Amended and Restated Financing Agreement Should Clearly State If Not Intended as Novation

David K. Duffee Frederick C. Fisher Adam C. Wolk

When a lawyer wants to modify the terms of an agreement, and the modifications are extensive and will affect many provisions of the agreement, the lawyer will often choose to draft an amended and restated agreement in order to effect those modifications. A single amended and restated agreement will often be easier to read than would be the original agreement and a separate amendment (or a series of separate amendments). In financing transactions, parties commonly use amended and restated credit agreements. When they do so for a secured financing, the parties almost always intend that the property that secured the original credit agreement continue to secure the obligations under the amended and restated credit agreement and, as a recent case shows, it is important that the parties ensure that the document clearly states that it is not intended as a novation of the obligations under the original credit agreement.

Recently, in Bash v. Textron Financial Corporation (In re Fair Finance Company) 1 , the US Court of Appeals for the Sixth Circuit reversed a determination of the District Court for the Northern District of Ohio that an amended and restated loan agreement did not constitute a novation of the original loan agreement. In so doing, the circuit court held, in largely reversing the dismissal of an adversary proceeding arising out of a Chapter 7 bankruptcy case, that the amended and restated loan agreement may actually have constituted (or at least it is ambiguous as to whether it constituted) a novation of the original loan agreement. If the amended and restated loan agreement did in fact constitute a novation, the security interests granted pursuant to the original loan agreement would have terminated at the time that the parties entered into the amended and restated loan agreement. 2 The circuit court, after reversing the district court’s determination, remanded the question to the lower court for further proceedings.

At common law, the essential elements of a novation are: (1) a previous valid obligation; (2) an agreement of the parties to a new contract; (3) extinguishment of the previous obligations; and (4) a valid new contract. To satisfy the second and third elements, all parties must have “clearly expressed their intention that a subsequent agreement superseded or substituted for an old agreement.” 3 Thus the key to analyzing whether a novation has occurred is the parties’ intent.

In In re Fair Finance Company, the amended and restated loan agreement (the “2004 Agreement”) expressly provided that the obligations thereunder would be secured by a security interest in the same collateral that secured the original credit agreement (the “2002 Agreement”) and that the 2004 Agreement set forth the parties’ “desire to amend and restate” the 2002 Agreement. 4 Nevertheless, the circuit court noted that the following provisions in the 2004 Agreement support the conclusion that the parties intended that the 2004 Agreement be a novation of the 2002 Agreement:

  1. A merger clause stating that the 2004 Agreement “supersedes any and all prior oral or written agreements relating to the subject matter thereof” 5 ;
  2. An entire agreement clause to the effect that the 2004 Agreement “constitutes the entire agreement of Borrowers and Lender relative to the subject matter hereof” 6 ;
  3. A granting clause in which the borrower agrees to “‘grant, pledge, convey and assign’ a new security interest in and lien upon their property to Textron ‘to secure the prompt and full payment and complete performance of all obligations of Borrowers to Lender under [the 2004 Agreement]’” 7 ; and
  4. An acknowledgment that the 2004 Agreement “was the product of ‘valuable consideration, the receipt and sufficiency of which are hereby acknowledged.’” 8

The circuit court also found the following circumstances surrounding the execution of the 2004 Agreement to indicate the parties’ intent to have the obligations under the 2002 Agreement extinguished and replaced with those under the 2004 Agreement:

  1. The 2004 Agreement was entered into on the date the 2002 Agreement expired;
  2. A new promissory note and new guarantees were issued to replace the ones delivered pursuant to the 2002 Agreement;
  3. The 2004 Agreement had a different interest rate than that in the 2002 Agreement and provided for new fees; and
  4. There were two lenders in the 2002 Agreement but only one lender in the 2004 Agreement.

While one may question the sufficiency of the evidence that the circuit court adduces to suggest that the parties may have intended to effect a novation, the lesson that a lawyer drafting an amended and restated financing agreement should draw from this decision is the importance of clearly stating the parties’ intent that the amended and restated agreement not constitute a novation. The court in In re Fair Finance Company noted that the 2004 Agreement did not explicitly provide that the parties’ intent was that the original security interests were to continue. 9 When drafting an amended and restated financing agreement, a lawyer should include an express statement that the agreement is not intended to constitute a novation or a termination of the obligations under the original agreement, and in the context of a secured financing, that the security interests created pursuant to the original agreement are intended to continue and to secure the obligations under the amended and restated agreement.