FINANCIAL SERVICES CLIENT ADVISORY GROUP
Law Alert
Will the Securitization Indenture Documents be Upheld Post Default?
By: Harriet B. Alexson
714.384.6578
halexson@bmkalaw.com
©2011. All Rights Reserved
In the case In re Zais Investment Grade Ltd. VII a senior noteholder of a collateralized debt obligation (“CDO”) placed the CDO issuer in an involuntary chapter 11 bankruptcy in order to advance an asset management plan that would otherwise require supermajority approval of all noteholders (including all junior classes) under the related indenture. Zais Investment Grade Limited VII (“ZAIS”) was a CDO issuer formed in the Cayman Islands in 2005. In March 2009, a covenant default (for failure to maintain a certain debt coverage ratio) occurred under the related indenture, which triggered an event of default and resulted in the declaration of the notes to be due and payable. Following such an event of default and acceleration of the notes, the indenture requires that the indenture trustee hold the CDO’s assets passively to maturity. Any deviation from this, including disposition of any of the CDO’s assets, is not permitted under the indenture except upon the direction of at least 66 2/3% of all noteholders. An involuntary bankruptcy petition was filed by the senior noteholder.
Junior noteholder Hildene Capital Management, LLC (“Hildene”) moved for dismissal of the involuntary petition. Hildene’s primary arguments were that (i) ZAIS is not an eligible debtor in the United States; (ii) Anchorage is not an eligible petitioning creditor; (iii) Anchorage is using the bankruptcy courts in bad faith; and (iv) the indenture is a subordination agreement or intercreditor agreement to be recognized under bankruptcy law. The court denied Hildene’s motion to dismiss.
The court stated that ZAIS, although formed and maintained in the Cayman Islands, is an eligible debtor in the United States because (i) ZAIS has a New York-based trustee and a New Jersey-based collateral manager who together perform the major portion of ZAIS’s operations on its behalf in the United States; therefore, ZAIS has a place of business in the United States and (ii) the CDO collateral, which, even though pledged to and held by the trustee, is nominally ZAIS’s property and is held in the United States; therefore, ZAIS has property interests in the United States.
Hildene argued that, because the indenture sufficiently addresses all post-default considerations and all necessary parties to the bankruptcy proceedings are bound by the indenture, Anchorage’s use of bankruptcy to circumvent limitations under the indenture also indicated bad faith. The court found that the indenture may be rejected as an executory contract under the Bankruptcy Code and mentioned in dicta that “any knowledgeable attorney opining on the enforceability of a contract will disclaim the effects of bankruptcy law.” The Zais court rejected the proposition that the use of bankruptcy proceedings to avoid certain contract limitations or restrictions is on its face an indication of bad faith.
Hildene asserted that the indenture is a subordination agreement that must be respected under the Bankruptcy Code and that the indenture’s non-petition provision is an intercreditor agreement to be enforced. In addressing the indenture’s non-petition provision, the court found that because the language did not specifically bar petitions by senior noteholders, such provision was intended to benefit senior noteholders rather than limit their ability to institute bankruptcy proceedings.
In securitization transactions, the operative documents should clearly set out limitations on bankruptcy petitions by noteholders. The ZAIS indenture non-petition provision established a period (from the closing date to the date that is one year and one day after the senior noteholders have been paid in full) during which junior noteholders may not place the issuer into bankruptcy for failure to make required payments. Because the Zais court found this provision allowed Anchorage, as a senior noteholder, to file the involuntary petition, operative deal documents will need to better reflect the intent, to bar involuntary petitions by all noteholders, and to clarify the circumstances in which noteholders may file.
For further information about this interesting topic please contact:
Harriet B. Alexson
Chair Financial Services Practice Group
Bohm, Matsen, Kegel & Aguilera, LLP
695 Town Center Drive, Suite 700
Costa Mesa, CA 92626
Tel: 714.384.6578
halexson@bmkalaw.com
info@alexsonlaw.com
www.alexsonlaw.com
Actual resolution of legal issues depends upon many factors, including variations of fact and state laws. This article is not intended to provide legal advice on specific subjects, but rather to provide insight into legal developments and issues. The reader should always consult with legal counsel before taking action on matters covered by this article.