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The Importance of Unambiguous Intercreditor Agreements
Bankruptcy court holds that junior secured creditors, under loosely drafted reservation in intercreditor agreement permitting the “exercise [of] rights and remedies as an unsecured creditor,” and in the absence of express restrictive language, may act in opposition to senior secured creditors and further holds that stock received by junior secured creditors under plan of reorganization is not shared collateral or the proceeds thereof and therefore not subject to the distributive provisions of the intercreditor agreement.
Intercreditor agreements — for example, those between holders of first-lien debt and second-lien debt — are often drafted to compromise seriously the ability of junior secured creditors to protect their interests. For example, such agreements may seriously limit (or virtually eliminate) the ability of the junior secured creditors to object to a sale of assets, use of cash collateral, a “priming lien” under debtor-in-possession financing, or even a plan when that action is supported by the senior creditors, even if the plan or sale essentially wipes out the junior creditors.
Courts have been willing to enforce the terms of such intercreditor agreements when they are appropriately drafted to cover the challenged conduct of the junior secured creditors and have suggested that damages for breaches thereof are appropriate, demonstrating the risks to junior secured creditors of taking actions in opposition to senior secured creditors.
For example, in Ion Media Networks v. Cyrus Select Opportunities Master Fund Ltd. (In re Ion Media Networks), 419 B.R. 585, 593-98 (Bankr. S.D.N.Y. 2009), appeal dismissed, 480 B.R. 494 (S.D.N.Y. 2012), Cyrus, a purchaser of second-lien claims that were subject to an intercreditor agreement, objected to confirmation of a plan supported by the first-lien creditors, primarily on the basis that the debtors’ Federal Communications Commission licenses were not part of the collateral on which the first-lien lenders had a perfected security interest, and that the value of those licenses should therefore be shared pro rata among all general unsecured creditors (including, presumably, the second lienholders’ unsecured deficiency).
The bankruptcy court held that Cyrus’ challenge was barred by the intercreditor agreement, and strongly implied that not only did the second-lien creditor lack standing to object to a plan supported by the senior lenders, but that it also would be liable for damages as a result of what the court characterized as a breach of the intercreditor agreement.
However, a recent opinion by a New York bankruptcy court dismissing two largely identical adversary proceedings commenced by the indenture trustees for the senior creditors against junior secured parties for breach of an intercreditor agreement (the “ICA”) highlights the leeway junior secured creditors may have in opposing senior secured creditors under a loosely drafted reservation of rights to act in the juniors’ capacity as unsecured creditors. That decision also demonstrates that an ICA whose scope is limited to shared “collateral” and its “proceeds” will not necessarily encompass all distributions to the junior secured creditors under a plan.
In BOKF NA v. JPMorgan Chase Bank NA (In re MPM Silicones LLC), Adv. No. 14-08247 (Bankr. S.D.N.Y. Oct. 14, 2014), and Wilmington Trust NA v. JPMorgan Chase Bank NA (In re MPM Silicones LLC), Adv. No. 14-08248 (Bankr. S.D.N.Y. Oct. 14, 2014), the first- and 1.5-lien trustees’ complaints asserted that the junior secured parties breached the applicable ICA, and their implied covenant of good faith and fair dealing, by:
(1) opposing the plaintiffs’ requests for adequate protection of their interests in the shared collateral;
(2) supporting the debtors’ financing and a priming lien that was given priority over the plaintiffs’ liens;
(3) intervening in support of the debtors’ objections to the plaintiffs’ claim to a make-whole payment under their indentures and notes and similar claims based on the prepayment of their debt and supporting confirmation of the debtors’ chapter 11 plan; and
(4) agreeing to receive in return for their secured claims property that the plaintiffs contended constitutes common collateral, or the proceeds thereof, including 100 percent of the common stock of the reorganized debtor.
