Mid-Atlantic Update - In re Taberna Preferred Funding IV, Ltd.

Secured Creditors Fail to Establish Ability to Waive Security Interests in Order to Qualify as Unsecured Creditors For Purposes of Filing Involuntary Chapter 11 Petition — In re Taberna Preferred Funding IV, Ltd., 578 B.R. 244 (Bankr. S.D.N.Y. 2017)

            In November, 2017, Judge Vyskocil of the Bankruptcy Court for the Southern District of New York denied a motion for partial summary judgment, ruling against a group of secured noteholders that had sought to establish their status as unsecured petitioning creditors by partially waiving a security interest held for their benefit by a third party.

            In 2005, Taberna Preferred Funding IV, Ltd., a CDO, issued eleven classes of secured notes that varied in priority but were all secured by a lien held by an indenture trustee for the benefit of the noteholders.  In 2009, Taberna defaulted on the notes.  Three senior noteholders (the “Petitioning Creditors”) filed in an involuntary Chapter 11 petition.  The Petitioning Creditors held all of the most senior Class A-1 Notes and approximately 34% of the second-priority Class A-2 Notes.

            Under § 303(b)(1) of the Bankruptcy Code, creditors petitioning for the involuntary commencement of bankruptcy proceedings must each hold unsecured claims of at least $15,775.  The Petitioning Creditors, realizing they did not qualify to file the involuntary petition if fully secured under the indenture, executed a waiver of their right to benefit from the lien securing exactly $15,775 of their Class A-2 Notes.

            Two alternative arguments were advanced in support of the efficacy of this waiver.  First, the Petitioning Creditors claimed they were entitled to waive their rights as beneficiaries of the collateral securing the notes, and therefore to become holders of unsecured claims to the extent of such waiver.  Second, they advanced a “common lien argument,” contending that since all the notes were secured by a single lien on common collateral, and the aggregate amount outstanding on all the notes significantly exceeded the value of the collateral, Petitioning Creditors therefore held unsecured claims in the aggregate greater than $15,775.

            Judge Vyskocil rejected both of the Petitioning Creditors’ arguments.  The court noted that the indenture in this case grants the security interest to the trustee rather than the noteholders.  Cases cited by the Petitioning Creditors did not support a finding that secured creditors have the authority to waive a security interest held by a third party on their behalf and thereby qualify as unsecured creditors eligible to file an involuntary petition.  Furthermore, the court pointed to express language in the indenture limiting the ability of noteholders to take direct action with respect to the collateral, which did not tend to indicate that some noteholders could waive the lien for their benefit and to the detriment of more junior noteholders.

            The Petitioning Creditors’ “common lien argument” was also rejected, with the court dismissing an analysis balancing the equities of the various creditors, and instead relying on the text of the indenture.  As in the waiver argument above, the court noted that the indenture granted the security interest at issue to the trustee, not the Petitioning Creditors.  This granting language strongly suggested to the court that any claim following from the security interest would also be held by the trustee, for the benefit of all noteholders.  The court was not persuaded that the Petitioning Creditors had carried the burden of showing they nevertheless held a distinct claim from the other creditors which they could assert on their own.

            This ruling highlights the importance of weighing the benefits and drawbacks of being a secured creditor versus an unsecured creditor in the context of a complex capital structure.