When lenders and borrowers want to modify the terms of an existing loan agreement, and the modifications are extensive and will affect many provisions of the agreement, the lender’s lawyer will often choose to draft an “amended and restated agreement” in order to document those modifications. A single amended and restated agreement will often be easier to read than would be the original agreement and a separate amendment (or a series of separate amendments). When they do so for a secured financing, the parties almost always intend that the collateral that secured the original loan agreement continue to secure the obligations under the amended and restated credit agreement;, as a result of a recent decision by the U.S. Court of Appeals for the Sixth Circuit, it is important that the document clearly states that it is not intended as a novation of the obligations under the original loan agreement.
Recently, in Bash v. Textron Financial Corporation (In re Fair Finance Company), 834 F.3d 651 (6th Cir. 2016), the U.S. Court of Appeals for the Sixth Circuit reversed a determination of the District Court for the Northern District of Ohio that an amended and restated loan agreement did not constitute a novation of the original loan agreement. In so doing, the court held, in largely reversing the dismissal of an adversary proceeding arising out of a Chapter 7 bankruptcy case, that the amended and restated loan agreement may actually have constituted (or at least it is ambiguous as to whether it constituted) a novation of the original loan agreement. If the amended and restated loan agreement did in fact constitute a novation, the security interests granted pursuant to the original loan agreement would have terminated at the time that the parties entered into the amended and restated loan agreement. The circuit court, after reversing the district court’s determination, remanded the question to the lower court for further proceedings.
The district court had rejected the novation argument, but the Sixth Circuit reversed, finding that the following provisions of the amended and restated loan agreement created a question of fact as to whether it was the parties’ intent to wholly replace and extinguish (i.e. novate) the original loan agreement and the security interest granted thereunder:
- The statement that the restated loan agreement was for “valuable consideration, the receipt and sufficiency of which are hereby acknowledged”;
- The language that the restated loan agreement “constitutes the entire agreement of Borrowers and Lender relative to the subject matter” thereof and would “supersede any and all prior oral or written agreements relating to the subject matter”; and
- The re-grant of the security interest under the restated loan agreement.
It is cause for concern that all of the provisions the Sixth Circuit found were evidence of a novation in In re Fair Finance Company are regularly found in amended and restated loan documents throughout the broader loan market.
Significantly, the Sixth Circuit distinguished this case from In re TOUSA, Inc., where a district court ruled that the execution of an amended and restated agreement did not constitute a novation. The amended and restated agreement in TOUSA contained an explicit statement that the parties intended that the security interest and liens granted in the original security agreement would continue in full force and effect. The district court in TOUSA explained that notwithstanding the general language in the amended and restated agreement that all prior agreements were being restated in their entirety, the specific terms the parties agreed to must be given effect.
While one may question the sufficiency of the evidence that the Court relied on in finding that the parties may have intended to effect a novation, the lesson that a lawyer drafting an amended and restated financing agreement should draw from this decision is the importance of clearly and expressly stating the parties’ intent that the amended and restated agreement not constitute a novation. When drafting an amended and restated financing agreement, a lawyer should include an express statement that the agreement is not intended to constitute a novation or a termination of the obligations under the original agreement, and in the context of a secured financing, that the security interests created pursuant to the original agreement are intended to continue and to secure the obligations under the amended and restated agreement.