The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:
A district court in New York has held that a group of junior creditors who supported a Chapter 11 debtor’s cramdown plan did not breach their obligations to the senior creditors under the terms of an intercreditor agreement because the juniors held both secured and unsecured claims, and the agreement did not prohibit the juniors from exercising their rights as unsecured creditors. [In re MPM Silicones, LLC, 2018 Westlaw 6324842 (S.D.N.Y.).]
Facts: In the wake of a ruinous leveraged buyout, a company was burdened with billions of dollars in debt. To simplify the debt structure, there was a group of fully-secured senior creditors. There was also a second group of junior secured creditors, who were only partially secured (at best).
The seniors and the juniors entered into an intercreditor agreement containing (among other things) provisions forbidding the juniors from “hindering” the rights of the seniors. The agreement also contained “turnover” provisions forbidding the juniors to accept “proceeds” of the collateral during a bankruptcy proceeding until the seniors had been paid in full. Finally, the agreement contained a provision stating that it was not intended to impair the “rights and remedies” of the borrower’s unsecured creditors.
Following the debtor’s Chapter 11 filing, the debtor propounded a “cramdown” plan of reorganization. Although the seniors objected to the plan, the juniors, who held a large unsecured deficiency claim, accepted the plan, thus making cramdown possible. As part of that arrangement, the juniors received stock in the reorganized entity, as well as other monetary consideration.
After a tortuous procedural history, the seniors brought suit against the juniors, arguing that their votes in favor of the debtor’s plan had violated the terms of the intercreditor agreement by “hindering” the seniors. The junior creditors moved to dismiss that suit, and the bankruptcy court granted that motion.
Reasoning: The district court affirmed the dismissal. The court grouped the seniors’ claims into two categories: “interference” claims, based on the exercise of the juniors’ voting rights, and “turnover” claims, based on the receipt of stock and other consideration by the juniors. The court began its analysis by noting that the juniors were “fulcrum” creditors because they held both secured and unsecured claims:
Fulcrum security holders are otherwise secured creditors who, based on the debtor’s assumed enterprise values, would be unable to receive a full recovery for their unsecured liens in cash. Therefore, they often seek other forms of consideration and are well-positioned to influence restructurings.
The court then reasoned that under the terms of the intercreditor agreement, the juniors had rights as unsecured creditors, and those rights were granted “notwithstanding anything to the contrary” in the agreement:
Notwithstanding anything to the contrary in this Agreement, the [Seconds] may exercise rights and remedies as an unsecured creditor against the Company or any subsidiary . . . . Nothing in this Agreement shall prohibit the receipt by any . . . . of the required payments of interest and principal so long as such receipt is not the direct or indirect result of the exercise by any [Second] of rights or remedies as a secured creditor in respect of Common Collateral.
Citing In re Boston Generating LLC, 440 B.R. 302, 319 (Bankr. S.D.N.Y. 2010), the court held that the juniors were acting in their capacity as unsecured creditors when they consented to the cramdown plan and therefore were within their rights to do so. The court refused to stretch the language of the intercreditor agreement to impair the juniors’ voting rights: “The growing consensus is that agreements that seek to limit or waive junior noteholders’ voting rights must contain express language to that effect.”
The court echoed the language of the bankruptcy judge praising the role of the juniors in promoting the goal of corporate reorganization:
[The bankruptcy court] explained the importance of assessing the economics of the underlying transaction so as not to disenfranchise unsecured stakeholders who were trying to contribute to restructuring efforts—instead of likening them to creditors engaging in ad hoc obstructionism.
The court then addressed the “turnover” claims, under which the seniors argued that the juniors had received stock and other consideration from the debtor in violation of the intercreditor agreement. The court held that the consideration received by the juniors did not constitute “proceeds” of their collateral and thus did not violate the “turnover” provisions in the agreement: “Liened collateral cannot be extrapolated to include the debtor’s other assets that do not relate to, or directly derive from, that collateral.”
