Secured creditors often seek agreement among themselves in order to limit intercreditor conflict and expedite realization of their respective claims against a borrower in a chapter 11 case. One might call it a “strength through peace” approach. However, in chapter 11 cases, some courts have ignored intercreditor agreements in cramdown situations, refused to enforce certain terms as contrary to public policy, and have construed a given intercreditor agreement term as not covering the controversy at issue. We note that the likely fate of an intercreditor agreement in a given venue may provide a good reason for the senior secured creditor to push for or require a certain venue choice by the debtor.
Intercreditor agreements may provide, in a bankruptcy setting, for the order in which parties to the agreement get paid, the respective priorities of parties’ liens over common collateral, and may determine which party has the exclusive rights to modify terms, extend maturity dates, make additional advances, and to transfer loans among multiple lenders.[i] For example, junior lenders often agree not to challenge the validity and enforceability of the senior lender’s security interest, and not to contest the senior lender’s entitlement to all initial collateral proceeds until its payment is satisfied in full.[ii] Sometimes, the junior lender may agree to limit its ability to vote on whether to accept or reject a chapter 11 debtor’s reorganization plan. It should be kept in mind that the junior lender had likely taken its position in the capital structure upon the expectation that, in a borrower’s chapter 11 case, the senior lender would drive.
But will the intercreditor agreement be enforced by the bankruptcy court? Intercreditor agreements most often subordinate one claimant’s rights to another’s, and so are a species of the genus Subordination Agreement. Thus, intercreditor agreements are routinely enforced by bankruptcy courts under section 510(a) of the Bankruptcy Code, which provides that a “subordination agreement is enforceable in a case under [the Bankruptcy Code] to the same extent that such agreement is enforceable under applicable nonbankruptcy law.”[iii]
Some courts interpret section 510(a) narrowly, applying it only to consensual alteration of the priority of payment amongst creditors; but not enforcing subordination agreements in bankruptcy cases to the extent they alter the parties’ rights under bankruptcy law.[iv] In a high-profile 2010 case,[v] second lien lenders challenged the enforceability of an intercreditor agreement in the context of a cramdown plan (where a plan is confirmed though a class of creditors rejects the plan — cramdown plans are discussed here and here). The principal confirmation standards for a cramdown are set by section 1129(b) of the Bankruptcy Code. In siding with second lien lenders, the court held that section 1129(b)(1) of the Bankruptcy Code deletes section 510(a) –- and its recognition that subordination agreements are enforeceable in bankruptcy — from plan confirmation governed by section 1129(b).[vi]
Having found that the debtors’ plan met the cramdown requirements of section 1129(b) and would be confirmed, the court determined that the intercreditor terms between the first and second lien lenders did not need to be respected.[vii] The court did not decide whether the intercreditor agreement was breached, but commented that “even if such a violation occurred, it would not impede the confirmation of [the plan] as proposed” due to key language of of section 1129(b).[viii]
Some courts have followed what they regard as the plain language of the 1129(b)(1) statute and have enforced intercreditor agreements according to their terms.[ix] Where a court adopts that approach, three considerations explain whether a given intercreditor agreement term will be enforced: (i) whether the provision explicitly addresses the action that the senior creditor seeks to preclude, (ii) whether the action constitutes a bankruptcy public policy that should be protected, and (iii) whether the subordinate lender is an obstructionist in the bankruptcy case.[x]
To illustrate the first of these considerations, we refer to a bankruptcy court in New York which held that a junior creditor may have the right to object to the sale of assets because the intercreditor agreement between the junior and senior did not contain a clear waiver of the junior’s right to object.[xi] To illustrate the second consideration, we note that courts have split on the enforceability of waivers of creditors’ rights in the bankruptcy context, such as the junior lenders’ right to vote on a chapter 11 plan – some will not enforce such waivers on the grounds that to do so would violate bankruptcy policy.[xii]
When drafting intercreditor agreement provisions that waive junior lenders’ rights, the best strategy to ensure the waivers are enforced is to combine a general waiver by the junior creditor of its enforcement and bankruptcy rights to the extent inconsistent with the provisions of the intercreditor agreement, and explicit waivers of the rights most commonly asserted by a junior creditor in a defaulted credit.[xiii]
In re TCI Holdings, LLC, 428 B.R. 117 (Bankr. D.N.J. 2010)
Background: Widely publicized case during which bankrupt owners of three Trump hotel-casinos in Atlantic City battled first lien lenders over competing Chapter 11 plans. lienholders battled for control of 3 Trump hotels in Atlantic City.
Key Holdings: (1)Debtors’ proposed Chapter 11 plan did not cause settlement to fall below lowest point in range of reasonableness or prevent court from confirming plan (2) risks imposed on dissenting class of first lien lenders under Chapter 11 plan proposed by debtors were neither substantial nor unfair, and did not prevent “cramdown” of plan over lenders’ objection (3)mere fact that one of proponents of competing Chapter 11 plan had purchased debt at 92.5% of par with intent to make profit was not, in and of itself, improper or illegal and did not affect its “good faith” in proposing this competing plan
In re Ion Media Networks, Inc., 419 B.R. 585 (Bankr. S.D.N.Y. 2010)
Background: Confirmation hearing was held in debtors’ jointly administered Chapter 11 cases on debtors’ proposed Chapter 11 reorganization plan, and second lien lender objected to first lien lenders’ right to recover, as provided in plan, for any of value attributed to debtors’ broadcasting licenses from the Federal Communications Commission (FCC).
