Thursday, July 28, 2011

Enforcement of Intercreditor Agreements In Bankruptcy

Enforceability of pre-petition Intercreditor Agreements in bankruptcy has drawn more attention with the increase in restructurings in bankruptcy in the wake of a troubled business climate. Of course, both first priority lenders and second priority lenders both desire protection during a restructuring. Not surprisingly, many lending arrangements involving multiple lenders take into account the potential of disputes and bankruptcy. Section 510(a) of the Bankruptcy Code upholds these arrangements providing that "[a] subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law." When it comes to subordination agreements during bankruptcy reorganizations, though, this provision must be read alongside the power of the bankruptcy court to confirm plans under §1129, approve sales under §363(b) and the mandate that the court appoint examiners in certain cases under §1104(c). Accordingly, whether, and to what extent, an intercreditor agreement falls under the protections of 510(a) and the authority of the bankruptcy court under other provisions has been the subject of several recent cases illustrating the limits of parties’ abilities to make arrangements prior to bankruptcy.

In one recent case, the Bankruptcy Court for the Southern District of New York acknowledged that a second priority lender had standing to object to a proposed sale of assets despite the existence of an intercreditor agreement, but concluded that a secondary lender could not prevent a sale of assets that is supported by “good business reason[s].” In re Boston Generating, LLC, 440 B.R. 302 (Bankr. S.D.N.Y. 2010)(concerned a proposed sale of assets in bankruptcy of a power plant that provides electricity to the Boston, Massachusetts area to a buyer who would take the assets free and clear of creditors’ claims). See also, In re GMC, 407 B.R. 463, 498 (Bankr. S.D.N.Y. 2010)(“[t]his is hardly the first time that this Court has seen creditors risk doomsday consequences to increase their incremental recoveries, and this court – which is focused on preserving and maximizing value, allowing suppliers to survive, and helping employees keep their jobs – is not of a mind to jeopardize all of those goals.”). Ultimately, the court determined that “[t]he Debtors’ assets are simply being sold; the First Lien Lenders will receive most of the proceeds in accordance with their lien priority; and the remaining consideration will be subsequently distributed under a plan."

In another recent case, the the United States Bankruptcy Court for the District of New Jersey held that a court can irrespective of a prepetition subordination agreement confirm a nonconsensual bankruptcy reorganization plan that meets the requirements of §1129(a). In re TCI Holdings, LLC, 428 B.R. 117 (Bankr. D.N.J. 2010)(when “the requirements of section (a) and (b) of [1129] are met with respect to more than one plan, the court shall consider the preferences of creditors and equity security holders in determining which plan to confirm.”). Essentially, the bankruptcy judge acts as a tiebreaker where the parties to the dispute are unable to negotiate an agreement among the competing interests at stake.

The treatment of intercreditor agreements by courts has important implications for lenders when it comes to drafting these agreements. Basically, attorneys should be mindful that general contract principles control issues such as interpretation of agreements and waiver even in the context of bankruptcy. See, e.g., In re Erickson Ret. Cmtys., LLC, 425 B.R. 309, 316 (Bankr. N.D. Tex. 2010)(“Michigan Retirement System Entities are sophisticated commercial entities who knowingly waived all legal and statutory rights that would be in conflict with their obligation to "standstill" until the Ashburn and Concord Project Lenders' indebtedness is paid in full.”). The In re Boston Generating court’s holding that a second lien holder has standing to object to the sale of assets in bankruptcy is a reminder to counsel that if a waiver of such rights is desired, it should be expressly and clearly stated in the agreement. Notwithstanding this holding, bankruptcy courts will enforce waivers when clearly stated in the intercreditor agreement. In re Erickson Ret. Cmtys., LLC, 425 B.R. at 316.

These cases as a whole serve to remind us that these disputes during bankruptcy typically revolve around creditors seeking to enhance returns even in the face of an intercreditor agreement that states otherwise. Pre-bankruptcy lender agreements are typically designed to ensure that lenders obtain specified restructuring benefits. The cases demonstrate that despite the involvement of legal counsel, agreements between lenders are commonly ambiguous and create interpretation issues which can lead to the delay of reorganization plans of the debtor, sales of assets and other bankruptcy decisions that preserve the value of the debtor’s assets. As I remind my students often, clarity in contract language at the outset, when possible, will speed up the resolution of disputes later.