Intercreditor Agreements

Editor's Note: This is the fourth article in a series covering various aspects of intercreditor agreements.

My least favorite season is upon us. No, I am not talking about spring (or summer). I do not refer to the seemingly endless NBA and NHL playoffs. And, while afflicted thereby, I did not have in mind the continual onslaught of airborne allergens. Rather, it is once again electoral season in most parts of America.

The airwaves are full of countless advertisements canonizing some candidates and demonizing others. Numerous dinners are being interrupted with informal surveys and robocalls. Yards and streets are teeming with signs promoting certain individuals or ballot initiatives.

Yet, despite all of these nuisances, I am looking forward to filling out my ballot, especially with regard to local candidates and issues. I talk to our children about the importance of voting and voting rights and why I choose to exercise the latter (though, as my parents did, I refuse to tell them for whom or what I may have voted).

Voting Rights

Voting rights ' or, rather, the assignability thereof in connection with confirmation of a bankruptcy plan or reorganization ' have become a contested issue as well. Over the past few years, courts have come down on both sides of the issue, thus creating uncertainty as to the status of a subordinate creditor's assignment of voting rights in the context of a bankruptcy proceeding.

In a typical intercreditor agreement, especially in the case of a first lien-second lien financing structure, a subordinate creditor will agree that its lien on certain collateral is junior in priority to the lien of a senior creditor. Furthermore, the junior creditor will agree to “standstill” provisions (limiting the ability of the junior creditor to foreclose on the collateral), and the junior creditor will agree to a host of other items, including an assignment to the senior creditor of the junior creditor's rights to vote in a Chapter 11 bankruptcy plan of reorganization.

Boston Hotel

In re SW Boston Hotel Venture, LLC, 460 B.R. 38 (Bankr. D. Mass. 2011) held that an assignment of voting rights in an intercreditor agreement was not enforceable. In Boston Hotel, all creditors except one, Prudential Insurance Company of America, voted in favor of a plan of reorganization. The City of Boston, another creditor in the Boston Hotel case, had entered into an intercreditor agreement with Prudential whereby the City assigned to Prudential its right to vote on any Chapter 11 bankruptcy plan of reorganization. Prudential sought to recast the vote of the City to be against the plan of reorganization based on this assignment.

The Boston Hotel court found, among other things, that the assignment was unenforceable. The court noted that Section 510(a) of the Bankruptcy Code stated subordination agreements were enforceable in bankruptcy proceedings (to the extent enforceable under state law). However, following the reasoning of In re N. Lasalle Street P'ship, 246 B.R. 325 (Bankr. N.D. Ill. 2000), the Boston Hotel court found that Section 510(a) applied only to the subordination of the lien, and that attempts to assign voting rights were contrary to Section 1126 of the Bankruptcy Code. Section 1126(a) states, in part, that “The holder of a claim or interest allowed under section 502 of this title may accept or reject a plan ' .” As the City held the claim, the City had the right to accept or reject the plan. Thus, the City's vote in favor of the plan of reorganization was valid. Absent specific language authorizing a waiver of Section 1126 rights, the court was unwilling to interpret the language of Section 510(a) to include voting rights. [Note: The Boston Hotel decision was recently reversed by the First Circuit. The Prudential Insurance Company of America v. City of Boston, 12-9008 (1st Cir. Apr. 11, 2014). However, the reversal was on grounds unrelated to the lower court decision on the assignability of voting rights.]

Croatan Surf Club

Similarly, In re Croatan Surf Club, LLC, No. 11-00194-8-SWH, 2011 WL 5909199 (Bankr. E.D.N.C. Oct. 25, 2011), held that a purported assignment of voting rights on a plan of bankruptcy reorganization was unenforceable. In Croatan Surf Club , two creditors, Royal Bank of America and Edwards Family Partnership, LP, entered into a subordination and intercreditor agreement. In the agreement, Edwards Family Partnership granted Royal Bank of America the right to file proofs of claim on behalf of the Partnership and to vote on the subordinated indebtedness of the Partnership in the event of a bankruptcy filing by Croatan Surf Club. When the latter filed for Chapter 11 bankruptcy, Royal Bank of America filed a proof of claim on behalf of Edwards Family Partnership and voted to reject Edwards Family Partnership's treatment under the proposed plan of reorganization. Edwards Family Partnership filed its own proof of claim and voted to accept its treatment under the plan.

