Court Upholds Implied Covenant Claim Based on SPV’s Failure to Remain Sufficiently Capitalized to Pay Loan

On September 5, 2024, the First Department issued a decision in Ria R Squared, Inc. v. DW Partners, LP, 2024 NY Slip Op. 04363, upholding a claim for the breach of the covenant of good faith and fair dealing based on an SPV’s failure to remain sufficiently capitalized to repay a loan, explaining:

Plaintiff entered into an agreement with DW 80 South (the 80 South Agreement), a special-purpose vehicle for that transaction, to invest $25 million in a loan to a property developer. DW 80 South itself borrowed most of this loan from a bank. Pursuant to DW 80 South’s Repurchase Agreement with the bank, that debt was senior to DW 80 South’s debt to plaintiff. Aware that DW 80 South had not invested its own money, and thus had no direct stake in the outcome, plaintiff negotiated a term obligating DW 80 South to repay its obligations under the Repurchase Agreement. When defendants warned plaintiff that DW 80 South might default on its loan to the bank, plaintiff declined to invest more money. Defendants then threatened to form an affiliated entity that would purchase the bank’s interest and foreclose on the loan. DW 80 South defaulted and defendants made good on their threat.

. . .

Plaintiff alleges not only a breach of the 80 South Agreement through failure to meet financial obligations, but separately, a scheme to divest plaintiff of its interest in the loan by purchasing and foreclosing on a senior loan. Plaintiff has accordingly stated a claim for breach of the covenant of good faith and fair dealing, which is not duplicative of its contract claim. In assuming that plaintiff would have lost its interest absent defendants’ conduct, the partial dissent improperly makes factual inferences favorable to the moving parties.

The dissent points out that DW 80 South was a special purpose vehicle, and that, at oral argument before Supreme Court, plaintiff agreed that adequate capitalization was not essential to its contract claim. From this, the dissent extrapolates that DW 80 South had no duty to maintain adequate capital. It does not follow, however, that DW 80 South did not implicitly covenant to act in good faith to maintain sufficient funds to carry out its express promise of making payments on the Repurchase Agreement.

(Internal citations omitted).

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