A recent decision by the U.S. District Court for the Western District of Washington found that certain distressed debt funds were not “financial institutions” under the definition of “Eligible Assignee” in the applicable loan agreement and thus were not entitled to vote on the debtor’s chapter 11 plan of reorganization. The District Court decision affirmed a bankruptcy court decision enjoining loan assignments to the funds and recently denied the funds’ motion to vacate the decision.”1

Although the decisions in Meridian may have been driven by the particular facts, the case nevertheless serves as a cautionary tale for distressed debt investors and more generally as a reminder for parties drafting and negotiating loan documents.

Background

In April 2008, Meridian Sunrise Village, LLC (“Meridian”) borrowed $75,000,000 (the “Loan”) from U.S. Bank National Association (“US Bank”), acting as initial lender and administrative agent (in such capacity, “Agent”), for construction of a shopping center. The loan agreement permitted the lenders to assign a portion of the Loan, but only to an “Eligible Assignee”—defined in relevant part as “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.”US Bank subsequently assigned portions of the Loan to Bank of America, N.A. (“BofA”) and two other banks (collectively the “Bank Group”).

In early 2012, the Loan was declared in default due to a financial covenant breach. However, the Bank Group did not begin charging default rate interest on the Loan. Instead, Meridian continued to accrue and pay interest at the original loan agreement rate while the Agent attempted to have Meridian waive and amend the “Eligible Assignee” definition in the loan agreement in order to facilitate sales of the Loan to “any person other than borrower or any affiliate of borrower.”3 After negotiations lasting over a month, Meridian refused to waive or amend the Eligible Assignee definition.

Subsequent to Meridian’s refusal to amend the “Eligible Assignee” definition, the Agent on behalf of the Bank Group began charging default interest. In January 2013, Meridian, unable to pay the additional default rate interest, filed a bankruptcy petition under chapter 11 in the United States Bankruptcy Court for the Western District of Washington (the “Bankruptcy Court”).

In March 2013, Meridian filed a plan of reorganization designating the Bank Group as a specific class for voting purposes. Each of the four Banks in the Bank Group was granted a single vote.

BofA thereafter assigned its interest in the Loan to NB Distressed Debt Limited Fund (“NB”), and NB in turn assigned a portion thereof to two other distressed debt funds (collectively the “Funds”). Meridian objected to these assignments, arguing that the Funds were not “Eligible Assignees” under the loan agreement.

In May 2013 Meridian filed a motion with the Bankruptcy Court seeking to enjoin (i) the Funds from exercising any of the rights of an “Eligible Assignee” under the loan agreement, including voting on Meridian’s plan of reorganization, and (ii) the Agent from recognizing and/or dealing with the Funds as “Eligible Assignees.”4