Seventh Circuit Denies Fees to Breaching DIP Lender

The Seventh Circuit affirmed a district court’s ruling that a debtor-in-possession (DIP) lender had breached its financing agreement, barring its claim for commitment and funding fees from the DIP. [1] Although the DIP itself had also breached the agreement, that breach was not, in the court’s view, effective until after the lender had already “walked away.” [2] Since the lender first breached the agreement, it could not now recover the fees from the DIP.

Facts
Arlington Hospitality Inc. and its subsidiaries (collectively, “Arlington”) operated a hotel chain. [3] On the eve of its chapter 11 filing in August 2005, Arlington negotiated a term sheet for a DIP loan to be provided by Arlington LF LLC (the lender). [4] The term sheet provided for a DIP credit facility of $11 million, including a revolver portion and a term loan portion. [5] Its terms included payment of, among other things, a commitment fee and funding fee (collectively, the “fees”) to the lender. [6]
           
Shortly thereafter, the bankruptcy court entered an interim order approving and largely adopting the Term Sheet. [7] Critically, though, the interim order (but not the term sheet) contained a notice provision requiring the lender to give Arlington notice of any default and three business days to cure. [8] According to the court, the notice provision “created a condition precedent which must have occurred before [the lender] stopped dealing with [Arlington].” [9] Thus, “Arlington could not, conceptually, be in breach of the Interim Order until after it had been given notice and opportunity to cure it.” [10] Like the term sheet, the interim order also provided that the fees were “payable immediately.” [11]
           
Arlington promptly drew $3.53 million under the revolver, but paid no fees to the lender. [12] At the time, the lender never sought payment of its fees, nor did it give Arlington notice of default pursuant to the notice provision. [13]
           
The relationship between Arlington and the lender later soured. [14] The lender became increasingly uncomfortable with both its contemplated asset purchase and the loan, ultimately making these concerns explicit. [15] On Sept. 29, 2005, the lender told Arlington’s investment banker that it “was unwilling to ‘fund any more money under the DIP [loan].’” [16] On Oct. 4, the lender’s counsel emailed the creditors’ committee, stating that “[w]e 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.” [17]
           
Arlington ultimately found another buyer willing to buy the assets. Following the closing of that sale, Arlington repaid the lender the $3.5 million that it borrowed, with interest, but did not pay the fees. [18] The lender moved in the bankruptcy court to recover the fees. [19]

Court’s Decision and Analysis
The Seventh Circuit found that the lender, by its Sept. 29 statement to the DIP’s agent and Oct. 4 email to the committee, had committed an “anticipatory breach” or “repudiation” of the lending agreement. [20] According to the court, the lender showed a clear intent not to perform any more of its lending obligations. [21] Despite the lender’s argument that it was merely uninterested in making additional lending agreements, the court found that interpretation to be incredible. [22]
           
Once the lender had repudiated the agreement, the court reasoned, Arlington was “free” of its obligations: “[a]t the moment [the lender] repudiated, Arlington was entitled to treat the agreement as having ended and was no longer under any obligation to perform… [the lender] clearly stated it would lend no more money and thus breached, and Arlington was entitled to treat it as such and walk away.” [23] Accordingly, the lender was “quite clearly” not entitled the fees.

Conclusion
The lender was apparently inexperienced, unaware of the landmines present in DIP lending. Thinking aloud in front of the creditors’ committee and the DIP’s investment banker doomed its legal position. A lender should call a default with notice when it arises. It can retreat later with a reservation of rights, but Lender’s failing to call the earlier default and preserve its rights was fatal here.