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May 6, 2011
An update on second-lien financings and intercreditor
agreements: Part III
This alert presents the latest in a series of articles and a handbook about second-lien financings and
intercreditor agreements co-authored by Mark N. Berman, a partner resident in our New York City
and Boston offices, and Jo Ann Brighton, a former Nixon Peabody partner, now a partner at K&L
Gates LLP resident in its Charlotte, NC and New York City offices. It is reprinted with permission
from the
ABI Journal
, Volume XXX, No. 2, March, 2011. This article discusses two non-bankruptcy
court decisions that examined mezzanine loan intercreditor agreements and also looks at the
jurisdictional issues present when a bankruptcy court considers whether it has jurisdiction to
enforce an intercreditor agreement.
Non-bankruptcy courts and intercreditor agreements
Mezzanine financing of real estate context
Second lien financings are not the only financing context in which you will find an Intercreditor or
Subordination Agreement. They are also used to define the relative rights of lenders in real estate
financing transactions where the ‘senior’ lender is lending to a borrower that owns the key real
property that will secure the loan while a separate ‘mezzanine’ or ‘junior’ loan is made to the equity
interest holder secured by the equity in the borrower. We now look at some noteworthy
intercreditor/subordination decisions issued by non-bankruptcy courts in the context of a troubled
real estate project.
In the
Bank of America, the senior secured lender, was granted judgment by a state
court declaring that the Intercreditor Agreement prevented PSW, the mezzanine lender, from
Bank of America N.A. v. PSW NYC LLC
, 2010 WF 4243437 (N.Y. Sup. Ct. September 15, 2010)
foreclosing on its equity collateral until it first paid the senior debt in full. The specific provision in
the Intercreditor Agreement
Section 6 is titled “
Foreclosure of Separate Collateral
at 54 (emphasis in original).
Subsection 6(d) provides as follows:
To the extent that any Qualified Transferee acquires the Equity Collateral
pledged to a Junior Lender pursuant to the Junior Loan Documents in
accordance with the provisions and conditions of this Agreement
but not limited to Section 12 hereof)
, such Qualified Transferee shall
acquire the same subject to (i) the Senior Loan and the terms, conditions and
provisions of the Senior Loan Documents
provided, however, that
(A) such
Qualified Transferee shall cause, within ten (10) days after the
transfer, (1) Borrower and (2) the applicable Senior Junior
Borrowers, in each case to reaffirm in writing … all of the terms,
conditions and provisions of the Senior Loan Documents and the
related Senior Junior Loan Documents, as applicable, on
Borrower’s or the applicable Senior Junior Borrower’s, as
applicable, part to be performed and
(B) all defaults under (1) the Senior
Loan and (2) the applicable Senior Junior Loans, in each case which remain
uncured or unwaived as of the date of such acquisition have been cured by such
Qualified Transferee
or in the case of defaults that can only be cured
by the Junior Lender following its acquisition of the Equity
Collateral, the same shall be cured by the Junior Lender prior to the
expiration of the applicable Extended Non-Monetary Cure Period.
(emphasis added).
Section II (d) is titled “
”, and subsection (ii) provides, in pertinent part, as
For as long as the Senior Loan shall remain outstanding, none of the Junior
Lenders shall solicit, direct or cause Borrower or any other entity which Controls
Borrower ... or any other Person to: (1) commence any Proceeding against
or any SPE Constituent Entity; (2) institute proceedings to
have Borrower or any SPE Constituent Entity adjudicated a
bankrupt or insolvent; (3) consent to, or acquiesce in, the institution
of bankruptcy or insolvency proceedings against Borrower ... or (9)
take any action in furtherance of any of the foregoing
... If any Junior Lender
commences an Equity Collateral Enforcement Action against any
Junior Borrower, and pursuant to such Equity Collateral
Enforcement Action, such Junior Lender takes title to the Equity
Collateral of such Junior Borrower, from and after the date title to
such Equity Collateral is vested in such Junior Lender (as
applicable), such Junior Lender shall be bound by the terms and
provisions of the respective organizational documents of such
Junior Borrower regarding bankruptcy and all matters requiring the
The Intercreditor Agreement used in this case is more indicative of mezzanine lending in the real estate
context and not second lien financing.
vote of the independent directors/managers/members of such
Junior Borrower.
