This article discusses potential pitfalls lenders may encounter in the face of loan agreement language purporting to limit and/or restrict the lender’s right of assignment, and ways to address these issues. The focus of this article is New York law.
New York Law
The general rule in New York is that unless there is an express contractual restriction on assignment of a loan, then the lender has the right to assign. It is typical in loan documents (other than among multiple lenders in syndicated or tiered credits) that there is no limitation on lender assignment. In construction loans, particularly syndicated ones in which future advances are an important part of the business arrangement, however, it is not unusual for there to be limitations on assignments of the loans without borrower and/or co-lender consent. Although, in the run up to 2008, borrowers had the ability, due to competition among lenders, to negotiate more restrictive assignment language than they previously could have.
Some typical limitations on assignability are:
• Neither party may assign the agreement, or any right or interest hereunder, without the consent of the other party;
• Lender may not assign to any Person all or a portion of Lender’s rights and obligations under the agreement, and any purported assignment or participation in violation of the foregoing shall be void and of no force and effect; and
• The lender may at any time assign, transfer or novate any of its rights and/or obligations as long as it satisfies certain stated conditions.
The Importance of the Restatement (Second) of Contracts Section 322. In New York, “courts generally recognize and enforce a contract provision prohibiting its assignment” as well as the right to “contest nonassignability.”1 Nevertheless, “a stipulation against assignment may be waived or modified by a course of business dealings or by a formal written instrument.”2 Furthermore courts in New York will examine the intentions found in the contract or agreement “[w]here there is no public policy or statutory bar to the assignment of a particular contract.”3
Section 322 of the Restatement (Second) of Contracts provides for various remedies when a party violates an anti-assignment provision. Unless a different intention is provided in the contract, a term prohibiting assignment does not prevent assignment, but does allow for damages caused by the assignor’s breach.4 Section 322, however, does not make the assignment ineffective.5 The resistance to limitations on assignability stem from the public policy supporting alienability and the negative view of restrictions.
The restriction on assignability is viewed as creating a personal right in the party in whose favor it is given, to be asserted against the violator only. In order to void the assignment, the agreement must contain express language that the assignment will be void or invalid if assigned in violation of the agreement’s terms.6 Otherwise, the party in whose favor the contract creates the restriction only has a right to damages caused by the contractually prohibited assignment.7
Courts May Void an Assignment if the Contract or Agreement Contains Clear, Definite and Appropriate Language Declaring the Invalidity of Such Assignments. A party may seek to void an assignment or transfer when the terms of the agreement explicitly provide that such an assignment is void. In Stewardship Credit Arbitrage Fund v. Charles Zucker Culture Pearl, the assignees of commercial loans originated by a non-party, asserted a variety of causes of action against the appraisers of the loans for “fraud, negligent misrepresentation, professional negligence, breach of contract, and breach of General Business Law (GBL) §239-c.”8 In turn, the appraisers moved to dismiss the assignees’ causes of action. The appraisers provided appraisal services for loans made by the originator to non-party borrowers.9 The originator provided loans to the borrowers in December 2006 and December 2007 under the condition that they pledged as security “collateral with an aggregate appraised value” that met specific determinations.10 Subsequently, the originator “assigned its rights and interest in the Loans, the pledged collateral and all related documents to the [assignees], who are direct and/or indirect assignees of [the originator].”11
The appraisers argued that both the initial assignment to the assignees and the subsequent assignment were ineffective in part because the loan agreement required prior notice to the borrowers before assignment.12 In relevant part, the loan agreement stated that “[l]ender may, upon notice to Borrower, assign to any Person all or a portion of Lender’s rights and obligations under this Agreement…[a]ny attempted assignment or participation in violation of this Section 13(f) shall be void and of no force and effect.”13 The court noted that the first set of assignments, that were made without notice to the borrowers, could certainly have been deemed void because of the specific language of the loan agreement.14 Nevertheless, since the originator recognized its error and made a second set of assignments to the assignees that included the appropriate notice to the borrowers as enunciated by the loan agreement, the previous defects were cured.15
Permitted/Eligible Assignee Context. As in the previous circumstances, the form of relief a party may seek in the permitted/eligible assignee context depends on the language of the loan documents. When loan agreements expressly permit assignments to “‘any financial institution,’ without restricting assignments ‘expressly in any way,’ [they do] not prohibit an assignment to an entity that was not a financial institution.”16 Once again, only express limitations that state that the assignment is null and void make the assignment null and void.17 Elliot Associates v. Republic of Panama exemplifies that an assignment will not be prohibited in the permitted/eligible assignee context unless the loan document contains express limitations on assignability and language that the assignment is void or invalid when assigned improperly.
