In re Consolidated Bedding, Inc., 2021 Bankr. LEXIS 1720 (2021), United States Bankruptcy Court, D. Delaware
The Bankruptcy Court for the District of Delaware denied a junior secured creditor’s claim for proceeds from lawsuits a chapter 7 trustee pursued as part of an agreement with a senior secured creditor. The Court found that the junior secured creditor agreed to not be paid until the senior secured creditor was paid in full when it entered into a pre-petition intercreditor and subordination agreement with the senior secured creditor.
Consolidated Bedding and its related companies (the “Debtors”) filed chapter 7 with two primary debt obligations—approximately $231 million on a senior secured basis and approximately $14.4 million to a junior secured creditor (approximately $11.4 million of that amount was secured)—encumbering substantially all of the Debtors’ assets. Prior to the petition date, the senior secured creditor and the junior secured creditor entered into an intercreditor and subordination agreement for the dual purposes of (1) subordinating the junior secured creditor’s liens on the Debtors’ assets to those of the senior secured creditor and (2) preserving the junior secured creditor’s position in the collateral as a junior secured creditor/lienholder behind the senior secured creditor.
During the course of the bankruptcy, the senior secured creditor and the chapter 7 trustee entered into proceeds sharing arrangements (the “Stipulations”) in which (a) the senior secured creditor was entitled to 75% of all proceeds from lawsuits the chapter 7 trustee pursued on behalf of the Debtors’ estate and (b) the chapter 7 trustee would keep the remaining 25% of the proceeds. After a decade of collections, the chapter 7 trustee held approximately $2.3 million after paying the senior secured creditor in accordance with the terms of the Stipulations. The junior secured creditor argued that it was entitled to the $2.3 million fund on account of its rights as a junior secured creditor.
The chapter 7 trustee filed an adversary proceeding to enforce the pre-petition intercreditor and subordination agreement to subordinate the junior secured creditor’s debt. The chapter 7 trustee argued that the “Estate Retained Share” negotiated between the chapter 7 trustee and the senior secured creditor was a carve-out free and clear of any lien, claim, or interest asserted by the junior secured creditor.
The junior secured creditor then asserted that it had a valid and enforceable lien on Debtors’ assets, which cannot be reduced or eliminated through this adversary proceeding. The junior secured creditor further argued that that it was not bound by the Stipulations as the chapter 7 trustee (i) was aware of its existence as a junior secured creditor prior to the negotiation and execution of the Stipulations and (ii) failed to provide notice when the Stipulations were entered into by the chapter 7 trustee and the senior secured creditor.
The Court first addressed whether the “Estate Retained Share” of the collateral proceeds represented an unencumbered carve-out. The chapter 7 trustee contended that the proceeds received by way of the Stipulations are carve-outs from the senior secured creditor’s collateral, whereas the junior secured creditor argued that the chapter 7 trustee’s share of the proceeds was not a carve-out because the term “carve-out” was absent from the Stipulations. The Court found that the proceeds-sharing arrangement between the chapter 7 trustee and the senior secured creditor was the senior secured creditor’s right to carve funds out from the proceeds of its collateral to incentivize the chapter 7 trustee to pursue claims on behalf of the Debtors’ estate.
The Court then addressed the intercreditor and subordination agreement which provided, in relevant part, the following:
- “In connection with any such disposition of Collateral . . . Junior Creditor shall (i) be deemed to have automatically and without further action released and terminated any Liens it may have on the Collateral (as and to the extent that Senior Creditor shall release and terminate its Liens) . . . .”;
- The junior secured creditor was to “hold the [proceeds] in trust, as trustee, for the benefit of Senior Creditor . . . .”; and
- The junior secured creditor waived notice of “(ii) the taking, exchange, surrender and releasing of Collateral or guarantees now or at any time held by or available to Senior Creditor for the Senior Debt” and “(iii) the exercise of, or refraining from the exercise of any rights against any Debtor or any other obligor or any Collateral . . . .”
The Court found that the intercreditor and subordination agreement provided the senior secured creditor with “broad authority to release liens in any collateral in connection with a sale or disposition of the collateral” and curtailed the junior secured creditor’s right to oppose or interfere with those actions. The Court also noted that although the junior secured creditor’s claim of lack of notice was troubling to the Court and that the junior secured creditor may technically have been deprived of the opportunity to object by failure of service, there was no legal harm done to the junior secured creditor as the junior secured creditor had already voluntarily waived any right to interpose an objection under the intercreditor and subordination agreement.
By: Margaret G. Parker-Yavuz (Akin Gump LLP) and Chanwon (Pio) Yoon (Akin Gump LLP)