In a typical chapter 11 reorganization, distributions to secured creditors are not distributions of collateral, at least when there is no sale, according to the Third Circuit. Furthermore, undersecured creditors are not entitled to post-petition interest when calculating the distributions among creditors secured by the same collateral, the appeals court held.
Although rulings are critical for corporate reorganizations in Delaware, the June 19 decision by Circuit Judge Stephanos Bibas was nonprecedential. The opinion puts Delaware firmly in line with New York.
The Energy Future Noteholders
Two groups of Energy Future noteholders had liens on the same collateral. The notes were issued four years apart, and the more recently issued notes carried a higher rate of interest. The two noteholder groups were undersecured.
The issuer, Energy Future, filed a chapter 11 petition and confirmed a reorganization plan that distributed cash, stock and the right to tax benefits to the noteholders. In deciding how to split up the plan distribution, the holders of the more recently issued notes contended that the intercreditor agreement called for calculating how much would be owed to the two noteholder groups at the time of distribution.
If hypothetical post-petition interest accruals were included in the calculation, the holders of the more recently issued notes would receive a larger distribution by $90 million.
The two noteholder groups duked it out before Bankruptcy Judge Christopher S. Sontchi of Delaware, who ruled on a motion to dismiss in favor of the holders of the older notes and held that the holders of the newer notes were not entitled to the additional $90 million. To read ABI’s reports on Judge Sontchi’s opinions, click here and here.
The district court upheld Judge Sontchi, prompting the holders of the recently-issued notes to appeal to the Third Circuit.
The Intercreditor Agreement Didn’t Apply
The intercreditor agreement between the noteholder groups contained a waterfall provision that would arguably give the additional $90 million to the holders of the newer notes because it allegedly required the inclusion of hypothetical post-petition interest in the calculation.
Judge Bibas explained that the waterfall “does not govern every asset the creditors receive.” Quoting the waterfall provision, he said it applies to “‘Collateral or any proceeds thereof received in connection with the sale or other disposition of . . . Collateral upon the exercise of remedies . . . by the Collateral Agent.’”
The noteholders were fighting over two types of distributions: The consideration handed out by the plan and adequate protection payments made throughout the course of the reorganization. Neither fell under the waterfall, Judge Bibas said.
“The waterfall provision would apply to the adequate protection payments and plan distributions if they were collateral. But they are not,” Judge Bibas ruled.
Conceding that the noteholders held liens on essentially all of the debtor’s assets, Judge Bibas nonetheless said that “not every payment from the subsidiary’s assets is a payment of collateral.” A payment of collateral reduces the debt, but neither the plan distribution nor the adequate protections payments reduced debt.
The adequate protection payments were for the use of collateral, but did not reduce the debt, Judge Bibas said. Judge Sontchi therefore correctly held, according to Judge Bibas, that the adequate protection payments were not payments of collateral.
With regard to the plan distributions, they were not made from assets on which the noteholders held liens. Instead, they derived from assets created by the plan over which the noteholders did not hold liens. Judge Bibas said, “plan distributions are not distributions of collateral,” citing Section 552(a), which generally cuts off the attachment of prepetition liens to property acquired after filing.
Even if the distributions were collateral, the waterfall still would not apply for a second reason, Judge Bibas explained.
For the waterfall to kick in, the intercreditor agreement imposed two requirements: (1) The proceeds must arise from the sale or disposition of collateral; and (2) The sale or disposition of collateral must result from a remedy implemented by the collateral agent.
The adequate protection payments and plan distributions were neither, Judge Bibas held.
Referring to the adequate protection payments, Judge Bibas said, “Proceeds cannot be from a sale when there is no sale.”
Although plan distributions might come from a sale or distribution, Judge Bibas said they did not stem from the collateral agent’s remedy. Even if the plan distributions were equivalent to a disposition of collateral, the distribution “was not part of a remedy implemented by the collateral agent.”
Even if the collateral agent’s participation in the chapter 11 process was seen as exercising a remedy, Judge Bibas said that “the restructuring was not part of a remedy implemented by the collateral agent.” The noteholders, not the collateral agent, voted for the plan, and the bankruptcy court confirmed it. “This corporate restructuring . . . is a far cry from a collateral agent’s typical remedy: selling the collateral at a foreclosure sale.”
Judge Bibas therefore held that “the plan distributions are not proceeds under the waterfall provision” because “the restructuring was not a remedy implemented by the collateral agent.” [Emphasis in original.]
Holding that the waterfall did not apply, Judge Bibas upheld the lower courts and ruled that the plan distributions must be made according to the debts owing to the noteholder groups on the filing date.
Observations
In this writer’s opinion, the result could have gone either way, depending on the prejudices of the presiding judge. However, the intercreditor agreement was negotiated between well represented, sophisticated parties. When an agreement like this is vague, the better result is one providing equal treatment. Giving $90 million in preferential treatment doesn’t seem right when parties could have written with clarity but didn’t. In other words, uncertainty demands equal treatment.
An intercreditor agreement could be drafted to achieve the opposite result, but we believe it must be very, very specific to evade the breadth of the ruling by Judge Bibas. Of course, the decision by Judge Bibas is not binding on later Third Circuit panels, because the opinion was nonprecedential.
Beyond the interpretation of a typical intercreditor agreement, the opinion is important for a second reason: The outcome will not lead to forum shopping because the result is the same in Delaware as it is in New York. Bankruptcy Judge Robert Drain of White Plains, N.Y. held that distribution under a plan are not distributions of collateral. BOKF NA v. JPMorgan Chase Bank NA (In re MPM Silicones LLC), 518 B.R. 740 (Bankr. S.D.N.Y. 2014).
In a typical chapter 11 reorganization, distributions to secured creditors are not distributions of collateral, at least when there is no sale, according to the Third Circuit. Furthermore, undersecured creditors are not entitled to post-petition interest when calculating the distributions among creditors secured by the same collateral, the appeals court held.
Although rulings are critical for corporate reorganizations in Delaware, the June 19 decision by Circuit Judge Stephanos Bibas was nonprecedential. The opinion puts Delaware firmly in line with New York.