A decision recently handed down by the U.S. District Court for the Western District of Washington should be of interest to lenders and distressed debt purchasers. In Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Ltd. (In re Meridian Sunrise Village, LLC), 2014 BL 62646 (W.D. Wash. Mar. 6, 2014), a lender group had provided $75 million in financing to a company for the purpose of constructing a shopping center. The loan agreement provided that the lenders were prohibited from selling, transferring, or assigning any portion of the loan to entities other than “Eligible Assignees.” The term “Eligible Assignees” was defined as “any Lender, Affiliate of a Lender or any commercial bank, insurance company, financial institution or institutional lender approved by Agent in writing and, so long as there exists no Event of Default, approved by Borrower in writing, which approval shall not be unreasonably withheld.”
After a nonmonetary default in 2012 triggered liability under the loan agreement for default interest and other penalties, the debtor filed for chapter 11 protection in the Western District of Washington on January 18, 2013. Over the debtor’s objection, one of the lenders then sold its debt to a hedge fund that later resold a portion of the debt to two other distressed investors (collectively, the “Funds”). Shortly afterward, the debtor sought an order from the bankruptcy court enjoining the Funds from exercising any rights that Eligible Assignees would have under the loan agreement, including the right to vote on the debtor’s proposed chapter 11 plan.
The debtor argued that it had negotiated those limitations specifically to avoid assignments of the debt to “predatory investors— investors who purchase distressed loans in the hope of obtaining control of the underlying collateral in order to liquidate for rapid repayment.” The bankruptcy court granted the injunction. After the Funds’ request for a stay pending appeal was denied, the court confirmed the debtor’s chapter 11 plan on the basis, in part, of votes cast in favor of the plan by the prepetition lenders that had not sold their claims. The Funds appealed the confirmation order as well as the injunction, claiming that the bankruptcy court erroneously denied them the right to vote on the plan when it concluded that they were not “financial institutions.”
On appeal, the debtor argued that, under the terms of the loan agreement, “hedge funds that acquire distressed debt and engage in predatory lending” do not fall within the meaning of “financial institutions” and should therefore not be included in the definition of “Eligible Assignees.” The district court agreed.
The court rejected as overly broad the Funds’ reading of “financial institution” to encompass any entity that manages money. This interpretation, the court wrote, would allow assignment to any entity that “has some remote connection to the management of money” and would drain any force from the limitation inherent in the Eligible Assignees provision. The court also reasoned that the remaining language in the loan agreement’s assignment limitation (“commercial bank, insurance company, . . . or institutional lender”) would have no meaning if the term “financial institution” were as broad as the Funds suggested.
The district court concluded that the parties knew of the materiality of the Eligible Assignees limitation in the loan agreement and had intentionally limited the term to exclude assignment to “distressed asset hedge funds who candidly admit they seek to ‘obtain outright control’ of assets.” The court ruled that “the Loan Agreement permitted only ‘Eligible Assignees’ to vote on the plan, and thus the Funds were rightfully precluded from voting.”
The district court also held that, even if the Funds had been permitted to vote, the three entities comprising the Funds would be entitled to one collective vote only (as distinguished from three). According to the court, a creditor-assignor cannot split up a claim in a way that artificially creates or enhances voting power that the original assignor never had. Permitting the Funds to have three votes, the court reasoned, would arbitrarily increase the voting power of their claim and violate the majority voting requirements of the Bankruptcy Code by preventing the remaining members of the class from accepting a chapter 11 plan without the Funds’ cooperation.