In LNV Corporation v. Ad Hoc Group of Second Lien Creditors (In re La Paloma Generating Company, LLC, Adv. Pro. No 19-50110 (JTD) (D. Del. January 13, 2020), a Delaware bankruptcy court recently held that actions taken by a senior secured creditor to enforce its rights under an intercreditor agreement did not constitute a breach of the duty of good faith and fair dealings owed to the junior lienholders. The circumstances in La Paloma are not uncommon.
Prepetition the debtors purchased and operated a electricity generating plant, which was funded by certain senior secured lenders and junior secured lenders, both of which had a secured interest in substantially all of the debtors’ assets. The rights of the senior secureds and junior secureds were governed by an intercreditor agreement, which generally entitled the senior secureds to first priority over the mutual collateral.
When the debtors filed bankruptcy in December 2016, it was apparent that their assets were insufficient to satisfy the debts owed to the senior secured lenders, leaving the senior secureds undersecured and junior secureds and general unsecured creditors out of the money.
But, due to certain lien defects with the prepetition liens held by the senior secureds and junior secureds, the debtors were able to enter into a settlement agreement with the senior secureds (without including the junior secured), whereby general unsecureds would be entitled to receive a distribution from their collateral. This settlement was incorporated into the debtors’ confirmed chapter 11 plan. While a portion of the distribution under the plan was allocated to the junior secured lenders (who were now unsecured), the senior secureds argued that they were entitled to all such funds (derived from their collateral) pursuant to the intercreditor agreement.
The bankruptcy court ultimately held that the senior secured lenders were indeed entitled to the funds set aside for the junior secureds, and the district court affirmed this ruling.
Subsequent to the Court’s first ruling, the senior secureds filed an adversary proceeding seeking to further enforce the intercreditor agreement, alleging that the junior secureds took several actions during the bankruptcy that violated their agreement. The junior secureds filed a counterclaim, alleging that the senior secureds breached the covenant of good faith and fair dealing by taking certain actions (including settling the defective lien issues with the debtors) that essentially stripped the junior’s secureds’ rights as general unsecured creditors, who otherwise would have been entitled to a distribution under the debtors’ plan.
The senior secureds moved to dismiss the counterclaim, which dismissal became the sole issue in the Bankruptcy Court’s instant ruling.
There was no issue in La Paloma that the intercreditor agreement between the secured parties provided that the senior secured lenders were allowed to:
enforce rights, exercise remedies . . . and make determinations regarding the release, disposition, or restrictions with respect to the[ir] Collateral without any consultation with or consent of the [Second Lien Lenders] . . . all in such order and in such manner as they may determine in the exercise of their sole discretion.
In the Bankruptcy Court’s prior ruling that the senior secureds were entitled to the plan funds allocated to the junior secured lenders, it found that such funds constituted the collateral of the senior secureds that must be turned over to the seniors and thus the seniors’ actions to collect such funds (in whatever manner they saw fit) were permitted under the intercreditor agreement.
Those findings became the law of the case, and were therefore binding in the senior secureds’ subsequent adversary proceeding. See In re Vaso Active Pharmaceuticals, Inc., 500 B.R. 384, 398-99 (Bankr. D. Del. 2013); In re Radnor Holdings Corporation, 564 B.R. 467, 482 (Bankr. D. Del. 2017) (the doctrine applies to “subsequent rulings by the same judge in the same case or a closely related one [and] to rulings by different judges at the same level.”).
Accordingly, the Court found in the adversary proceeding that when the senior secureds were acting to collect their collateral (including settling with the debtors), they were exercising their contractual rights and therefore could not be in breach of any duty of good faith and fair dealing. See Hartford Fire Ins. Co. v. Federated Dept. Stores, Inc., 723 F.Supp. 976, 991 (S.D.N.Y 1989).
In the same vein, the Court found that the junior secureds were not deprived of any contractual benefit that they were not entitled to receive. Under the terms of the intercreditor agreement, even if the junior secureds had received a distribution as general unsecured creditors, because such funds were derived solely from the mutual collateral of the senior secureds, the junior secureds would have been required to turn over such distribution to the senior secureds. According to the Court, the intention behind the intercreditor agreement was that the junior secureds were not entitled to any recovery from the mutual collateral until the senior secured debt was satisfied in full.
It seems almost axiomatic that the senior secureds in La Paloma, armed with an intercreditor agreement, would only be looking to protect their own interests from a dwindling pool of collateral. Who could blame them? At this late stage in the game, it also seems uncertain what, if anything, the junior secureds could have done to side step the earlier agreement with the seniors, which seemed pretty clear. This fact pattern is not uncommon and is likely to play out in future bankruptcies, given the prevalence of intercreditor agreements in multi-tiered financing transactions.