Bankruptcy Judge Robert Drain dismissed each count contained in the complaints, finding that there was either no breach of the ICA as a matter of law, or because the plaintiffs had inadequately pled such cause of action,[1] noting that the complaints rarely, if ever, identified the provisions of the ICA that were allegedly breached, and further finding there could be no breach of the implied covenant of good faith and fair dealing where there was no breach of contract.
In the complaints, plaintiffs asserted that defendants had violated the ICA by objecting to plaintiffs’ request for a make-whole payment and by supporting the debtors’ plan of reorganization. The bankruptcy court dismissed this claim, finding that such actions did not breach the ICA, based on (1) the retained right of the junior secured creditors to “exercise rights and remedies as an unsecured creditor against the Company or any Subsidiary that has guaranteed the Second-Priority Claims ...”[2] and (2) the absence of a “clear beyond peradventure” waiver of the right to object to this transaction.[3]
Further, the bankruptcy court distinguished actions directly pertaining to adequate protection, which directly affect the senior secured creditors’ interests in the shared collateral, with actions pertaining to the amount and treatment of the senior-lien holders’ claims based on arguments that any unsecured creditor could reasonably make. The court explained that:
[T]he defendants’ claim objection was just that, a claim objection, rather than opposition to the plaintiffs’ pursuit of remedies in respect of the shared collateral. In this context ICA section 5.4 must be read to give the defendants the unfettered right to act as unsecured creditors to object to the senior lien holders’ claims. Such actions would not conflict with any more specific provision in the ICA in a way that might create any contextual ambiguity.[4]
Although the bankruptcy court acknowledged that the defendants’ support of the cramdown plan was a closer question, because cramdown affects the manner in which the senior lienholders are paid under the plan, not the amount of their claim, the court nonetheless determined that the debtors’ pursuit of the cramdown plan was proper and defendants’ support thereof was consistent with an action any unsecured creditor would rightly take.
The court further emphasized that the junior secured creditors’ action was not a holdup; it was, in its view, consistent with ensuring that the debtors acted properly in the interests of unsecured creditors in not overpaying the plaintiffs with a higher present value rate under Section 1129(b)(2)(A)(i)(II) of the Bankruptcy Code. Senior secured creditors should take note of the reluctance of the court to read the ICA to restrict the junior secured creditors’ rights to be heard as unsecured creditors — at least so long as their actions are viewed as the type “that any unsecured creditor would rightly take.”[5]
Importantly, the bankruptcy court noted that the “loosely drafted” ICA at issue was drafted quite differently from the ICA in In re Erickson Retirement Communities LLC, 425 B.R. 309, 313 (Bankr. N.D. Tex. 2010), which contained “very tight language prohibiting the junior lien holders from taking almost every action against the general interests of the senior secured party” — under which the junior lienholders would, in the court’s words, be “silent seconds” and yield in all respects to the senior lienholder until the claim of the senior lienholder was fully satisfied.[6]
Thus, Judge Drain’s ruling highlights the point that drafting and language matters; if senior secured creditors desire to keep junior secured creditors from using their standing as unsecured creditors to oppose senior secured creditors, an intercreditor agreement must be drafted in clear, tight and unambiguous language.
In addition, “and perhaps most significantly for purposes of the underlying economics of this litigation,”[7] the court dismissed plaintiffs’ claim that defendants had violated the ICA by receiving shared collateral consisting of 100 percent of the new common stock of the reorganized debtor distributed under the confirmed plan. In so doing, the court made the highly significant holding that the distributive provisions of an intercreditor agreement covering “collateral” and its “proceeds” did not apply to stock of the reorganized debtor received by the junior secured creditors.[8]
The court’s reasoning was that, by their terms, the distributive provisions of the intercreditor agreement applied only to the “Common Collateral or proceeds thereof.” The court found, however, that the new common stock “is concededly not Common Collateral,”[9] and that, as a matter of law, the new common stock did not constitute “proceeds” of the common collateral under any definition of “proceeds,” either.
