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December 17, 2018

Stroock Special Bulletin

By: Erez E. Gilad, Kenneth Pasquale, Jason M. Pierce

In a recent decision in the high-profile Momentive bankruptcy cases, the United States District Court for the Southern District of New York upheld the Bankruptcy Court’s dismissal of an intercreditor action brought by senior debt holders against junior debt holders arising from the implementation of Momentive’s chapter 11 plan of reorganization.[1]  


Upon a de novo review, the District Court affirmed Judge Drain’s ruling in its entirety, finding that the second lien noteholders did not violate an intercreditor agreement when they (1) voted for the bankruptcy plan that was opposed by the senior lienholders, or (2) received new common stock of the reorganized debtors, a backstop fee (payable in the form of new common stock), and professional fees, even though the seniors did not receive payment in full in cash for all of their asserted secured claims.  The decision offers further insight into how complex intercreditor provisions may be reconciled in the bankruptcy context and could have a significant impact upon the negotiation and drafting of intercreditor agreements in the future.   

Background
Upon its bankruptcy filing in April 2014, Momentive’s debt structure consisted of (a) $1.1 billion of first lien notes and $250 million of 1.5 lien notes (“Senior Debt” or “Seniors”), (b) $1.35 billion of second lien notes (“Second Lien Debt” or “Seconds”), and (c) $382 million of unsecured subordinated notes.  Momentive’s obligations arising under the Senior Debt and Second Lien Debt were secured by shared “common collateral” and the debt holders’ relative rights and priorities with respect to that common collateral were memorialized in an intercreditor agreement (“ICA”).

Momentive commenced its chapter 11 cases in order to implement a plan of reorganization it had negotiated with holders of a majority of the Second Lien Debt, who executed a restructuring support agreement (“RSA”) and agreed to support, and vote for, that plan (“Plan”).  As ultimately confirmed by the Bankruptcy Court, the Plan reflected that the Seconds were significantly under-secured, i.e., the “fulcrum” securities entitled to the equity value of the reorganized enterprise, and thus entitled to receive the new common stock issued by the reorganized debtors.  The Seconds also received rights to participate in a $600 million new money rights offering backstopped by some of the Seconds (“Second Lien Backstop Parties”).  In exchange for the backstop commitment, the Second Lien Backstop Parties received a $30 million fee (payable in the form of new common stock) and were entitled to the reimbursement of their professional fees pursuant to a backstop commitment agreement (“BCA”) and the RSA.

The Plan offered the Seniors the option to either (1) accept the Plan and receive cash at par plus accrued interest, but no make-whole premium the Seniors argued they were entitled to receive pursuant to the documents governing the Senior Debt,[2] or (2) reject the Plan and receive replacement notes in a principal amount equal to the allowed amount of their secured claims and litigate the make-whole issue; the “cram-up” interest rate for the new replacement notes would be determined by the Bankruptcy Court.  The Seniors opted to reject the Plan.  Following a multi-day confirmation hearing, Judge Drain, among other rulings, disallowed the Seniors’ claim for a make-whole premium, determined the cram-up interest rates for the replacement notes issued to the Seniors to be 4.10% for the replacement first lien notes and 4.85% for the replacement 1.5 lien notes, overruled the Seniors’ objections and confirmed the Plan.[3]

The Seniors subsequently filed suit against the Seconds, alleging various breaches of the ICA.  The suit was ultimately removed to the Bankruptcy Court, which dismissed the Seniors’ claims.[4]  On appeal, the District Court reviewed each of the Seniors’ claims de novo and affirmed dismissal of the Seniors’ claims.

