COVID-19 Litigation Concerns for Lenders

BY&S Quarterly News & Updates

While long-term care facilities have generally been kept afloat over the last year through various stimulus packages and/or lenders willing to work through defaults given the pandemic, some may face financial trouble in the near future due to litigation arising from COVID-related deaths. 

Long-term care fatalities account for a staggering 40% of all COVID-related deaths. As the death tolls continue to climb, cases are being filed across the country alleging negligence for failure to protect residents from the virus and failure to provide adequate care for residents after they contract the virus. 

In an attempt to prevent this type of litigation, over 25 states created immunity from civil liability claims arising from COVID for long-term care facilities and other health care providers. Three states have also imposed immunity from criminal liability. The level of protection varies by state, but for the most part, actions for ordinary negligence are barred.

Most immunity provisions do not bar claims for gross negligence or willful misconduct. These claims are difficult to prove. They require proof of deliberate or reckless disregard for a resident’s health and safety, which is a higher standard than simply showing the facility did not follow the common standard of care.

Despite this higher burden of proof, lawsuits are being filed against long-term care facilities. For many facilities, COVID spread like wildfire, resulting in a number of residents contracting the virus and dying as a result. These facilities are at a greater risk of being found liable because similar acts of negligence and misconduct across cases could rise to gross negligence or willful misconduct. While there will be a number of liability issues that courts will need to sort through in these cases, if successful, the financial liabilities for facilities will be significant.

As always, lenders need to be mindful of litigation involving their borrowers. Just one large judgment can be enough to put a long-term care facility in dire financial straits. For facilities with a significant number of fatalities, one judgment will likely be a precursor to additional judgments and likely significant financial repercussions. 

On the front end of transactions, lenders should double check borrower disclosures with a litigation search and ensure covenants for immediate reporting of such claims are set forth in the documentation. If litigation exists prior to making the loan, close review should be given to the claims and potential implications on the particular business. 

For existing loans, lenders should be proactive in tracking litigation claims against their borrowers. If you don’t have a litigation tracking platform internally, outside counsel can easily assist with the tracking. Once litigation is initiated, a close review of the claims should be performed to determine financial implications and proper safeguards in anticipation thereof.

Lenders should confirm their loan documents provide that their security interest is in place without preconditions or qualifications. While a lender’s properly perfected security interest typically has priority over a judgment creditor that receives its judgment post-perfection by the secured lender, there is some caselaw holding that a secured creditor can waive its right of priority in collateral if it does not act against its collateral post-default.  The waiver hinges on the language in the applicable security agreement. If the security agreement provides that the secured party’s rights arise after an event of default and the secured creditor does not exercise its rights after a default, the secured creditor cannot prevent a judgment creditor from recovering from the collateral. Several cases out of the Northern District of Illinois found that lenders had no present rights in their collateral because they had not taken any steps to exercise their rights as secured creditors. The judgment lien creditor, who ordinarily would have been subordinate in priority to the prior-filed secured creditor, had superior rights in the collateral. See, One CW, LLC v. Cartridge World North America, LLC, 661 F. Supp.2d 931, 935 (N.D. Ill. 2009). Conversely, if the security agreement contains no preconditions or qualifications regarding the security interest being limited in the absence of an event of default, the secured creditor may be able to overcome a waiver argument. See, West Bend Mutual Insurance Company v. Belmont State Corp. 2010 WL 5419061 (N.D. Ill. 2010).

Lenders should further confirm that their security interest is properly perfected. If a lender has a security interest in accounts receivable, it must ensure it is holding the cash at its institution or has a proper deposit account control agreement in place. It should also ensure proper UCC financing statements have been filed and continued as necessary and that proper mortgages have been recorded.

These simple checks will help protect the lender if a borrower is forced to file a bankruptcy to address the judgments or if the judgment creditors band together and file an involuntary bankruptcy (an involuntary bankruptcy case be filed by 3 more creditors that have undisputed claims – a final judgment is an undisputed claim). Typically, in a chapter 11 case, tort claimants are treated as a class of creditors and are each entitled to the same treatment (percentage of recovery) under a plan of reorganization and/or liquidation. Bankruptcy can be a tool to fairly compensate creditors when the debtor does not have the financial means to pay all creditors in full, but there will be the financial costs of a bankruptcy process itself that needs to be considered. Administrative fees in bankruptcy cases have increased over the years. There are fees for the US Trustee, fees for patient ombudsman and its counsel, fees for counsel to the debtor and fees for counsel to any committee appointed. Tort claimants have had some success in having a committee appointed on their behalf. This could be a separate committee from unsecured creditors and add additional administrative expenses. 

Lenders faced with a financially strapped borrower may want to avoid these costs and move to have a receiver appointed. With strategic planning, receiverships can be an effective remedy for a lender to control, protect and dispose of its collateral. While not publicized in the news as often as bankruptcy cases, we’ve recently seen an increased number of receiverships, especially in the skilled nursing sector. Over the last two years alone, we filed receiverships for over 20 skilled nursing facilities across the country and represented numerous lenders in the state-initiated receiverships in Kansas, Nebraska, Arkansas and Florida filed against an operator of over 100 facilities. The process provides the lender with a fair amount of control, but also shields the lender from the burdens that come with a foreclosure or bankruptcy. For example, in a foreclosure, the lender risks having to take title to the property. Taking title is usually a deal breaker for many lenders given the liabilities that come along therewith.  In a receivership, the lender never has to take title. It remains with the title holder and the property is sold by the receiver standing in the shoes of the title holder.  In a voluntary bankruptcy case, a lender is at the mercy of the borrower deciding when and where to file its case and the borrower remains in control of its cash and operations (albeit with the oversight of the court). In a receivership, the lender files the case, controls the choice of jurisdiction and timing, and the borrower is removed from control and replaced by the receiver, typically chosen by the lender. And, as mentioned above, the costs in a bankruptcy case can be significant. Receiverships can be powerful remedies for lenders, but the lender must be strategic in planning to ensure it has the right law, jurisdiction and receiver on its side and be cognizant of the potential negatives of a receivership.

In sum, it’s critical for lenders to monitor COVID-related litigation against their borrowers, know that there are still risks associated therewith despite the numerous immunity protections implemented by many states, ensure that their loan documentation properly protects them from priming by a judgment creditor, ensure proper perfection of security interests and be proactive and strategic in considering restructuring and financial relief options for borrowers.

“COVID-19 Litigation Concerns for Lenders,” by Paige Barr Tinkham and Kenneth J. Ottaviano was published in BY&S Quarterly News & Updates on January 29, 2021. Reprinted with permission.