Enter to open, tab to navigate, enter to select
Bankruptcy Court Upholds Second Lien Lenders' Waivers in Intercreditor Agreement
Practical Law Legal Update 3-500-9541 (Approx. 4 pages)
Bankruptcy Court Upholds Second Lien Lenders' Waivers in Intercreditor Agreement
by PLC Finance and Practical Law Bankruptcy & Restructuring
| Published on 07 Dec 2009 • USA (National/Federal) |
An update on the US Bankruptcy Court for the Southern District of New York's decision in In re ION Media Networks, Inc., in which the court upheld certain waivers by a second lien lender in an intercreditor agreement.
Key Litigated Issues
The main issues presented in In re ION Media Networks, Inc. are whether:
- The provisions in an intercreditor agreement in which a second lien lender agreed not to challenge the validity and priority of the first lien lenders' security interests are enforceable.
- Second lien lenders have the right to object to the debtor's plan of reorganization.
Generally, in transactions that include senior and junior debt, the junior debt holders are required to waive certain rights with respect to the security interests granted in the security agreement so as not to interfere with or impair the rights of the senior lenders, including the priority of their senior liens. The enforceability of these waivers depends on a number of factors, including the language of the waivers. For more information on the rights of first and second lien lenders, see Article, Second-Lien Financings in Bankruptcy: Expectations v. Reality.
Background
In 2005, ION Media Networks, Inc. (ION) entered into secured loan transactions with first and second lien lenders. The security agreement for the loans identified as collateral Federal Communications Commission (FCC) licenses held by ION special purpose entity (SPE) subsidiaries but excluded any "license agreement... to the extent that any requirement of law applicable thereto prohibits the creation of a security interest therein". The first and second lien lenders also entered into an intercreditor agreement thatprohibits the second lien lenders from asserting certain claims, including the validity and priority of the first lien lenders' security interests.
On May 19, 2009, after negotiating a restructuring support agreement (RSA) with certain first lien lenders, ION and other affiliated companies filed for bankruptcy under Chapter 11. In accordance with the RSA, the debtors filed a motion for DIP financing and a plan of reorganization in which the first lien lenders would ultimately receive close to 100% of the common equity of the reorganized debtors. Both the plan and the terms of the DIP financing purported to treat the FCC licenses as collateral to which the first lien lenders are entitled. For more information on Chapter 11 filings and DIP financing, see Practice Notes, Bankruptcy: Overview of the Chapter 11 Process and DIP Financing: Overview.
Cyrus Select Opportunities Master Fund Ltd. (Cyrus), a distressed investor fund, purchased certain second lien loans of ION at a significant discount. During the course of the ION bankruptcy proceedings, Cyrus objected to both the DIP financing and the reorganization plan (among other objections). Cyrus argued that under federal law, FCC licenses cannot be encumbered by any security interest and as such are not collateral under the intercreditor agreement. As a result, licenses are unencumbered assets and any recovery based on the licenses should be shared pari passu among first and second lien lenders.
Both the debtors and Cyrus filed adversary proceedings to litigate the issue. Among other points, the debtor argued that Cyrus did not have standing to object to the liens on the FCC licenses under the terms of the intercreditor agreement between the first and second lien lenders.
Outcome
On November 24, 2009, the Court issued a decision in favor of the debtor in which it ruled that under the terms of the intercreditor agreement, Cyrus lacks standing to challenge the liens of the first lien lenders and the plan of reorganization.
Second Lien Lenders Lacked Standing to Challenge the Validity and Priority of First Lien Lenders' Claims
The Court held that the intercreditor agreement prohibited the second lien lenders from challenging the priority of the first lien lenders' claims. In reaching its decision, the Court found that the second lien lenders expressly acknowledged in the intercreditor agreement their relative priorities and that such priorities would not be affected by "any nonperfection of any lien purportedly securing any of the Secured Obligations".
The Court concluded that "affirming the legal efficacy of unambiguous intercreditor agreements leads to more predictable and efficient commercial outcomes and minimizes the potential for wasteful and vexatious litigation". In cases where the language in the agreement and the intent of the parties are clear, the court "will not disturb the bargained for rights and restrictions".
Second Lien Lenders Lacked Standing to Object to the Plan
The Court held that the second lien lenders lacked standing to object to the plan. In reaching its conclusion, the Court found that the intercreditor agreement provided that, unless the first lien lenders were paid in full, the second lien lenders could not "oppose, object to or vote against any plan of reorganization... the terms of which are consistent with the rights of the First Priority Secured Parties under the Security Agreement".
Given that the first lien lenders had not been paid, this provision barred Cyrus's objections to the plan.
Practical Implications
By making it clear that the provisions of an unambiguous intercreditor agreement will be upheld, the Court's decision in ION should give some comfort to senior lenders seeking to enforce waivers of rights by junior lenders. Up to now, it was not clear that these waivers would be upheld by bankruptcy courts.
Although not a critical part of the decision, the opinion provides some guidance on what constitutes appropriate conduct by a second lien lender. In holding that Cyrus did not have the right to raise its objections in the bankruptcy proceedings, the Court found that Cyrus willfully breached the intercreditor agreement. The Court stated that Cyrus's "aggressive" tactics in violation of the intercreditor agreement likely caused the other parties to incur increased administrative expenses, and suggested that those increased expenses may be claimed as damages against Cyrus.