Southern District of New York Orders Priority of Payment for Interest on Subordinated Lenders’ Claim – U.S. Bank Nat’l Ass’n v. T.D. Bank, 2017 U.S. Dist. LEXIS 14954 (S.D.N.Y. Jan. 27, 2017).
On January 27, 2017, the Southern District of New York issued a ruling based on its reading of an intercreditor agreement that resulted in the unusual result of a subordinated creditor receiving payment of post-petition interest on its claim prior to the payment of principal on a senior creditor’s claim.
In 2008, Bionol Clearfield, LLC entered into a senior credit agreement that consisted of five tranches of secured loans. T.D. Bank, N.A. was administrative agent under the three most-senior tranches and U.S. Bank National Association was successor trustee for the subordinated lenders under the fourth tranche. Following’s Bionol’s filing for bankruptcy protection, over $10 million of collateral proceeds were released to TD Bank on account of its senior claim. US Bank filed an action for a declaratory judgment seeking payment of post-petition interest and fees it claimed it was entitled to under Bionol’s credit agreement and under an intercreditor agreement that all of the lenders had entered into contemporaneously with the execution of the credit agreement.
The intercreditor agreement provided that proceeds received “upon the exercise of remedies (whether prior to or during the pendency of any Insolvency or Liquidation Proceeding),” were to be applied among the creditors, as relevant to the dispute at hand, as follows: first, to pay fees, costs and expenses due and payable under the credit agreement and intercreditor agreement, second, to pay any interest then due and payable on debt issued under all five tranches of the credit agreement on a pro rata basis and third, to pay any principal amount due and payable in respect of each tranche, in order of such tranche’s priority. The credit agreement, in turn, provided that
Interest hereunder shall be due and payable in accordance with the terms hereof, before and after judgment, regardless of whether an Insolvency or Liquidation Proceeding exists in respect of the Borrower, and, to the fullest extent by law, the Lenders shall be entitled to receive post-petition interest during the pendency of an Insolvency or Liquidation Proceeding.
US Bank argued that the agreements clearly provided for the distribution of post-petition interest to all lenders out of collateral proceeds prior to repayment of any lender’s principal. TD Bank asserted that it was entitled to the collateral proceeds because no post-petition interest had lawfully accrued. TD Bank claimed that the Rule of Explicitness, a rule that originated in bankruptcy law and that normally protects subordinated creditors by requiring that post-petition interest provisions be unambiguous prior to enforcement, applied as a principle of New York contract law and did not permit post-petition interest to be paid to US Bank.
The court noted that the Rule of Explicitness is codified in the bankruptcy code at section 502(b)(2), which disallows claims for post-petition interest except under limited circumstances, such as when a creditor is oversecured or where the debtor is able to pay its other debts. Parties may negotiate around this provision, but bankruptcy courts have required that agreements clearly suspend the rule in order to protect subordinated creditors from senior creditors recovering for post-petition interest on their claims before subordinated creditors receive any recovery. In its decision, the court agreed with TD Bank that the Rule of Explicitness applied as a general principle of New York contract law, but went on to interpret it in US Bank’s favor.
The court concluded that the intercreditor agreement’s waterfall provision unambiguously required payment of interest before principal, and that the credit agreement expressly provided that post-petition interest would continue to accrue even during a bankruptcy. The court looked to the general principles of interpretation provided in the credit agreement and intercreditor agreement and determined that the “interest” referenced in the intercreditor agreement’s waterfall provision included payment of post-petition interest. Therefore, the creditors had expressly negotiated for recovery of post-petition interest by all lenders prior to recovery of the principal amount of any lender’s claim.
Under an unusual set of facts, the Southern District of New York employed a rule of contract interpretation that typically protects subordinated creditors from senior creditors recovering post-petition interest to require payment of interest to such subordinated creditor at the expense of the senior creditor’s recovery of principal. When negotiating and entering into intercreditor agreements, lenders should consider how provisions in a borrower’s credit agreement inform the interpretation of waterfall provisions separately agreed to among lenders.
