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Does a lender’s demand for the appointment of a Chief Restructuring Officer (or CRO) by its borrower constitute “undue duress” for purposes of invalidating a personal guarantee? That question was before the Fifth Circuit in Lockwood International, Inc. v. Wells Fargo, National Association et al. v. Michael F. Lockwood, Case 20-40324 (5th Cir. 2021). The personal guarantee at issue was granted by the sole owner of certain entities (the “Borrowers”) that were parties to a $90 million secured revolving loan agreement with certain lenders (the “Lenders”). Not long after entering into the agreement, the Borrowers found themselves in default under a number of financial covenants. In order to address the defaults, the parties entered into an amendment which, among other things, reduced the commitment to $72 million. In connection with amendment, the Borrowers’ owner (the “Guarantor”) executed a guarantee of all obligations of the Borrowers in favor of the Lenders (the “Guarantee”). As common practice for a borrower in distress, the Borrowers also retained a CRO at the recommendation, or insistence, of the Lenders.

Following the amendment, the Borrowers were again in default. At this time, the Lenders demanded that the CRO be granted full authority over the businesses. If not, the Lenders purportedly threatened to accelerate the loans and exercise their remedies against the collateral as permitted under the loan agreement. The Guarantor and the Borrowers relented and granted the CRO control of the company’s operations. Notwithstanding the escalation of the CRO’s role, defaults persisted and the parties ultimately executed a number of forbearance agreements. As typical of such agreements, the Guarantor acknowledged the validly of his obligations and that he had no defense to enforcement, effectively ratifying the Guarantee. The Guarantor further granted a full release and waiver of claims in favor of the Lenders. Following expiration of the second forbearance, the Lenders accelerated the loans.

After much litigation between the parties and a bankruptcy filing by the Borrowers, a final claim remained – the Lenders’ breach of guarantee claim against the Guarantor. On that point, the District Court granted the Lenders’ motion for summary judgment. It considered, and rejected, the Guarantor’s affirmative defenses — fraudulent inducement, duress, unclean hands, and equitable estoppel – and ordered the Guarantor to pay more than $58 million. The Guarantor appealed to the Fifth Circuit with a focus on his claims of duress, particularly as it related to the threats of acceleration to compel the appointment of a CRO with full authority.

The Fifth Circuit explained that, in order to prevail, the Guarantor must show that the Guarantee, and each forbearance agreement, was voidable and that “the lenders obtained his signature by fraudulent means or by taking advantage of his dire financial straits.” Id. at p. 5. The Guarantor argued that “economic duress” compelled him to enter into each of the agreements. With respect to the first forbearance agreement, he argued that the Lenders threatened acceleration which would prove ruinous for the Borrowers. The Court explained, “[n]o doubt [the Guarantor] feared the looming prospect of the banks’ demanding the tens of millions of dollars that he and his companies owed. The banks used that leverage to seek something they wanted: a transfer of authority to the CRO. But using leverage is what negotiation is all about. And difficult economic circumstances do not alone give rise to duress.” Id. at p. 7. (citation omitted). Under applicable law, duress requires: “(1) a threat to do something a party has no legal right to do, (2) an illegal exaction or some fraud or deception, and (3) an imminent restraint that destroys the victim’s free agency and leaves him without a present means of protection.” Id. (citation omitted).

The decision should provide further comfort to lenders that the exercise of their leverage to extract value in face of defaults (in this case, the appointment of a CRO with full authority), should not raise to the level of undue duress needed to void otherwise valid and enforceable obligations.