Dismissal of Involuntary Bankruptcy Petition Against Taberna CDO is Win for Securitization Industry

On November 8, 2018, Judge Vyskocil of the U.S. Bankruptcy Court for the Southern District of New York issued a decision dismissing the involuntary petition that had been filed against Taberna Preferred Funding IV, Ltd. (“Taberna”), a non-recourse CDO, thus ending a nearly seventeen-month-long saga that was followed closely by bankruptcy practitioners and securitization professionals alike. See Taberna Preferred Funding IV, Ltd. v. Opportunities II Ltd., et. al., (In re Taberna Preferred Funding IV, Ltd.), No. 17-11628 (MKV), 2018 WL 5880918, at *24 (Bankr. S.D.N.Y. 2018). Judge Vyskocil’s decision to dismiss the involuntary petition came in response to a motion filed by certain of Taberna’s junior noteholders that were fighting against senior noteholders’ attempt to use the chapter 11 process to liquidate the Taberna CDO’s collateral in an accelerated fashion in a manner inconsistent with the terms of the underlying indenture.

Cadwalader advised the Structured Finance Industry Group (“SFIG”) in connection with the case, arguing, via amicus brief, that involuntary chapter 11 petitions against securitization vehicles like Taberna serve no valid reorganizational purpose, violate public policy, and threaten industry expectations that such vehicles are bankruptcy-remote. Further, SFIG argued that investors in non-recourse and bankruptcy-remote securitizations should not be eligible to commence involuntary cases.

This decision is significant in that it sends a clear message to the capital markets that noteholders of non-recourse securitizations will face obstacles if they attempt to invoke the involuntary bankruptcy process as a strategic tool to try to override bargained-for liquidation provisions in underlying transaction documents. Here, Judge Vyskocil rejected the petitioning noteholders’ attempt to manufacture eligibility credentials to qualify for commencing an involuntary bankruptcy case under the Bankruptcy Code, in turn creating a formidable barrier that should make investors pause before attempting strategic maneuvers against other nonrecourse, bankruptcy-remote vehicles similar to those that were attempted here.

On the heels of other unsuccessful attempts to initiate a fast liquidation via a failed tender offer and a failed consent solicitation, on June 12, 2017, three funds managed by HH Holdco (the “Petitioning Creditors”) filed an involuntary chapter 11 petition against Taberna. The Petitioning Creditors were holders of all of the senior priority Class A-1 notes, and a large percentage of the second priority Class A-2 notes. Since the filing of the involuntary petition, several junior noteholders (the “Junior Noteholders”) had been opposing and contesting the Petitioning Creditors’ filing of the involuntary petition and generally arguing that the Petitioning Creditors wrongly filed the involuntary petition in order to accelerate payments by liquidating the collateral that secures both the Petitioning Creditors and junior creditors’ notes, in contravention of the terms of the applicable indenture.

On August 14, 2017, following weeks of discovery amongst the parties, the Petitioning Creditors moved for summary judgment on the threshold Bankruptcy Code requirement for commencing an involuntary case under section 303(b)(1) of the Bankruptcy Code, which requires that a petitioning creditor hold, in the aggregate, claims that exceed the value of any lien(s) securing those claims by a certain dollar threshold ($15,775). Taberna’s collateral manager and the Junior Noteholders, supported by SFIG’s amicus brief, opposed the Petitioning Creditors’ summary judgment motion and argued that, among other things, because the notes were nonrecourse, even if the Petitioning Creditors’ could show that their claims were not fully secured, they still would have no unsecured claims against Taberna itself (as opposed to Taberna’s property) as required to qualify under Bankruptcy Code section 303(b)(1). Ultimately, Judge Vyskocil denied the Petitioning Creditors’ motion for summary judgment, and a trial commenced on the eligibility of the Petitioning Creditors to maintain the case. After five days of trial, on February 1, 2018, the Junior Noteholders filed a motion seeking entry of a judgment on partial findings on the specific issue of whether the Petitioning Creditors were not eligible petitioners, and the matter has been under advisement since February 28, 2018.

On September 27, 2018, Judge Vyskocil subsequently entered an order to show cause “why, in light of the decision in In re Murray, 900 F.3d 53 (2d Cir. 2018), the Court should or should not dismiss the involuntary petition in this case pursuant to Sections 305(a), 1112(b), and 105(a) of the Bankruptcy Code.” In Murray, the Second Circuit affirmed the lower courts’ dismissal of an involuntary petition, including for the reason that that New York law offered adequate remedies for the petitioning creditors such that bankruptcy was not necessary. Murray, 900 F.3d. at 61-62.

Against this backdrop, on November 8, 2018, Judge Vyskocil issued the much-anticipated decision dismissing the involuntary petition.

Judge Vyskocil dismissed the involuntary petition on the grounds that: (1) as holders of nonrecourse claims, the Petitioning Creditors did not hold claims against the person (Taberna) as required by section 303(b) of the Bankruptcy Code and, therefore, were not eligible to file the involuntary petition; and (2) cause existed for dismissal pursuant to section 1112(b) of the Bankruptcy Code, including because the case served no legitimate bankruptcy purpose and dismissal was in the best interest of the creditors and the estate.¹ Taberna Preferred Funding IV, Ltd. v. Opportunities II Ltd., et. al., (In re Taberna Preferred Funding IV, Ltd.), No. 17-11628 (MKV), 2018 WL...