United States: Delaware Bankruptcy Court Intercreditor Decision Raises Claim Subordination Issues

Intercreditor agreements between secured creditors are intended to limit the potential for litigation and result in predictable commercial outcomes with respect to recoveries from collateral in enforcement actions and bankruptcies. Despite the extensive drafting efforts of sophisticated counsel to eliminate ambiguities in these agreements, the interpretation of intercreditor agreements has been the subject of substantial bankruptcy litigation. 

A key issue in every intercreditor agreement is whether it provides for payment subordination or only lien subordination. The difference between the two types of subordination is that payment subordination renders the junior debt subordinated in its right to recovery from all sources (whether collateral or not), whereas lien subordination renders the junior second lien debt subordinate in its right to receive payment from collateral (but otherwise would leave the debt pari passu with the first lien debt for non-collateral based recoveries). Although the outcome of intercreditor litigation necessarily is highly dependent on the language of the agreement at issue and the underlying facts of the case, a recent Delaware Bankruptcy Court decision in the chapter 11 case of La Paloma Generating Co.1 is of interest because the Bankruptcy Court suggested that payment subordination was intended by the parties despite the lack of any express payment subordination provision in the document. 

As discussed in greater detail below, the La Paloma case presented a somewhat complex fact pattern involving whether recoveries to the second lien debt that were made available to all unsecured creditors (including what otherwise would have been the deficiency claim of the second lien creditors) as a result of the fact that the first lien debt had not properly perfected its security interest were subject to the turnover provisions of the intercreditor agreement. Although the decision could have turned, and seemingly did turn, solely on whether the proceeds of improperly perfected "collateral" were subject to the turnover and waterfall provisions of the intercreditor agreement, the court took a seemingly unnecessary turn and expressed its view, without any real support, that the intercreditor agreement in question provided for claim subordination. The junior creditors have appealed the decision. 

Background

La Paloma Generating Company, LLC and certain of its affiliates (collectively, the "Debtors") commenced voluntary chapter 11 cases before the United States Bankruptcy Court for the District of Delaware in December 2016. The Debtors' prepetition capital structure included first lien and second lien facilities that were subject to an intercreditor agreement and secured by substantially all of the Debtors' assets. 

The Debtors filed a plan of reorganization in September 2018 that incorporated a settlement of a number of disputes with the first lien creditor, including disputes arising out of the fact that the UCC financing statement filed by the collateral agent had lapsed prepetition. Specifically, the plan provided that the first lien lenders would, among other things, credit bid for substantially all of the Debtors' assets and forgo the benefit of their liens on certain assets for the benefit of unsecured creditors. The plan then provided that distributions that otherwise would have gone to the second lien lenders on account of their unsecured claims would be held in reserve with the collateral agent, pending a determination by the Bankruptcy Court as to whether the second lien lenders were entitled to such amount in light of the turnover and related provisions of the intercreditor agreement. The first lien and second lien lenders subsequently brought dueling motions before the Bankruptcy Court seeking to enforce the intercreditor agreement. 

Decision

The Bankruptcy Court granted the first lien lenders' motion to enforce the intercreditor agreement largely focusing its analysis on the "turnover" provision of the intercreditor agreement. The turnover provision requires that second lien creditors turn over to the Collateral Agent, any collateral or the proceeds of collateral that they receive prior to the payment in full of the first lien creditors. The court concluded that the first lien lenders needed to show that four elements were satisfied in order to trigger a payment turnover by the second lien lenders: (i) the distribution must be collateral or proceeds thereof; (ii) the distribution must be received in connection with the exercise of any right or remedy by the second lien creditors; (iii) any such exercise of a right or remedy must relate to the collateral; and (iv) the exercise of such right or remedy must be in contravention of the intercreditor agreement. The Bankruptcy Court analyzed each of the four elements in turn and then examined the "waterfall" provision of the intercreditor agreement.

