Lessors Beware of the Enforceability of Stipulated Loss Value Tables

By: LEAN Attorneys Frank Peretore, Robert L. Hornby & Ryan O’Connor - Chiesa Shahinian & Giantomasi PC

A recent ruling by a judge in the influential Bankruptcy Court for the District of Delaware may indicate that Stipulated Loss Value tables are more at risk than is commonly believed in the industry.

The opinion arose in a Chapter 11 bankruptcy case filed by Tidewater Inc. and its affiliated debtors (the “Tidewater Debtors”), entities that own and operate “Offshore Support Vessels” that support energy exploration and production activities. In 2013 and 2014, prior to the bankruptcy filings, certain of the Tidewater Debtors sold ships to six different bank-lessors which banks subsequently leased the ships back to the Tidewater Debtors pursuant to sale-leaseback agreements. Those agreements, referred to as “bareboat charter agreements,” are a type of charter agreement that governs the terms and conditions for the lease of a vessel. The agreements expressly provided that upon an event of default (as defined in the agreements), the lessors would be entitled to recover from the lessees a stipulated loss value (“SLV”) as liquidated damages. The SLVs were set forth in a table contained within each agreement. As part of the consideration for each lessor to enter into the sale-leaseback transaction, Tidewater Inc. guaranteed absolutely and unconditionally the payment and performance of the obligations of the lessees under the agreements.

The Tidewater Debtors’ subsequent rejection of the agreements under Section 365(a) of the Bankruptcy Code constituted an event of default under the agreements. Accordingly, the bank-lessors sought summary judgment determining the Tidewater Debtors’ liability (and therefore Tidewater Inc.’s liability as guarantor) in the amounts set forth in the SLV table. The bank-lessors asserted that the SLV provisions were enforceable because they allowed them to get the benefit of their bargain, irrespective of market conditions, and that because the actual damages exceeded the SLV, the SLV was not a windfall. The Tidewater Debtors opposed the motion on the basis that the SLVs were penal in nature and bore no relationship to the bank-lessors’ actual damages, and also cross-moved for summary judgment on their own calculation of the liability, which was based on the total maximum amount owed under each bareboat charter agreement discounted to present value. The Tidewater Debtors argued that liability should be limited to “the reasonable expectation damages” of the lessors. The difference between the value asserted by the bank-lessors and the value asserted by the Tidewater Debtors was dramatic – approximately $60 million.

Judge Brendan Shannon, in an oral opinion, sided with the Tidewater Debtors by rejecting the SLVs. Relying on prior federal case law in the Third Circuit, he found that the SLVs constituted penalty provisions, and were therefore unenforceable as a matter of public policy. Significantly, Judge Shannon found that section 2A-504 of the Uniform Commercial Code (“UCC”) (generally approving the use of liquidated damages provisions in lease agreements and expressly blessing common industry provisions such as SLV’s so long as they are reasonable in light of the harm anticipated when the formula was agreed to) did not abrogate the Third Circuit Court of Appeals’ decision in In re T.W.A. Airlines, Inc., 145 F.3d 124 (3d Cir. 1998), which reviewed the enforceability of a liquidated damages provision in a lease that was executed prior to the adoption of section 2A-504 of the UCC and held the provision unenforceable under New York state law (which also applied in the Tidewater case). The court also cited favorably the Third Circuit’s opinion in In re Montgomery Ward Holding Corp., 326 F.3d 383 (3d Cir. 2003), which applied Illinois law and similarly held that a liquidated damages provision was unenforceable despite the blessing of reasonable industry liquidated damages provisions in commercial leases (including SLVs) in the Official Comment to section 2A-504.

For any questions regarding the above Frank, Robert and Ryan can be reached here: