Assignees of Loan Only Entitled to One Collective Vote on Plan
The recent decision by a Federal District Court in Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Ltd., et al (In re Meridian Sunrise Village, LLC) No. 13-5503 (W.D. Wash. filed Mar. 6, 2014), should be of interest to financial lending institutions and distressed debt investors. In this case, Meridian, the debtor, argued and the District Court agreed that, under the terms of a loan agreement, “hedge funds that acquire distressed debt and engage in predatory lending” did not fall within the meaning of “financial institutions” and were, therefore, not included in the definition of “Eligible Assignees.” The loan agreement provisions and language relating to these two terms were usual and customary. Owing to the District Court’s narrow interpretation of these loan agreement provisions and the District Court’s reading out of the definition a class of investors that are otherwise generally considered financial institutions, the ruling should be considered with care in interpreting and drafting such provisions in the future.
In 2008, Meridian borrowed $75,000,000 from U.S. Bank National Association for the construction of Sunrise Village, a shopping center. The loan agreement negotiated by the parties provided that the lender was prohibited from selling, transferring or assigning any portion of the loan to entities other than “Eligible Assignees,” 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.” 1 Based on prior negative experiences, Meridian argued that it had negotiated these limitations specifically to avoid future assignments 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.” Portions of the loans were assigned by U.S. Bank to Bank of America, Citizens Business Bank, and Guaranty Bank and Trust Company (collectively, the “Lender Group”).
In early 2012, Meridian triggered a non-monetary covenant default under the loan agreement. In late 2012, U.S. Bank, as agent under the loan agreement, requested that Meridian waive the “Eligible Assignees” limitation to facilitate a sale of the loans held by the Lender Group. When Meridian refused to grant such waiver, the agent threatened to enforce its rights arising from Meridian’s default. By reason of Meridian’s refusal to waive the provision in question, U.S. Bank started charging Meridian default interest at an incremental cost of $250,000 per month. As a result, on January 18, 2013, Meridian filed a petition for relief under chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the Western District of Washington (the “Bankruptcy Court”). Over Meridian’s objections, Bank of America transferred its interests in the loan to NB Distressed Debt Limited Fund, which subsequently assigned one-half of its interest to Strategic Value Special Situations Master Fund II, L.P. and another part of its interest to NB Distressed Debt Master Fund L.P. (collectively, the “Funds”). All three of the Funds focused on distressed debt investing. On May 23, 2013, Meridian asked the Bankruptcy Court to enjoin the Funds from exercising any rights that Eligible Assignees would have under the loan agreement, including the right to vote on Meridian’s proposed chapter 11 plan.
Bankruptcy Court Ruling
The Bankruptcy Court granted Meridian’s request for an injunction. In turn, the Funds appealed to the United States District Court for the Western District of Washington (the “District Court”), seeking to stay the injunction. Because the District Court did not stay the injunction, the Funds were not permitted to vote on the chapter 11 plan and the plan was approved by the balance of the Lender Group. In September of 2013, the Bankruptcy Court confirmed the plan. The Funds appealed the Bankruptcy Court’s preliminary injunction and confirmation of the plan, arguing that the term “financial institutions” should be interpreted broadly, and that the Bankruptcy Court erred by holding that the Funds were not financial institutions and denying them the right to vote on the plan.
District Court Ruling and Analysis
The District Court, in affirming the Bankruptcy Court, concluded that the Funds did not qualify as “financial institutions” and, consequently, as Eligible Assignees under the loan agreement. The District Court held that the Bankruptcy Court’s decision would be reviewed de novo because the outcome of the case turned on the interpretation of a term in the parties’ loan agreement. In considering whether the Funds were “financial institutions” under the definition in the loan agreement of “Eligible Assignees,” the District Court noted that (i) the Funds’ interpretation of “financial Institution” as any entity that manages money is too broad, as it 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, and (ii) the remaining phrases in the limitation (“commercial bank, insurance company, … or institutional lender”) would have no meaning if the term “financial institution” was as broad as asserted by the Funds. Reasoning that consideration of extrinsic evidence is permitted to determine the meaning of a specific contractual phrase, the District Court focused on the parties’ actions and intent. 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 District Court held that “the Loan Agreement permitted only 'Eligible Assignees' to vote on the plan, and thus the Funds were rightfully precluded from voting.”
When crafting a proposed chapter 11 plan, consistent with section 1122 of the Bankruptcy Code, a debtor may separate its creditors into different classes. Under section 1129 of the Bankruptcy Code, a court may confirm a chapter 11 plan if, among other requirements, at least one impaired class of claims votes to accept the plan. Under section 1126 of the Bankruptcy Code, a class of claims accepts a plan if it is accepted by creditors that hold at least two-thirds in dollar amount and more than one-half in number of the allowed claims of the class that are held by holders that actually vote to accept or reject the plan. Under its plan, Meridian had organized one class consisting of the Lender Group, which included Bank of America. Each member of the Lender Group had one vote.
Equally troubling for investors is the District Court’s determination that even if the Funds were permitted to vote, all three Funds would only be entitled to one collective vote (not three). The District Court noted that a creditor cannot split up a claim in a way that artificially creates and increases voting power and voting rights that the original assignor never had. In the District Court’s view, allowing the Funds to have three votes would result in an arbitrary increase in voting power that would prevent the remaining three members of the class from accepting a plan without the cooperation of the Funds, and thereby nullify the majority voter requirements of the Bankruptcy Code. Based on all of the above reasons, the District Court affirmed the Bankruptcy Court’s confirmation of Meridian’s chapter 11 plan.
While isolated and fact driven, the case is of significance to distressed debt investors, as it highlights in general the importance of determining in advance of purchase whether the assignment clause in loans may preclude full participation and voting in a chapter 11 case context. In particular, such investors may not be able to rely on being included within the meaning of “financial institutions” in the context of a loan provision limiting eligible assignees. For purchasers of claims, the case also implicates the potential effect on voting rights when lenders break up their original loan positions and trade with multiple entities.