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Intercreditor Agreements Get Trumped
July 15, 2010
Intercreditor agreements between first and second lien lenders are created all the time and are therefore not usually glitzy topics for client updates. But the recent intercreditor dispute between Donald Trump and corporate raider Carl Icahn over control of Trump's Atlantic City casinos had all the drama and glamour of the gambling dens and billionaires involved, including two competing but confirmable plans and senior and junior creditors vying for ownership of a gaming empire and its attendant upside. In the end, the parties got an important precedent on the enforceability of intercreditor agreements in chapter 11 cases.
As a result of the recent filings by companies with second lien debt, issues about the enforceability of intercreditor agreements between senior and junior lenders have become more commonplace in chapter 11 cases. Until recently, these issues have revolved around the ability of a junior lender to waive fundamental bankruptcy rights in an intercreditor agreement. Precedents relating to what can and can't be waived have been mixed, with restrictions on voting on a bankruptcy plan the most likely to be struck down by courts as going too far. With each decision, intercreditor agreements continued to evolve as first lien lenders searched for their holy grail – the "silent second."
Recently, the bankruptcy court in New Jersey in In re TCI 2 Holdings, LLC, 428 B.R. 117 (Bankr. D.N.J. 2010), issued a ruling on intercreditor agreements with significant implications for first and second-lien lenders. In the TCI 2 case, the bankruptcy court was asked to determine whether a "cram down" plan could be confirmed if it violated an intercreditor agreement between the first and second lien lenders. At stake was ownership of the Trump Atlantic City casinos - Carl Icahn and the first lien lenders against Donald Trump and the out-of-the money second-lien lenders. Also at stake was whether the second lien lenders would get any recovery on their investment or have $1.25 billion of junior debt simply wiped out.
Intercreditor Agreements Generally
Typically, second lien or "tranche B" loans have security interests in the same collateral as the first lien or "tranche A" loans. Since most senior loan documents have a prohibition on the borrower granting security interests or liens on collateral to any other lenders, first lien lenders typically dictate (to the borrower and its second lien lenders) the terms upon which they will consent to the creation of second liens. The understanding of the lenders on their respective rights to the collateral is then memorialized in an intercreditor agreement between the parties. Secondary purchasers of the "tranche A" and "tranche B" debt are bound by the intercreditor agreement when they buy the debt.
The terms of an intercreditor agreement are greatly dictated by the parties' respective bargaining positions. Senior lenders push for junior lenders to be as silent as possible, with little to no rights to object to actions taken by the senior lenders upon an event of default or a bankruptcy. Junior lenders, in turn, try to retain as many rights as they can to protect their own interests, including the full panoply of rights available to unsecured creditors in a bankruptcy case. The end result often comes out somewhere in-between. Restrictions on junior lenders' ability to foreclose on collateral, propose DIP financing or offer an alternative chapter 11 plan that is not supported by the senior lenders, are common. Also common are payment subordination provisions, which prevent junior lenders from receiving any payments until the senior lenders are paid in full (or require them to turn over any recoveries they do get).
Intercreditor agreements (and subordination provisions) are routinely upheld by bankruptcy courts under section 510(a) of the Bankruptcy Code, which provides in relevant part, that a "subordination agreement is enforceable in a case under [title 11] to the same extent that such agreement is enforceable under applicable nonbankruptcy law." However, courts have split on the enforceability of waivers of creditors' rights in the bankruptcy context, such as the junior lenders' right to vote on a chapter 11 plan.
The Trump Decision
In February 2009, TCI 2 Holdings and its affiliates filed for chapter 11 protection in the District of New Jersey. The debtors own or manage three Trump hotel casinos in Atlantic City – Trump Taj Mahal, Trump Plaza and Trump Marina. When they filed, the debtors had approximately $488 million in first lien debt, $1.25 billion in second lien notes and $39.3 million in general unsecured claims outstanding. It became evident immediately that the debtors needed to significantly deliver to emerge from bankruptcy as viable entities.
During the chapter 11 case, the bankruptcy court granted both the Icahn-led first lien lenders and the second-lien noteholders the ability to propose and solicit a chapter 11 plan. Both groups put forth confirmable chapter 11 plans. Under the Icahn/first lien plan, the first lien debt was to be equalized into 100% of the equity of the debtors after they emerged from bankruptcy. Junior creditors, including the second-lien noteholders and trade creditors, were to receive no recovery under the plan. The debtors, along with the second lien noteholders, proposed a competing plan that paid the first lien lenders deferred cash payments up to the value of their secured claims, including $125 million in cash on the effective date of the plan and a new secured loan in the amount of $335 million at a market rate of interest (asserted to be 11%). In return, the second lien noteholders received the right to participate in a backstopped rights offering for up to 70% of the equity in the post-emergence debtors. The rest of the equity was distributed to certain noteholders who agreed to backstop the rights offering and Donald Trump, who entered into a settlement agreement with the second lien lenders to retain a minority ownership in the Trump casinos.
Icahn and the first lien lenders objected to the debtors' plan on various grounds, including the fact that the plan violated the intercreditor agreement between the first and second lien lenders. Among other things, Icahn and his group asserted that under the intercreditor agreement, the second lien lenders did not have the right to propose their own chapter 11 plan and, under the payment subordination provisions of the intercreditor agreement, the first lien debt had to be paid in full in cash before any proceeds of shared collateral could be paid to holders of the second lien debt. Icahn argued that since the first lien lenders were being paid over time and not in full on the effective date, the second lien lenders could not recover any cash, rights or other property under their chapter 11 plan.
The bankruptcy court overruled Icahn's objection that the intercreditor agreement barred approval of the debtors' plan. In siding with the second lien lenders, the court found that on its face, section 1129(b)(1) of the Bankruptcy Code, which governs confirmation of nonconsensual plans, removes section 510(a) from the scope of section 1129. Specifically, section 1129(b)(1) provides that, "[n]otwithstanding section 510(a) of [the Bankruptcy Code]", the court shall confirm a plan over dissenting classes if the plan meets the "cram down" requirements of section 1129, does not discriminate unfairly and is fair and equitable with respect to each class of claims or interests that is impaired and has not accepted the plan. Having found that the debtors' plan met the "cram down" requirements of section 1129, the bankruptcy court confirmed the debtors' plan and determined that the intercreditor terms between the first and second lien lenders did not need to be respected.
The decision of the New Jersey bankruptcy court has been appealed by the Icahn group. If, however, the decision is upheld on appeal, it will be a significant precedent on the limits of the enforceability of intercreditor agreements in the bankruptcy context. Much like the decisions in which courts have held that voting rights cannot be waived by junior lenders, this decision makes clear that intercreditor terms prohibiting junior lenders from proposing a chapter 11 plan or "cramming up" senior lenders will not be enforceable to prevent confirmation of an otherwise confirmable plan. So once again, the "silent second" will not be so silent.
Notably, the bankruptcy court left undecided whether the second-lien lenders breached the intercreditor agreement, which could give rise to a contractual claim against them by the first lien lenders. The Court left that decision, and presumably more litigation between Carl Icahn and The Donald, to another court and another day.