On March 7, 2014, the US District Court for the Western District of Washington in Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Ltd. ruled that because certain hedge funds were not "financial institutions" and therefore did not qualify as "Eligible Assignees" under a debtor's prepetition loan agreement, they could not vote on the debtor's plan of reorganization (No. 13-5503, (W.D. Wash. Mar. 7, 2014)).

In April 2008, Meridian Sunrise Village, LLC (Meridian) borrowed $75 million from U.S. Bank. As is common in loan agreement assignment provisions, the loan agreement included a restriction which limited the bank's ability to sell, transfer or assign the loan only to "Eligible Assignees." The loan agreement defined "Eligible Assignee" to include "any commercial bank, insurance company, financial institution or institutional lender" approved by the administrative agent and, if there was no event of default, approved by Meridian, which could not unreasonably withhold its consent. Because of prior negative experiences, Meridian negotiated for these restrictions on lender assignments to avoid future assignments to "predatory investors."

U.S. Bank assigned portions of the loan to Bank of America (BoA), Citizens Business Bank and Guaranty Bank and Trust Company. In early 2012, the lenders declared a non-monetary default based on Meridian's breach of a financial covenant in the loan agreement. U.S. Bank requested that Meridian waive the "Eligible Assignee" limitations to enable a sale of the loan. Meridian refused, and in January 2013, U.S. Bank informed Meridian that it would begin charging default interest if Meridian did not cooperate. Meridian was unable to pay the additional interest, and filed for bankruptcy under Chapter 11 of the Bankruptcy Code.

Meridian proposed a plan which categorized the lenders as a specific class for the purpose of voting on the plan. Before the vote, BoA transferred its interest to NB Distressed Debt Limited Fund (NB) over Meridian's objections. NB subsequently split its interest between itself and two other distressed debt funds (collectively, the Funds). Meridian immediately objected to the transfer, arguing that the Funds did not qualify as "Eligible Assignees" under the loan agreement, and requested that the bankruptcy court enjoin them from voting on the proposed plan. The bankruptcy court granted Meridian's motion, and the Funds appealed to the Court, seeking a stay of the bankruptcy court's preliminary injunction. The Court denied the motion to stay but granted the motion for leave to appeal the preliminary injunction. The Funds were not permitted to vote, and the lenders voted in favor of Meridian's plan which the bankruptcy court confirmed.

The Funds appealed the preliminary injunction and confirmation of the plan, arguing that:

Meridian argued, based on the plain language of the loan agreement, the specific text surrounding the reference to "financial institutions" in the definition of "Eligible Assignees" and the parties' actions, that the parties intended "financial institutions" to exclude entities like the Funds. The Funds argued that the term "financial institutions" should be read more broadly. They claimed that the Court should only look to the definitions in Webster's and Black's dictionaries, which include any and all enterprises that specialize in the handling and investment of funds, and not consider any extrinsic evidence.

The Court agreed with Meridian that the Funds were specifically excluded from the definition of "Eligible Assignees" in the loan agreement. The Court explained that:

The Court further agreed that since the Funds were not "financial institutions" under the loan agreement, and therefore not within the definition of "Eligible Assignees," the bankruptcy court rightfully precluded them from voting on the plan. The Court also held that even if the Funds were "Eligible Assignees," they would be entitled to only one vote, instead of three, as the Funds claimed, and their single vote would not have changed the outcome of the plan's vote. Under the plan, each one of the four banks in the lenders' class received one vote. The interest that the Funds had in the loan stemmed from BoA's original right and therefore they were entitled only to the one vote that belonged to BoA. If the Funds' interpretation was correct, this would artificially create voting rights that the original assignor never had and would enable any voter to veto a plan by merely assigning its claim to enough assignees to create a majority vote.

This case is a reminder to practitioners to carefully review assignment restrictions and consider their impact on later purchases of the loans in the secondary market. This is especially important in certain jurisdictions outside of New York or Delaware, where judges may be less familiar with the role of distressed investors in bankruptcy and restructuring events. Even though the Loan Syndications and Trading Association's (LSTA) Model Credit Agreement Provisions typically permit distressed investors to qualify as assignees, Meridian makes clear that these provisions can be varied by negotiation.

Practitioners should also remember that courts may consider extrinsic evidence, including a lender's conduct, when interpreting provisions in a loan agreement. When negotiating loan agreements, parties must be sure to use precise and exact wording to limit or qualify lenders' assignment rights. However, lenders wishing to preserve broad assignment rights should ensure that their conduct is consistent with their interpretation of these provisions.