The Croatan Surf Club court acknowledged that the subordination agreement was enforceable under state law and, accordingly, in the bankruptcy. However, the court indicated that Section 510(a) of the Bankruptcy Code was not an implicit avenue to circumvent other provisions of the Bankruptcy Code. Specifically, the court stated that Section 1129(b) of the Bankruptcy Code grants a court the power to confirm a plan so long as the plan “[n]otwithstanding section 510(a) ' does not discriminate unfairly, and is fair and equitable.” The court determined that the “[n]otwithstanding section 510(a)” language in Section 1129(b) permitted a bankruptcy court to approve a plan with lien priority that differs from the priority in an intercreditor agreement (as long as the plan is fair and equitable and does not discriminate unfairly). Thus, an intercreditor agreement does not trump the Bankruptcy Code.

The court then stated that Section 510(a) did not overrule Section 1126(a) and that only the holder of a claim may vote the claim in a bankruptcy proceeding. Since Edwards Family Partnership held the claim, only Edwards Family Partnership could vote the claim. Finally, the court ruled that Bankruptcy Rule 3018(c), allowing an authorized agent of a claimholder to submit a ballot, did not apply because Royal Bank of America was not an agent. Royal Bank of America would be acting in its own interest and not in the interest of its purported principal, Edwards Family Partnership.

Case Law

As noted above, there is case law deciding that assignments of voting rights in an intercreditor agreement are enforceable. Blue Ridge Investors, II, LP v. Wachovia Bank, N.A. ( In re Aerosol Packaging, LLC), 362 B.R. 43 (Bankr. N.D. Ga. 2006), held that a pre-petition assignment of voting rights on a plan of bankruptcy reorganization was enforceable. In Aerosol Packaging , Blue Ridge Investors II Limited Partnership and Wachovia Bank, National Association, both creditors of Aerosol Packaging, executed a subordination agreement, whereby Blue Ridge granted to Wachovia broad rights to act on its behalf, even if such actions were to the detriment of the latter. These rights included the right to vote the claims of Blue Ridge.

The Aerosol Packaging court decided that the N. Lasalle case cited above was not persuasive. The court held that, while Section 1126(a) of the Bankruptcy Code stated who was entitled to vote a claim, Section 1126(a) did not expressly or implicitly prevent the claimholder from delegating or assigning that right. Since the subordination agreement was enforceable under state law, the court ruled that the assignment was enforceable. Additionally, the court cited Bankruptcy Rules 3018 and 9010 as expressly permitting agents and other representatives to take action ' including voting action ' on behalf of parties. The court likened Wachovia to a real estate lender executing a deed as the agent for a borrower under power of sale to convey title to foreclosed property. Even though Wachovia would be acting in its own interest, it was still acting as agent of Blue Ridge.

Similarly, Avondale Gateway Center Entitlement, LLC v. National Bank of Arizona (In re Avondale Gateway Center Entitlement, LLC), CV-10-1772-PHX-DGC, 02-09-BK-12153-CGC, 2011 WL 1376997 (D. Ariz. April 12, 2011) held that a subrogation clause in an intercreditor agreement effectively assigned the voting rights from a junior creditor to a senior creditor. Avondale Gateway, National Bank of Arizona and MMA Realty Capital entered into a subordination and intercreditor agreement. Unlike other cases, the agreement did not contain an outright assignment of voting rights. Rather, the agreement contained a subrogation clause that subrogated all of MMA Realty's claims, rights, liens and security interests to those of National Bank of Arizona until it had been paid in full. The bankruptcy court permitted National Bank of Arizona to cast two votes in connection with Avondale Gateway's plan of reorganization, one on its own behalf and one on behalf of MMA Realty. The bankruptcy court held that the subrogation clause authorized National Bank of Arizona to vote on behalf of MMA Realty.

The district court affirmed the decision of the bankruptcy court. First, the court noted that the subrogation clause did not contain an express assignment of voting rights. Then the court classified a bankruptcy claim as a right to payment and that voting rights, while not claims per se , were derivative rights held by holders of claims. The district court finally turned to subrogation, determining that subrogation is the substitution of one party for another with respect to a claim. In a subrogation, the subrogating party steps into the shoes of the party being subrogated, thus assuming all of the rights of the party being subrogated. Since MMA Realty agreed to be subrogated to National Bank of Arizona, National Bank of Arizona was entitled to exercise the voting rights of MMA Realty with respect to Avondale Gateway's plan of reorganization.

Conclusion

Much like the current state of American politics, American courts are deeply divided on the issue of the assignability of voting rights in connection with a bankruptcy plan or reorganization. Similarly, much like American politics, there does not appear to be a definitive resolution of this issue in the near future.

Sean M. Gillen is a partner in the Omaha, NE, office of Kutak Rock LLP. He can be reached at [email protected].

