Court Rulings Could Rattle Resale Provisions

By Fest, Glen | American Banker, June 17, 2014 | Go to article overview

Court Rulings Could Rattle Resale Provisions


Fest, Glen, American Banker


Byline: Glen Fest

Sunrise Village, an idyllic shopping center in Puyallup, Wash., was financed with an unremarkable $75 million commercial loan. But the retail outlet might end up being the epicenter of another pitched battle for distressed debt holders trying to uphold traditional creditor rights in Chapter 11 bankruptcies.

A federal district court in Washington recently upheld a bankruptcy court ruling disallowing three hedge funds controlling portions of the shopping center's defaulted loan from voting on a reorganization plan that the owners -- known as Meridian Sunrise Village -- sought to pursue.

The district court ruled that the funds, engaged as "predatory lenders," were not "eligible assignees" entitled to a vote because Meridian, regardless of default, had such funds excluded from participation in loan syndication through its original credit agreement.

The decision has spread like brush fire in legal and investor circles surrounding bankruptcy case law, with worries about the potential disruption of distressed debtholders' rights to participate in Chapter 11 plans.

"It remains to be seen whether this holding [in Meridian] will be followed and if and how it will change the face of bankruptcy plan class construction and voting," said David Tawil, president and co-founder of Maglan Capital, a hedge fund specializing in investing in companies in bankruptcy or restructuring. (Maglan was not involved in the Meridian case).

It is rare for borrowers in syndicated and participated loans to have resale provisions, loan sale experts say.

"Most agreements make it very clear that the lender can sell it without restrictions," says Jon Winick, chief executive of Clark Street Capital, a Chicago advisory firm that handles loan sales. "Distressed borrowers would much rather deal with a bank than a hedge fund, but this is a provision that is rarely seen."

Still, borrowers have an advantage negotiating terms in an environment where banks are starved for loans and are willing to make concessions.

In an opinion piece, lawyers at Reed Smith, Jonathan Korman and Bart Cicuto wrote that the case "may also encourage borrowers to become more pro-active in scrutinizing a lender's assignment of its loans if the borrower feels that the assignment is beyond the scope of assignments permitted under the loan agreement."

If borrowers were to negotiate more strongly to deter banks from syndicating loans to so-called "vulture funds," the strategy for hedge funds and other stakeholders who buy distressed loans to gain control of assets could be stymied.

The secondary market for traded loans could also face some disruption with the legal ambiguity of how far credit agreement language protects borrower interests, even in the event of a default.

Additionally, in several analyses published since the district court's March decision, which is under appeal, legal observers say that, while the case is based partially on specific Washington state laws, it has broken new ground and could become a blueprint for subsequent Chapter 11 filers to dilute or deny distressed debt holders their traditional say in reorganization.

The Sunrise Village case, along with the high-profile bankruptcy case involving wireless technology provider Lightsquared, are running parallel with recent controversial court decisions that also focused on the rights of distressed debt holders, such as the limits on credit bidding.

The root of the Sunrise Village case was the original loan agreement Meridian signed with U.S. Bank in 2008, according to court documents. At the time, the owners of the prospective shopping center sought to exclude hedge funds and other vulture investors, negotiating a clause that gave the bank the right to syndicate the loan only to other institutions.

One of the developers with Meridian purportedly had a bad experience with a hedge fund operator. …

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