Collateral or Proceeds Thereof

The definition of "collateral" in the intercreditor agreement included all property "...intend[ed] to constitute" collateral for the first lien or second lien obligations. Moreover, the intercreditor agreement contained the standard savings provision that the priority of the first lien creditor over the second lien creditor would not be affected by any issue concerning the perfection or avoidability of liens securing the first lien obligations or any defects or deficiencies in, or failure to perfect, such liens. The first lien lenders contended that substantially all of the Debtors' assets were subject to the lapsed lien, and, therefore, when the assets were sold pursuant to the plan of reorganization, the proceeds of the sale were proceeds of collateral. Although the second lien creditors asserted that there were unencumbered assets, which presumably would have fallen outside of the definition of collateral, the Bankruptcy Court rejected that assertion as being without evidentiary support, and concluded that under the facts before it, and the broad definition of "collateral," such distributions were "collateral or proceeds thereof."

Exercise of Remedies

The Bankruptcy Court concluded that this factor had been satisfied by the filing of a proof of claim in the bankruptcy case by the second lien agent. In reaching that conclusion, the Bankruptcy Court distinguished its own decisions in Energy Future Holdings,[2] on the basis that the definition of "exercise of remedies" in the intercreditor agreement in that case did not include the filing of a proof of claim. The Court found that the intercreditor agreement at issue, in which the filing of a proof of claim was one of the limited exceptions to the prohibited exercise of remedies, made such filing an explicit exercise of a remedy.

Exercise of Remedies Must Relate to the Collateral

The Bankruptcy Court concluded that this factor was easy. Given the Bankruptcy Court's determination that the filing of a proof of claim was an exercise of remedies and "collateral" includes all distributions under the plan of reorganization, the Bankruptcy Court found that this element was met.

Contravention of Intercreditor Agreement

The Bankruptcy Court found the fourth element satisfied in the event the second lien creditors, prior to the satisfaction in full of the first lien obligations, received distributions as a result of their exercise of remedies (i.e., filing the proof of claim).

Application of Waterfall

With the Bankruptcy Court having reached the conclusion that the distributions under the Plan were the proceeds of collateral, it could easily have concluded that the distribution of those proceeds would have been subject to the intercreditor agreements waterfall—which provided for the Collateral Agent to make distributions first to the first lien lenders. Rather than simply ending the analysis there, the Bankruptcy Court took a curious turn into whether the intercreditor agreement provided for payment subordination, and, without real support other than the waterfall itself, concluded that based upon the totality of the "intercreditor agreement," the parties intended for there to be payment subordination. The detour taken by the Bankruptcy Court was unnecessary because, having found that the distributions in question were the proceeds of collateral, whether payment subordination was contemplated simply was not relevant. 

Discussion

As would be expected, the second lien lenders appealed the Bankruptcy Court's decision to the United States District Court for the District of Delaware.3 The issues on appeal are whether the four elements required for a payment turnover were met and whether an explicit lien subordination intercreditor agreement implicitly provided for payment subordination. The breadth of the Bankruptcy Court's interpretation of the subordination provisions of the intercreditor agreement is concerning from a junior creditor perspective and if the decision is upheld on appeal it will provide a basis for senior creditors to argue for payment subordination even in the absence of an express payment subordination provision. 

Although it is possible that the Bankruptcy Court misconstrued the facts and the applicability of the specific terms of the intercreditor agreement when it waded into its view on whether claim subordination was intended, the language of the decision could prove beneficial to first lien creditors (and detrimental to second lien creditors) in future disputes where recoveries are derived from intentionally unencumbered assets. The impact will be more significant if the reasoning in the decision is upheld on appeal.

Footnotes

1 In re La Paloma Generating Company, et al., 1:16-BK-12700 (CSS) 2018 WL 682227 (Bankr. D. Del. Dec. 27, 2018).

2 Delaware Trust Co. v. Wilmington Trust, N.A. (In re Energy Future Holdings Corp.), 566 B.R. 669 (Bankr. D. Del. 2017), aff'd, 585 B.R. 341 (D. Del. 2018).

3 Absent a settlement, it is likely there would be a further appeal of the District Court decision to the Third Circuit Court of Appeals.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions