In a case of first impression: bankruptcy court rules that Law 75 arbitration award of damages is not part of a lender’s security interest

PRHS has won important victories in litigation and arbitration against Johnson & Johnson International and now against Banco Santander, a lender.

In Santander de Puerto Rico v. Puerto Rico Hospital Supply, Inc., ADV. PROC. No. 19-00448 (ESL), _____ B.R.____(D.P.R. April 3, 2020), the bankruptcy court for the District of Puerto Rico (Lamoutte, J.) in a thorough 25-page Opinion & Order granted the debtor’s PRHS’s motion to dismiss an adversary proceeding filed by the lender-creditor Banco Santander. Banco Santander has a security interest over the debtor’s receivables and other collateral, as specified in the instrument, to guarantee a commercial loan of $32 million.

Struck by both its principal supplier of medical products and devices Johnson & Johnson International's termination of the distribution agreements and Banco Santander's foreclosure of its security interest, PRHS filed for Chapter 11 bankruptcy. Vital for the debtor’s plan of reorganization is the estate’s claim over the million-dollar plus damages arbitration award against J&JI for its termination without just cause of a non-exclusive agreement (later confirmed by the federal district court and pending on appeal) and the ensuing claim of over $10 million for termination of the exclusive agreements pending in a parallel stayed federal case.

In the bankruptcy, the lender Santander claims that the proceeds of the arbitration award and the federal case belong to it as part of its collateral guaranteed by the security interest. In In re American Cartage, Inc., 656 F.3d 82, 88 (1st Cir. 2011), the First Circuit- itself addressing an issue of first impression under Massachusetts U.C.C. law- held that the lender’s security interest in that case did not extend over commercial tort claims. The question presented in the Santander adversary proceeding raised the same novel issues under Puerto Rico law.

First, the bankruptcy court ruled that the plain language of Law 75 creates a right of action for the tortious act of terminating a dealer’s contract. This meant that the proceeds of the arbitration award did not originate from the dealer’s performance of a contract or contract rights guaranteed by the collateral, but instead arose from a violation of tort law. Second, the Law 75 tort claim was a commercial tort claim instituted by a corporation within the meaning of Puerto Rico’s Uniform Commercial Code. As such, commercial tort claims do not fall within the meaning of accounts or intangibles in the U.C.C., and are thus, excluded from the collateral. Third, and dispositive as in In Re American Cartage, which the court found persuasive, Santander’s security interest did not specify commercial tort claims as part of its collateral. Fourth, the after-acquired damages award arose after the execution of Santander’s security agreement and the collateral instruments did not specify it, as held in In Re American Cartage.

CAB represents PRHS in the arbitration, in the federal confirmation proceeding and J&JI’s First Circuit appeal, and in the stayed federal litigation.