Restructuring

Contributed by Kelly E. McDonald
The Weil Bankruptcy Blog previously discussed the bankruptcy court’s memorandum opinion approving a preconfirmation section 363 sale motion in In re Boston Generating, LLC, proceeding in the Southern District of New York (Case No. 10-14419) (Chapman, J.).  This is the second article in a series of Blog features discussing the bankruptcy court’s December 3, 2010 lengthy opinion that has caused quite a bit of static in the bankruptcy world.    
As we noted previously, Boston Generating’s 363 sale was supported by its senior lenders (who stood to receive over 98% of the proceeds of the sale) but was hotly contested by its junior lenders (who would not have received any portion of the sale proceeds).  Although, ultimately, the senior lenders in In re Boston Generating prevailed—the court approved the sale order (and, as we noted previously, the sale closed on January 3, 2011)—the senior lenders also were forced to fight a battle they might not have otherwise had to fight if, among other things, their intercreditor agreement with the junior lenders had been drafted differently.
From the beginning, the senior lenders maintained that the junior lenders lacked standing to contest the section 363 sale.  The senior lenders argued vociferously that the spirit of the intercreditor agreement was to render the holders of second liens “silent seconds.”  In fact, one section of the intercreditor agreement expressly stated that the senior lenders had the “exclusive right to enforce rights, exercise remedies … and make determinations regarding the release, sale, disposition or restrictions with respect to the Collateral” without consulting with the junior lenders or obtaining their consent (so long as the junior lenders’ liens remained on the proceeds subject to the lenders’ relative priorities).  And another section stated that the junior lenders’ rights with respect to the collateral were limited, although they retained the right to vote on a plan of reorganization and the right to assert any “right and interest available to unsecured creditors.”
For some reason the court could not explain, however, the senior lenders stipulated that their consent to the 363 sale under section 363(f)(2) of the Bankruptcy Code was not an “exercise of remedies” under the intercreditor agreement.  The term was not defined in the agreement, but because all of the lenders urged the court to accept a stipulation that there was no “exercise of remedies” by the senior lenders, the court accepted the stipulation.  The court, however, noted that absent the senior lenders’ stipulation, it might have concluded that consent under section 363(f)(2) was an “exercise of remedies.”  This likely would have led the court to find that, because the intercreditor agreement precluded the junior lenders from interfering with the senior lenders’ “exercise of remedies,” the junior lenders lacked standing to object to the sale.
This left the court to examine whether any other portion of the intercreditor agreement prohibited the junior lenders’ objections.  The senior lenders argued that the intercreditor agreement vested in them the exclusive right to make decisions concerning the collateral.  But the junior lenders countered by asserting that the intercreditor agreement only allowed the senior lenders to act without consulting with the junior lenders and that the intercreditor agreement did not expressly prevent them from objecting to 363 sales.  In fact, the intercreditor agreement expressly preserved for the junior lenders any rights that unsecured creditors might have.
The court held that the intercreditor agreement was an enforceable agreement under section 510(a) of the Bankruptcy Code to the extent that it was a subordination agreement and refused to interpret the agreement in a way that “re-drafted” or “re-negotiated” the parties’ bargained-for rights.  Citing state law, the court held that if a secured lender wanted to waive its rights to object to a section 363 sale “it must be clear beyond peradventure that it has done so” and pointed to the ABA’s Model Intercreditor Agreement that contains an express waiver of the right to object to a section 363 sale.
Stating that she thought the junior lenders’ attempt to block the disposal of collateral supported by the senior lenders went against the “spirit” of the intercreditor agreement, Judge Chapman, nonetheless, seemed to find she had to play the hand she had been dealt.  In light of the ambiguities in the intercreditor agreement (which, among other things, did not expressly prohibit the junior lenders’ objections to the 363 sale), the junior lenders’ right to exercise the rights of unsecured creditors, and the fact that the senior lenders stipulated that their consent to the 363 sale was not an “exercise of remedies” under the agreement, the court held that the junior lenders had standing to object to the sale.
The agent for the senior lenders has appealed the part of the sale order [Docket No. 494] and the opinion [Docket No. 536] granting standing to the second lien lenders by direct appeal to the U.S. Court of Appeals for the Second Circuit.  Perhaps the appeal brought by the senior lenders will explain one of the lingering questions from the Boston Generating decision: why did the senior lenders agree that their consent to the sale was not an “exercise of remedies” under the intercreditor agreement? 
In the meantime, the Boston Generating decision underscores the importance of a carefully drafted intercreditor agreement.  While, as the court pointed out, the purpose of the intercreditor agreement was to ensure that the senior lenders were “in the driver’s seat,” the agreement’s failure to provide expressly that the junior lenders would be deemed to have consented to a sale of the collateral pursuant to section 363(f) was one of the factors that ultimately enabled the junior lenders to object to the sale, spawning a whirlwind of litigation.  Expressly identifying the scope of each party’s rights in an intercreditor agreement might just make it “shock-proof” later.