Loss of Voting Rights Must Be Expressly Stated to Be Enforceable, District Judge Says

Upholding an opinion by Bankruptcy Judge Robert D. Drain, District Judge Nelson S. Román of White Plains, N.Y., ruled that an intercreditor agreement must expressly bar second-lien lenders from voting before the junior creditors can be prevented from approving a chapter 11 plan and enabling the debtor to confirm the plan over the first-lien lenders’ objection.

Judge Román’s opinion is the latest installment in the protracted fight over the reorganization of MPM Silicones, also known as Momentive Performance. The case began with a chapter 11 filing in April 2014 and ostensibly concluded with confirmation of a plan in September 2014. The plan was consummated the next month.

First-lien bondholders and second-lien bondholders were at war. They shared the same collateral. The subordinated lenders were sponsors of the plan that the senior lenders vigorously opposed. The common collateral was sufficient to cover the senior debt but not the second-lien bonds.

Among other things, the senior creditors claimed that the indenture entitled them to a so-called makewhole premium, designed to compensate them for being forced to reinvest at a lower rate of interest because the debt was repaid before maturity.

The Plan

The plan gave the senior lenders an option: They could forsake the makewhole premium in return for payment in cash, in full, on confirmation. Or, if they rejected the plan (which is what they did), they would be given new secured notes for the full amount of the debt at an interest rate that turned out to be below market. By rejecting, the senior lenders had the right to continue litigating for the makewhole.

The plan gave new stock to the junior secured lenders in return for their debt. They voted for the plan, enabling Bankruptcy Judge Drain to confirm the plan over the senior lenders’ “no” vote. Judge Drain ruled that the senior lenders were not entitled to the makewhole premium.

The Second Circuit upheld confirmation in October 2018. Splitting with the Third Circuit, the Second Circuit ruled that automatic acceleration resulting from a chapter 11 filing did not entitle secured creditors to the makewhole premium. To read ABI’s discussion of the opinion, click here.

The Intercreditor Litigation

The disputes were not over when the Second Circuit upheld the plan, because the senior lenders had sued the junior bondholders in state court, alleging that the subordinated lenders breached the intercreditor agreement between the two groups.

Oversimplified, the senior lenders’ complaint alleged that the subordinated bondholders breached the intercreditor agreement by voting in favor of the plan before the senior lenders had been paid in full, in cash.

The senior lenders’ contentions were based on several provisions in the intercreditor agreement. One provided that the junior lenders would not “hinder any exercise of remedies undertaken” by the senior lenders until the senior lenders were paid in full. Another provision waived the junior bondholders’ rights “to object to the manner in which the [senior lenders] seek to enforce or collect” their claims.

The senior lenders’ complaint in state court argued that the junior bondholders had hindered the enforcement of their remedies, and therefore breached the intercreditor agreement, by voting and enabling confirmation of the plan.

The junior lenders removed the suit to federal court, where it was referred to Bankruptcy Judge Drain, who subsequently dismissed the complaint for failure to state a claim. Judge Román upheld dismissal in his 53-page opinion on November 30.

Judge Román’s Opinion

The handwriting was on the wall when Judge Román found a “growing consensus . . . that agreements that seek to limit or waive junior noteholders’ voting rights must contain express language to that effect.” [Emphasis in original.] However, he did not base his decision on precedent. Instead, he meticulously dissected the intercreditor agreement and declined to base his ruling just on the dictionary meaning of the word “hinder.”

Looking at all of the potentially relevant provisions in the indenture, Judge Román found “no express waiver or specific constricting language” barring the junior bondholders from voting. The provision prohibiting the junior lenders from hindering the exercise of the senior lenders’ remedies, he said, “was not intended to mean that the [junior lenders] were waiving all the voting rights that they are otherwise entitled to under bankruptcy law.”

Like Judge Drain, Judge Román also concluded that the indenture did not require the junior lenders to turn over the new stock to the senior lenders, because the new stock was not proceeds of the shared collateral. According to Judge Román, the collateral was intact, since it continued to secure the new debt that the senior lenders received on confirmation.

Because the shared collateral was insufficient to pay the junior lenders in full, they had rights as unsecured creditors alongside their rights as secured lenders, Judge Román said. In turn, nothing in the intercreditor agreement barred the junior lenders from exercising their rights as unsecured creditors, including the right to vote on the plan.

This discussion only scratches the surface of the myriad subordination issues covered by Judge Román. To draft an intercreditor agreement with a “deep” subordination that will hold up in court, use Judge Román’s opinion as a roadmap.