The court noted, among other reasons, that: “From the perspective of the debtors, that stock is not something that any currently secured party’s existing lien would attach to ... because the new common stock comprises proceeds of the defendants’ liens and claims, not the proceeds of the debtors’ assets that constitute the Common Collateral.”[10] Further, “the property constituting the Common Collateral will not change.”[11] The court further noted that, from the perspective of the senior secured creditors, the common collateral would remain unaffected and was not diminished at all by the distribution of the new stock.
The implication of the decision that the stock of the reorganized debtor received by the junior secured creditors is neither shared collateral nor proceeds, and hence not subject to the distributive provisions of the intercreditor agreement, is that senior secured creditors’ only basis for objecting to the junior secured creditors’ receipt of stock would be the seniors’ rights under the cramdown provisions of the Bankruptcy Code.
This decision should serve as an important reminder to both senior and junior secured creditors of the importance of careful drafting of an intercreditor agreement. Senior secured lenders should be aware that courts may not go out of their way to read an intercreditor agreement such as this one as limiting the rights a junior secured creditor can assert as an unsecured creditor. Because junior secured creditors and unsecured creditors often have standing to make the same objections or arguments in opposition to senior secured creditors as to a particular matter, the opinion highlights the point that an intercreditor agreement may still provide the junior secured creditor considerable leeway to oppose actions of the senior secured creditor.
Similarly, the court’s ruling as to the limited scope of the phrase “collateral and proceeds” in distributive provisions of an intercreditor agreement highlights the point that senior secured creditors may need broader language to capture distributions of property such as common stock of the reorganized debtor to junior secured creditors.
All of this being said, the case also serves as a reminder that junior secured creditors that are parties to an intercreditor agreement face the risk of suit for breach or damages when acting in opposition to senior secured creditors, even if the suit is later found to be without merit, and that an intercreditor agreement should be reviewed carefully before taking any such action.
[1] The court dismissed plaintiffs’ claim that defendants had violated the intercreditor agreement by opposing plaintiffs’ request for adequate protection. Although the ICA expressly prohibited the junior secured creditors from contesting or supporting any other person contesting any request by the senior secured creditors for adequate protection, the bankruptcy court determined that, as pled, the complaints did not adequately demonstrate that the junior secured creditors had opposed a request of the senior secured creditors for adequate protection, given that no objection, or pleading in support of another’s objection, had ever been filed by the junior secured creditors. The bankruptcy court, however, declined to rule that a provision allowing junior secured creditors to exercise their rights and remedies as an unsecured creditor would trump a provision prohibiting opposition to adequate protection, as was the holding in In re Boston Generating LLC, 440 B.R. 302 (Bankr. S.D.N.Y. 2010).
Similarly, the bankruptcy court dismissed plaintiffs’ claim that the junior secured creditors violated the ICA by supporting a priming lien in a third-party financing, where the complaint failed to state what actions the defendants took to support the issuance of such a lien, and further, where the complaint did not identify which section of the ICA prohibited such an action.
[2] Bench Ruling at 13 (quoting ICA § 5.4).
[3] Id. at 18 (quoting Boston Generating, 440 B.R. at 319). In addition, the bankruptcy court found that based on its prior decisions disallowing the make-whole payment, no-call or perfect-tender claims as a matter of New York law, the defendants could not be liable under the intercreditor agreement for objecting to invalid claims.
[4] Bench Ruling at 21.
[5] Id. at 22.
[6] Id. at 23.
[7] Id. at 9.
[8] In addition, plaintiffs contended that a possible $30 million payment to defendants under a backstop agreement and ongoing cash reimbursement of their professional fees also constituted a prohibited receipt of shared collateral. With respect to any payment under the backstop agreement, the court determined that there was no breach of the ICA because any payment would be made under the backstop agreement rather than based on any defendant’s status as a secured creditor. In addition, the court found the plaintiffs had not adequately asserted which source of repayment of professional fees was at issue, and dismissed such claim as inadequately pled.
[9] Bench Ruling at 27.
[10] Id. at 29.
[11] Id. at 30.
Reprinted with permission of Portfolio Media, Inc. All rights reserved.