Junior creditors are often described as holding a “silent second” under standard intercreditor agreements, which address the relative rights of senior and junior creditors and the extent to which junior creditors can seek to enforce remedies without the consent of senior creditors. The increased complexity of capital structures has led to litigation over the degree junior creditors must remain silent after the borrower has commenced a chapter 11 case. In a recent decision rendered by Delaware Bankruptcy Judge Christopher Sontchi in the LBI Media case, the court rejected the debtors’ and senior creditors’ efforts to mute the junior creditors to pave the way for a restructuring that would leave the junior creditors little to nothing. Noting that the intercreditor agreement did not give any party the “right to enforce a smooth bankruptcy”, the court rejected an expansive view of an intercreditor agreement that would have immediately halted junior creditors’ actions in a chapter 11 case as a violation of the automatic stay that arises in bankruptcy.
Intercreditor agreements typically restrict the junior secured creditor until the senior secured creditor is repaid in full. These agreements are generally respected in bankruptcy. However, those restrictions are often written in broad terms, and it is common for the agreement to retain for the junior lienholder rights that an unsecured creditor would have. Judge Sontchi found that an intercreditor agreement does not necessarily afford rights to the borrower. Thus, the creditors’ failure to comply with the intercreditor agreement is not necessarily a violation of the automatic stay that arises in a bankruptcy case. As a result, an intercreditor agreement of the kind in place between LBI Media’s secured creditors may not be enforced through a borrower simply seeking to enforce the automatic stay.
Judge Sontchi’s ruling was part of a since settled row among LBI Media and its first and second lien note holders. LBI Media is the largest privately held, minority-owned Spanish-language broadcaster in the U.S. Prior to the commencement of chapter 11, in May 2018, LBI Media refinanced its existing $233 million first lien notes with new first lien notes over the opposition of the holders of its $262 million second lien notes.
As part of the refinancing, the collateral agent, on behalf of the new first lien note holders, stepped into the existing intercreditor agreement governing the relative rights and priorities of the Debtors’ first lien and second lien note holders. That intercreditor agreement contained more-or-less customary terms, including the following prohibitions expressly applicable in bankruptcy:
- seeking relief from the automatic stay in any insolvency proceeding in respect of any assets that constitute collateral of the first lien secured parties;
- challenging claims of the first lien secured parties for post-petition interest, fees, or expenses, including any make-whole amount;
- contesting the validity, extent or enforceability of a lien securing any first priority claim;
- objecting to or otherwise contesting the use of cash collateral or any debtor-in-possession financing; and
- commencing any proceeding with respect to any lien on common collateral or any subordinated lien claims.
In the LBI Media chapter 11 case, initiated barely six months after the refinancing, the second lien note holders commenced an adversary proceeding asserting claims against the Debtors and filed a motion seeking standing and relief from stay to bring claims against non-Debtors (including the majority first lien note holder, HPS Investment Partners LLC (“HPS”), and the Debtors’ principals), alleging that the refinancing was part of a scheme to defraud the second lien note holders. Among a number of other things, the second lien note holders asserted that a make-whole in the new first lien notes was tailored to create an incremental $87 million claim for a clearly impending bankruptcy to intentionally deprive value from the second lien note holders.
On January 30, LBI Media filed a motion to enforce the automatic stay, asserting that the second lien creditors’ actions violated the intercreditor agreement, including by bringing breach of contract claims against the debtors (i.e. a proceeding in respect of the subordinated claims) and seeking to derivatively assert claims challenging the enforceability of the first lien note holders’ claims. Underlying the debtor’s action was assertion that breach of a contract with the debtor constituted a violation of the stay. HPS and the collateral trustee for the first lien note holders joined in the debtors’ motion.
The second lien note holders responded that the motion should be denied for at least five separate reasons:
(1) The second lien note holders did not breach the precise terms of the intercreditor agreement. For example, the intercreditor agreement expressly allows the second lien note holders to act in their capacity as unsecured creditors, which is all they have done. Moreover, while the intercreditor agreement prohibits certain actions in respect of the collateral or challenges to the first lien note holders’ liens, the actions taken by the second lien note holders did neither--seeking relief solely in respect of non-debtors or the first lien note holders’ pre-petition claims rather than liens.
(2) The doctrine of “unclean hands” precludes equitable relief. The second lien holders asserted that knowing and intentional breaches of the second lien indenture, perpetration of a fraudulent scheme and bad faith acts by the debtors and first lien parties barred relief for them under the intercreditor agreement.
(3) Neither bringing direct claims in the bankruptcy court (as opposed to bringing derivative claims or seeking relief in another forum) nor requesting leave to assert derivative claims violates the automatic stay as a matter of well-established law.
(4) Even if there were a breach of the intercreditor agreement, that is not a violation of the automatic stay because the intercreditor agreement is not a legal or equitable interest of the Debtors in property--while the Debtors were parties to the agreement, they did not have any rights thereunder to enforce its provisions against the other parties.
(5) Finally, the motion was procedurally improper--a request for injunctive relief must be brought through an adversary proceeding in which there would be an opportunity to more fairly develop the record.
In an oral ruling, Judge Sontchi adopted the fourth and fifth arguments of the second lien note holders above, concluding that the intercreditor agreement did not grant the Debtors the rights they sought to enforce. The court also credited the argument that enforcement through the automatic stay raised equitable issues and the possibility of an unclean hands defense. Finally, the court indicated that, in any event, seeking an injunction through a motion to enforce the automatic stay without commencing an adversary proceeding was procedurally improper. Underpinning the bankruptcy court’s ruling is the idea that the intercreditor agreement does not define a debtor’s rights as to the collateral and instead defines the secured creditors’ rights.
Notably, the bankruptcy court reserved on the question of whether the intercreditor agreement was in fact violated by the actions of the second lien note holders--its resolution of the motion before it was only that the automatic stay was not violated by those actions. But the court did agree with the second lien note holders that, if the parties to the intercreditor agreement committed fraud, they would not be able to hide behind the agreement as a shield--this would be exactly the sort of claim that unsecured creditors (and, therefore, the second lien note holders acting within the scope of unsecured creditor’s rights expressly preserved under the intercreditor agreement) could pursue. As LBI Media’s first lien note holders--parties whom, unlike the Debtors, presumably do have enforceable rights under the intercreditor agreement--have since commenced their own adversary proceeding and a multi-day plan confirmation hearing has been scheduled for later this month, the bankruptcy court’s determination on the Debtors’ motion to enforce the automatic stay is not the end of this intercreditor dispute.
Judge Sontchi’s relatively narrow ruling reinforced the fundamental concept that borrowers simply do not generally have enforceable rights and remedies under intercreditor agreements. Perhaps more significantly and portending, the ruling suggests that only the precise terms of the intercreditor will be enforced and those terms may not be as all-encompassing as intended (or hoped) by senior creditors. In addition, a clear trend of bankruptcy court decisions continues to refuse to enforce intercreditor provisions in a summary manner, and many will, as was the case here, end up ultimately being resolved by global settlements. While second lienholders may act with some risk, senior creditors may find them unwilling to remain silent in a chapter 11 case.