This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece).We’ve switched over to Section F of the Report regarding “Plan Voting and Confirmation Issues.” Subsection 2, the focus of this post, addresses “Assignment of Voting Rights.”
It’s not uncommon for creditors with claims against a common debtor to enter into pre-petition subordination or intercreditor agreements. Although they usually address payment priority, allocation of collateral, and the like (i.e., state law matters), they might also address bankruptcy matters, including the assignment or waiver of Chapter 11 plan voting. Creditors might also seek voting assignments outside of such agreements.
As a result, courts have had to determine whether pre-petition voting assignments are enforceable. When they’re embodied in subordination agreements, the starting point is 11 U.S.C. 510(a). Section 510(a) provides that a “subordination agreement is enforceable . . . to the same extent that such agreement is enforceable under applicable nonbankruptcy law.” Section 510(a) is pretty straightforward for agreements involving state law matters. However, courts have struggled with subordination agreements that address (federal) bankruptcy rights, including voting.
The Commission summarizes the two competing views:
- View 1: Section 1126 provides that the “holder of a claim or interest allowed under section 502 of this title may accept or reject a plan.” Therefore, if a junior creditor holds a particular claim against the debtor, then only the junior creditor can vote the claim (not the senior creditor via assignment ). Additionally, this view questions whether parties can waive federal rights that are only available under federal law.
- View 2: Section 1126 should be read more broadly. Specifically, it does not “prohibit the delegation of rights associated with claims held by a creditor.” Additionally, this view looks to Section 510(c) and Bankruptcy Rules 3018 and 9010 for the idea that enforceability under state law is the only condition for enforcement.
Additionally, the Commission raises the “empty creditor problem” (i.e., the decoupling of voting and economic rights that results from a waiver or assignment). The Commission explains that such a decoupling can not only change the interests and objectives of the party holding the decoupled claim, but it might also cause creditors in a particular class (i.e., those with economic risk versus those without economic risk) not to be “similarly-situated.” (We discussed the “similarly-situated” requirement in our last post). The Commission points out that the empty creditor problem is mostly an issue with credit default swaps but it can also be an issue with voting assignments.
Similar to its approach to other issues, the Commission approaches the voting assignment issue by weighing (i) the need to respect private contract rights, on the one hand, and (ii) fostering the goals of Chapter 11, on the other hand.
The Commission recommends respecting private contract rights when it comes to payment priority agreements. However, it recommends prohibiting voting assignments that are separate and apart from the economic claim. The Commission does not believe that prohibiting voting assignments will damage or significantly impact payment priority agreements.
First, the Commission expresses concerns that subordination agreements have expanded well beyond payment ordering among non-debtors. Second, it concludes that “holder of the claim” in Section 1126(a) suggests that some sort of “nexus” between the vote and right to payment is necessary. Finally, the Commission is concerned that voting assignments can give senior creditors the ability to “influence the plan structure or control the vote on the plan” and “affect valuations of the debtor’s assets,the debtor’s postconfirmation operations and capital structure, and the value ultimately available for distributions to other stakeholders.”
The Commission’s rationale extends to partial claim assignments and voting assignments that arise outside of subordination agreements: maintaining the link between the vote and the right to payment should help mitigate the potential for abuse. And any wrinkles arising in the “derivative or swap product” context can–you guessed it–be resolved by the court on a case-by-case. (Actually, it’s a little more nuanced than that–the Commission suggests that such case-by-case issues can be resolved by “vote designation” principles under Section 1126–a topic that we will cover in our next post.)