As a result of the financial crisis, many attorneys find themselves more frequently advising clients regarding foreclosure, bankruptcy, liens and out-of-court restructuring alternatives. Often a first lien holder client will assume that they have a first lien on all assets and, therefore, they will recover prior to all other parties. As we have seen, particularly through the past few years, this is not always the case. Preparing for this possibility has become increasingly more critical for attorneys and their clients as the dynamic between first and second lienholders changes and as the estate and unsecured creditors’ committees aggressively seek value. The analysis is always document- and party-specific, but there are some basic parameters in which attorneys can educate clients so they are aware of the outcome permutations.
The Basics
Once a debtor is showing signs of distress, it is crucial that lien searches and other confirmatory diligence regarding perfection of security interests in the collateral is performed as early as possible. It is easy enough to run lien searches, but it is just as easy to overlook control agreements being in place over deposit and securities accounts, confirming possessory collateral such as stock certificates, powers and pledged promissory notes, reviewing real estate records for mortgages and confirming that assets such as vehicles or aircraft are properly perfected under the proper regulatory regime. Often during negotiations of a credit facility, lenders will agree not to take certain perfection actions due to cost or burdensome obligations; however, when a company starts to fail, these arrangements should be revisited and remedied as quickly as possible so they don’t run into preference challenges (discussed below). Moving forward with enforcement without a proper understanding of the collateral package and what liens may be subject to avoidance, could lead to disastrous results that may have been avoided.
