In my last post I discussed the Meridian Sunrise Village v. NB Distressed Debt Investment Fund Ltd. opinion handed down by the United States District Court for the Western District of Washington in March of this year. The prior blog post focused on the Court’s holding that distressed loan investors are not “financial institutions” and therefore, cannot exercise rights and remedies under a loan agreement as permitted assignees. The Court didn’t stop there, however.  Within the opinion, the Court also signed off on the debtor’s gerrymandering of votes in respect of its plan of reorganization.  Today’s blog post discusses this second significant ruling.

As previously reported, Meridian Sunrise Village (“Meridian“) borrowed approximately $75 million from U.S. Bank for the construction of a shopping center.  Shortly after closing, U.S. Bank sold off pieces of the loan to other institutional lenders, including Bank of America.

Following a series of defaults under the loan agreement, Meridian filed for chapter 11 in early 2013.  During the course of the bankruptcy case, Bank of America sold its piece of the loan (“Ratable Loan“) to NB Distressed Debt Fund Limited (“NB“), which subsequently assigned one half of its interest to two other distressed debt investors (together with NB, the “Funds“).

Meridian, in an attempt to undermine the Funds’ position in its bankruptcy case, sought an injunction from the bankruptcy court limiting the Funds’ voting rights in respect of Meridian’s plan of reorganization.  Meridian’s argument focused on the fact that, immediately prior to the bankruptcy petition date, Bank of America was the sole owner of the Ratable Loan.  Therefore, notwithstanding the fact that each of the three Funds held a piece of the Ratable Loan at the date on which voting was to occur, Meridian asserted that the Funds should only have one vote (and not the normal three votes). Unfortunately for the Funds, the bankruptcy court concurred with Meridian and granted the injunction.

Notwithstanding the Funds’ attempt at an interlocutory appeal, voting on Meridian’s plan commenced to the exclusion of NB and its assignees.  The plan, which was supported by Meridian’s other lenders, was confirmed by the bankruptcy court in September 2013.  The Funds then appealed both the confirmation order and the bankruptcy court’s preliminary injunction to the District Court.

The Implications of the Court’s Ruling

After tackling the meaning of the phrase “financial institution,” the District Court considered the issue of allocation and counting of votes in favor of a plan of reorganization.  Under the Bankruptcy Code, a class of creditors is only deemed to accept a plan if more than 50% of the class members and 2/3 of the claimed dollar amount of the class vote in favor of the plan.

As discussed above, Meridian had allocated one vote to Bank of America as the prepetition holder of the Ratable Loan.  Notwithstanding Bank of America’s sale of the loan to NB and NB’s subsequent assignment to the Funds, the District Court held that that the Funds were only entitled to one vote (assuming they were entitled to vote at all), as per Meridian’s classification.  In relevant part, the District Court stated:

“A creditor does not have the right to split up a claim in such a way that artificially creates voting rights that the original assignor never had . . . .  If the Funds received the number of votes it [sic] desired by simple assignment, any creditor could assign its interest to multiple parties to increase its voting power.  [Another creditor] is correct that ‘the numerosity requirement cannot be so easily manipulated.’”

This is another controversial ruling with perhaps even more far ranging impact than the financial institution ruling discussed in my last post.  The district court effectively gave the debtor the ability to gerrymander voting on a plan of reorganization, at least in terms of satisfying the numerosity requirement.

While it remains to be seen whether this holding will be widely adopted and how it will affect plan classification and voting, we can concede that the district court added a new tool to a debtor’s arsenal vis-à-vis its lenders, particularly lenders who acquire loans post-petition.  In light of the Meridianopinion, lenders should take care when drafting loan agreements to include language addressing a lender’s ability to assign its loan and related rights (including the right to vote on a plan of reorganization) to multiple parties following a borrower’s bankruptcy filing.

The case is Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Ltd., 2014 WL 909219 (W.D. Wash. Mar. 7, 2014).  The Funds have appealed the decision to the United States Court of Appeals for the Ninth Circuit.