On November 8, 2018, the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) issued a decision dismissing an involuntary chapter 11 case filed against Taberna Preferred Funding IV, Ltd. (“Taberna”), a CDO, by holders of non-recourse notes (the “Petitioning Creditors”). The Bankruptcy Court held that the Petitioning Creditors’ non-recourse claims against Taberna’s collateral (as opposed to claims against Taberna itself) were not claims against the debtor for purposes of eligibility to commence an involuntary case pursuant to the Bankruptcy Code. In the alternative, the Bankruptcy Court concluded that, even if there were a proper basis for the commencement of the involuntary chapter 11 case, it would exercise its discretion under section 1112 of the Bankruptcy Code to dismiss the case for cause, finding that no bankruptcy purpose was served by the involuntary filing. In doing so, the Bankruptcy Court cautioned that rewarding the Petitioning Creditors’ tactics with an order for relief would create significant uncertainty across capital markets, as CDOs are designed to avoid bankruptcy.
BackgroundIn 2005, Taberna issued eleven classes of notes pursuant to an indenture. In August of 2009, an event of default occurred under the indenture due to Taberna’s payment default with respect to the Class B notes, which notes were accelerated the following month. Over six years later, the Petitioning Creditors purchased the most senior and second-most senior classes of notes (the “A-1 Notes” and the “A-2 Notes,” respectively). At all times, Taberna remained current on its payments to Class A noteholders.
Prior to filing the involuntary petition, the Petitioning Creditors took a number of steps in a failed effort to liquidate the collateral securing the notes (which collateral consisted mostly of long-term securities issued by REITs and other real estate entities). Thereafter, they immediately purchased the remaining A-1 Notes that they did not own, and two months later filed an involuntary petition against Taberna. The Petitioning Creditors simultaneously filed a “partial waiver,” waiving their rights to benefit from security interests in any asset of Taberna solely on account of their ownership interests in the Class A-2 Notes, in an amount not to exceed $5,259.00.[1] The day after filing the involuntary petition, the Petitioning Creditors moved to terminate Taberna’s exclusivity period in order to pursue their proposed plan, which plan permitted an auction of the collateral at the option of a majority of the holders of the A-2 notes.[2]
Taberna, its collateral manager, and five holders of the junior classes of notes moved to dismiss the involuntary petition, seeking a judgment that the Petitioning Creditors failed to establish that they hold a claim against the target of the petition as required by the Bankruptcy Code.[3] These parties argued that the Petitioning Creditors’ claims are only against the collateral securing the notes, and not against Taberna itself.[4] At the close of discovery, the Petitioning Creditors moved for partial summary judgment seeking a ruling that, having filed the partial waiver, they now held unsecured claims against Taberna. The collateral manager and several junior noteholders opposed the summary judgment motion, arguing that the Petitioning Creditors’ note claims are both oversecured and nonrecourse.
Summary judgment was denied and a bench trial ensued concerning the eligibility of the Petitioning Creditors to maintain the case. The issues before the Bankruptcy Court were whether the note claims are nonrecourse, and, if so, whether the Petitioning Creditors nonetheless meet the eligibility requirement of section 303(b) of the Bankruptcy Code. The Petitioning Creditors argued, among other things, that section 1111(b) of the Bankruptcy Code, which governs how undersecured nonrecourse claims are to be treated under a chapter 11 plan for allowance and distribution purposes, treats nonrecourse claims as recourse under all circumstances. As a result, the Petitioning Creditors argued, nonrecourse creditors must be treated as holding recourse claims when determining eligibility to commence an involuntary case. The objecting parties, on the other hand, took the position that section 1111(b) takes effect only after a bankruptcy case has been filed, and does not operate to render a party eligible to commence an involuntary case.
At the close of trial, the objecting parties sought a determination that the Petitioning Creditors’ note claims are nonrecourse and, as holders of nonrecourse claims, the Petitioning Creditors are ineligible under section 303(b) of the Bankruptcy Code to...
