Part 1 – a brief précis by Clive Minchom of Jewish Business News.
Part 2 – a more detailed commentary by David Tawil who is a partner in the New York-based hedge fund Maglan Capital, which he co-founded with Steven Azarbad and which includes distressed debt investing in its portfolio.
Part One – précis by Clive Minchom
Just over a month ago, on March 6th, 2014 the US District Court for the Western District of Washington at Tacoma made an unusual judgment in a US$75 million defaulted loan case between a bankrupt debtor, Meridian Sunrise Village and a vulture fund that had purchased some of the Washington State shopping centre’s debt at a substantial discount.
The judgment had to do with the transferability of voting rights of defaulted loan securities to an acquiring distressed debt purchaser, typically known as a “vulture fund”.
Commercial loan agreements typically have long spoken of “financial institutions” which are normally taken to be banks or other historically well defined such lending institutions, and the court judgment was unusual in saying that a vulture fund or a hedge fund is, however, not a financial institution at all as it was defined under the Meridian Sunrise Village loan agreements, thereby affecting the rights of the entities which had purchased the defaulted debt.
If you have ever borrowed money for your business, or takSunriseen a mortgage on your house you may not even realize that financial institutions such as banks, or insurance companies from time to time sell what are for them just tradable assets to others, sometime for portfolio balancing reasons or sometimes just to raise some money.
They might do this even when your obligation is in good standing, depending on the language of the loan agreement entered into, and they tend to do it even more if the loan has run into trouble. Rather than pursue you themselves in such a circumstance a bank may then wash its hands of the loan, at a big discount, to a vulture fund that specializes in going after delinquent borrowers, sometimes even taking over their companies thereby and reorganizing the business to run better in order to get their money back and make a profit.
Historically the rules over how such a vulture fund might exercise its rights under a loan instrument it acquires, and how it will behave once it exercises them, are driven by what is considered “boilerplate” language of the loan agreements that characterize a loan when it was first taken out.
In the Meridian Sunrise village case the distressed loan purchaser got a shock when the court ruled it was not a financial institution at all for the purposes of the disputed language.
In Part 2 David Tawil, who is co founder with Steven Azarbad of hedge fund Maglan Capital, which includes distressed debt investing in its portfolio, tells us why and, just as important, what the case may mean for investors like him and other purchasers of distressed debt in the future. His analysis is inevitably quite technical, but very well worth the read for those with a particular interest in this area of finance.
Part 2 By David Tawil, co-founder of Maglan Capital, likely legal impact of Meridian Sunrise Village bankruptcy case ruling by Washington State Western District Court.
The recent ruling in the bankruptcy case of Meridian Sunrise Village, coming out of the District Court for the Western District of Washington (Case No. 13-5503RBL; Bankruptcy Case No. 13-40342-BDL; Adversary Case No. 13-04225-BDL) is remarkable for two reasons.
First, it casts distressed-debt investors in a considerably negative light, and it will encourage such investors to be wary of jurisdictions that are outside of those in which debt-holders historically have comfortably enforced their rights. The second, more subtle, possibly more wide-reaching ruling is the court’s enforcement of the debtor’s delineation of the votes for the class of debt, without regard to the actual, current ownership of the debt.
In the case of Meridian Sunrise Village, the Bankruptcy Court and, in turn, the District Court, we’re confronted with unique facts relating to a debtor’s senior, secured debt. Specifically, based on prior negative experiences with the sale and assignment of debt by a lender, Meridian (the borrower) was able to negotiate with its current lenders, U.S. Bank and others, a very limited assignment provision, requiring express consent from Meridian for assignment of the loan (in whole or in part) to any entity other than an “Eligible Assignee.”
In the loan document, an “Eligible Assignee” was defined to include only “any Lender or any Affiliate of a Lender or any commercial bank, insurance company, financial institution or institutional lender.” It seems clear that the Borrower negotiated a right to avoid a sale of its debt to an “unnatural” lender, like a hedge fund.
Eventually, Meridian filed for Chapter 11 protection and U.S. Bank transferred its interest in the loan to a distressed debt fund managed by Neuberger Berman (http://www.nbddif.com/pindex.html) (“NB Distressed Debt Limited Fund”), and the NB fund thereafter transferred some of its interests to another Neuberger Berman-related fund (the “NB Affiliate Fund”) and to a Strategic Value Partners-related fund (“SVP”).
The Bankruptcy Court and the District Court found that the assignment of U.S. Bank’s interests in the loan was void because the assignee, NB Distressed Debt Limited Fund, was not an Eligible Assignee under the loan document.
With respect to this finding it seems that the precedent set will not be pervasive since the facts surrounding the Meridian loan were unique (in terms of background and particular language used); nevertheless, the courts chose to interpret the language in the loan document very narrowly, when a broader reading of the definition (like, the words “financial institution or institutional lender”) was available and could have been interpreted to include the hedge fund buyers of the debt.
The broader takeaway for distressed debt investors on this point is that in the case of unfamiliar jurisdictions (such as the Western District of Washington), there may be a bias against “vultures” and that potential bias may have to be factored into any possible investment that may be subject to local legal interpretation.
The effect of the secondary finding of the District Court could possibly be more wide ranging, because the court addressed an issue which to date has not been repeatedly discussed and decided by bankruptcy courts, and it is an issue that is pervasive in bankruptcy cases.
That issue is the allocation and counting of votes in favor or against a bankruptcy plan of reorganization. Under the Bankruptcy Code, a class of creditors is deemed to have accepted a plan of reorganization when over 50% of the class members and 2/3 of the claimed dollar amount of the class vote in favor of the plan. In the Meridian plan, U.S. Bank’s claim was given one vote in the lenders’ class (the other original lenders were Citizens Bank, Guaranty Bank and Trust and Bank of America).
However, the U.S. Bank claim was eventually split and held by NB Distressed Debt Limited Fund, NB Affiliate Fund and SVP. The court held that Meridian’s classification of U.S. Bank’s claim was binding, and that the ultimate hedge fund holders of the debt were bound by the classification and, therefore, were only entitled to one vote.
This finding is quite groundbreaking and can easily be seen as being critical in and used to manipulate the outcome of certain contentious cases where numerosity (i.e. soliciting more than 50% of the class claim holders) will be an issue when voting on a plan of reorganization. It remains to be seen whether this holding will be followed and if and how it will change the face of bankruptcy plan class construction and voting.