Bankruptcy Court Finds Assignment of Voting Rights Unenforceable

December 2011

The Massachusetts bankruptcy court recently ruled that the assignment of voting rights from a junior lender to a senior lender pursuant to an intercreditor agreement was unenforceable. The ruling follows decisions by bankruptcy courts in Illinois and Minnesota, and demonstrates a growing resistance among courts to contractual provisions that alter substantive rights under the Bankruptcy Code.

In In re Hotel Venture, LLC, No. 10-14535, 2011 WL 5520928 (Bankr. D. Mass. Nov. 14, 2011), SW Boston Hotel Venture LLC (“SW”) and a group of related entities filed a chapter 11 petition in April 2010. SW developed and owned the W Boston Hotel and Residences.

Prior to SW’s bankruptcy filing, its two largest creditors – Prudential Insurance Company of America and the City of Boston – entered into an intercreditor agreement pursuant to which the City agreed to subordinate its rights to payment to those of Prudential under its senior loan. The intercreditor agreement further provided that, in the event of a bankruptcy, the City would assign certain of its voting rights to Prudential.

SW filed a plan of reorganization that proposed to pay all allowed claims in full. Except for Prudential, all classes of creditors accepted or were deemed to have accepted the plan. In an effort to thwart confirmation of the plan, Prudential cast votes rejecting the plan for itself and on behalf of the City. Prudential argued that the court should disregard the City’s vote approving the plan because the intercreditor agreement assigned the City’s voting rights to Prudential. The City and SW opposed Prudential’s attempt to vote the City’s claim and argued that the plan should be confirmed as a “cramdown” plan with Prudential as the only objecting creditor.

The court ruled against Prudential and held that the City’s assignment of voting rights to Prudential was not enforceable. The court observed that subordination agreements are generally enforceable under section 510(b) of the Bankruptcy Code, but reasoned that such agreements cannot alter substantive provisions of bankruptcy law. The court went on to confirm the plan as a cramdown plan under section 1129(a)(10) of the Bankruptcy Code.

Hotel Venture follows decisions from around the country that have invalidated waivers of the right to vote on a plan of reorganization. The ruling serves as a reminder to players in the second lien financing market that agreements to assign voting rights in a chapter 11 case or otherwise alter substantive rights under the Bankruptcy Code may not survive judicial scrutiny.  

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