Judge Vincent Bricetti of the United States District Court for the Southern District of New York issued a ruling in the Momentive Performance Materials cases affirming the Bankruptcy Court’s confirmation rulings on Monday, May 4. Key themes raised in this case of interest to distressed investors and addressed in Judge Bricetti’s ruling include the appropriate interpretation of certain indenture subordination provisions, an affirmation of the “Till” approach to cramdown interest rates in the Second Circuit, and a reminder that the ability to receive a make whole based on automatic acceleration requires explicit language in the applicable indenture.
The Momentive plan of reorganization confirmed by Judge Drain in September 2014 provided for no recovery for certain holders of subordinated notes. The indenture trustee for the subordinated noteholders appealed confirmation of Momentive’s plan, arguing (among other things) that the plan was not fair and equitable under the Bankruptcy Code to the subordinated noteholders. In order to be fair and equitable, the position taken by subordinated noteholders was that Momentive’s plan provided for subordinated noteholder claims to be treated on a pari passu basis with second lien noteholder claims based on the subordination provisions of the indenture governing the subordinated notes.
The debtors, the bankruptcy court, and, now, the district court disagreed with this position. Agreeing with the bankruptcy court, the district court held that the subordinated notes were, indeed, subordinated to the second lien notes, and that the second lien notes were “Senior Indebtedness” as the term was defined in the subordinated note indenture. The district court decision rested on a “plain meaning” interpretation of the subordinated note indenture, and the distinction between payment subordination (where a subordinated creditor does not receive a recovery on account of its subordinated claim until the senior creditor has been paid in full), and lien subordination (where a subordinated secured creditor has no recourse to collateral until the senior creditor has recovered in full). The key difference between the two is that lien subordination is only concerned with rights to collateral, meaning that unsecured deficiency claims would recover pari passu, while payment subordination encompasses all recoveries and, until the senior creditor is paid in full, would divert recoveries from the subordinated creditor’s unsecured claims.
Thanks to organizations like the Loan Syndications and Trading Association, credit documents are trending towards more standardized provisions to ensure predictability for debt holders. This harmonization effort has not made much headway when it comes to intercreditor and subordination provisions though, where forms tend to be drafted by individual law firms and provisions between one indenture to the next can diverge widely in these areas. If you are buying paper where intercreditor and subordination provisions impact your investment decisions, you shouldn’t expect to find “market” terms in the underlying debt documents. A failure to analyze the credit documents for debt you purchase will increase the risk in your portfolio in an intercreditor and subordination scenario.