Too Close for Comfort? LATAM Judge Upholds $1.3B in Intercompany Loans
Kelley Drye Client Advisory
A decision earlier this year in the LATAM Airlines Group bankruptcy addressed the validity of claims arising from intercompany loans between a corporate debtor’s affiliates. Judge James L. Garrity’s opinion overruling objections to the claims provides helpful guidance on an issue that often gives rise to disputes in chapter 11 cases.
Prior to its bankruptcy filing in 2020, the LATAM Airlines Group had various means of raising capital to finance its operations in different countries. In 2016, LATAM Airlines Group S.A. (“Parent”) created a new subsidiary, LATAM Finance Ltd. (“Finance”), for the sole purpose of issuing bonds and then purportedly loaning the proceeds to an affiliate, Peuco Finance Ltd. (“Peuco”), which in turn upstreamed the funds to Parent in exchange for the purchase of intercompany account receivables held by Parent. As a matter of actual practice, Peuco had no bank account and Finance would transfer the funds directly to Parent.
As of the time of the bankruptcy filing, the amounts loaned by Finance to Peuco aggregated over $1.3 billion. Peuco listed the amount owed to Finance as an allowable claim in its schedules of assets and liabilities filed in the chapter 11 cases, and Finance in its schedules similarly listed the corresponding amount due as an asset.
Claims based on intercompany transactions invariably draw close attention in bankruptcy cases, even where there is no suggestion of misconduct of any kind. The official committee of creditors appointed in most chapter 11 cases is charged with scrutinizing a debtor’s pre-bankruptcy behavior. In this instance, the LATAM creditors’ committee (the “Committee”) filed objections to Finance’s claims against Peuco and put forward several arguments that Parent, Finance and Peuco had failed to document the purported loans properly and that the claims should be disallowed. An invalidation of the claims would ultimately have left Parent with a much larger pool of funds to distribute to its creditors at the expense of the holders of the bonds issued by Finance.
The loans to Peuco took place between 2017 and 2019, ranged in amounts between $34 million and $608 million, and were each evidenced by a separate loan agreement. The agreements contained the same material provisions, including an obligation to repay the loan in full or in part on demand and a default interest rate of 2%, and each provided Finance with the right to accelerate the loan in response to an event of default. The Committee argued, however, that the agreements lacked key terms under New York law, having no pre-default interest rate, maturity date, or schedule of payments. The Committee further pointed out that Peuco never actually received the funds it purportedly borrowed, and contended that corporate formalities for approval of the loans had not been followed.
The LATAM debtors, together with an ad hoc group of Finance’s bondholders, pushed back against the Committee’s arguments. They pointed out that the intercompany loans served legitimate business purposes for the LATAM Airlines Group, and that it was a common business practice for multi-national Latin American companies to access the capital markets in a similar manner.
After laying out the facts, Judge Garrity rejected the Committee’s arguments and upheld the validity of Finance’s loans to Peuco. Although the loan agreements were missing certain terms typically found in arm’s-length transactions, Judge Garrity determined that the terms they did contain were sufficient to establish a “valid loan” under New York law – “an advance of money with a promise to repay it at a future time[.]”
He further rejected the Committee’s urging to look to cases in which transfers designated as “loans” from controlling shareholders to troubled companies were recharacterized as contributions of equity capital. Judge Garrity found the “recharacterization” cases to be inapplicable to the Committee’s contention that the loans from Finance to Peuco should be disallowed. “Application of the doctrine of recharacterization does not provide a basis for disallowing a claim; it is a separate and distinct inquiry from disallowance under [the Bankruptcy Code].”
Judge Garrity gave little credence to the Committee’s argument that the transfer of funds directly from Finance to Parent affected the validity of the loans. He noted that it was common practice for transfers among affiliated companies to be evidenced solely by recordings in corporate ledgers.
Lastly, Judge Garrity turned aside the Committee’s assertions that the intercompany loans had not been authorized by necessary corporate formalities. Although the execution of the loan agreements by Finance and Peuco were not all supported by appropriate board actions, he had no trouble finding sufficient contemporaneous extrinsic evidence, including internal communications and the consistent treatment of the transactions as loans on Finance’s and Peuco’s corporate ledgers, to confirm the assertions that the transfers were always intended to be loans from Finance to Peuco.
Intercompany loans will continue to draw close scrutiny in chapter 11 cases, and Judge Garrity’s opinion will not be the last word on this topic. But his detailed analysis upholding Finance’s claims against Peuco, based on the validity and enforceability of the loans under New York law, will provide useful direction in future cases.