District Court Ruling
A.  The Seconds Did Not Violate the ICA by Voting to Accept the Plan
The District Court rejected the Seniors’ claim that the Seconds’ vote in support of the Plan over the objections of the Seniors violated Section 3.1(c) of the ICA, which provided that no Second shall take any action that would “hinder any exercise of remedies undertaken by the [Seniors] with respect to the Common Collateral,”[5] and that each Second “waives any and all rights it . . . may have as a junior lien creditor or otherwise to object to the manner in which the [Seniors] seek to enforce or collect the Senior . . . Claims or the Liens granted in any of the Senior . . . Collateral.”[6]  The District Court held that Section 5.4 of the ICA effectively overrode Section 3.1(c) to the extent the Seconds were significantly under-secured creditors and “wore both secured and unsecured hats.”[7]  Specifically, Section 5.4 provides in relevant part:

Notwithstanding anything to the contrary in this Agreement, the [Seconds] may exercise rights and remedies as . . . unsecured creditor[s] against the Company or any subsidiary . . . .  Nothing in this Agreement shall prohibit the receipt by any . . . of the required payments of interest and principal so long as such receipt is not the direct or indirect result of the exercise by any [Second] of rights or remedies as a secured creditor in respect of Common Collateral.[8]


Applying a holistic reading of the ICA that harmonizes all of its provisions in context, the District Court held that the “broad and unambiguous” language of Section 5.4 of the ICA trumps the general restrictions of Section 3.1(c), and effectively provides the Seconds with “unfettered reign to act against the Company” when acting in their capacity as unsecured creditors.[9]  The District Court surveyed case law interpreting similar ICA provisions and found the growing consensus to be that “agreements that seek to limit or waive junior noteholders’ voting rights must contain express language to that effect.”[10]  Absent such an express waiver, the District Court found that the ICA had not been violated.

B.  The Seconds Did Not Violate the Turnover Provisions of the ICA
The District Court also rejected the Seniors’ claim that the Seconds breached Sections 3.1(b) and 4.2 of the ICA by receiving and failing to turn over (1) new common stock in the reorganized debtors, (2) the $30 million backstop fee, and (3) professional fee payments, all because the Senior Debt had not been paid in full, in cash. 
Section 3.1(b) of the ICA provides, in relevant part:

So long as the Discharge of [Senior] claims has not occurred, each [Second] agrees that it will not, in the context of its role as secured creditor, take or receive any Common Collateral or any proceeds of Common Collateral in connection with the exercise of any right or remedy . . . with respect to any Common Collateral.[11]


Section 4.2(c), in turn, provides that any “Common Collateral or proceeds thereof received by any [Seconds] in connection with the exercise of any right or remedy . . .  relating to the Common Collateral in contravention of this Agreement shall be segregated and held in trust for the benefit of …. the applicable Senior Lenders.”[12]

Parsing through these provisions, the District Court found that the new common stock was received by the Seconds in their capacity as unsecured “fulcrum” creditors, not as secured creditors.[13]  Significantly, the District Court also affirmed Judge Drain’s determination that the new common stock was neither Common Collateral nor proceeds thereof as a matter of law.  Agreeing with Judge Drain, the District Court found that in order to constitute “proceeds” of collateral, the new common stock “would have had to have been the result of a change in the collateral that diluted the collateral’s value.”[14]  Noting that the term “proceeds” was not defined in the ICA, the District Court evaluated its meaning under Section 9-102(a)(64) of the Uniform Commercial Code, and found that the term relates to actions that in some way exhaust, decrease, dilute or otherwise use up collateral.[15]  Here, the District Court found, no transformation or exchange of the collateral took place.  As Judge Drain noted, the new common stock comprises proceeds of the Seconds’ liens and claims, not the proceeds of Momentive’s property, and thus does not constitute proceeds of Common Collateral.[16]

For similar reasons, the District Court found that the receipt of the $30 million backstop fee, payable in the form of new common stock, and the reimbursement of professional fees, did not represent proceeds of common collateral or reflect the exercise of a right or remedy with respect to common collateral.  The District Court adopted Judge Drain’s rationale, holding that the backstop fee was “based on the [Seconds’] rights under the BCA, not in respect of remedies as secured creditors,” and that such a payment, even if made in cash, “would not be on account of a secured obligation but, rather, a separate, unsecured obligation undertaken by the debtors to the [Seconds] for backstopping new exit financing for the debtors . . . .”[17]  Highlighting the Seconds’ status as fulcrum security holders, whose deficiency claim exceeded the secured portion of their claim, the District Court affirmed that the Seconds had “nearly unfettered rights whenever they wore just their unsecured hats.”[18]

