You are a PE Fund manager. Your Fund employs loan-to-own strategies to effect take-overs of target companies. You are accustomed to exerting powerful leverage in chapter 11 cases, particularly when you buy enough claims to confirm a plan, or else to block confirmation of a plan by other parties.
For a plan to be approved consensually, each class of claims or interests must approve it. Approval by a class of claims requires a “yes” vote by a majority of the claimants in a class, who also represent at least two-thirds of the aggregate claim amount of the class.
So, Fund can block acceptance by a class by controlling half the votes, or any number of votes that together represent more than one-third of aggregate class claims. This means Fund may be able to force a debtor to “buy” class acceptance by changing the plan to enlarge the Fund’s take. However, a debtor may be able to:
Click here to read more about what it takes to confirm a plan.
In re Meridian Sunrise Village, LLC, 2014 WL 909219 (W.D. Wash), a recent bankruptcy case, highlights a couple of risks Fund should be aware of.
Putting the bottom line up front (“BLUF” for readers who are former military), the take-aways for Fund from Meridian Sunrise are:
Meridian Sunrise Village, LLC borrowed $75 million from U.S. Bank for the construction of a shopping center in Washington state. U.S. Bank assigned portions of the debt to other lenders, including Bank of America, thus creating a lending group, with U.S. Bank as agent for the lending group.
Agent later declared a non-monetary default of a debt coverage covenant in the loan agreement. After Agent threatened to enforce the rights of the lending group, including charging default interest, Meridian filed a bankruptcy petition in the Western District of Washington.
The Debtor quickly proposed a reorganization plan. The plan placed the lending group into one claims class, and provided for one vote for each of the four members of that class.
Before the plan could be voted on, BofA assigned all of its interest to NB Distressed Debt Limited Fund (“NBDDL”), which then assigned parts of its interest to Strategic Value Special Situations Master Fund II, L.P. (“SVP”) and to NB Distressed Debtor Master Fund LP (“NBMF” and, collectively with NBDDL and SVP, the “Funds”).
As three entities, the Funds appeared to have three votes among themselves, leaving three votes for the remaining lending group members. With three votes among them, the Funds would have a blocking position, because no majority of votes in the class could prevail against the Funds’ three votes against confirmation of the plan. With a blocking position, the Funds could thwart Debtor’s confirmation of the plan or permit it for a price.
Debtor sued the Funds for declaratory judgment and permanent injunctive relief, and moved for a preliminary injunction to prevent the Funds from, among other things, voting on the plan. The Bankruptcy Court granted the injunction and, on appeal, the District Court affirmed the Bankruptcy Court’s ruling. The plan was confirmed without the Funds voting on it. The Funds’ bid for control of the process was foiled.
Both the Bankruptcy Court’s ruling and the District Court’s affirmance of that ruling hinged on the provision in the underlying Loan Agreement that limited U.S. Bank’s ability (and, ultimately that of any member of the lending group) to assign the loan to other entities. The provision barred any transfer or assignment of any portion of the loan to an entity other than an “Eligible Assignee.” An Eligible Assignee was defined in the Loan Agreement to mean, “any Lender or affiliate of any Lender or any commercial bank, insurance company, financial institution or institutional lender [approved by Agent or, if there is no default, and approved by Meridian]” (emphasis added). [i]
The Funds argued that the words “financial institution” included the Funds. Applying interpretive rules of Washington state law (which included consideration of the context of the words of the agreement, plus the parties’ post-agreement behavior), the Bankruptcy Court and later the District Court each concluded that the Loan Agreement required that any Eligible Assignee, including any “financial institution,” must be in the business of lending money. The courts held that the Funds were not Eligible Assignees because they were not principally in the business of lending money (a fact the Funds did not dispute). The District Court described the Funds as, “broadly, hedge Funds that acquire distressed debt and engage in predatory lending” (emphasis added).[ii]
At the close of its opinion, in a discussion not necessary for its affirmance of the Bankruptcy Court’s order, the District Court commented that even if the Funds had been Eligible Assignees, they should have had only one vote. The court noted that: (i) the Debtor organized a plan class that included the four members of the lending group (U.S. Bank and the three lenders to which U.S. Bank had assigned partial interests in the loan); and (ii) the three Funds’ interests in the loan stemmed from (and purportedly replaced) BofA’s interest. The District Court declared: “A creditor does not have the right to split up a claim in such a way that artificially creates voting rights that the original assignor never had. If the Funds’ reading was correct, any voter could veto the Plan by assigning its claim to enough assignees.”[iii]
[i][ii]forced Meridian into a non-monetary default. Id. (emphasis added) The Bankruptcy Court made no such finding and no such evidence was taken by the District Court.
Mr. Cahill is counsel with Lowis & Gellen LLP, in Chicago, Illinois. He guides secured lenders, creditors, debtors, creditors’ committees, potential purchasers and others through bankruptcy cases, out-of-court workouts, assignments for the benefit of creditors, and receiverships. Mr. Cahill has substantial mega-case experience at national law firms representing very large debtors, and has counseled and…
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