(emphasis added).
Bank of America also sought an injunction, pursuant to a provision of Intercreditor Agreement,
prohibiting PSW from forcing the borrowers into bankruptcy before the senior debt was paid in full
(PSW could have accomplished this by foreclosing on and purchasing the equity collateral of the
borrowers’ parent company, which secured the mezzanine loan, and then having the parent’s board
of directors vote to have the wholly owned subsidiaries/borrowers file for bankruptcy). The Court
denied Bank of America’s motion for injunctive relief holding that Bank of America’s argument was
moot and speculative. The injunctive relief sought with regard to the bankruptcy portion of the
Intercreditor Agreement was speculative because no foreclosure/sale of the equity collateral had
occurred, and it was moot because the Court had already held via the declaratory judgment that the
Intercreditor Agreement required that the senior debt be paid in full before the equity collateral
could be foreclosed upon.
However, the Court’s discussion appears to suggest that the bankruptcy
portion of the Intercreditor Agreement would have been enforceable had it not been
moot/speculative. The Court also pointed out that the Intercreditor Agreement specifically
provided that monetary damages were not an adequate remedy to redress a breach, and instead that
specific performance and injunctive relief were available remedies to the non-breaching party.
Highland Park
Highland Park
Wells Fargo, the senior secured lender, was granted injunctive relief in federal
district court preventing Highland Park, the mezzanine lender, from exercising rights or remedies
under guarantees supporting the mezzanine loan. Repayment of the mezzanine loan was
subordinated to the senior loan by a specific provision of the Intercreditor Agreement that
prevented the mezzanine lender from receiving payments before the senior loan was repaid in full.
Both loans were guaranteed by individuals associated with the borrower and, following default, the
mezzanine lender brought suit against the guarantors. The Court held that the Intercreditor
Agreement, which also provided that the remedies of injunction and specific performance were
available to the non-breaching party, prohibited the mezzanine lender from recovering on the
mezzanine loan, either from the borrower or from a guarantor, until the senior loan was repaid in
Taken together,
Highland Park
reflect a willingness by non-bankruptcy courts to enforce
specific terms in intercreditor agreements either by declaratory or injunctive relief.
Bankruptcy court jurisdiction and enforcement of intercreditor agreements
Several bankruptcy cases have had to come to grips with the extent to which a bankruptcy court has
the jurisdiction necessary to resolve intercreditor disputes. The ‘Core’ vs. ‘Non-Core’ comparison as
well as the trilogy of ‘Arising Under’, ‘Arising In’ and ‘Related To’ are at issue. Given that the
Intercreditor Agreement used in a second lien financing is between two non-debtors, each time a
Id. at *9.
Highland Park CDO I Grantor Trust v. Wells Fargo Bank, N.A.
, 2009 WF 1834596 (S.D.N.Y. June 16,
non-debtor seeks to have a bankruptcy court address an intercreditor agreement issue, the question
of jurisdiction must be addressed.
Charter Communications, Orion Pictures and Best Products
a pre-negotiated plan of reorganization was filed containing a central treatment provision
calling for the reinstatement of billions of dollars of debt.
JPMorgan, as administrative agent under
the prepetition credit facility, opposed reinstatement of the pre-petition debt asserting that Charter
committed various non-monetary and non-curable pre-petition breaches of the credit agreement
that foreclosed reinstatement, a claim treatment deemed to unimpair the affected creditor, depriving
it of voting rights under the Bankruptcy Code.
JPMorgan commenced an adversary proceeding
seeking to prove that the debtor had non-curable defaults under the credit agreement. JPMorgan
contended that the adversary proceeding was non-core and, thus, that the Bankruptcy Court could
not render a final judgment.