Author’s Comment: The court is right that the trend is against the enforceability of draconian voting restrictions in intercreditor agreements; and in light of that trend, I predict affirmance. But strictly on the merits, I have doubts about the logic of this decision. Note that under the court’s interpretation of the inter-creditor agreement, the juniors (as fully secured creditors) would have been handcuffed by the standstill agreement. But as soon as they became undersecured (even by one dollar), the “notwithstanding” language sprung into effect, empowering them to circumvent the standstill clause in order to “hinder” the seniors by voting for a cramdown plan, over the seniors’ strenuous objections.
Does that make sense? If both sets of creditors were fully secured, is it likely that the debtor would have been in default? To put it another way, the prohibition on “hindering” the seniors would be dormant while the juniors were fully secured and would be enforceable (but trumped) when the juniors became undersecured. That means that this “springing hindrance” provision was just surplusage, violating a key rule of construction.
Regardless of the outcome of this case, the drafting lesson is obvious: a senior creditor that wishes to control a junior creditor’s post-default behavior must do so in stark language that plainly relegates the junior to the lowly status of a “silent second.”
Finally, note the court’s colorful description of the undersecured juniors as “fulcrum creditors,” because of the pivotal role they played in the reorganization. That is a useful phrase. (Or perhaps they could be called “snorkel creditors:” they were somewhat underwater but still breathing.)
For a discussion of the bankruptcy court’s ruling in this case, see 2014-47 Comm. Fin. News. NL 94, Although Intercreditor Agreement Barred Junior Secured Creditors from Opposing Senior Creditors’ Adequate Protection Motion, Juniors Did Not Breach Agreement Because They Acted As Unsecured Creditors.
For a discussion of the Boston Generating case cited by the court, see 2010 Comm. Fin. News. 100, Junior Creditor Has Standing to Object to Sale of Assets Because Intercreditor Agreement Does Not Contain Clear Waiver of Junior’s Right to Object.
For discussions of other cases dealing with closely-related issues, see:
- 2013-36 Comm. Fin. News. NL 73, Bondholders Waived Right to Participate in Bankruptcy Proceedings Under “No Action” Clauses, Even Though Clauses Do Not Mention Bankruptcy.
- 2012 Comm. Fin. News. 68, Junior Lender Retains Right to Seek Receiver Because Subordination Agreement Does Not Expressly Negate Remedies.
- 2012 Comm. Fin. News. 28, Acquisition Of Senior Debt By Borrower’s Insiders Is Not Forbidden By Subordination And Standstill Agreement, But Junior Creditor’s Enforcement Actions Against Guarantors Are Permissible.
- 2011 Comm. Fin. News. 32, Intercreditor Agreement Expressly Empowers Borrower to Block Junior Creditor’s Suit Due to Failure to Obtain Consent of Senior Creditors.
- 2010 Comm. Fin. News. 81, Standstill Provisions in Subordination Agreement May Be Strictly Enforced by Senior Creditor to Prohibit Junior Creditor from Taking Any Action against Debtor.
- 2010 Comm. Fin. News. 23, Subordinated Creditors Lacked Standing to Seek Appointment of Bankruptcy Examiner Because Subordination Agreement Prohibits Junior Creditors from 2010 Comm. Fin. News. 15, Debtor May Prevent Subordinated Creditors from Bringing Suit When Subordination Agreement Requires Prior Consent by Senior Lienholder.
- 2009 Comm. Fin. News. 99, “Gag Clause” in Intercreditor Agreement Prohibits Assignee of Junior Claim from Contesting Validity and Priority of Senior Liens.
- 2008 Comm. Fin. News. 08, Junior Creditors May Appear as “Parties in Interest” Despite “No Action” Clause, but “X-Clause” in Subordination Agreement Prohibits Distribution of Securities in Debtor’s Reorganization.
These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.