On November 24, 2009, Judge James M. Peck of the United States Bankruptcy Court for the Southern District of New York issued a significant decision  in the ION Media Networks, Inc. bankruptcy case regarding the interpretation and enforceability of certain waivers of rights by second lien lenders in an intercreditor agreement. In upholding the waivers, Judge Peck held that the objecting second lien lender lacked standing to challenge the liens and priority of the first lien lenders or to object to the Debtors' plan of reorganization. The court also suggested that the objecting lender may well be liable for damages for breaching the intercreditor agreement, in the amount of the increased administrative expenses caused by its persistent and unsuccessful litigation tactics.
ION Media Networks, Inc. ("ION", and collectively with its affiliated debtors, the "Debtors") owns and operates the largest U.S. broadcast television station group (approximately 60 broadcast television stations) and ION Television, the country's only independent broadcast television network, which reaches about 96 million cable, satellite and broadcast homes. In 2005, the Debtors incurred first and second lien indebtedness, purportedly secured by a lien on certain of the Debtors' assets, including FCC broadcast licenses (the "FCC Licenses"). On May 19, 2009, after reaching an agreement with a majority of the holders of first lien debt to swap their debt for nearly all of the equity in a newly capitalized company, the Debtors filed for Chapter 11 bankruptcy protection to implement the restructuring.
The subordination of the second lien facility was governed by an intercreditor agreement, which broadly prohibited the second lien lenders from bringing certain challenges against the first lien lenders, described in more detail below. Despite these prohibitions, throughout the Debtors' cases Cyrus Select Opportunities Master Fund Ltd. ("Cyrus"), a distressed investor that purchased second lien debt for "pennies on the dollar," vigorously challenged the rights of the first lien lenders to recover as secured creditors any value attributable to the FCC Licenses under the theory that the Communications Act of 1934 and FCC rules and regulations prohibited the Debtors from granting a security interest in those licenses and, as a result, the value of the licenses should be shared pari passu among the first lien lenders, the second lien lenders and other unsecured creditors.
In confirming the Debtors' plan of reorganization, the court rejected Cyrus's arguments and held that Cyrus lacked standing to challenge the purported liens of the first lien lenders and to object to plan confirmation.
The Second Lien Lenders Lacked Standing to Challenge the Purported Liens of the First Lien Lenders
In holding that Cyrus lacked standing to challenge the validity and priority of the purported liens, the court relied on the provision in the intercreditor agreement pursuant to which the second lien lenders agreed to the relative priorities of the "Collateral," and that such priorities shall not be affected by "any nonperfection of any lien purportedly securing any of the Secured Obligations (including, without limitation, whether any such Lien is now perfected, hereafter ceases to be perfected, is avoidable by any bankruptcy trustee or otherwise is set aside, invalidated, or lapses)." The term "Collateral" was defined to include "FCC Licenses," but excluded "Excluded Property," which in turn encompasses any "license agreement or other personal property held by any Grantor to the extent that any Requirement of Law applicable thereto prohibits the creation of a security interest therein."
The court found that the use of the term "purportedly securing" to describe the universe of liens granted by the Debtors evidences the intent of the lenders to establish their relative rights vis-à-vis each other, regardless of the ultimate validity of the liens granted by the Debtors, and obligated the second lien lenders to be silent with respect to any dispute regarding the validity or perfection of the liens. The court held that "[b]y virtue of the Intercreditor Agreement, the parties have allocated among themselves the economic value of the FCC Licenses as 'Collateral' (regardless of the actual validity of liens in these licenses)." In a resounding policy pronouncement, the court reasoned that "[a]ffirming the legal efficacy of unambiguous Intercreditor Agreements leads to more predictable and efficient commercial outcomes and minimizes the potential for wasteful and vexatious litigation."
The court recognized that there are other cases in which a public policy rationale was used to prevent junior creditors from waiving statutory rights in intercreditor agreements. Here, however, the court concluded that the "plainly worded contracts establishing priorities and limiting obstructionist, destabilizing and wasteful behavior should be enforced [under section 510(a) of the Bankruptcy Code] and creditor expectations should be appropriately fulfilled."
The Second Lien Lenders Lacked Standing to Object to Plan Confirmation
Using the same public policy rationale, the court held that Cyrus lacked standing to object to the Debtors' plan of reorganization. It relied principally on the second lien lenders' agreement not to "oppose, object to or vote against any plan of reorganization or disclosure statement the terms of which are consistent with the rights of the First Priority Secured Parties under the Security Agreement," unless the first lien lenders are paid in full.
The court rejected Cyrus's argument that the provision of the intercreditor agreement permitting the second lien lenders to exercise rights and remedies as unsecured creditors permitted Cyrus to raise its plan objections.
There are relatively few reported decisions regarding the enforceability of "silent" second lien lenders' waivers of rights in an intercreditor agreement. Several courts (outside of New York) have declined to enforce such provisions as being outside the scope of section 510(a) of the Bankruptcy Code (which mandates the enforcement of subordination agreements, but not necessarily terms ancillary to the subordination) and contrary to public policy.
The ION decision weighs heavily in favor of first lien lenders seeking to enforce provisions designed to "silence" second lien lenders in a bankruptcy case. Notably, Judge Peck went beyond simply enforcing such provisions – he characterized Cyrus's breach of the intercreditor agreement as "willful" and "without regard for the consequences of its actions," and suggested that Cyrus may be liable for damages (observing that "Cyrus' tactics have caused a material increase in administrative expenses in these cases and . . . such expenses may be a measure of damages to be claimed against Cyrus"). The prospect of a damage claim against junior lenders will likely provide significant additional leverage to debtors and senior lenders in DIP financing and plan negotiations in future cases.
Finally, in analyzing the ION decision, it is interesting to note the level of frustration the court exhibited toward Cyrus's "consistent and insistent" litigation tactics throughout the case. The opinion observed that Cyrus "has been using aggressive bankruptcy litigation tactics as a means to gain negotiating leverage or obtain judicial rulings that will enable it to earn outsize returns on its bargain basement debt purchases at the expense of the First Lien Lenders." Even though the court stated that there was "nothing wrong with raising and pursuing opportunistic legal theories as a means to reap profits in connection with acquired, deeply discounted bankruptcy claims," Judge Peck appeared hostile to Cyrus's continuing efforts to stymie the bankruptcy proceedings, and took pointed notice of Cyrus's status as the only remaining objecting party to the Debtors' plan of reorganization.
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1. In re ION Media Networks, Inc., Case No. 09-13125 (JMP), [Dkt. No. 438] (Bankr. S.D.N.Y. Nov. 24, 2009).