In Elliot Associates, the original lenders assigned the debt. Subsequently, after the original borrower failed to repay the debt, the assignee brought a breach of contract action. Among the defenses raised by the borrower, was that the assignee did not qualify as a financial institution under the loan agreement, which stated in relevant part, that “[e]ach Lender may at any time sell, assign, transfer…or otherwise dispose of…its Loans to other banks or financial institutions.”18 Nevertheless, the court held that it did not matter whether the assignee qualified as a financial institution because the loan agreement contained permissive assignment language and did not “expressly restrict assignments to banks and financial institutions.”19 Thus, in the permitted/eligible employee context, a party’s right to void an assignment is only available if stated explicitly in the express terms of the loan agreement.
Unless Another Type of Remedy Is Otherwise Specified in the Documents for Assignments in Violation of Anti-Assignment Provisions, Benefitted Parties May Seek Damages. Unless an anti-assignment provision contains language that the assignment is null and void, the only remedy for benefited parties is to seek damages.
In Lexington 360 Associates v. First Union Nat’l Bank of North Carolina, the mortgage borrower brought an action against the mortgage lender, based on the alleged breach of a modification and estoppel agreement.20 The relevant section of the modification and estoppel agreement provided that the mortgage lender had to “‘use its best efforts to notify the Borrower of any contemplated sale or assignment by the Lender.’”21 The mortgage borrower claimed that the mortgage lender failed to notify it of the proposed sale of the loan. Since the relevant agreement did not contain explicit language that voided the assignment, however, the mortgage borrower was only allowed to seek damages.22
Lexington 360 Associates also helps to illustrate that proving damages based on violation of an anti-assignment clause may be difficult. “Where a party has failed to come forward with evidence sufficient to demonstrate damages flowing from the breach alleged and relies, instead, on wholly speculative theories of damages, dismissal of the breach of contract claim is in order.”23 Unlike the lower court’s holding, the appellate court held that the modification and estoppel agreement did not require the mortgage lender to identify the purchaser—the mortgage borrower was given 60 days notice before the sale and thus could not demonstrate that it was damaged in any way.24
Special Situations. Empresas Cablevision v. JPMorgan Chase Bank, 680 F.Supp.2d 625 (S.D.N.Y. 2010), presents an interesting factual scenario that presents a fact-specific exception to the New York rule requiring clear, definite and appropriate language to declare an assignment invalid. There, the borrower moved for a preliminary injunction against the lenders from consummating a transaction in which the lenders would sell a 90 percent participation in the loan to a third party.25 According to the borrower, the transfer to the third party was to a bank that had the same ownership as the borrower’s main competitor.26
The borrower argued that the 90 percent participation was in fact an impermissible assignment of the loan without its consent, which was in violation of the loan documents.27 The controlling credit agreement contained restrictive covenants that limited the lender’s ability to assign its obligations and rights without the plaintiff’s written consent.28 The credit agreement also contained limitations on the lender’s ability to sell participations in the loan; however, participations did not require the borrower’s consent.29
Once the lender sold the 90 percent participation to the third party, it still did not inform the borrower of the participation. The participation agreement allowed the third party to “receive nearly unlimited information from [the borrower].”30 In addition, the participation agreement allowed the assignee to use the lender to disclose the borrower’s confidential information.31
The court rejected the bank’s attempt to disguise an assignment of the loan by structuring the arrangement as a participation.32 The court granted the preliminary injunction because “there is as a factual matter a strong likelihood of irreparable harm arising from [the assignee's] ability to seek and obtain [the borrower's] confidential business information under the Credit Agreement and then use it to [the borrower's] detriment.”33 At first read, Empresas appears to contradict the New York requirement of clear, definite, and appropriate language to void an assignment. Upon further analysis, however, it is clear that the court granted the borrower’s preliminary injunction because the transaction created too great a risk of placing the borrower’s confidential information in the possession of a competitor and not because the participation was actually a thinly veiled attempt to circumvent the anti-assignment provision.
