Court Grants Prepetition Lenders’ Preliminary Injunction Against SPV Lender Aequum; Escrows Cardone Liquidation Proceeds

Judge Christopher Lopez granted the preliminary injunction requested by First Brands ABL agent Bank of America, term loan agent Wilmington Savings Fund Society and side-car loan agent GLAS USA LLC in their lien-priority suit against off-balance-sheet lender Aequum Capital. Judge Lopez separately took Aequum’s motion to dismiss the adversary complaint under advisement. The hearing began on June 11 but was continued to allow additional discovery.

Judge Lopez found an injunction escrowing proceeds from Aequum’s ongoing liquidation of disputed collateral is necessary to preserve any remedy in the underlying litigation. The judge noted that Aequum is contractually obligated to remit the funds to its investors, which could render the funds untraceable and cause irreparable harm to the prepetition lenders’ ability to maintain their security interests.

The judge extended the parties’ agreed status quo order to June 19 from June 17 and directed the parties to submit a proposed order reflecting his ruling within 24 hours. The judge noted, however, that he would not require a bond and that the injunction is temporary until the merits of the dispute are resolved.

The dispute centers on inventory owned by debtor Cardone Industries over which both the senior lenders and Aequum assert liens. Aequum liquidated the Cardone inventory under an agreed stay-relief order for approximately $20 million, and the lenders seek to enjoin Aequum from distributing the sale proceeds until the court adjudicates the parties’ lien priority. Judge Lopez noted Aequum may elect to cease liquidating the collateral, but any cost sharing is already captured by the fact that the stay order provides for Aequum to cover its liquidation costs.

Judge Lopez rejected Aequum’s defense that the stay-relief order bars the injunction, noting the order “anticipated” and “preserved” the lien-priority dispute, including by providing that all inventory liens would attach to the proceeds. The judge also concluded that the injunction would not violate the U.S. Supreme Court’s 1999 Grupo Mexicano decision, which prohibits the prejudgment attachment of funds in the absence of claims sounding in equity. Judge Lopez found the lenders are exercising a claim to particular assets sounding in equity, not a legal-based money judgment claim.

Although the judge emphasized that he is not resolving ultimate ownership of the inventory, Judge Lopez surveyed the various automatic release provisions under the prepetition credit agreements invoked by Aequum to assert the priority of its liens. The judge found the prepetition lenders made a prima facie case that none of the lien release conditions were satisfied.

Aequum’s lien stems from $43.8 million in off-balance-sheet financing it provided to debtor Broad Street Financial. According to Aequum, First Brands Group, or FBG, sold the Cardone inventory to Broad Street, which then pledged the inventory to Aequum as collateral. Aequum maintains the inventory sales were permitted under the governing credit agreements, which automatically released the lenders’ liens. The lenders, however, contend that FBG never owned Cardone’s inventory and had no power to transfer it, so the inventory sales to Broad Street were a “fiction” and Aequum’s liens never attached.

Judge Lopez noted that substantially all the loan proceeds were transferred out to nondebtor Bowery Finance, an entity controlled by First Brands founder Patrick James. The judge observed that the fact that no funds reached Cardone undercut the argument that the prepetition lenders’ liens were released in connection with a transaction for fair-market value. The judge also said the current record does not reflect any board resolutions, ledger entries or other documentation of inventory transfers to Broad Street from Cardone or the broader FBG enterprise. The fact that the companies shared common management does not “make a transfer happen” as a matter of law, given the presumption of corporate separateness, he added.

During oral argument, Beau Cox of Norton Rose Fulbright, counsel to ABL agent Bank of America, reiterated that the inventory sale was a “complete fiction,” pointing out the inventory never left Cardone’s books and Broad Street did not pay FBG for the inventory but instead sent the money to a non-FBG entity used by former executives Patrick and Edward James in their alleged fraud. Cox emphasized that Aequum did nothing wrong, but it lent money into a “schema” run by people that used the funds for other purposes.

According to Cox, Aequum assumes there was a valid conveyance and focuses on the lien release issue, but the court does not need to reach this second question if it finds there was no transfer. The focus, Cox says, should be on the purchase agreement and whether “those transactions actually happened.”

Aequum’s counsel, William Dorsey of Blank Rome, countered that there was an actual transfer of the inventory because FBG had authority to act as an agent for other FBG entities, the inventory was listed on Broad Street’s general ledger and the purchase price eventually went to FBG-related entities. Dorsey also stressed there was nothing nefarious with Aequum’s loan and there was no fraud or double-pledging involved because the inventory was not on the borrowing base certificates of any other lenders.

Cox also argued that if the inventory was transferred to Broad Street “in defiance of the facts,” there are issues about the terms of the credit agreements that have not been “fully fleshed out.” Dorsey disagreed and focused his argument on the release of the lenders’ liens under the credit agreements, arguing they contain an automatic release of liens if all the triggers were satisfied, which they were.

The court also heard testimony from Eric Weisheit, Aequum’s corporate representative, and forensic accountant Nathan Hein of FTI Consulting, an expert witness for the senior lenders. Hein’s potential conflict of interest prompted the continuation of the hearing from June 11.

Hein testified about the books and records of Broad Street, Cardone and First Brands and where the disputed inventory was recorded. He said he was not opining on whether the lenders’ liens under the credit agreement were released.

Weisheit described the actions taken by Aequum following the debtors’ bankruptcy filing to protect the inventory and the impact of a preliminary injunction on its warehouse loan with Wells Fargo. He also testified that in initial discussions with the senior lenders, they did not express any concerns with Aequum’s liquidation of the inventory, saying there were no overlapping liens.

The parties again sparred over the balance of harms in granting a preliminary injunction. Cox argued that without a preliminary injunction, the inventory sale proceeds would be “gone forever.” Dorsey countered that a preliminary injunction would trigger a default under the Wells Fargo warehouse loan facility and Aequum would need a bond.

Judge Lopez also denied the motion of the chapter 7 trustee for certain special purpose vehicle debtors to intervene in the proceedings in an order earlier today.