Mid-Atlantic Update - In re Taberna Preferred Funding IV

In re Taberna Preferred Funding IV, Ltd., 594 B.R. 576, United States Bankruptcy Court, S.D. New York

Overview:

The Bankruptcy Court for the Southern District of New York granted a motion to dismiss in an involuntary chapter 11 petition against a structured finance entity known as a collateralized debt obligation (CDO) filed by certain of its senior creditors.  The Court held that the petitioning creditors failed to make a prima facie case that they were eligible under section 303(b) of the Bankruptcy Code to file an involuntary petition against the debtor because the notes they held were nonrecourse and, accordingly, their claims were against the collateral securing the notes and not against the debtor itself.  The Court further held that, even if the petitioning creditors were eligible under section 303(b), their involuntary petition should be dismissed pursuant to section 1112 of the Bankruptcy Code because it did not serve any legitimate bankruptcy purpose.

Full Summary:

In 2005, Taberna Preferred Funding IV, Ltd. (“Taberna”), a structured finance entity known as a collateralized debt obligation (CDO), issued several series of notes of descending priority pursuant to an indenture.  The notes were secured primarily by securities issued by REITs and other real estate entities.  In August 2009, an event of default occurred under the indenture when Taberna defaulted in a payment on one of the junior series of notes.  The notes were accelerated the following month.  In 2017, three holders of the two most senior classes of notes who had purchased their notes in the secondary market in 2016, several years after Taberna defaulted (the “Petitioning Creditors”), filed an involuntary chapter 11 petition against Taberna.  Their petition was opposed by Taberna, its collateral manager and five holders of the junior classes of notes, who filed a motion for judgment that the Petitioning Creditors were ineligible to commence an involuntary case under section 303(b) of the Bankruptcy Code.  The parties opposing the involuntary petition argued that the Petitioning Creditors failed to make a prima facie case with respect to section 303(b)’s requirement that a petitioning creditor hold claims against the target of the involuntary petition (in this case, Taberna) because the notes held by the Petitioning Creditors were nonrecourse and, therefore, Petitioning Creditors’ claims were only against the collateral securing the notes and not against Taberna.

The Bankruptcy Court found that the notes held by the Petitioning Creditors were nonrecourse.  The Court noted that debt is nonrecourse if it may be satisfied only out of the collateral securing the debt and not out of the debtor’s other assets and that, under New York law (which was the governing law of the indenture), contracts are interpreted in accordance with the plain meaning of the language used in the contract.  The indenture in this case expressly stated that the obligations of Taberna under the notes and the indenture were nonrecourse obligations payable solely from the collateral.  In reaching its finding, the Court rejected the Petitioning Creditors’ argument that the notes do not become nonrecourse until the collateral has been liquidated on the grounds that their argument was inconsistent with the plain language of the indenture.

The Bankruptcy Court held that the Petitioning Creditors failed to meet the eligibility criteria of section 303(b) of the Bankruptcy Code requiring that they hold claims against Taberna.  The Court noted that section 303(b) requires that a petitioning creditor hold an unsecured claim against the actual person or entity that is the subject of the involuntary petition, and that the Bankruptcy Code’s definition of “person” (in section 101(41)) does not include a person’s property.  The Court concluded that, because the Petitioning Creditor’s notes were nonrecourse, they held claims against the collateral only, and not against Taberna.  In reaching its conclusion that the Petitioning Creditors failed to meet the eligibility criteria of section 303(b), the Court rejected the Petitioning Creditors’ assertion that section 1111 of the Bankruptcy Code supported their argument for eligibility; the Court stated that section 1111 is a provision dealing with the allowance of claims in a chapter 11 case and is not applicable in determining a party’s eligibility to initiate an involuntary bankruptcy under section 303.

The Bankruptcy Court further held that, even if the Petitioning Creditors were eligible under section 303(b), their involuntary petition against Taberna should be dismissed pursuant to section 1112 of the Bankruptcy Code.  The Court noted that section 1112 authorizes dismissal of a case for cause when it is in the best interest of the creditors and the estate to do so and grants a bankruptcy court broad equitable discretion to grant relief based on the facts and circumstances of a particular case.  The Court also noted that the Bankruptcy Code’s goal is to secure equal distribution among creditors, and an involuntary chapter 11 case is appropriate where the petitioning creditor seeks to guard against other creditors obtaining an unfair and disproportionate share of the debtor’s assets or to achieve objectives that benefit all creditors.  The Court found that cause to dismiss existed because the Petitioning Creditors’ filing did not serve any such bankruptcy purpose.  The Court noted that it was clear from the evidence that the Petitioning Creditors were seeking to liquidate the collateral solely for their own benefit and at the expense of other note holders, and that they purchased the defaulted notes with an eye towards commencing an involuntary petition.

Summary courtesy of Margaret G. Parker-Yavuz of Akin Gump.