While derivations of intercreditor agreements continue to enhance the rights of the senior secured party, whether the many provisions provided for are enforceable in bankruptcy remains a burning question. Recently, the Bankruptcy Court for the Northern District of Georgia in In re Aerosol Packaging, LLC, 2006 WL 4030176 (Bankr. N.D.Ga. 2006) helped bring clarity to one of the most important of these issues: is the right of a senior creditor to vote the claim of a junior creditor on whether to accept or reject a plan of reorganization enforceable in bankruptcy? In In re Aerosol Packaging, LLC, the debtor proposed an amended plan of reorganization, and sought solicitation of the plan. Blue Ridge, a creditor of the debtor’s estate that had executed a subordination agreement with Wachovia Bank, voted against the plan, while Wachovia Bank voted in favor of the plan.
Pursuant to the terms of this agreement, Blue Ridge had subordinated its claims against the debtor and its liens on the debtor’s assets in all respects to those of Wachovia Bank. The subordination agreement provided that Blue Ridge could not take any action against the debtor until all of the Wachovia claims were paid in full in cash. More specifically, the agreement stated that Blue Ridge irrevocably authorized and empowered Wachovia to take certain action on behalf of Blue Ridge, including “the right to vote the claims of Blue Ridge in any bankruptcy proceeding of the debtor.” Id. at 2. As a result, Wachovia asserted that it was entitled to vote the claim of Blue Ridge.
Blue Ridge challenged the application of this provision of the subordination agreement arguing that it was unenforceable. Blue Ridge further requested that the Bankruptcy Court declare that Blue Ridge, and not Wachovia, is entitled to vote the Blue Ridge claim. In support of this position, Blue Ridge cited section 1126 of the Bankruptcy Code and the Court’s decision in Bank of America, N.A. v. North LaSalle Street Limited Partnership (In re 203 North LaSalle Street Partnership), 246 B.R.
325 (Bankr. N.D. Ill. 2000), a case in which a somewhat similar subordination provision was not enforced. The debtor and Wachovia disagreed, arguing that the LaSalle decision was wrongly decided and citing contrary authority, including In re Curtis Center Limited Partnership, 192 B.R. 648 (Bankr. E.D. Pa. 1996) and In re Inter Urban Broadcasting of Cincinnati, Inc., 1994 WL 646176 (E.D. La. 1994), among other caselaw. Wachovia also argued that the assignment of voting rights should be enforceable, relying on sections 510(a) and 1126 of the Bankruptcy Code, which maintain the enforceability of a subordination agreement in bankruptcy, and Bankruptcy Rules 3018 and 9010, which permit agents and other representatives to vote claims. Additionally, Wachovia argued that waivers that have not been enforced are inapposite because it is the debtor in those cases whose rights were waived.
The Bankruptcy Court concluded that section 510(a) of the Bankruptcy Code requires that the Court enforce subordination agreements in bankruptcy to the same extent they are enforceable under applicable non-bankruptcy law. Because Blue Ridge did not present evidence that the subordination agreement was subject to challenge outside of bankruptcy, the Court concluded that the agreement should be enforced by its terms. The Court further found that section 1126(a) of the Bankruptcy Code grants a right to vote to the holders of a claim, “but does not expressly or implicitly prevent that right from being delegated or bargained away by such holder.” Id. at 47. The Court surmised that, in this case, Wachovia was acting as the duly authorized agent of Blue Ridge. The Court explained:
The express terms of the Subordination Agreement- to which Blue Ridge is a party and to which it agreedcompel the conclusion that the right to vote any claim of Blue Ridge in Debtor’s bankruptcy proceeding was assigned by Blue Ridge to Wachovia. The result is that Wachovia would, in the event of a bankruptcy, vote the Blue Ridge claim and take other actions in support of its own interests and potentially contrary to the wishes and immediate interests of Blue Ridge.
Id. at 47. While this was a seemingly draconian remedy, the Court was unsympathetic to the plight of Blue Ridge, explaining that Blue Ridge could always exercise its right to cash out Wachovia in order to vote its claim. Because Blue Ridge had determined not to take this step, Wachovia was entitled to vote the Blue Ridge claim. Whether other courts will follow the decision of Aerosol has yet to be seen, but senior creditors will certainly be emboldened by this encouraging decision affirming their ability to enforce subordination rights. The ruling of Aerosol could discourage investors from purchasing second lien debt, especially in a market that has cast doubt on other secured investments. In any event, the Aerosol decision will put teeth into one of the most important provisions negotiated for and obtained by senior creditors--the right to voice an opinion on distribution decisions embodied in a debtor’s chapter 11 plan of reorganization.