Voiding an Assignment. Apthorp Associates v. Anglo Irish Bank, 652492-2011 (Sup. Ct. New York Co. Nov. 28, 2011), presents a recent example of the difficulties involved in attempting to void an assignment when the loan documents do not explicitly allow for such action. Apthorp Associates attempted to enjoin its lender, Anglo Irish Bank Corporation Limited, from selling its entire interest in its existing loan in violation of a provision in the building loan agreement requiring Anglo to maintain at least 51 percent interest in the loan.
The existing loan “consisted of a loan of up to a maximum principal of $385,000,000, and was made in connection with the acquisition, development and conversion into condominiums…of the Apthorp Building…a historic landmarked residential building in Manhattan.”34 The terms of the agreement did not state that an assignment in violation of the assignment restriction was void.
Apthorp eventually voluntarily dismissed the action with prejudice on Nov. 28, 2011. The significance of this matter, however, is that Apthorp brought it in the first instance and sought an injunction despite the fact that contract terms did not provide that the assignment would be void. Thus, even if the assignor ultimately prevails and its risk is limited to damages (which may be difficult to prove), there is still litigation cost and uncertainty associated with making and/or receiving an assignment in the face of prohibitive language.
Given the landscape of the treatment of non-assignment clauses in loan documents, at the outset of drafting assignment provisions, parties must be aware of whether they want to include specific language that voids a violative assignment or whether they are comfortable enough not to have the “void and no force and effect” statement. This will depend in large part on each party’s awareness of the issue and its negotiating strength. In addition, a prospective assignor, who faces claims for damages, may decide to keep reserve cash proceeds to cover potential damages or decide to accept an adjustment in the price it charges or require an indemnification from an assignee.
Andrew H. Levy is senior counsel at DLA Piper. Joshua S. Sohn is a partner at the firm and the head of its real estate litigation practice group. Jermaine L. McPherson is a litigation associate with the firm. The authors are based in the New York office.
1. University Mews Assocs. v. Jeanmarie, 122 Misc.2d 434, 439, 471 N.Y.S.2d 457, 461 (Sup. Ct. New York Cty. 1983).
2. Id. at 439-440.
3. Id. at 440.
4. Restatement (Second) of Contracts §322 (1981).
6. Jeanmarie, 122 Misc.2d at 440.
8. 31 Misc.3d 1223(A), at 1, 929 N.Y.S.2d 203 (Table), at 1 (Sup. Ct. New York Cty. 2011).
12. Id. at 3.
14. See id.
16. Elliot Assocs. v. Republic of Panama, 975 F. Supp. 332, 338 (S.D.N.Y. 1997).
17. See id. (citation omitted).
18. Id. at 338.
19. Id. The court in Pravin Banker Assocs. v. Banco Popular del Peru, also came to the same conclusion. See 109 F.3d 850, 856 (2d Cir. 1997). The assignee of the creditor brought an action against the borrower in order to enforce the underlying debt. The borrower argued that the assignment from the creditor to the assignee was invalid. The agreement at issue allowed the creditor to “‘assign all or any part of our interest in this letter agreement to any financial institution.’” Id. at 856. According to the U.S. Court of Appeals for the Second Circuit, “[t]his language fails to restrict the assignment expressly in any way. While it explicitly permits assignments to financial institutions, it does not limit assignments only to these entities.” Id. As such, the Second Circuit ruled that the assignment from the creditor to the assignee was valid.
20. 234 A.D.2d 187, 188, 651 N.Y.S.2d 490, 491 (1st Dept. 1996).
21. Id. at 191.
22. Id. at 189.
23. Id. at 190.
24. Id. at 192.
25. 680 F. Supp. 2d 625, 626 (S.D.N.Y. 2010).
28. Id. at 627.
31. Id. at 632.
32. See id. at 633.