Originally published April 22, 2008
Keywords:transferred rights, Loan Syndications and Trading Association, LSTA, distressed debt, purhcase and sale agreements, Bankruptcy Court, Southern District of New York, reimbursement rights
Buyers and sellers of distressed debt buy and sell bank loans in the secondary market using standardized documents containing standardized definitions. These documents, and their definitions, have not often been tested in the courts. Significantly, though, a recent decision by the Chief Judge of the Bankruptcy Court for the Southern District of New York put the forms and definitions to the test in the context of examining the transferability of reimbursement rights.
Reimbursement Rights After a Sale
M. Fabrikant & Sons, et al. (the "Debtors"), commenced a chapter 11 bankruptcy case on November 17, 2006. In exchange for allowing the Debtors to use their collateral (which was pledged to several lenders under the terms of a credit agreement), the court granted the Debtors' lenders adequate protection, pursuant to the Final Order Authorizing Debtors' Use of Cash Collateral and Granting Adequate Protection Claims and Lien (the "Order"), which included an administrative priority claim for the reimbursement of a lender's reasonable expenses relating to all proceedings in connection with the enforcement and validity of the prepetition agreements (the "Reimbursement Rights"). After the Order was entered, the original lenders (the "Sellers") sold their loans on the secondary market to the current lenders (the "Buyers") using standard Loan Syndications and Trading Association ("LSTA") documents.
About one year later, the Official Committee of Unsecured Creditors sued the Sellers seeking, among other things, to avoid the security interests granted to the Sellers. The Sellers incurred substantial legal fees defending this adversary proceeding and, as such, when the Debtors filed a plan that failed to provide for payment of the Sellers' legal fees, the Sellers objected to the plan arguing that: (a) the legal fees constituted Reimbursement Rights that were Retained Interests (as defined below) under the LSTA standard documents and not transferred to the Buyers, and (b) the failure to provide for payment in full to the Sellers violated the Bankruptcy Code's priority scheme.
Transferred Rights, Retained Interests and Adequate Protection Payments
On April 9, 2008, Chief Judge Stuart Bernstein overruled the Sellers' objection to the Debtors' plan. In doing so, Judge Bernstein focused on the standard LSTA purchase and sale agreement, finding that the Sellers had transferred their post-transfer reimbursement rights to the Buyers and, consequently, the Reimbursement Rights were not required to be paid in full under the plan.
Under the LSTA's terms for the purchase and sale of distressed trades, "Transferred Rights" include, among other things:
[c]ommitments (if any) and, to the extent related thereto, the following (excluding, however, the Retained Interest, if any): all claims (including "claims" as defined in Bankruptcy
Code § 101(5)), suits, causes of action, and any other right of Seller or any Prior Seller, whether known or unknown....
Retained Interest is defined as follows:
Finally, Adequate Protection Payments (the narrowest of the three definitions) means, with respect to the "Transferred Rights," amounts (other than "PIK Interest") ordered to be paid by the Bankruptcy Court as adequate protection under an "Adequate Protection Order" for the loans and obligations owed under the "Credit Agreement" that accrue during the period before (but excluding) the earlier of (a) the settlement date and (b) the trade date plus 20 days (T + 20). None of these definitions had been tested by the courts until this decision.
Reimbursement Rights as Transferred Rights
The Sellers asserted that the Reimbursement Rights were not transferable because they: (a) fell outside of the Bankruptcy Code's definition of claim which excludes claims arising post-petition, such as the Reimbursement Rights; (b) were personal to the Sellers; (c) were counterclaims preserved by paragraph 22 of the Order; and (d) were future rights unable to be assigned. The court disagreed with each of these assertions declaring generally that the LSTA transfer agreements represent an "all-encompassing assignment of rights" 1and, more specifically, that the Reimbursement Rights fell squarely within the definition of Transferred Rights because they were contingent indemnification rights related to and arising in connection with the Credit Documents or the transactions related thereto or contemplated thereby.2
Conclusion
The decision makes clear that the rights assigned to a buyer under the standard LSTA documents are broad and include both contingent and postpetition claims unless specifically excluded. Thus, lenders that are, or may be, subject to lender liability or other litigation, should explicitly negotiate carve outs at the time of trade.
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Footnotes
1. In re: M. Fabrikant & Sons, Inc., et al., No. 06-12737 (SMB), 2008 WL 943953, at 18 (Bankr. S.D.N.Y. 2008)
2. Id. at 15.
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