David W. Morse, Head, Bank and Finance, Otterbourg
David W. Morse, Head, Bank and Finance, Otterbourg

Since the Great Recession, the outcome of a series of bankruptcy cases has turned on the court’s view of the exact wording of an intercreditor agreement. Frequently, this careful scrutiny by the courts has led to first lien lenders’ disappointment at the scope of their rights. If the intercreditor agreement does not address the issues regarding bid procedures or priority of collateral, for example, or does not address them specifically enough for the court, there is a good chance the first lien lender will not prevail in a dispute with a second lien lender.

An early example is the Boston Generating decision where the second lien lender objected to the bid procedures for a 363 sale approved by the first lien lender.1 The intercreditor agreement prohibited the second lien lender from objecting to a “sale” approved by the first lien lender. However, it did not say the second lien lender could not object to the bid procedures for such a sale. Consequently, the bankruptcy court found that the second lien lender did not breach the intercreditor agreement by objecting to the bid procedures.

In BOKF v. JPMorgan Chase Bank,2 the first lien lenders argued that the second lien lenders breached the intercreditor agreement by:

  • Entering into a restructuring support agreement before the commencement of the case, and supporting a plan of reorganization that resulted in a cramdown of the first lien lenders
  • Supporting the debtors’ objections to the first lien lenders’ right to a make-whole payment
  • Supporting the debtors’ DIP financing that was given a lien with priority over the lenders’ liens
  • Opposing the first lien lenders’ request for adequate protection in the form of reimbursement of the first lien trustee’s financial advisors’ fees and expenses
  • Receiving a series of payments and assets that the first lien lenders said were collateral that should have been paid to the first lien lenders

The payments and assets in dispute were:

  • A $30 million fee paid to second lien lenders for backstopping a rights offering by the debtor
  • The distributions to second lien lenders of shares of the reorganized debtor
  • The reimbursement of expenses of the second lien lenders

The court found that the intercreditor agreement dealt with the priority of the liens in the collateral and the priority of the application of the proceeds of the collateral. The court determined that the $30 million fee, the shares received by second lien lenders and the expenses reimbursed were not subject to the liens of any lender and therefore were not collateral or the proceeds of collateral, so the intercreditor agreement did not apply to them. Therefore, the court determined there was no breach of the intercreditor agreement.

The first lien lenders charged the second lien lenders had made other violations of the agreement, but they failed to tell the court where and when the second lien lenders took these actions.

Failure to Provide Limitations

Further, the court ruled, even if the first lien lenders had documented those perceived violations, they would still have lost because of a fatal flaw in the intercreditor agreement. The agreement stated “notwithstanding anything to the contrary” second lien lenders could exercise rights and remedies as unsecured creditors against the debtor. Each of the listed actions by the second lien lenders were rights and remedies of an unsecured creditor.

If a first lien lender is willing to allow the second lien lender to act as an unsecured creditor without condition or limitation, then the first lien lender is going to be surprised when it wants to provide DIP financing and expects the second lien lender to go along because of the intercreditor agreement. The first lien lender will be surprised again when it approves a 363 sale and the second lien lender objects. The basis for the objections may change, but these are within the rights of an unsecured creditor.

For a first lien lender to maintain control, any rights of the second lien lender as an unsecured creditor must be specified in the intercreditor agreement.

Specifically Defining Collateral

In March 2016, the Bankruptcy Court of the District of Delaware held that certain distributions to one group of lenders were not a breach of the intercreditor agreement. In this case, the agreement was different from the more typical first lien/second lien intercreditor agreement, but the principles were the same.

This case involved three different groups of creditors, each of whom held a pari passu first lien. There was $22.6 billion of debt under a credit agreement, $1.75 billion of debt evidenced by first lien notes and $1.255 billion of debt under interest rate swaps and commodity hedge agreements.
There were two issues pending. The first concerned when the clock started ticking to determine the amount of the claim. The court ruled that pro rata shares should be determined on the petition date.

But, as in the earlier cases, the more important issue was determining which payments constituted proceeds of collateral to be applied in the order specified in the intercreditor agreement. While the three categories of creditors argued about how to calculate the amount of their claims in order to divvy up payments, the court argued that the payments were not subject to the intercreditor agreement, making the dispute between the lenders irrelevant.

In this case, the court determined that the intercreditor agreement only applied to collateral received in connection with the disposition of the collateral upon the exercise of remedies under the security documents and by the collateral agent.

Then, the court looked at the two types of distributions to creditors. First, there were the distributions under the plan of reorganization. The first lien creditors argued that each of the following were collateral:

  • common stock of the reorganized debtor
  • cash on-hand and reorganized debtor debt
  • the right to purchase holding company common stock under a rights offering
  • stock in the debtor’s ultimate parent
  • the right to payments under a tax receivable agreement

The Delaware Bankruptcy Court concluded that the shares of the reorganized entity were not collateral or its proceeds, and found that the cash, stock and debt under the plan of reorganization did not satisfy the requirements of the intercreditor agreement. Since the assets were not collateral and did not meet the required stipulations, the intercreditor agreement did not apply.

Second, there were distributions of adequate protection payments of post-petition interest under a cash collateral order. The court ruled the adequate protection payments were also not collateral. Instead, it determined that “adequate protection is designed to protect secured creditors against diminution in value of their collateral” and is not subject to the intercreditor agreement.
What does this all mean for the first lien lender?

  • The intercreditor agreement should include the consent of the second lien lender to the bid procedures approved by the first
    lien lender.
  • If the first lien lender does not want the second lien lender voting for a plan of reorganization that provides for a cramdown of the first lien debt, the intercreditor agreement needs to say so.
  • If the first lien lender is not paid out under a plan in cash and expects to receive equity in the reorganized debtor or debt issued by it, before the second lien lender, the intercreditor agreement should say so.
  • If the first lien lender does not want the second lien lender opposing reimbursement of the first lien lenders’ expenses or other adequate protection, it must be stated in the intercreditor agreement.
  • An “anti-priming” provision where the second lien lender agrees not to offer a DIP financing with a lien that has priority over the lien of the first lien lender should be in the agreement.
  • In no event should the intercreditor agreement allow the second lien lender to retain all of the rights of an unsecured creditor except to the extent that such rights are subject to the other provisions of the agreement.

In the past, there were concerns that bankruptcy courts might not enforce the terms of intercreditor agreements because the creditors party to them were not in bankruptcy. Now, the trend is clearly for bankruptcy courts to enforce them strictly and literally. This approach by the courts means that first lien lenders need to fully understand how the drafting of the intercreditor agreement affects their rights.

  1. In re Boston Generating LLC, No. 10-14419 (Bankr. S.D.N.Y. October 12, 2010).
  2. In re BOKF, N.A. v. JPMorgan Chase Bank, N.A., 2014 Bankr. LEXIS 4353 (Bankr. S.D. N.Y. 2014).