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Lender Beware: David Kupetz Authors Article in the Recorder
In Grede v. Bank of New York Mellon Corp. (In re Sentinel Management Group, Inc.), the U.S. Court of Appeals for the Seventh Circuit held that a lender who should have discovered that its borrower lacked authority to pledge assets is not protected by a good faith defense to a fraudulent transfer action. Without this defense, the lender lost its security. Left with an unsecured claim, the court also addressed the question of whether the priority of the lender’s claim should be further reduced through equitable subordination.
In the article “Lender Beware: Ignore Suspicious Activity at Your Own Peril,” published in the Recorder, David Kupetz discusses the case of Sentinel, a cash management firm that traded on its own account with money borrowed from Bank of New York Mellon Corp. and Bank of New York (affiliated entities referred to jointly as BNYM). In 2007, Sentinel commenced a chapter 11 bankruptcy case, and BNYM attempted to assert a secured claim for $312 million so it could liquidate the collateral Sentinel had pledged to secure the loan. The chapter 11 trustee rejected this claim, asserting that transfers of customers’ assets to accounts that Sentinel used to collateralize BNYM’s loans constituted avoidable fraudulent transfers.
BNYM would have had a defense to this action if it had received the pledge of Sentinel’s assets in good faith. The court found, however, the defense was not available to BNYM because it was in possession of information that should have resulted in the bank becoming suspicious of Sentinel and investigating further. This negligence, however, was not adequate to cause BNYM’s claim to be equitably subordinated.