Key Holding: (1) intercreditor agreement in which second lien lenders expressly acknowledged priority of first lien lenders’ interests and agreed not to challenge that priority upon any ground, including nonperfection of any lien “purportedly securing” first lien lenders’ claims, prevented second lien lender from asserting that subordination of its interests to blanket liens of first lien lenders did not extend to whatever interest first lien lenders claimed in debtor/media company’s broadcasting licenses from the FCC
In re GWLS Holdings, Inc., 2009 WL 7215668 (Bankr. D. Del. Jan. 27, 2009)
In re Erickson Retirement Communities, 425 B.R. 309 (Bankr. N.D. Tex. 2010)
Key Take-aways: Both rulings reflect the applicability of the general rule that an intercreditor agreement, like any other contract, must be enforced according to the plain meaning of its terms.
In re Boston Generating, LLC, 440 B.R. 302 (Bankr. S.D.N.Y. 2010)
Background: Chapter 11 debtors moved for authority to dispose of substantially all of their assets outside plan, as part of sale not in ordinary course of business, and second lien lenders objected.
Key Holding: (1) intercreditor agreement between lenders holding first and second liens on substantially all of Chapter 11 debtors’ assets did not deprive second lien lenders of standing to object to proposed sale (2) debtors had articulated business justification and good business reason for seeking to sell substantially all of their assets outside plan, before they ran out of cash to operate (3) sale could proceed free and clear of all liens, both on theory that price at which assets were being sold was greater than aggregate value of all liens thereon and on theory that nonbankruptcy procedures existed to compel second lien lenders to accept money satisfaction of their interests
In re Avondale Gateway Center Entitlement, LLC, 2011 WL 1376997 (2011)
Key Take-away: Held a subrogation clause can effectively transferred a junior lender’s reorganization plan voting rights to the senior lender
In re 203 N. LaSalle St. P’ship, 246 B.R. 325 (Bankr. N.D. Ill. 2000)
Take-away: “Section 510(a), in directing enforcement of subordination agreements, does not allow for waiver for voting rights under 1126(a)”… intercreditor agreement allowed senior lien holder the right to vote a junior lien holder’s claim
Blue Ridge Investors, II, Ltd. P’ship v. Wachovia Bank, National Ass’n, 362 B.R. 43, (Bankr. N.D. Ga. 2006)
Take-away: Enforced contractual provisions of an intercreditor agreement granting the senior lien holder the right to vote the claims of a junior lien holder)[i] Ned Graber, Enforceability of Intercreditor Agreements, (Aug. 17, 2012), at http://www.acmaatty.org/events/handouts/4-EnforceabilityofIntercreditorAgreements.pdf. [ii] Id. [iii] Bracewell & Giuliani, LLP, Intercreditor Agreements Get Trumped, (2014), at http://m.bracewellgiuliani.com/news-publications/updates/intercreditor-agreements-get-trumped. [iv] Michael Venditto, Are Those Bankruptcy Waivers in Your Intercreditor Agreements Effective?, (Feb. 28, 2014), at http://www.lendinglawreport.com/tags/intercreditor-agreement/, at 1. [v] In re TCI Holdings, LLC, 428 B.R. 117 (Bankr. D.N.J. 2010) (lienholders battled for three Trump Hotels in Atlantic City). [vi] The court referred to that portion of the section which provides, (paraphrased) “notwithstanding section 501(a) of this title the court shall confirm a plan over dissenting classes if the plan meets the ‘cram down’ requirements of section 1129, does not discriminate unfairly and is fair and equitable with respect t each class of claims or interests that is impaired and has not accepted the plan.” See also Bracewell & Giuliani, at 3. [vii] See Bracewell & Giuliani, at 3. [viii] See Elaine Stangland & Daniel Ferguson, Intercreditor Case Law Update, 129 Banking L.J. 280 (2012). [ix] See Venditto, [x] Id. [xi] In re Boston Generating, LLC, 2010 WL 4922578, (Bankr. S.D.N.Y. 2010). See, generally, Dan Schechter, Junior Creditor Has Standing to Object to Sale of Assets Because Intercreditor Agreement Does Not Contain Clear Waiver of Junior’s Right to Object, 2010 Comm. Fin. News. 100, (2010). [xii] See Schechter. [xiii] See Stangland & Ferguson.
Prior to joining the faculty in 2000, Professor Kuney was a partner in the San Diego office of Allen Matkins Leck Gamble & Mallory LLP where he concentrated his practice on insolvency and reorganization matters nationwide. Before that he received his legal training with the Howard, Rice and Morrison & Foerster firms in his hometown…
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