Property Deposited in Escrow Prior to Bankruptcy Is Not a Part of the Debtor's Bankruptcy Estate
December 22, 2004
Michael Weissman - Chicago
In In re NTA, LLC v. Concourse Holding Company, LLC, 380 F.3d 523 (1st Cir. 2004) the issue was whether LLC membership interests that had been placed in escrow prior to bankruptcy were part of the bankrupt’s estate. The First Circuit Court of Appeals said they weren’t.
NTA and NTA II (collectively NTA) owned 100 percent of the membership interests in Concourse Communications (Concourse) which entitled NTA to exercise total control over Concourse. Concourse was worth more than $20 million.
In August 1999, Concourse borrowed $14 million for working capital. Three years later Concourse Holding Company (Holding) bought the loan from the original lender. At the same time, Holding entered into an agreement with Concourse and NTA wherein Holding would provide $4.1 million in additional funding to Concourse and Holding would have an option to purchase NTA’s membership interests in Concourse. In a separate agreement, executed at the same time, NTA guaranteed Holding’s loans to Concourse and gave the membership interests that it owned in Concourse as security. Under the latter agreement, if Concourse defaulted on its debt to Holding, NTA would transfer its member interests in Concourse to Holding.
In December 2002, Holding declared Concourse in default because of a failure to make a scheduled interest payment. As a preemptive matter, Concourse filed a lawsuit in Illinois seeking a declaration that it was not in default. In March 2003, the parties suspended the litigation and entered into a Standstill Agreement and Escrow Agreement.
The Standstill Agreement gave Concourse two options: (1) pay off its loan to Holding or (2) obtain a letter of intent for takeout financing from another lender by April 30, 2003, with a closing no later than June 30, 2003. The Standstill Agreement called for both parties to submit general releases that would be exchanged if Concourse satisfied its debt to Holding, and for NTA and Concourse to submit a confession of judgment for $13 million that would be delivered to Holding if Concourse did not pay off the loan.
But there was more. The Standstill Agreement also required NTA to deposit in escrow an assignment of all its right, title and interest in Concourse to Holding. The escrow agent was to release the assignment to Holding if NTA did not supply a letter of intent by April 30, 2003 or close by June 30, 2003. More specifically the escrow agent was to release NTA’s assignment at the earlier of: two business days after receipt of a copy of a written notice from Holding to Concourse, or July 31, 2003.
On May 16, 2003, Holding sent a letter to the escrow agent giving notice that Concourse had not provided a letter of intent from another lender by April 30, 2003. NTA’s response was to file a petition for relief under Chapter XI of the Bankruptcy Code. NTA claimed that the membership interests in Concourse were part of NTA’s bankruptcy estate and that the estate had a right of redemption. The Court did not see it that way.
The Court began by pointing out that the bankruptcy estate had no greater right to the membership than NTA did immediately prior to the bankruptcy filing. It said that when the Standstill and Escrow Agreements were executed, they superseded all previous agreements between the parties. The Standstill Agreement gave Holding the power to exercise substantial control over Concourse’s business and NTA’s membership interests. The Standstill Agreement left NTA with only a limited right to reclaim the membership interests by meeting the requirements for takeout financing.
The Court’s opinion then noted that the bankruptcy estate could not exercise the reclamation rights NTA once had because a letter of intent had not been provided by April 30, 2003. In conclusion, the Court said, “the bankruptcy estate has no remaining property interest in the Membership Interests.”
What’s the point? A creditor desiring to insulate itself
against the statutory rights of a trustee in bankruptcy or a Chapter 11
debtor-in-possession to property of the bankrupt can generally do so by
creating an escrow prior to bankruptcy and directing the debtor to deposit
the property with the escrow agent. If the debtor’s redemption rights expire
prior to the bankruptcy filing, the creditor can claim the property.
For more information e-mail Michael L. Weissman at
michael.weissman@hklaw.com or call toll free, 1-888-688-8500.