United States: ION Media: Developments in Intercreditor Disputes

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With the flood of debt-heavy capital structures created over the past decade, bankruptcy courts have been left to clean up the remnants of many failed transactions. Given the volume of debt provided, courts are likely to continue to be called upon to determine the relative rights of creditors that result from multi-tiered debt structures. Consequently, it is important to examine how recent decisions have handled intercreditor disputes as today's markets continue to loosen and financial sponsors once again have the opportunity to use various forms of subordinated debt to finance acquisitions and refinance existing credit facilities.

One issue that senior and junior lenders should be particularly aware of is the difference between lien subordination and claim subordination. Lien subordination refers to the agreement between the lenders that one party's priority with respect to any of its liens on common collateral will be junior to any liens of the other party. This ensures that the senior lender has priority in the event of a bankruptcy and is generally accompanied by a standstill provision, allowing the senior lender the exclusive right to foreclose on the collateral for a period of time before the junior creditor may seek to exercise its remedies. The junior lender also typically agrees not to contest or otherwise challenge the validity, perfection or priority of any liens held or asserted by the senior lender's liens, and not to take any action or vote inconsistent with the priorities established under the Intercreditor Agreement in any bankruptcy case of the borrower. Claim subordination gives the senior lender priority in connection with any unsecured deficiency claims between the lenders.

This distinction played a integral role in the Bankruptcy Court's 2009 decision in In re ION Media Networks, Inc. ("ION"). The documentation for the credit facility, which included an intercreditor agreement between the holders of ION's first lien and second lien debt (the "Intercreditor Agreement"), was somewhat ambiguous with respect to the definition of "Collateral." The Pledge and Security Agreement (the "Security Agreement") provided for liens to be granted on all of ION's "Collateral," specifically stating that FCC licenses were to be included in the Collateral. However, the Security Agreement also included a carve out excluding from the Collateral "special property" in which any requirement of law prohibited the creation of a security interest. The limitations imposed by Federal communications law on the granting of liens against FCC licenses arguably meant that ION's FCC licenses were "special property" excluded from the Collateral.

In an attempt to block ION's proposed Chapter 11 plan, Cyrus, a distressed debt fund that had purchased a significant amount of ION's second lien debt at a steep discount, claimed that the lien subordination language of the Intercreditor Agreement did not apply to the FCC licenses or any value attributed to them because a security interest in the FCC licenses was prohibited under federal law and therefore they did not constitute "Collateral" subject to the terms of the Intercreditor Agreement. Cyrus argued that it could oppose the Chapter 11 plan under the theory that the FCC licenses were not "Collateral," thus, since the Intercreditor Agreement did not include claim subordination provisions, its claims should be treated on a pari passu basis with those of the senior lender with respect to any value attributable to such FCC licenses.

In rejecting Cyrus's arguments, the court relied upon, among other things, the language of the Intercreditor Agreement that stated "that the Second Priority Secured Parties' claims against [ION] in respect of the Collateral constitute second priority claims separate and apart from . . . the First Priority Secured Parties' claims against [ION] in respect of the Collateral." Despite the fact that this subordination language only explicitly refers to "claims ... in respect of the Collateral," the court's broad application of this clause led it to an intriguing conclusion.

The court held that the Intercreditor Agreement prevented the second lien lender from challenging the validity of any lien "purportedly securing" the first lien lenders claims. Despite the fact that FCC licenses were arguably not Collateral based on federal law, they fell within the category of "purportedly securing" the obligations since they were expressly included in the Security Agreement. The court also addressed public policy concerns in upholding the negotiated terms of the Intercreditor Agreement, stating that "the parties fully intended to place the Second Lien Lenders in an indisputably subordinate position and to prevent interference with the stipulated senior rights of the First Lien Lenders." Thus, it was clear that the court preferred to broadly interpret what it termed "bargained-for rights and restrictions" over allowing a second lien creditor to disrupt a bankruptcy plan with a "technical argument."

Lenders should be cognizant of the fact that courts may favor applying the terms of a negotiated intercreditor agreement between sophisticated parties over allowing a second lien lender (especially one that has purchased its debt at a discount) to argue an ambiguity or technicality with respect to lien or claim subordination. In taking a commercial perspective, courts may prefer upholding bargained-for terms between creditors without regard to whether their intercreditor agreement specifically addresses lien subordination, claim subordination or some variation of the two.

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.

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