Confirmation than the second-lien lenders. 28 their litigation - - PDF document

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44CanalCenterPlaza,Suite400Alexandria,VA22314(703)739-0800Fax(703)739-1060www.abiworld.org Proskauer;NewYork

SLIDE 1 44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org

JOURNAL

A M E R I C A N B A N K R U P T C Y I N S T I T U T E

The Essential Resource for Today’s Busy Insolvency Professional

Contributing Editor: Richard฀J.฀Corbi Proskauer;฀New฀York rcorbi@proskauer.com Editor’s Note: For more on this topic,

rder ABI’s Handbook on Second Lien

Loans and Intercreditor Agreements, 116 pages, and is $25 for members. Order at www.abiworld.org/abistore.

s more levels of debt-holders fight for their piece of the bank- rupt estate’s remains, courts have shifted to enforcing prepetition agreements to sort out the mess. Most recently, in In re ION Media Networks Inc.,1 the U.S. Bankruptcy Court for the Southern District of New York held that a prepetition intercreditor agreement in which second-lien lenders expressly acknowledged the priority of the first- lien lenders’ rights to certain collateral, and agreed not to challenge such pri-

rity and rights of first-lien lenders in

a bankruptcy proceeding, barred such second-lien lenders from asserting that the first-lien lenders’ security interests did not extend to the debtors’ Federal Communications Commission (FCC) broadcasting licenses.2

Facts

Cyrus Select Opportunities Master Fund Ltd. (Cyrus), a distressed-debt investor, purchased the discounted sec-

nd-lien debt of ION Media Networks
Inc. (the debtors) for “pennies on the

dollar.”3 The focal point of contention was the intercreditor agreement (ICA) between the first-lien lenders and the subordinated second-lien lenders. Cyrus challenged the first-lien lenders’ rights as secured creditors to recover the enterprise value of the debtors’ FCC broadcast licenses (FCC licenses).4 The court noted that activist strategies by distressed investors have become common- place in mega chapter 11 cases.5 Cyrus argued that FCC licenses were immune from being encumbered under the ICA due to their character as a federally- regulated right to use the airwaves and because they did not fit the definition of “collateral” as set forth in the ICA and, thus, should be deemed available for pari passu sharing by the first- and second- lien lenders.6 Since the debtors filed for chapter 11, the first-lien lenders argued that Cyrus lacked standing to object to confirmation of a plan of reorganization based on provisions in the ICA.7 The bankruptcy court noted that in order for Cyrus to pre- vail in showing that its objections to plan confirmation were not barred by the ICA, Cyrus had to prove that the FCC licenses were not collateral subject to the provisions of the ICA.8 The bankruptcy court found that the FCC licenses constituted “collateral” as the term was used in the ICA, and as a result, Cyrus breached the ICA and lacked standing to object to the debtors’ plan of reorganization.9

Circumstances Surrounding the Chapter 11 Filing and Plan

In 2005, the debtors entered into a series of agreements (transaction documents) with the first- and second-lien lenders, which included a security agreement setting forth the rights of the first- and second-lien lenders to the debtors’ assets, as well as the ICA that governed the relationship between the first- and second-lien lenders.10 In 2009, the debt-

rs and the first-lien lenders entered into

a restructuring support agreement (RSA), which provided the basis for the financing of a chapter 11 case and an exit from chapter 11.11 Pursuant to the RSA, the first-lien lenders would receive 100 percent of the common stock of the debtors upon exiting chapter 11.12 On May 19, 2009, the debtors filed for chapter 11, and their debtor-in-pos- session (DIP) financing motion, consis- tent with the RSA terms, provided that $150 million of the DIP loans would convert to 62.5 percent of the reorganized debtors as part of the plan of reorganization.13 Cyrus, as a second-lien debt-holder, objected to the DIP financing on the basis that the debtors’ FCC licenses were not receiving value from the DIP financing and the DIP financing contained an improper roll-up of first- lien lender obligations as they related to the FCC licenses.14 Cyrus presented an alternative DIP financing proposal, which the bankruptcy court did not approve because of the inclusion of a due-diligence contingency that would have allowed Cyrus to walk away from the financing arrangement.15 Cyrus sub- sequently appealed, but to no avail. After the failure of Cyrus to obtain court approval for its alternative DIP financing, the debtors commenced an adversary proceeding attempting to

About the Author

Richard฀Corbi฀is฀an฀associate฀in฀the฀ Bankruptcy฀and฀Restructuring฀Group฀at฀ Proskauer฀in฀New฀York.

