Bankruptcy Judge Robert Drain was recently affirmed in approving assumption of a restructuring support agreement that was premised upon a credit bid by the collateral agent for a secured lender group acting at the direction of the majority lenders. In re Empire Generating Co., No. 19-CV-5721 (CS) (S.D.N.Y. March 23, 2020). The minority lenders that held approximately 45% of the secured debt were not parties to the RSA, objected to the assumption and then appealed the order approving the assumption, as well as the companion order approving the bidding procedures reflecting that credit bid as the stalking horse. The equity of the debtor's subsidiary was the subject of the sale. There were fair value estimates of the assets subject to sale approximating $250 million. The RSA contemplated a credit bid of $353 million, which was the entire amount of the secured loan; and a Chapter 11 plan which, assuming, as was expected, that the credit bid was the successful bid, treated the secured debt as fully satisfied and unimpaired. In accordance with the lender agreements, the equity was to be ratably distributed to the secured lenders. Importantly, the equity was to be sold without modification, whether to reflect the value differential inherent in the control premium received by the majority lenders or any protections for the minority lenders.

The majority lenders relied upon a collective action provision in the intercreditor agreement among the lenders under the credit facility to direct the agent to credit bid the full amount of the secured loan, notwithstanding that such amount far exceeded the estimated value of the debtors' assets. In contrast, if the Chapter 11 plan provided for distribution of the equity on account of the secured debt, acceptance by the class of secured claims would require a two-thirds vote. While the minority lenders would receive their ratable share of the equity purchased with the credit bid, the majority lenders became the controlling equityholders without having agreed to any minority protections. The minority lenders argued that they were essentially forced into the Chapter 11 plan where the majority lenders, by virtue of receiving control of the reorganized debtor, would recover more than the minority lenders. The bankruptcy judge looked to the intercreditor contract as controlling, declining to reach the question of whether the majority unfairly evaded the protections generally available under the Bankruptcy Code and was affirmed.

Background and Procedural History

Empire Gen Holdings, LLC (Holdco) with its direct and indirect subsidiaries (collectively with Holdco, Empire Generating) owned and operated an electric power plant in New York. TTK Empire Power, LLC (TTK) owned 100% of the membership interests in Holdco and held no other assets. Prior to the Chapter 11 petitions, Empire Generating's primary indebtedness was approximately $353 million under a credit agreement secured by a first lien on substantially all assets of each Empire Generating entity. TTK pledged the membership interests in Holdco as collateral under the credit agreement, but was not a guarantor and its pledge was non-recourse.

In early 2018, Empire Generating defaulted on the debt service coverage ratio covenants under the credit agreement. Following the default, it attempted to negotiate a prepackaged bankruptcy plan with an ad hoc group of lenders under the credit agreement. The negotiations contemplated a transfer of ownership of the plant to the lenders in satisfaction of the secured debt. However, the lenders were unable to agree on the post-restructuring governance terms and the ad hoc group dissolved. In particular, the minority lenders wanted minority member protections built into the LLC agreement that the majority lenders were unwilling to provide.

After the breakdown in negotiations the company negotiated and entered into a restructuring support agreement (the RSA) with the majority lenders. The RSA provided that TTK would sell its membership interests in Holdco through a bankruptcy sale. The parties agreed that the majority lenders would cause the collateral agent to credit bid the entire outstanding amount of the secured debt for the membership interests. The intercreditor agreement included a collective action provision that gave the collateral agent the exclusive power to credit bid the entire amount of the secured debt at the direction of the majority of lenders. The minority lenders were not party to the RSA.

On May 20, 2019, Empire Generating and TTK filed Chapter 11 petitions. The first day motions in their jointly-administered cases included motions to assume the RSA and to approve bidding procedures for a §363 sale of TTK's membership interests in Holdco. The bidding procedures contemplated a stalking horse bid by the collateral agent for the secured lenders, bidding the entire amount outstanding under the credit agreement. The debtors also filed a Chapter 11 plan on the first day that assumed the credit bid would be successful and thus treated the secured debt as unimpaired. The key to the plan was the complete satisfaction of the secured debt through the §363 sale and credit bid.

The minority lenders objected to the RSA assumption and bidding procedures motions. In their objections, the minority lenders argued that (1) the RSA was a sub rosa plan designed to evade the protections of §1129, and (2) the sale process was a sham because the credit bid amount far exceeded value of the assets such that no other bidders would be able to compete. The objection also argued that the lenders should not be permitted to credit bid for a number of reasons including that (1) the credit bid would violate the intercreditor agreement, and (2) the lenders did not have a secured claim against the seller, TTK, because TTK only pledged the membership interests in Holdco and was not otherwise obligated on the credit agreement.