In issuing a decision that the adversary proceeding was core, the Court applied the two part test
United States Lines, Inc
The Court stated that “[a]lthough the instant adversary proceeding
related to asserted breaches of a pre-petition agreement – a factor which weighs against finding core
status – the close relationship between the adversary proceeding and the bankruptcy process
overwhelmingly renders this dispute core.”
The Court stated that, while a breach of contract action
is not unique to the bankruptcy process, JPMorgan brought this adversary proceeding as “part of a
coordinated and carefully executed strategy to oppose confirmation of the pre-negotiated plan.”
Because the adversary proceeding directly affects “confirmation of the bankruptcy plan – a
quintessentially core bankruptcy function – the matter is core.”
Finally, the Court stated that the
“determination of the existence of defaults under the Credit Agreement . . . would likely be
dispositive of whether or not reinstatement is permissible under the Debtors’ plan.”
this reasoning, a dispute over enforcement of an Intercreditor Agreement going to the heart of a
bankruptcy process would fall within the bankruptcy court’s core jurisdiction, but a first lien
lender’s recovery of damages from the breaching second lien lender would not.
Charter Communication
is not a massive expansion of a bankruptcy court’s jurisdiction. In
Pictures Corp.
, the United States Court of Appeals for the Second Circuit held that a bankruptcy
409 BR 649 (Bankr. SDNY 2009). See footnote 29
. at 652-53.
United States Lines, Inc. v. American Steamship Owners Mutual Protection and Indemnity Association
(In re U.S. Lines, Inc.)
, 197 F.3d 631 (2d Cir. 1999), stated that “[p]roceedings can be core by virtue
of their nature if either (1) the type of proceeding is unique to or uniquely affected by the bankruptcy
. . . or (2) the proceedings directly affect a core bankruptcy function.”
at 655 (quotations omitted).
. at 656.
. at 657.
. (quotations omitted).
, p. 42-43.
4 F.3d 1095 (2d Cir. 1993).
court does not have core jurisdiction over a contract dispute between the debtor and a third party in
the context of the debtor’s efforts to make a record supporting assumption of an executory
The Second Circuit, taking an extremely limited view of the bankruptcy court’s
jurisdiction, held that the bankruptcy court erred in deciding a contract issue between the parties in
the context of deciding a motion to assume.
scope has since been limited by the Second Circuit in the decision in
In re Best Products
which held that a contract dispute between two creditors was core because it involved
issues “at the heart of the bankruptcy process.”
Charter Communication
is consistent with that
distinction. Many commentators have criticized the
but it is possible to read
as an outlier espousing severely limited bankruptcy court jurisdiction, or, to at least limit its
applicability to situations where the debtor sues a third party who has not filed a proof of claim in
the debtor’s chapter 11 case.
Still, to expect to resolve an intercreditor dispute in the bankruptcy
court, plan to present the bankruptcy court with reasons why the dispute goes to the core of the
reorganization process and must be resolved before the case can proceed.
Extended Stay
If a bankruptcy court determines that an intercreditor dispute does not fall within the court’s
“arising under” or “arising in” jurisdiction, and is not “related to” the bankruptcy case, then the
bankruptcy court cannot assert jurisdiction over the dispute. However, if the intercreditor dispute is
core to the reorganization process because its outcome would significantly affect property of the
debtor’s estate or the rights of creditors to participate in events that are unique to the bankruptcy
process, then the court will exercise jurisdiction over the dispute and is authorized to enter a final
judgment. Perhaps the most instructive single case on this issue is
Extended Stay, Inc. v. Lightstone
Holdings, LLC (In re Extended Stay, Inc.)
With Extended Stay’s chapter 11 filing, Bank of America commenced a state court action seeking to
enforce “bad-boy” guarantees. Similarly, Five Mile started a state court action seeking a declaratory
judgment that certain of the debtor’s certificate holders breached the Trust and Servicing
. at 1102.
. at 1098.
68 F.3d 26 (2d Cir. 1995).
See, e.g., Janine C. Ciallella,
Should Bankruptcy Judges be Permitted to Conduct Jury Trials?
, 8 AM.
