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Subordination Agreements: Enforcement and Reorganization Participation
Section 510 of the Bankruptcy Code recognizes that agreements between creditors of a debtor that one creditor's claim will be subordinated in payment to another creditor's claim will be enforceable in a bankruptcy case. As is often the case, over the years bankruptcy and finance practitioners expanded the concept of payment subordination in these agreements to include many terms anticipating any and every action and right the subordinated creditor may take or have in the bankruptcy case. So what provisions in a subordination agreement can be enforced, and can the subordinated creditor participate in the reorganization process if there is no prospect it will receive any distribution as a result of being subordinated?
These issues were addressed by Chief Bankruptcy Judge Dale L. Somers of the U.S. Bankruptcy Court for the District of Kansas in In re Fencepost Productions, Case No. 19-41545 (Bankr. D. Kan. Mar. 31, 2021). The court held that provisions in the subordination agreements that provided for the transfer of subordinated creditors' bankruptcy voting rights were unenforceable, but also held that because they were out of the money, the subordinated creditors did not have standing to object to the plan.
Deeply Subordinated Junior Creditors Sought to Assert Claims and Participate In Plan Process
According to the opinion, Associated Bank, N.A. (Associated) was the debtors' principal creditor, having provided a secured loan of up to $14 million. Associated and creditors BMS Management Inc. and related individuals (collectively, BMS) entered into subordination agreements that provided, among other things, that the payment of all of the debtors' obligations to BMS was postponed and subordinated to the payment in full in cash of all of the debtors' obligations to Associated. Further, in the event of a bankruptcy filing, all payments on account of the BMS obligations would be paid to Associated, Associated was authorized to vote for the debtors' bankruptcy plan with respect to BMS claims against the debtors, and BMS was prohibited from filing any motion or other pleadings or otherwise taking any action contrary to the priorities and other rights of Associated provided in the subordination agreements.
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