In approving the RSA assumption and bid procedures, Judge Drain reasoned that the RSA and bid procedures were in the best interests of the estate because they paved the way for a plan under which all claims would be paid in full. In overruling the objections, Judge Drain noted that intercreditor agreement delegated the authority to the collateral agent to credit bid the entire amount of the debt, positing that the minority lenders' concerns were matters of state law for the minority and majority lenders to work out outside of the bankruptcy proceedings.

The minority lenders unsuccessfully appealed the RSA assumption order and the bidding procedures order, later followed by still-pending appeals of the sale order and confirmation order.

The Court's Opinion

The RSA Appeal. With respect to the RSA assumption order, the minority lenders' argued that the bankruptcy court erred in its determination that the credit bid, as supported by the RSA, should be allowed.

First, the minority lenders posited the RSA was an improper sub rosa plan of reorganization, characterizing the alleged asset sale subject to the inflated credit bid as a device that ignored the economic reality that such creditors were not fully paid, and served as the predicate to improperly deny their right to vote against or otherwise meaningfully participate in the proposed plan process. On appeal, the court agreed with the bankruptcy court that the RSA did not "cement a reorganization" because it did not approve the sale or the proposed plan, both of which would still be subject to the bankruptcy court's approval. More importantly, however, the court went on to reject the minority lenders' argument that the credit bid improperly restricted their voting rights, holding that "any limitation on Appellants' voting rights arises out of their own [intercreditor agreement]."

Next, the minority lenders argued that the credit bid was not permissible under the language of §363(k) because the lenders did not have an allowed claim against the selling debtor, TTK, because the pledge of its assets was nonrecourse. It was uncontested, however, that TTK's membership interests in Holdco secured the other debtors' obligations under the credit agreement, giving rise to allowed secured claims against such debtors. The court concluded that the credit bid proposed in the RSA satisfied the statute.

Finally, the minority lenders argued that the credit bid violated the intercreditor agreement. The intercreditor agreement provided that the agent "will act for the benefit solely and exclusively of all present and future Secured Parties." The minority lenders argued that the credit bid violated this provision because it was for the benefit of the majority lenders at the expense of the minority lenders. The court agreed with the majority lenders that this general provision should not be read to limit the collective action provision that gave the collateral agent the exclusive power to exercise remedies with respect to the collateral as directed by holders of more than 50% of the debt. According to the court, doing so would "undermine, and in some circumstances eviscerate the Majority Lenders' right to direct the collateral agent to take actions." The court found that the unambiguous terms of the intercreditor agreement permitted the majority lenders to direct the collateral agent to credit bid the entire outstanding amount.

Accordingly, the court held that the bankruptcy court did not err in approving the assumption of the RSA and declining to find cause to limit the credit bid.

The Bidding Procedures. The minority lenders also appealed the bidding procedures order, making the same arguments against allowing the credit bid. In its opinion, the court first held that the order approving the bidding procedures was not a final order for purposes of appellate jurisdiction because the sale still remained subject to bankruptcy court approval.

The minority lenders sought leave to appeal the order to the extent it was interlocutory. The court rejected each of their arguments. First, it ruled that the permissibility of a credit bid is not a pure question of law, but rather a fact-bound inquiry not appropriate for interlocutory review. The court then, as discussed in the affirmance of the RSA assumption order, noted that it did not have genuine doubt that the bankruptcy court applied the correct standard in determining whether to limit the credit bid. The court noted that, if it agreed with any of the appellant's arguments against the credit bid, it would have found so in its review of the RSA appeal, which contained the same arguments. Further, granting leave to appeal would not "materially advance the litigation" and "would likely result in unnecessary duplication." As such, the court denied leave to appeal the bidding procedures order.

The Pending Appeals. The minority lenders have also appealed the bankruptcy court's sale and confirmation orders. The district court has not yet issued a decision regarding those appeals. However, the arguments that the appellants make in the pending appeals largely mirror those addressed in the court's review of the RSA assumption order.

Conclusion

This decision confirms the importance of intercreditor agreements as determinative of rights as among the creditors subject to the contract. This affirmance gives weight to the view that the bankruptcy court is not an appropriate forum for what is strictly an intercreditor dispute. It also stands as a clear statement that the bankruptcy court's consideration of the authorization of the collateral agent and its actions is sufficient. Indeed, whether the impact of that authorized action leads to potential liabilities of one creditor to another still may be an issue for another day and another court. The credit bid structure may have been motivated by a desire to gain a controlling equity interest without making concessions to an active minority, but on these facts, following the intercreditor agreement took priority. This decision avoided what otherwise might be cognizable bankruptcy issues regarding the potentially differing value recovered by creditors within a class, an issue which is more likely to occur when the distribution to a class of claims under a plan consists of equity. This decision suggests, but does not determine, that to the extent creditors in a class of claims have an intercreditor agreement, such inter se issues may be better addressed in that agreement. Perhaps, in the future, intercreditor agreements will contain a prohibition on credit bidding beyond estimated value or a prohibition or other limitation on credit bidding for collateral consisting of equity interests.

Corinne Ball is a partner at Jones Day.