SDNY Bankruptcy Court Allows as a Claim Unamortized Original Issue Discount Generated in a Fair Market Value Exchange

by Dechert LLP
Contact

The Bankruptcy Court for the Southern District of New York overseeing the Residential Capital (“ResCap”) cases issued an opinion on November 15, 2013 (the “Opinion”)2 allowing the unamortized interest associated with original issue discount (“OID”) that was generated in a fair market value exchange and claimed by ResCap’s junior secured noteholders (the “Holders”). While the OID ruling is only one component of the Opinion,3 it may have far reaching implications, as already evidenced in the pricing of other OID notes that were the product of fair market value exchanges.

Facts and Background

The ResCap debtors engaged in prepetition financing transactions pursuant to which approximately $6 billion of old unsecured notes were exchanged for approximately $4 billion in junior secured notes and $500 million in cash.4 The exchange created $1.549 billion of OID amortized over the life of the junior secured notes.5 In an adversary proceeding within the ResCap bankruptcy cases, the Holders have argued, among other things, that they are oversecured (and therefore entitled to postpetition interest and fees) and sought an allowed adequate protection claim on account of diminution in the value of their prepetition collateral. At issue before the Bankruptcy Court was whether unamortized OID in the amount of approximately $380 million would be treated as an allowed component of the Holders’ claims.6

The ResCap debtors and the Committee (collectively, the “Plaintiffs”) asked the Bankruptcy Court to disallow that portion of the Holders’ claims attributable to OID.7 As a basis for disallowing the OID created in the fair market value exchange, the Plaintiffs relied on Bankruptcy Code section 502(b)(2), which disallows a claim “to the extent that… such claim is for unmatured interest.” 11 U.S.C. 502(b)(2). In response, the indenture trustee acting on behalf of the Holders moved to dismiss that count, arguing that, even if taxable OID was generated, it does not result in unmatured interest for bankruptcy purposes.8

The Bankruptcy Court denied the motion to dismiss and held a subsequent hearing to determine the “matter of first impression” of whether a fair market value exchange generates disallowable OID.9

During the subsequent hearing, the parties did not dispute that the exchange in question, whereby old securities were exchanged for new securities with a reduced principal amount equal to the fair market value of the old securities, was a “fair value” exchange.10 While the Second Circuit had previously held in LTV Corp. v. Valley Fidelity Bank & Trust Co. (In re Chateaugay Corp.), 961 F.2d 378 (2d Cir. 1992) that a face value exchange does not generate new OID for the purposes of claim allowance under the Bankruptcy Code, no court had decided the same question in the context of a fair market value exchange.

Unlike a face value exchange which modifies the outstanding debt’s terms or conditions but does not reduce its principal amount, a fair market value exchange involves the exchange of the principal amount of debt for a lower amount representing its fair market value. Chateaugay contained dicta suggesting that its ruling might not extend to a fair market value exchange.11 While acknowledging that Chateaugay specifically left open the possibility that different rules apply to fair market value exchanges, the Bankruptcy Court held that “despite the differences between face value and fair value debt-exchanges, the same rule on disallowance of OID should apply in both circumstances.”12

The Opinion

In its ruling on the OID issue, the Bankruptcy Court determined that there was not a meaningful basis to distinguish between OID generated pursuant to face value and fair value exchanges. As a result, the Bankruptcy Court held that Chateaugay is controlling regarding a fair value exchange.13 The Bankruptcy Court noted that issuers can use the same features in structuring both face value and fair market value exchanges.14 The Bankruptcy Court then listed the following elements as applicable to both face value and fair market value exchanges:

  • the market value of the old exchanged debt is likely depressed in either situation;

  • OID is created for tax purposes in both exchanges;

  • there are concessions and incentives in either situation; and

  • both exchanges offer companies the opportunity to restructure out-of-court, avoiding the time and costs of bankruptcy.15

The Bankruptcy Court also was persuaded that, should OID created in fair market value exchanges be disallowed, out-of-court debt restructurings would be more difficult and more bankruptcy filings would result.16 In particular, the Bankruptcy Court discussed the concern that, should the Court not extend Chateaugay, “bondholders could simply reject fair value exchanges altogether.”17

The Bankruptcy Court also cited Chateaugay and other precedent for the proposition that how a transaction is treated for tax purposes is not dispositive of its treatment for bankruptcy purposes.18 Finally, the Bankruptcy Court recognized that the Holders would receive a greater recovery than the noteholders who did not participate in the exchange, even if the exchange generated disallowable OID.19 Nevertheless, the Bankruptcy Court stated that the outcome of whether a transaction creates disallowable OID should not hinge on whether a party “got a ‘good deal’ in bankruptcy.”20

Impact of the Opinion

The Opinion is the first of its kind to find that unamortized OID generated in a fair market value exchange is allowable as a bankruptcy claim. As a result, the Opinion may have significant and immediate implications for investors holding notes with OID generated in fair market value exchanges. E.g., Caesars Entertainment, Energy Future Holdings and LBI Media, among others. We understand that, within hours of the Opinion being published, pricing jumped on Caesars Entertainment’s 10% second-lien notes due 2018.

Being a question of first impression, the Opinion’s import is yet to be seen as the time to appeal it has not lapsed and it is not binding on any other court.

Footnotes

1 Dechert LLP represents The Bank of New York Mellon and The Bank of New York Mellon Trust Company, N.A. (collectively, “The Bank of New York Mellon”), in its capacity, among other things, as the indenture trustee for certain of the residential mortgage-backed securitization trusts that have asserted claims in the chapter 11 bankruptcy cases of Residential Capital LLC and its affiliates. The Bank of New York Mellon is also a member of the Official Committee of Unsecured Creditors (the “Committee”) appointed in the cases.

2 Memorandum Opinion, and Findings of Fact and Conclusions of Law, after Phase I Trial, (Case No. 12-12020) [Docket No. 5772].

3 The Opinion more generally established that the Holders’ claims are undersecured and thus not entitled to postpetition interest and fees.

4 Opinion at 37.

5 Id. at 53.

6 In light of the Opinion’s ruling that the Holders’ claims should not be reduced by the amount of unamortized OID, the Bankruptcy Court did not resolve the parties’ disagreement over the OID amount. Id. at 53, n.27.

7 Id. at 53.

8 See generally id. at 8-9.

9 See Official Comm. of Unsecured Creditors v. UMB Bank, N.A. (In re Residential Capital, LLC, 495 B.R. 250, 266 (Bankr. S.D.N.Y. 2013).

10 Opinion at 38 (fair value exchanges are also commonly referred to as “fair market value” exchanges).

11 Chateaugay, 961 F.2d at 382 (“The bankruptcy court’s decision [finding unallowable OID] might make sense in the context of a fair market value exchange, where the corporation’s overall debt obligations are reduced.”).

12 Id. at 55.

13 Id. at 56.

14 Id. at 57-58 (referencing, among other things, granting collateral, interest rate, maturity date, payment priorities, guarantees, etc.).

15 Id. at 58.

16 Id. at 41.

17 Id.

18 Id. at 55-56.

19 Id. at 58.

20 Id.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dechert LLP | Attorney Advertising

Written by:

Dechert LLP
Contact
more
less

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.