The Bottom Line
The Bankruptcy Court for the Southern District of New York recently held in Taberna Preferred Funding IV, Ltd. v. Opportunities II Ltd. (In re Taberna Preferred Funding IV, Ltd.), No. 17-11628 (MKV), 2018 WL 5880918 (Bankr. S.D.N.Y. Nov. 8, 2018) that holders of nonrecourse secured claims against the alleged debtor were not qualifying creditors entitled to commence an involuntary petition because they did not hold claims against the target of the involuntary petition (separate from their claims against the underlying assets).
What Happened
The alleged debtor, Taberna, was a collateralized debt obligation (CDO) structured finance entity that had issued several series of secured notes in descending priority. Taberna had defaulted on the notes approximately eight years before the filing. The petitioning creditors had purchased a large percentage of the most senior notes and had been attempting, through various means, to liquidate the collateral outside of bankruptcy. When those efforts failed, the petitioning creditors filed a chapter 11 involuntary petition against Taberna.
Holders of the junior notes and the collateral agent opposed the petition. They argued that because the notes held by the petitioning creditors were nonrecourse to Taberna, the petitioning creditors did not hold claims against the entity. Despite the petitioning creditors’ arguments to the contrary, the court held that the plain language of the indenture provided that the notes held by the petitioning creditors were nonrecourse to Taberna.
The petitioning creditors advanced two primary arguments to show they held claims against Taberna despite the nonrecourse nature of the debt. First, they argued that section 1111(b) of the Bankruptcy Code allows a nonrecourse secured creditor to assert an unsecured claim against the debtor if the value of the collateral is less than the debt, which applied to their claims. Second, they argued that section 102(2), which provides that a “claim against the debtor” includes a claim against the debtor’s property, meant they held claims against Taberna. The court rejected both of these arguments.
With respect to section 1111(b), the court held that this section only applied after a bankruptcy case had been commenced and was not applicable for determining a creditor’s eligibility to file an involuntary petition. The petitioning creditors argued that section 1111(b) allowed them to treat their secured claims as recourse claims to the extent they were undersecured. And, since the petitioning creditors had waived their security interests on a portion of their claims (in an amount conveniently calculated to exactly equal the claim threshold required to commence an involuntary petition), they were entitled to file the petition.
The court rejected this argument and found that the plain language of the statute applied only to the allowance of claims and would only treat the petitioning creditors’ claims as nonrecourse under certain circumstances. Since the petitioning creditors’ claims were not before the court for allowance, there was no basis for the court to conclude whether they would be treated as recourse or nonrecourse at this time. The court also found that the congressional intent behind the statute was to protect undersecured creditors in cases where the debtor was retaining the collateral. Thus, this section could not be used to support an argument on the petitioning creditors’ eligibility to commence the case.
With respect to section 102(2), the court found that the eligibility language used in section 303(b) governing who may file an involuntary petition was decisively different from the language used in section 102(2). The petitioning creditors had argued that because section 102(2) provides that a claim against a debtor’s property is a claim against the debtor, their nonrecourse claims to Taberna’s assets were claims against Taberna.
The court rejected this argument because section 303(b) does not use the phrase “claim against the debtor.” Instead, it uses the phrase “claim against such person.” The court found that this difference in language manifested an intention by Congress to limit eligibility to file an involuntary petition to creditors that hold claims specifically against the target entity. This conclusion was supported by what the court referred to as “the purpose of the underlying restrictions contained in section 303(b).” Taberna, 2018 WL 5880918, at *13. Because an involuntary petition can be abused and has the potential to seriously harm the target, Congress placed strict limits on who could invoke it, and gave the court wide discretion to police such petitions.
In addition to finding that the petitioning creditors were ineligible to commence an involuntary petition, the court determined that there was cause to dismiss the case under section 1112(b). Citing a recent Second Circuit case that upheld a bankruptcy court’s ability to dismiss a chapter 11 case for cause on its own motion, the court sua sponte determined that the petition was contrary to the purpose of an involuntary bankruptcy. The court stated that the purpose of an involuntary bankruptcy is to prevent other creditors from obtaining an unfair advantage. Here, the petitioning creditors were seeking to use the involuntary bankruptcy for their own benefit. The record clearly showed their repeated efforts to liquidate the collateral solely for their benefit. In addition, the petitioning creditors had adequate state law remedies available to them. Therefore, the court held that no bankruptcy purpose was served by the filing.
Why This Case Is Interesting
The Bankruptcy Code contains a variety of powerful tools to assist debtors and creditors. It has been recognized that a debtor may file a voluntary case to take advantage of these tools – for example, a retail debtor filing primarily to reject burdensome leases and cap damage claims; at the same time, a creditor cannot necessarily use these tools to bootstrap a basis to commence a nonconsensual bankruptcy. This decision holds that provisions of section 1111(b) that will, under certain instances, allow for a nonrecourse claim to have recourse against the debtor cannot be the basis to permit those same creditors – whose non-bankruptcy remedy is limited to an in rem right against certain assets – to have standing as unsecured creditors against the issuer-entity to file an involuntary bankruptcy. Section 1111(b) applies only after a proper bankruptcy case has been commenced. Financial investors and lenders should factor this into their structuring decisions.