BANKR. INST. L. REV. 175, 196 (2000) (noting that
is inconsistent with other bankruptcy
courts’ opinions regarding the distinction between core and non-core issues); Lawrence Ponoroff,
The Dubious Role of Precedent in the Quest for First Principles in the Reform of the Bankruptcy
Code: Some Lessons from the Civil Law and Realist Traditions
, 74 AM. BANKR. L.J. 173, 178-79
(2000) (stating that Orion
holding is “costly and wasteful, . . . deplet[ing] the estate to no particular
end”); Jonathan L. Flaxner,
Bankruptcy Court Power to Adjudicate Contract Disputes
, 2 AM.
BANKR. INST. L. REV. 369, 394 (1994) (stating that the Orion decision “vividly demonstrates the
continuing inefficiency of the current system of bankruptcy jurisdiction”).
It remains the case that if a party has a right to a jury trial, and that right has not been waived—for
example, by filing a proof of claim— the litigation must be withdrawn to the district court, at least
for trial, unless the district court has authorized the bankruptcy court to conduct a jury trial and the
parties consent to a jury trial in the bankruptcy court. This is ample reason for senior secured lenders
to insist upon a waiver of a jury trial clause in all Intercreditor Agreements.
418 B.R. 49 (Bankr,. S.D.N.Y. 2009).
Agreement by engaging in negotiations with the debtor without Five Mile’s consent. Additionally,
Line Trust commenced an action against the guarantors and Bank of America (among others)
asserting breach of the implied covenant of good faith and fair dealing, tortuous interference, and
breach of fiduciary duty relating to the mortgage loan, the mezzanine loan, and the guarantees. All
these lawsuits were removed to the federal district court and referred to the bankruptcy court. None
of the lawsuits involved the debtor as a party. Each claimant filed a motion to remand the case to
state court.
On the Bank of America and Line Trust actions, the court determined it did not have “related to
jurisdiction,” because, in its view, the claims—i.e. enforcement of a guaranty—were “a garden
variety contract action which is in no way related to” the bankruptcy case, and the guarantor had
waived any right of indemnification against the debtor.
On Five Mile’s action, the bankruptcy
court held the dispute was core because whether parties would be permitted to negotiate with the
debtor over a reorganization would impact the reorganization process.
In each, the dispute was
between non-debtors, no assets of the bankruptcy estate were at risk, and the dispute’s resolution
would not affect the chapter 11 case. Both the Bank of America and Line Trust proceedings were
remanded to state court. The bankruptcy court retained jurisdiction over the Five Mile dispute.
The results in Extended Stay were predictable. Recoveries by creditors from a non-debtor will not
impact the chapter 11 case or are likely beyond the bankruptcy court’s jurisdiction. However, where
the dispute involves the debtor as a party or the conduct of the bankruptcy process, the bankruptcy
court may feel it has the right to resolve the dispute.
As anticipated, the current economy has resulted in more instances where bankruptcy courts have
been forced to consider the impact of Intercreditor Agreement provisions in chapter 11 cases.
While the general trend to favor enforcement at some level, every case will be reviewed on a case-
by-case basis and be somewhat dependent upon the facts of the case. Specificity in drafting is very
helpful in producing predictable results, but whether a bankruptcy court will exert jurisdiction to
hear disputes among competing creditors will continue to be an issue going forward.
If you have questions, do not hesitate to contact Mark Berman at 617-345-6037 or
The foregoing has been prepared for the general information of clients and friends of the firm. It is
not meant to provide legal advice with respect to any specific matter and should not be acted upon
without professional counsel. It is always necessary to review specific transaction documents and
identify the parties to the transaction. If you have any questions or require any further information
regarding these or other related matters, please contact your regular Nixon Peabody LLP
representative. This material may be considered advertising under certain rules of professional
. at 60.
Id. at 58.
One consideration that should be given when the Intercreditor Agreement is first negotiated is,
therefore, whether the debtor should be a party to it. Removing the debtor as a party can eliminate
one thread of bankruptcy court jurisdiction.
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