Introduction: A groundbreaking decision in a high profile case1 opens the door for confirmation of chapter 11 plans that distribute value to junior creditors over the objection of first lienholders, despite the parties' subordination agreement. This is in contrast to the general rule that subordination agreements are enforceable in bankruptcy.
What happened: A battle for control of three Trump hotel casinos in Atlantic City pitted a group of first lienholders against a group of second lienholders. The first lienholders group—which included Carl Icahn and held a majority of the debtor's first lien debt ($488 million)—proposed a plan of reorganization which would have converted the first lien debt to equity and wiped out all second lien and other debt. The group holding the majority of the debtor's second lien debt ($1.25 billion) proposed its own competing plan, which would satisfy the first lien debt through a package including a $125 million cash distribution coupled with a secured note for $334 million. Under their plan, which the debtors supported, the second lienholders had the right to invest $225 million through subscription rights in exchange for 75% of the reorganized debtor's equity. The bankruptcy court found that both plans met the legal requirements for confirmation, but selected the second lienholders' plan because it provided value to more creditor constituencies and gave the second lienholders the opportunity to participate in the upside potential of the reorganization.
The first lienholders objected to confirmation of the second lienholders' plan arguing, among other things, that the plan violated the parties' intercreditor agreement by impermissibly providing for distributions to second lienholders before the first lienholders were to be paid in full. The first lienholders contended that the second lienholders' plan could not be confirmed via a cram down (i.e. over the first lienholders' objection) because it failed to preserve the subordination rights under the intercreditor agreement.
The holding: The bankruptcy court, without deciding whether the intercreditor agreement was actually breached, overruled the first lienholders' objections and confirmed the plan, holding that the violation of subordination provisions could not form the basis for denial of confirmation. The court stated that it could find no case addressing this issue, but held that the statutory language providing for confirmation of a cram down plan allowed for confirmation of the second lienholders' plan, despite the plan's violation of a subordination agreement. In other words, the Bankruptcy Code's cram down provision overrides a subordination provision in an intercreditor agreement.
What it means: The decision is under appeal, but first lien lenders should not be too confident that a subordination clause in an intercreditor agreement will protect them from being crammed down by a plan that provides value to second lien lenders in violation of that clause. Other provisions in an intercreditor agreement may still be enforceable in bankruptcy cases. Nevertheless, this case illustrates that bankruptcy courts have the power to override subordination provisions to the detriment of senior secured creditors by confirming a cram down plan of reorganization.
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1 In re TCI Holdings, LLC, 428 B.R. 117 (Bankr. D.N.J. 2010).