This post was written by Michael J. Venditto, a partner in Reed Smith's Commercial Restructuring & Bankruptcy department. A special thanks to Mike for contibuting to the lending lawyer blog!
If you have negotiated an intercreditor agreement, you are familiar with the lengthy bankruptcy waivers typically drafted by counsel for first-lien lenders. Intended to take effect if the borrower files a bankruptcy case, these provisions commonly include advance waivers (e.g., of the junior lender’s right to seek adequate protection of its interest in the common collateral), advance consents (e.g., to the priming of the junior lender’s liens by any debtor-in-possession financing provided by the senior lender) and plan support provisions (e.g., an agreement that the junior lender will not support a plan opposed by the senior lender), to name a few in a long list.
Many of these provisions, in addition to being lengthy, are heavily negotiated. So, it is appropriate to wonder if they actually work. There are surprisingly few rulings analyzing these provisions and, to the extent that courts have ruled on their enforceability, the results are mixed.
Section 510(a) of the Bankruptcy Code provides 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.”
Some courts have followed the plain language of the statute and enforced intercreditor agreements according to their terms. Other courts interpret the statute more narrowly, viewing section 510(a) as applying only to a consensual alteration of the priority of payment amongst creditors but not allowing them to alter the parties’ rights under the bankruptcy laws. This uncertainty has given second-lien lenders some leverage. After agreeing to bankruptcy waivers in an intercreditor agreement, they challenge the enforceability of these provisions following the commencement of a chapter 11 case by the borrower.
The problem is illustrated by looking at decisions on bankruptcy voting provisions. Is a provision that transfers the second-lien creditor’s right to vote to accept or reject a proposed reorganization plan enforceable? In one heavily cited decision, In re 203 North LaSalle Street Partnership, 246 B.R. 325 (Bkrtcy. N.D. Ill. 2000), a bankruptcy judge said no, ruling that an intercreditor provision giving the senior lender the right to vote the subordinated lender’s claim was not enforceable on the reasoning that it was inconsistent with Bankruptcy Code § 1126(a), which governs class voting. But, some more recent cases have given effect to these provisions. In re Coastal Broadcasting Systems, Inc., 2012 WL 2803745 (Bkrtcy. D.N.J. July 6, 2012) held that the assignment of voting rights was unambiguous and its enforcement was “necessary to prevent junior creditors from receiving windfalls after having explicitly agreed to accept less lucrative payment arrangements.” Using a different rationale, another court found that a voting provision was enforceable because the junior lender had made the senior lender its agent for purposes of voting (see, e.g., In re Aerosol Packaging, LLC, 362 B.R. 43, 47 (Bkrtcy. N.D. Ga 2006), holding that the right to vote any claim in the borrower’s bankruptcy had been assigned to the senior lender with the result that it could vote the claim and take other actions in support of its own interests even if they were potentially contrary to the wishes and immediate interests of the second-lien lender).
Is there a discernable trend toward giving effect to these bankruptcy-voting provisions? Not really. Some decisions evidence a sentiment that sophisticated parties should be held to pre-petition agreements that are intended to streamline a chapter 11 case. See, e.g., Ion Media Networks, Inc. v. Cyrus Select Opportunities Master Fund, Ltd (In re Ion Media Networks, Inc.), 419 B.R. 585 (Bkrtcy. S.D.N.Y. 2009) (“plainly worded contracts establishing priorities and limiting obstructionist, destabilizing and wasteful behavior should be enforced and creditor expectations should be appropriately fulfilled.”). However, bankruptcy courts are protective of the rights of all parties to be heard and will not enforce bankruptcy waivers unless they are clear. In re Boston Generating LLC, 440 B.R. 302, 320 (Bankr. S.D.N.Y. 2010) (“Although I believe it goes against the spirit of the subordination scheme in the Intercreditor Agreement to allow the Second Lien Lenders to be heard and to attempt to block the disposition of the Collateral supported by the First Lien Agent, I am … constrained by the language of the Intercreditor Agreement. After extensive briefing and oral argument as well as detailed review of the Intercreditor Agreement, the Court finds no provision which can be read to reflect a waiver of the Second Lien Agent’s right to object ….”).
The case law on the enforceability of intercreditor provisions that go beyond mere lien and payment subordination remains unsettled. Nevertheless, these provisions are an important element of intercreditor agreements and first-lien lenders will not, and should not, be willing to eliminate them.