ICAs Prevent Bankruptcy Objections

1 419 B.R. 585 (Bankr. S.D.N.Y. 2009). 2 Id. at 594-98. 3 Id. at 588. 4 Id. at 588. 5 Id. at 589. 6 Id. at 589. 7 Id. at 590. 8 Id. at 590. 9 Id. at 590.

Lien on Me

10 Id. at 590-91. 11 Id. at 591. 12 Id. at 591. 13 Id. at 591. 14 Id. at 591. 15 Id. at 591.

SLIDE 2 44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org enjoin Cyrus from contesting the validity of the security interests on all of the debtors’ assets that the first-lien lenders had, contesting the priority rights of the first-lien lenders as set forth in the ICA and opposing or objecting to the debtors’ plan of reorganization and disclosure statement.16 Cyrus, in response, commenced an adversary proceeding against the debtors, seeking a declara- tory judgment as to whether the FCC licenses were encumbered by any valid and enforceable security interest.17 The subsequent plan confirmation ruling ren- dered the court’s ruling on the adversary proceedings moot. On Aug. 19, 2009, the debtors filed a disclosure statement and plan of reorganization in which the reorganized debtors’ total enterprise value was between $310 million and $445 million, which was insufficient to satisfy the debtors’ $850 million first-lien debt.18 The plan of reorganization provided that the first-lien lenders would receive almost all of the common stock of the reorganized debtors while, as part of an agreement with the creditors’ commit- tee and second-lien lenders, the general unsecured creditors would receive their pro rata share of an aggregate $5 million cash distribution and warrant to purchase 5 percent of the common stock in the reorganized debtors.19 The plan

f reorganization also presumed that

the first-lien lenders were entitled under the transaction documents to receive all the value of the FCC licenses.20 Cyrus

bjected to the plan of reorganization on

the grounds that the FCC licenses were unencumbered assets. Cyrus, similar to the DIP loan, proposed an alternative plan that the debtors’ rejected.21

Confirmation

On Nov. 3, 2009, the bankruptcy court held a confirmation hearing. The court examined the ICA.Specifically, §9(a) of the ICA stated: “Each of the Secured Parties acknowledges and agrees (x) to the relative priorities as to the Collateral (and the application of the proceeds therefrom) as provided in the Security Agreement...and acknowledges and agrees that such priorities...shall not be affected or impaired in any manner whatsoever including, without limitation,

n account of...(iii) any nonperfection of

any lien purportedly securing any of the Secured Obligations (including, without limitation, whether any such Lien is now perfected, hereafter ceases to be perfected, is avoidable by any bankruptcy trustee or otherwise is set aside, invali- dated, or lapses.)”22 The court interpreted this ICA language in two parts. First, the use of the term “purportedly securing” to describe the universe of liens granted by the debtors to the lenders illustrates the debtors’ intent to estab- lish the priority rights between the first- and second-lien lenders regardless of the validity of the liens granted by the debt-

rs.23 Second, the ICA expressly stated

that the second-lien lenders agreed to be silent as to “dispute[s] regarding the validity of liens granted by the Debtor in favor of the First Lien Lenders,” and therefore, the second-lien lenders accepted the lien priorities “regardless of whether a lien was even properly granted

n the FCC Licenses.”24

In the face of this direct language from the ICA, Cyrus continued to argue that the subordination of claims of the second-lien lenders did not extend to claims arising from the FCC licenses because such licenses were not “collateral” as defined in the ICA.25 The court stated that the transaction documents state the opposite because §9(a) of the ICA granted the first-lien lenders an indisputable first lien in all of the debt-

rs’ collateral, regardless of “actual per-

fection of a security interest.”26 The court explained that the pur- pose of the ICA was to prevent the technical arguments about the validity

f liens.27 The ICA allocated the eco-

nomic value of the debtors’ collateral, including the FCC licenses, and as a result, the claims of the first-lien lenders were entitled to a higher priority than the second-lien lenders.28 The bankruptcy court enforced the ICA’s plain language for public policy reasons in that “[a]ffirming the legal efficacy of unambiguous intercreditor agreements leads to more predictable and efficient commercial outcomes and minimizes the potential for wasteful and vexatious litigation.”29 The court also noted that the first- and second-lien lenders were “sophisticated parties who entered into the [ICA]” knowing and understanding the debtors’ business and the restrictions and limitations on the security interests to the FCC licenses.30 Despite the court’s rigid enforcement of the ICA, its decision did not conflict with the general bankruptcy policy of allow- ing parties to be heard in a bankruptcy case.31 For instance, the court explained that nothing prevents Cyrus from voting

