In re Coastal Broadcasting Systems: Court Enforces Assignment of Voting Rights in Subordination Agreement | Practical Law

In re Coastal Broadcasting Systems: Court Enforces Assignment of Voting Rights in Subordination Agreement | Practical Law

The US District Court for the District of New Jersey held that junior creditors' prepetition assignment of voting rights to a senior creditor in a subordination agreement was enforceable and allowed the senior creditor to exercise these rights to vote in favor of a plan that left the junior creditors without a distribution.

In re Coastal Broadcasting Systems: Court Enforces Assignment of Voting Rights in Subordination Agreement

by Practical Law Finance and Practical Law Bankruptcy & Restructuring
Published on 30 Jul 2013 • USA (National/Federal)
The US District Court for the District of New Jersey held that junior creditors' prepetition assignment of voting rights to a senior creditor in a subordination agreement was enforceable and allowed the senior creditor to exercise these rights to vote in favor of a plan that left the junior creditors without a distribution.
On June 28, 2013, the US District Court for the District of New Jersey held, in Rosenfeld v. Coastal Broadcasting Systems, Inc. (In re Coastal Broadcasting Systems, Inc.), that junior creditors' prepetition assignment of their voting rights to a senior creditor in a subordination agreement was enforceable and allowed the senior creditor to exercise these rights to vote in favor of a plan that left the junior creditors without a distribution.

Background

On December 31, 2008, Coastal Broadcasting Systems, Inc. (Coastal) redeemed the stock of several of its shareholders, including Rosenfeld and Hur (Appellants), in exchange for a secured promissory note. As part of this transaction, Appellants signed a subordination and intercreditor agreement (Agreement), which, among other things:
  • Subordinated the Appellants' claims and liens to the claims and liens of Sturdy Savings Bank (Sturdy), which had provided other secured loans to Coastal.
  • Irrevocably authorized Sturdy to take certain actions, including voting the Appellants' claims in any reorganization proceeding, as Sturdy deemed necessary or advisable.
On January 9, 2011, Coastal filed a voluntary Chapter 11 bankruptcy petition in the US Bankruptcy Court for the District of New Jersey. Coastal and Appellants filed competing plans of reorganization. At the July 6, 2012 confirmation hearing, Sturdy argued that under the Agreement it was entitled to vote the Appellants' debt in favor of the plan, which would leave the Appellants with no distribution. The Bankruptcy Court analyzed the Agreement, and held that Sturdy was entitled to exercise the Appellants' voting rights, and that such an assignment of voting rights does not violate the Bankruptcy Code.
The Appellants appealed to the District Court, arguing that:
  • Section 510(a) of the Bankruptcy Code, which provides that subordination agreements are enforceable to the extent they are enforceable under applicable nonbankruptcy law, applies only to priority and not to voting rights.
  • The assignment of voting rights provision in the Agreement conflicts with section 1126(a) of the Bankruptcy Code, which only permits the "[t]he holder of a claim" to vote on a plan.
  • Allowing the assignment of voting rights would violate public policy, because a creditor's voting rights are analogous to a debtor's right to an automatic stay and to discharge, which cannot be waived prepetition.
  • The assignment of voting rights provision in the Agreement conflicts with Federal Rule of Bankruptcy Procedure 3018 (Rule 3018), which limits voting rights to "the creditor or equity security holder or authorized agent," and Sturdy is neither.

Outcome

The District Court interpreted the Agreement under New Jersey law, and agreed with the Bankruptcy Court that applying the plain language of the Agreement, Sturdy was entitled to vote the Appellants' claims. It then went on to consider the Appellants' arguments about whether this assignment of voting rights is permitted under the Bankruptcy Code.
As an initial matter, the District Court noted that the Appellants failed to argue to the Bankruptcy Court that the assignment of voting rights to Sturdy was prohibited by the Bankruptcy Code. However, it stated that it would reject this argument anyway because under section 510(a) of the Bankruptcy Code, subordination agreements are enforceable to the extent they are enforceable under applicable nonbankruptcy law. Because the Appellants did not identify any nonbankruptcy law that would render the voting rights provision unenforceable, the provision was not unenforceable under section 510(a).
Next, the District Court rejected all of the Appellants' arguments based on bankruptcy law that the Agreement should not be enforced, explaining that:
  • By its plain terms, section 510(a) of the Bankruptcy Code provides for the enforcement of a subordination agreement as a whole and does not differentiate between individual components of these agreements.
  • There is nothing in section 1126(a) of the Bankruptcy Code that forecloses the assignment of a holder's voting rights to another.
  • The public policies behind a debtor's rights to discharge and to an automatic stay are much stronger than the policies behind a creditor's voting right, and according to a majority of courts, even automatic stay rights can be waived. There is no similar special protection for creditors, whose rights and associated voting rights, can be freely contracted away. Further, the District Court saw no reason why a creditor can sell its rights in full, but would be barred from selling a portion.
  • Sturdy qualifies as a creditor and as an authorized agent under Rule 3018. The District Court held that under the Agreement, Sturdy sat in the shoes of the Appellants and it would improperly elevate form over substance to not view Sturdy as a creditor for voting purposes. Also, because Rule 3018 does not define "authorized agent," the District Court looked at how the term is used in Federal Rules of Bankruptcy Procedure 2019 and 3001. It found that these provisions only require an authorized agent to provide the instrument under which it is empowered to act on behalf of the creditor. Because an agent's interests need not align with the creditor's, and the Agreement authorized Sturdy to vote on the Appellants' behalf, the District Court held that Sturdy was also an authorized agent under Rule 3018.

Practical Implications

Coastal Broadcasting is the latest in a series of decisions that have analyzed the enforceability of waivers of bankruptcy rights in otherwise enforceable subordination or intercreditor agreements. It stands in direct contrast to another recent decision on voting right waivers (see Legal Update, Assignment of Voting Rights in Bankruptcy Proceeding Held Unenforceable: In re SW Boston Hotel Venture).
While many courts carefully scrutinize waivers of bankruptcy rights that are unrelated to subordination and the priority of payment among lenders, this case serves as a reminder that some courts are more willing than others to enforce them. Therefore, creditors seeking to improve their position by bargaining away voting rights in the hope that the court will not enforce the waiver may end up forfeiting these rights. Until the issue is resolved by a higher court, parties negotiating subordination agreements should carefully consider the laws in their jurisdiction.
For more information on the enforceability of waivers of bankruptcy rights in intercreditor agreements and the Chapter 11 plan process, see Practice Notes, Bankruptcy Provisions in Intercreditor Agreements and Chapter 11 Plan Process: Overview.

Court Documents