Intercreditor Agreements: Recognize That Second Lien Financings Are A Special Case Of Subordinated Lending

BOKF, N.A. v. JPMorgan Chase Bank, N.A. (In re MPM Silicones, LLC), 518 B.R. 740 (Bankr. S.D.N.Y. 2014) –

Senior lienholders sued lenders holding junior liens on common collateral, arguing that the junior lienholders violated an intercreditor agreement.  The bankruptcy court addressed the issues in the context of motions to dismiss the senior lienholder complaints. 

While acknowledging that the court generally is required to accept allegations as true and draw inferences in favor of the moving party, (1) it is not required to accept legal conclusions that are presented as facts, and (2) the facts must be plausible as opposed to mere speculation.  Further, if a claim is not plausible on its face, then there must be sufficient acts to “nudge the claim across the line from conceivable to plausible.”

The case turned on interpretation of an Intercreditor Agreement (ICA), which was governed by New York law.  The court commented that, among other things, a contract should be construed in light of the entire agreement, as opposed to taking isolated provisions out of context.  In this case, the court noted that the overall context was an agreement regarding the parties’ rights with respect to shared collateral.

The court also commented that the ICA was different from agreements in other cases that included specific language requiring that the junior lienholders “be ‘silent seconds’ and yield in all respects to the senior lienholder until the claim of the senior lienholder was fully satisfied.”

Breaches alleged by the senior lienholders included the following:

  • Entering into a Restructuring Support Agreement prior to bankruptcy regarding a proposed plan of reorganization, and then supporting confirmation of that plan, which included a cramdown of the senior lenders’ claims.
  • Supporting the debtors’ objection to the senior lenders’ claims for a make-whole payment based on prepayment of the senior debt.
  • Supporting a priming lien for postpetition financing, opposing the senior lenders’ request for adequate protection, and objecting to reimbursement of the senior lenders’ financial adviser’s fees and expenses.
  • Accepting property under the plan that the senior lienholders contended was common collateral.

With respect to the claim based on objecting to adequate protection for the senior lenders as a condition of granting a priming lien to the DIP lender, the ICA did include a section that prohibited the junior lienholders from contesting a request by the senior lienholders for adequate protection.  However, the court was not aware of any action by the defendants and there was nothing in the docket to support the contention that the junior lienholders objected.  Since the claim was no more than a conclusory recitation of the cause of action, the court held that it was not sufficient to state a claim.

The court declined to go further (as requested by the junior lienholders) and hold that the objecting to provision of adequate protection to the senior lenders (including in the form of reimbursement of advisors’ fees) could never lead to a breach.  The junior lienholders’ argument to this effect hinged on the provision allowing them to assert the rights of an unsecured creditor:

Notwithstanding anything to the contrary in this Agreement, the Second-Priority Agents and the Second-Priority Secured Parties may exercise rights and remedies as an unsecured creditor against the Company or any Subsidiary that has guaranteed the Second-Priority Claims in accordance with the terms of the applicable Second-Priority Documents and applicable law.

While acknowledging that this provision could be read to say that the junior lienholders were permitted take any actions that an unsecured creditor could take, the court pointed out that another plausible reading was that the junior lienholders could exercise rights and remedies against the debtors, as opposed to entitling them to obstruct the senior lenders.

With respect to the priming lien for the DIP financing, the senior lenders conceded that they never objected to that lien and did not identify any objections made by the junior lienholders.

Turning to support of the debtors’ objection to the senior lienholders’ claims for a make-whole payment and supporting confirmation of a plan that provided for cramdown of the senior lenders:  The court noted that if it disallowed the claim for a make-whole payment, the senior lenders would not have a claim, and therefore the ICA would not be breached.  Although a final order had not yet been issued, the court concluded that the claim would not be allowed, so the junior lienholders were merely supporting the debtors’ objection to invalid claims.

The court also distinguished between arguments with respect to the parties’ interests in the shared collateral from arguments regarding the amount and treatment of the senior lenders’ claims that any unsecured creditor could make.  Thus, the court concluded that the second lienholders were entitled to object to the make whole claims.  In other words, this was a claim objection as opposed to objecting to enforcement of remedies against the collateral.

Although support of a cramdown plan was a closer question, the second lienholders were encouraging the debtors, which was consistent with an action that could be undertaken by an unsecured creditor.

The charge that the junior lienholders were improperly retaining collateral or its proceeds was based on (1) a potential $30 million payment under an agreement in which the junior lienholders agreed to backstop exit financing, (2) payment of fees and expenses of professionals (the court was unable to determine the basis for this payment), and (3) receipt of 100% of the common stock in the reorganized parent debtor in satisfaction of their claims. However, the court did not consider this to involve collateral or proceeds of the collateral.

The $30 million payment was clearly not on account of the collateral, but rather for backstopping the new financing.  The basis for reimbursement of the fees was less clear.  However, the senior lienholders also failed to specify the basis for their claims.  And the common stock was clearly not proceeds of the collateral.  Further, the senior lienholders retained their liens on the common collateral.  Allowing the senior lienholders argument would unfairly allow it to add to its collateral.

Consequently, the court dismissed all of the senior lienholder claims.

It is important to recognize that there is a difference between second lien financing and subordinated debt financing.  In the first case, liens are subordinated, while in the second case, the claims and right to payment in general (as opposed to just through realization on the collateral) is subordinated.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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