Editor's Note: This is the fourth article in a series covering various aspects of intercreditor agreements.

My least favorite season is upon us. No, I am not talking about spring (or summer). I do not refer to the seemingly endless NBA and NHL playoffs. And, while afflicted thereby, I did not have in mind the continual onslaught of airborne allergens. Rather, it is once again electoral season in most parts of America.

The airwaves are full of countless advertisements canonizing some candidates and demonizing others. Numerous dinners are being interrupted with informal surveys and robocalls. Yards and streets are teeming with signs promoting certain individuals or ballot initiatives.

Yet, despite all of these nuisances, I am looking forward to filling out my ballot, especially with regard to local candidates and issues. I talk to our children about the importance of voting and voting rights and why I choose to exercise the latter (though, as my parents did, I refuse to tell them for whom or what I may have voted).

Voting Rights

Voting rights ' or, rather, the assignability thereof in connection with confirmation of a bankruptcy plan or reorganization ' have become a contested issue as well. Over the past few years, courts have come down on both sides of the issue, thus creating uncertainty as to the status of a subordinate creditor's assignment of voting rights in the context of a bankruptcy proceeding.

In a typical intercreditor agreement, especially in the case of a first lien-second lien financing structure, a subordinate creditor will agree that its lien on certain collateral is junior in priority to the lien of a senior creditor. Furthermore, the junior creditor will agree to “standstill” provisions (limiting the ability of the junior creditor to foreclose on the collateral), and the junior creditor will agree to a host of other items, including an assignment to the senior creditor of the junior creditor's rights to vote in a Chapter 11 bankruptcy plan of reorganization.

Boston Hotel

In re SW Boston Hotel Venture, LLC, 460 B.R. 38 (Bankr. D. Mass. 2011) held that an assignment of voting rights in an intercreditor agreement was not enforceable. In Boston Hotel, all creditors except one, Prudential Insurance Company of America, voted in favor of a plan of reorganization. The City of Boston, another creditor in the Boston Hotel case, had entered into an intercreditor agreement with Prudential whereby the City assigned to Prudential its right to vote on any Chapter 11 bankruptcy plan of reorganization. Prudential sought to recast the vote of the City to be against the plan of reorganization based on this assignment.

The Boston Hotel court found, among other things, that the assignment was unenforceable. The court noted that Section 510(a) of the Bankruptcy Code stated subordination agreements were enforceable in bankruptcy proceedings (to the extent enforceable under state law). However, following the reasoning of In re N. Lasalle Street P'ship, 246 B.R. 325 (Bankr. N.D. Ill. 2000), the Boston Hotel court found that Section 510(a) applied only to the subordination of the lien, and that attempts to assign voting rights were contrary to Section 1126 of the Bankruptcy Code. Section 1126(a) states, in part, that “The holder of a claim or interest allowed under section 502 of this title may accept or reject a plan ' .” As the City held the claim, the City had the right to accept or reject the plan. Thus, the City's vote in favor of the plan of reorganization was valid. Absent specific language authorizing a waiver of Section 1126 rights, the court was unwilling to interpret the language of Section 510(a) to include voting rights. [Note: The Boston Hotel decision was recently reversed by the First Circuit. The Prudential Insurance Company of America v. City of Boston, 12-9008 (1st Cir. Apr. 11, 2014). However, the reversal was on grounds unrelated to the lower court decision on the assignability of voting rights.]

Croatan Surf Club

Similarly, In re Croatan Surf Club, LLC, No. 11-00194-8-SWH, 2011 WL 5909199 (Bankr. E.D.N.C. Oct. 25, 2011), held that a purported assignment of voting rights on a plan of bankruptcy reorganization was unenforceable. In Croatan Surf Club , two creditors, Royal Bank of America and Edwards Family Partnership, LP, entered into a subordination and intercreditor agreement. In the agreement, Edwards Family Partnership granted Royal Bank of America the right to file proofs of claim on behalf of the Partnership and to vote on the subordinated indebtedness of the Partnership in the event of a bankruptcy filing by Croatan Surf Club. When the latter filed for Chapter 11 bankruptcy, Royal Bank of America filed a proof of claim on behalf of Edwards Family Partnership and voted to reject Edwards Family Partnership's treatment under the proposed plan of reorganization. Edwards Family Partnership filed its own proof of claim and voted to accept its treatment under the plan.

