrie’s “bashing” after the infamous Post-It Note break-up (because as uncouth as it was, the break-up was, in fact, “legally binding”), so too was the DIP Lender forced to pay the price for its repudiation of the DIP loan.  Essentially, the Seventh Circuit called the DIP Lender out on its “break-up” style.
Although hindsight is 20/20, there are a number of actions the DIP lender could have taken to avoid the predicament in which it ultimately found itself.  For starters, LF sat on its rights.  The interim order made clear that the fees at issue were immediately due; nothing prevented LF from sending Arlington a notice of non-payment with the allotted cure window as soon as the fees were not paid.  However, even if the delay was an oversight, once LF realized that it was no longer willing to make additional loans under the DIP, before communicating its intentions to various constituencies in the chapter 11 case, it should have requested the unpaid fees from the debtor.  As both Arlington and Sex and the City show, communication is key, and communicating in the right way may just help avoid a lot of heartache in the long run.