• The Effect of the Purchase of Senior Debt on Subordinate Creditors
  • January 31, 2013
  • Law Firm: Lerch Early Brewer Chartered - Bethesda Office
  • A Florida appellate court recently held that senior debt was not satisfied when guarantors of both the senior and junior debt formed a limited liability company that purchased the senior debt. Additionally, the court found that while the junior mortgagee could obtain a judgment against the guarantors on its debt—despite the fact that there was a subordination and standstill agreement governing the transaction—until the senior debt was paid in full, the junior mortgagee would have to give any payment it received to the senior mortgagee.

    Paragon Mortgage Holdings, LLC made one or more loans to Fuel Investment and Development II, LLC, the principal amount of which was at least $1.48 million. This debt was secured by a mortgage and personal guaranties from four of Fuel’s investors. Later, when Fuel needed additional capital, it borrowed $4.8 million from Broadway Bank, predecessor to MB Financial Bank, N.A. Broadway Bank’s loan was secured by a mortgage and personal guaranties from the same four individuals. In connection with this new loan, Paragon, Broadway Bank and Fuel entered into a Subordination and Standstill Agreement (“Standstill Agreement”). The effect of the Standstill Agreement was that Broadway Bank became the senior lender and Paragon the junior lender. Paragon's loan was curtailed by $1 million to reduce Fuel’s obligation to it and its exposure.

    Two years later, when the loan from Broadway Bank matured, Fuel failed to pay the debt. Broadway Bank engaged in discussions with the guarantors, after which two of the guarantors decided to form a new entity, Downtown St. Pete Properties, LLC, to purchase the senior debt from Broadway Bank. The purchase was funded by a $1 million payment to Broadway Bank and a new $3.8 million loan from Broadway Bank to Downtown Properties. This loan “was secured by a security interest in the loan documents for the senior debt with Broadway Bank, including the mortgage and guaranties.” The security interest permitted Broadway Bank to recoup its interest in the mortgage and guaranties if it believed its collateral was in jeopardy.

    Paragon, concerned that it would be unable to collect on its junior debt, filed actions to enforce its guaranties; the actions were consolidated into a single lawsuit. Broadway Bank and Downtown Properties intervened in the lawsuit and filed an action against Paragon, asking the court to find that Paragon could not file suit against the guarantors until the senior debt was satisfied. Paragon argued that Broadway Bank’s loan to Fuel was satisfied by virtue of the sale of the loan to Downtown Properties.

    The appellate court upheld the trial court’s decision that the Standstill Agreement did not prohibit Paragon from bringing an action against the guarantors. If Paragon was successful in obtaining a judgment against the guarantors, any payments made on the judgment would have to be given to Downtown Properties or whoever held the senior debt at the time, as the appellate court noted that the Standstill Agreement clearly provided that the senior debt must be paid before the junior debt.

    The appellate court held that the trial court’s determination that “the transfer of the loan to Downtown Properties operated as a full satisfaction of the senior debt because the creation of Downtown Properties and this transaction ‘were intended to defeat the intent of the parties to the [Standstill Agreement]’” was erroneous and reversed the trial court’s decision on this issue. Among other things, the appellate court found that Paragon did not provide any facts or legal theories why the purchase by Downtown Properties of the senior debt operated as the equivalent of a payment on the senior debt. The court also noted that the Standstill Agreement did not prohibit the assignment or transfer of the Broadway Bank note and mortgage to another entity as the Standstill Agreement contained “an express provision regulating the assignment of the junior debt.”

    This case is cited as MB Financial Bank, N.A. v. Paragon Mortgage Holdings, LLC, 2012 WL 933598 (Fla. Dist. Ct. App. 3/21/2012).