The Croatan Surf Club court acknowledged that the subordination agreement was enforceable under state law and, accordingly, in the bankruptcy. However, the court indicated that Section 510(a) of the Bankruptcy Code was not an implicit avenue to circumvent other provisions of the Bankruptcy Code. Specifically, the court stated that Section 1129(b) of the Bankruptcy Code grants a court the power to confirm a plan so long as the plan “[n]otwithstanding section 510(a) ' does not discriminate unfairly, and is fair and equitable.” The court determined that the “[n]otwithstanding section 510(a)” language in Section 1129(b) permitted a bankruptcy court to approve a plan with lien priority that differs from the priority in an intercreditor agreement (as long as the plan is fair and equitable and does not discriminate unfairly). Thus, an intercreditor agreement does not trump the Bankruptcy Code.

The court then stated that Section 510(a) did not overrule Section 1126(a) and that only the holder of a claim may vote the claim in a bankruptcy proceeding. Since Edwards Family Partnership held the claim, only Edwards Family Partnership could vote the claim. Finally, the court ruled that Bankruptcy Rule 3018(c), allowing an authorized agent of a claimholder to submit a ballot, did not apply because Royal Bank of America was not an agent. Royal Bank of America would be acting in its own interest and not in the interest of its purported principal, Edwards Family Partnership.

Case Law

As noted above, there is case law deciding that assignments of voting rights in an intercreditor agreement are enforceable. Blue Ridge Investors, II, LP v. Wachovia Bank, N.A. ( In re Aerosol Packaging, LLC), 362 B.R. 43 (Bankr. N.D. Ga. 2006), held that a pre-petition assignment of voting rights on a plan of bankruptcy reorganization was enforceable. In Aerosol Packaging , Blue Ridge Investors II Limited Partnership and Wachovia Bank, National Association, both creditors of Aerosol Packaging, executed a subordination agreement, whereby Blue Ridge granted to Wachovia broad rights to act on its behalf, even if such actions were to the detriment of the latter. These rights included the right to vote the claims of Blue Ridge.

The Aerosol Packaging court decided that the N. Lasalle case cited above was not persuasive. The court held that, while Section 1126(a) of the Bankruptcy Code stated who was entitled to vote a claim, Section 1126(a) did not expressly or implicitly prevent the claimholder from delegating or assigning that right. Since the subordination agreement was enforceable under state law, the court ruled that the assignment was enforceable. Additionally, the court cited Bankruptcy Rules 3018 and 9010 as expressly permitting agents and other representatives to take action ' including voting action ' on behalf of parties. The court likened Wachovia to a real estate lender executing a deed as the agent for a borrower under power of sale to convey title to foreclosed property. Even though Wachovia would be acting in its own interest, it was still acting as agent of Blue Ridge.

Similarly, Avondale Gateway Center Entitlement, LLC v. National Bank of Arizona (In re Avondale Gateway Center Entitlement, LLC), CV-10-1772-PHX-DGC, 02-09-BK-12153-CGC, 2011 WL 1376997 (D. Ariz. April 12, 2011) held that a subrogation clause in an intercreditor agreement effectively assigned the voting rights from a junior creditor to a senior creditor. Avondale Gateway, National Bank of Arizona and MMA Realty Capital entered into a subordination and intercreditor agreement. Unlike other cases, the agreement did not contain an outright assignment of voting rights. Rather, the agreement contained a subrogation clause that subrogated all of MMA Realty's claims, rights, liens and security interests to those of National Bank of Arizona until it had been paid in full. The bankruptcy court permitted National Bank of Arizona to cast two votes in connection with Avondale Gateway's plan of reorganization, one on its own behalf and one on behalf of MMA Realty. The bankruptcy court held that the subrogation clause authorized National Bank of Arizona to vote on behalf of MMA Realty.

The district court affirmed the decision of the bankruptcy court. First, the court noted that the subrogation clause did not contain an express assignment of voting rights. Then the court classified a bankruptcy claim as a right to payment and that voting rights, while not claims per se , were derivative rights held by holders of claims. The district court finally turned to subrogation, determining that subrogation is the substitution of one party for another with respect to a claim. In a subrogation, the subrogating party steps into the shoes of the party being subrogated, thus assuming all of the rights of the party being subrogated. Since MMA Realty agreed to be subrogated to National Bank of Arizona, National Bank of Arizona was entitled to exercise the voting rights of MMA Realty with respect to Avondale Gateway's plan of reorganization.

Conclusion

Much like the current state of American politics, American courts are deeply divided on the issue of the assignability of voting rights in connection with a bankruptcy plan or reorganization. Similarly, much like American politics, there does not appear to be a definitive resolution of this issue in the near future.

Sean M. Gillen is a partner in the Omaha, NE, office of Kutak Rock LLP. He can be reached at [email protected].