The District Court also noted that the Seniors failed to adequately plead that the reimbursement of fees was a function of adequate protection of liens.  The District Court noted that Judge Drain required that the DIP order provision authorizing the payment of the Seconds’ fees be subject to section 506(b) of the Bankruptcy Code, such that these fees could only be received to the extent the Seconds were over-secured; otherwise, they should be recharacterized as principal.[19]  Thus, the Seniors’ complaint did not adequately allege whether the fees were actually received as adequate protection.[20]

Conclusion
The District Court’s affirmation of the Momentive intercreditor decision underscores various considerations implicating intercreditor rights and remedies, such as:  (1) valuation and the lien status of second lien creditors in a restructuring, (2) the contractual limitations (and exceptions) imposed upon the parties’ conduct during a restructuring, and (3) ensuring that the plan structure and currency conform with the priority and turnover provisions of any ICA.  Significantly, creditors should be mindful of the scope of subordination contemplated by an intercreditor agreement, including the definition of “common collateral,” as well as the circumstances under which junior creditors may be required to turn over distributions to senior creditors.

For more information:
Erez E. Gilad, 212.806.5881, egilad@stroock.com
Kenneth Pasquale, 212.806.5562, kpasquale@stroock.com
Jason M. Pierce, 212.806.5960, jpierce@stroock.com


This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such. 


[1]  BOKF, N.A. v. Wilmington Savings Fund Society, FSB (In re MPM Silicones, L.L.C.) (Momentive II), No. 15-cv-2280 (NSR), 2018 WL 6324842 (S.D.N.Y. Nov. 30, 2018), aff’g BOKF, N.A. v. JPMorgan Chase Bank, N.A. (In re MPM Silicones, L.L.C.) (Momentive I), 518 B.R. 740 (Bankr. S.D.N.Y. 2014) (as subsequently corrected and modified).
[2]  “A make-whole premium is a contractual substitute for interest lost on Notes redeemed before their expected due date . . . .  [I]ts purpose is to ensure that the lender is compensated for being paid earlier than the original maturity of the loan for the interest it will not receive . . . .”  Momentive II, 2018 WL 6324842, at *4 n.10 (citation omitted).  Although the Momentive make-whole dispute is beyond the scope of this article, last year the Second Circuit affirmed the lower courts’ rulings that denied the Seniors’ claim for a make-whole premium.  See In re MPM Silicones, L.L.C., 874 F.3d 787 (2d Cir. 2017).
[3]  See In re MPM Silicones, L.LC, No. 14-22503-rdd, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014) (as corrected and modified).
[4]  Momentive I, 518 B.R. at 748–49, 752–54, 756–57.
[5]  Momentive II, 2018 WL 6324842, at *8 (emphasis in original).
[6]  Id.
[7]  Id. at *9 (emphasis in original).
[8]  Id. (emphasis in original).
[9]  Id.
[10]  Momentive II, 2018 WL 6324842, at *10 (citing In re Boston Generating LLC, 440 B.R. 302, 319 (Bankr. S.D.N.Y. 2010) (“If a secured lender seeks to waive its right to object to a 363 sale, it must be clear beyond peradventure.”) (emphasis in original)).
[11]  Id. at *12 (emphasis in original).
[12]  Id.
[13]  See id. at *16.
[14]  Id. at *13 (citing Momentive I, 518 B.R. at 754–56) (emphasis in original).
[15]  Momentive II, 2018 WL 6324842, at *13–14.
[16]  Id. at *14–16.
[17]  Id. at *18 (quoting Momentive I, 518 B.R. at 753).
[18]  Id. at *19 (emphasis in original).
[19]  Id. at *20.
[20]  Id.

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