In re Energy Future Holdings Corp., et al. v. Morgan Stanley Capital Group, Inc., No. 18-1957, 2019 WL 2535700 (3d Cir. June 19, 2019)
The Court of Appeals for the Third Circuit held that adequate protection payments and bankruptcy plan distributions payable to two groups of creditors should be allocated pro rata based on the amounts owed to them at the time of debtor’s bankruptcy filing. The Court rejected the argument of one of the creditor groups that the waterfall provision in the intercreditor agreement applied to the adequate protection payments and plan distributions and that, under the waterfall provision, post-position interest owed to the creditors should be taken into account in the allocation.
Energy Future Holdings Corp. (“Energy Future”) and its subsidiary, Texas Competitive Electric Holdings Company LLC (“TCEH”), filed for bankruptcy in April 2014. TCEH had indebtedness owing to two groups of creditors which was secured by the same collateral. The indebtedness owed to one creditor group was issued in 2011 and had an interest rate that was higher than the indebtedness owed to the other creditor group, whose debt was issued in 2007. The two creditor groups shared the collateral on an equal priority basis pursuant to an intercreditor agreement. The text of the intercreditor agreement specified that the waterfall provision applied to “Collateral or any proceeds thereof received in connection with the sale or other disposition of, or collection on, such Collateral upon the exercise of remedies under the Security Documents by the Collateral Agent.”
After Energy Future and TCEH filed for bankruptcy, the bankruptcy court ordered TCEH to make adequate protection payments to both the 2011 creditors and the 2007 creditors. In addition, TCEH’s bankruptcy plan provided for certain plan distributions to be made to both groups of creditors. Under the terms of the plan, all assets owned by TCEH as a result of the restructuring implemented under the plan would be free and clear of any liens or other encumbrances. As part of the plan, both groups of creditors gave up any claims they had to the collateral, but they were entitled to receive the plan distributions.
The 2011 creditors filed suit arguing that, under the waterfall provision in the intercreditor agreement, each creditor’s share of the adequate protection payments and plan distributions should be based on the amount it would have been owed at the time the payments and distributions were made had interest continued to accrue after TCEH filed for bankruptcy (i.e., taking into account post-petition interest). Since the interest rate on the 2011 creditors’ debt was higher than the interest rate on the 2007 creditors’ debt, this allocation would favor the 2011 creditors. Certain of the 2007 creditors moved for judgment, arguing that each creditor’s share of the adequate protection payments and plan distributions should instead be based on what TCEH owed the creditor at the time it filed for bankruptcy (not taking into account post-petition interest).
The bankruptcy court found in favor of the 2007 creditors, and the District Court affirmed. The Third Circuit further affirmed the District Court’s decision. The Court found that the waterfall provision in the intercreditor agreement did not apply to the adequate protection payments or the plan distributions. It noted that by its terms the waterfall provision applied to collateral and certain proceeds of collateral. The court reasoned that the adequate protection payments did not constitute collateral because a payment of collateral reduces the amount of money owed on a debt; the adequate protection payments did not reduce the amount owed to the creditors, and therefore could not constitute collateral. The Court found that the plan distributions also did not constitute collateral since, under the terms of the plan, they were made from assets which were free of all liens.
The Court also found that the adequate protection payments and plan distributions did not constitute proceeds of collateral under the waterfall provision. The text of the waterfall provision stated that it applied to proceeds “received in connection with the sale or other disposition of, or collection on, such Collateral upon the exercise of remedies under the Security Documents by the Collateral Agent.” The Court reasoned that the adequate protection payments did not fall within this language because the 2011 creditors failed to identify any sale, collection or disposition of collateral prior to the making of the payments. The Court also found that the plan distributions did not fall within the provision because, while they might have been received in connection with a sale or disposition of collateral, they were not received as part of an exercise of remedies by the collateral agent since the corporate restructuring effected under the bankruptcy plan was not a remedy implemented by the collateral agent.
The Court’s opinion noted that it was not an opinion of the full Court and, therefore, under its Internal Operating Procedures, is not binding precedent.
Article courtesy of Margaret G. Parker-Yavuz of Akin Gump Strauss Hauer & Feld LLP.