Section 510(a) of the Bankruptcy Code provides that “[a] subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law.”  However, while Section 510(a) provides for the enforceability of subordination agreements “enforceable under applicable nonbankruptcy law”, some courts have held that such agreements cannot nullify provisions of the Bankruptcy Code.  These courts have ruled that to the extent a provision in a subordination agreement purports to alter substantive rights under the Code, the provision is invalid and unenforceable.  Based on this reasoning, they have ruled that a provision in a subordination agreement in which the subordinated creditor purported to agree to assign its voting rights in a future Chapter 11 case to a senior secured creditor was contrary to Section 1126(a) of the Code and was unenforceable.  See, Beatrice Foods Co. v. Hart Ski Mfg. Co. (In re Hart Ski Mfg. Co.), 5 B.R. 734 (Bankr.D.Minn.1980); Bank of Amer. v. 203 N. LaSalle Street Ltd. P’ship (In re 203 N. LaSalle Street P’ship), 246 B.R. 325, 331 (Bankr.N.D.Ill.2000) (“The holder of a claim or interest allowed under section 502 of this title may accept or reject a plan * * * *”); and In re SW Boston Hotel Venture, LLC, 460 B.R. 38 (Bankr.D.Mass.2011).

This was the conclusion reached in In re Fencepost Productions, Inc., 629 B.R. 289 (Bankr.D.Kan.2021), which found the LaSalle Street analysis of Section 1126(a) persuasive.  Section 1126(a) of the Bankruptcy Code provides that “[t]he holder of a claim” may vote to accept or reject a plan, and found that none of the arguments submitted by the senior lender there justified deviation from the statute’s plain language.  It noted that LaSalle Street held that the fact that the junior lender agreed that the senior lender could vote on its behalf was not controlling because “[i]t is generally understood that prebankruptcy agreements do not override contrary provisions of the Bankruptcy Code.”  Second, it held that Section 510(a), providing for the enforcement of subordination agreements, does not allow for waiver of voting rights under Section 1126(a) because subordination affects the priority of payment of claims in bankruptcy, not voting rights.

In Fencepost, the court found that agreement between the junior and senior lenders, allowing the senior lender to vote on behalf of the junior lender, did not appoint the senior lender the junior lender’s agent.  “Unlike an agent, who has fiduciary duty to act at the direction of the principal, Associated would be acting for its own benefit, contrary to the wishes of the BMS Group.” Id. at 295.  The court concluded that “subordination merely reorders priorities among creditors.  Unlike the circumstance where a claim is assigned to another party, subordination does not involve transfer of the subordinated creditor’s legal interest.”

Notwithstanding the fact that Fencepost found the subordination agreement ineffective in transferring voting rights to the senior lender, it also found that the junior lender did not have “prudential standing” to participate in the confirmation process, or raise objections to the debtor’s plan.  The court reached this conclusion by finding that there were no circumstances under which the junior lender (BMS Group) had any financial stake in the outcome of the confirmation process because it subordinated its claim, and there were insufficient funds or assets to pay it anything after the senior lender.  The court stated:

In this case, the BMS Group, if permitted to participate in the Plan confirmation proceedings, would be litigating issues affecting the rights of third parties, not itself. As noted above, there is no scenario under which the BMS Group will receive any direct financial benefit.  If the Plan were amended to provide larger payment to Class 5A, the subordinated BMS Group claims, Associated could benefit financially, but other unsecured creditors would likely receive less.  The BMS Group seeks to vote against confirmation to force Debtors to satisfy the § 1129(b) requirements of cram down.  But the BMS Group would not benefit from enforcement of the requirements that the Debtors’ plan not discriminate, be fair and equitable to impaired classes, and satisfy the absolute priority rule.  It is other creditors, Associated in particular, who have a financial stake in these matters.  This case therefore fits with the circumstance of special concern to the Second Circuit, quoted above, when a “constituency seeks to disturb a plan of reorganization” though asserting rights other than its own.

Id. at 299-300.

A contrary conclusion was reached in Blue Ridge Investors, II, LP v. Wachovia Bank (In re Aerosol Packaging, LLC), 362 B.R. 43 (Bankr.N.D.Ga.2006).  This court found that “[t]he express terms of the Subordination Agreement * * * compel the conclusion that the right to vote any claim of Blue Ridge in Debtor’s bankruptcy was assigned by Blue Ridge to Wachovia,” making Wachovia the “duly authorized agent of Blue Ridge.”  It reasoned that the subordination agreement appeared to be enforceable under applicable state law, and rejected the reasoning of LaSalle finding that although Section 1129(a) grants a right to vote to a holder of claim, it does not expressly or implicitly prevent that right from being delegated or bargained away by the holder of the claim. Additional cases support enforcement.

In In re MPM Silicones, L.L.C., 2019 WL 121003 (S.D.N.Y.2019), the court approached the issue from a different perspective.  Here, the first lienholders pleaded that the second lienholders breached an intercreditor agreement (“ICA”) by entering the Restructuring Support Agreement and voting to approve the Chapter 11 Plan over the first’s objections, and which ultimately paid the firsts less than payment in full, in cash, of their liened securities.  The relevant clauses in the intercreditor agreement provided:

will take any action that would hinder any exercise of remedies undertaken by the [firsts] with respect to the Common Collateral * * * including any sale, lease, exchange, transfer or other disposition of the Common Collateral, whether by foreclosure or otherwise

It also provides that each second:

waives any and all rights it * * * may have as a junior lien creditor or otherwise to object to the manner in which the [Seniors] seek to enforce or collect the Senior Lender Claims or the Liens granted in any of the Senior Lender Collateral

Finally, the intercreditor agreement also provided as follows:

Notwithstanding anything to the contrary in this Agreement, the [seconds] may exercise rights and remedies as an unsecured creditor against the Company or any subsidiary.* * * * Nothing in this Agreement shall prohibit the receipt by any … of the required payments of interest and principal so long as such receipt is not the direct or indirect result of the exercise by any [second] of rights or remedies as a secured creditor in respect of Common Collateral

The court ruled that the prohibition on hindering the firsts’ remedies was not intended to mean that the seconds were waiving all the voting rights that they are otherwise entitled to under bankruptcy law.  The court noted that those agreements that have been enforced contained specific waivers, assignment of rights, or express agreements that the juniors would be “silent seconds.” Id. at *11.  It stated that “the case law, equities, economics, and practicalities of this case favor a reading of the ICA that does not write an express waiver of voting rights into the general language and does not nullify entire provisions of the agreement, such as Section 5.4.” Id.  Therefore, absent “express constraints or waivers in the ICA” an effort to strip the seconds of their voting rights would not be allowed.  Id. at *12.

Matthew T. Gensburg
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