n the plan of reorganization or appear-

ing as an unsecured creditor.32 Instead, the bankruptcy court explained that by strictly enforcing the ICA, “plainly-worded con- tracts establishing priorities and limiting

bstructionist, destabilizing and wasteful

behavior should be enforced and creditor expectations should be appropriately ful- filled.”33 Based on the foregoing, the ICA was an enforceable contract under §510(a)

f the Code.34

The court explained that in this case, the first- and second-lien lenders “con- temporaneously recognized and dis- closed the uncertainty surrounding the ability to grant a direct security interest in an FCC license. Notwithstanding such uncertainty, the parties expressly manifested their intent to insulate the First-Lien Lenders’ collateral package from attack by the Second-Lien Lenders and to thereby ensure that any economic value associated with the FCC Licenses was included in the First-Lien Lenders’ collateral package.”35 Furthermore, the court explained that the final DIP order barred Cyrus from challenging the first-lien lenders’ claims.36 In particular, paragraph 4 of the final DIP order provided that the first-lien lenders’ debt is “secured by ‘first priority liens on and security interest in sub- stantially all of the Debtors’ assets.’”37 Based on the language of the final DIP

rder, Cyrus’ litigation tactics were not

allowed in the same way the ICA barred their litigation tactics. The bankruptcy court continued to point out that when Cyrus purchased some of the debtors’ second- lien debt, the transaction documents clearly noted that Cyrus was subject to the ICA’s requirement that it remain silent in a chapter 11 case.38 Specifically, §11(b) of the ICA stated: “[U]pon the commencement of a case under the Bankruptcy Code by or against any Grantor…(b) each secured party agrees not to take any action or 16 Id. at 591. 17 Id. at 592. 18 Id. at 592. 19 Id. at 593. 20 Id. at 593. 21 Id. at 593. 22 Id. at 594 (emphasis in original). 23 Id. at 594. 24 Id. at 594. 25 Id. at 594. 26 Id. at 594. 27 Id. at 594-95. 28 Id. at 595. 29 Id. at 595. 30 Id. at 595. 31 Id. at 595. 32 Id. at 595. 33 Id. at 595. 34 Id. at 595. 35 Id. at 595-96. 36 Id. at 596. 37 Id. at 596. 38 Id. at 597.

SLIDE 3 vote in any way inconsistent with this Agreement so as to contest (1) the validity or enforcement of any of the Security Documents...(2) the validity, priority, or enforceability of the Liens, mortgages, assignments, and security interests granted pursuant to the Security Documents…

r (3) the relative rights and duties of

the holders of First Priority Secured Obligations.”39 Again, the court relied on the “plain and purposeful language” of the ICA to prohibit Cyrus from objecting to the plan of reorganization. Following its analysis of the ICA and the various rights of the first- and sec-

nd-lien lenders, the bankruptcy court

had presumed that Cyrus, had a right to be heard.40 After an exhaustive analysis

f the ICA, however, the court concluded

that Cyrus lacked standing to be heard in the cases because they “surrendered any and all challenges to lien validity in the Intercreditor Agreement.”41

Conclusion

The ION Media case illustrates that a court will enforce a prepetition, bar- gained-for ICA in order to preserve commercial certainty and the agreed-upon priorities of secured creditors. n Reprinted฀with฀permission฀from฀the฀ABI฀ Journal,฀Vol.฀XXIX,฀No.฀2,฀March฀2010. The฀ American฀ Bankruptcy฀ Institute฀ is฀ a฀ multi-disciplinary,฀nonpartisan฀organization฀ devoted฀ to฀ bankruptcy฀ issues.฀ ABI฀ has฀ more฀than฀13,000฀members,฀representing฀ all฀facets฀of฀the฀insolvency฀fjeld.฀For฀more฀ information,฀ visit฀ ABI฀ World฀ at฀ www. abiworld.org. 44฀Canal฀Center฀Plaza,฀Suite฀400฀฀•฀฀Alexandria,฀VA฀22314฀฀•฀฀(703)฀739-0800฀฀•฀฀Fax฀(703)฀739-1060฀฀•฀฀www.abiworld.org 39 Id. at 597. 40 Id. at 598. 41 Id. at 598, 603.