By: Rossella Scarpa
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
In In re Energy Future Holdings Corp., the United States Court of Appeals for the Third Circuit held that the lenders who funded the “Deposit Letter of Credit Facility” did not have payment priority over the non-contributing lenders.[1] The Third Circuit’s decision affirmed the United States Bankruptcy Court for the District of Delaware and the United States District Court for the District of Delaware’s dismissals of the Appellants complaint.[2] Texas Competitive Electric Holdings (“TCEH”) entered into a leveraged buyout, where it borrowed $24.5 billion from nine lenders.[3] On October 10, 2007, a Creditor Agreementwas executed between TCEH and its nine lenders, specifying that the $24.5 billion loan would be divided among three credit facilities.[4] Subgroups of the nine lenders funded the credit facilities,[5]so an Intercreditor Agreement was made to govern the lenders’ relationship.[6] At issue was the third credit facility, the Deposit Letter of Credit Facility.[7] Appellants funded the $1.25 billion cash deposit for this Credit Facility with Citibank.[8]
TCEH granted asecurity interest in the Collateral Account and its cash proceeds to all nine lenders in the Creditor Agreement.[9] Subsequently, on April 29, 2014, TCEH filed a petition for relief under Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).[10] Later, Appellants filed a complaint seeking a declaratory judgment stating they had payment priority on the Collateral Account and its cash proceeds over the “Other Lenders” because Appellants funded the deposit for the Collateral Account.[11] Both the Bankruptcy Court for the District of Delaware and the District Court for the District of Delaware dismissed Appellants complaint, so Appellants appealed to the Third Circuit.[12]
The Third Circuit concluded that the Intercreditor Agreement was ambiguous as to payment priority between the lenders for any remaining portion of the $1.25 billion deposit, so the Court determined there was a contract interpretation issue.[13] Accordingly, the Third Circuit interpreted the contract through Section 4.1 of the Intercreditor Agreement, particularly its “waterfall” provision, which dictated payment priority for the remaining funds in the Collateral Account.[14] The “waterfall” provision was broken into five tiers, which numerically indicated the order of payment.[15] For example, the first tier had first payment priority, while the fifth tier was paid last if any funds remained.[16] The Court interpreted and Appellants conceded that the first three tiers of the provision apply only to TCEH’s payment obligations to the Letter of Credit issuer, Citibank.[17] Thus, Appellants contended that they fit into the fourth tier of payment priority because it would be redundant for the fourth tier to be reserved for payment to the issuer again.[18] Appellants believed the “Other Lenders” fit into the fifth tier.[19]
Despite Appellants contentions, the Third Circuit determined that the plain language of the fourth tier signaled that it was meant to be a catch-all provision to protect the issuer from outstanding and contingent amounts still owed to it.[20] The Court noted that the purpose of the “waterfall” provision was to protect the Deposit Letter of Credit Issuer.[21] Further, Section 3.9 of the Creditor Agreement enforced this notion by explaining that the purpose of the “waterfall” provisionwas “to secure TCEH’s obligations to the Deposit Letter of Credit Issuer, and then give the issuer a right to be paid first from the funds in the Account.”[22] Thus, the Third Circuit held that Appellants do not have payment priority over the “Other Lenders” for remaining undrawn funds in the Collateral Account.[23] Accordingly, all nine lenders fell into the fifth tier, where any remaining funds in the Account after payment to Citibank, were then distributed among the lenders based on pro ratashares loaned.[24]
The Third Circuit’s approach to resolving the ambiguity in the Intercreditor Agreement focused on the fact that the nine lenders were highly sophisticated parties.[25] Therefore, if the lenders wanted to create payment priority among themselves for any remaining funds in the Collateral Account, the parties should have expressly included such a provision in the Intercreditor Agreement.[26] Instead, the Court held that the plain language of the Intercreditor Agreement only prioritized payment to the issuer, Citibank.[27] The Third Circuit’s holding is consistent with the principle that courts will only “give effect to the intent of the parties as revealed by the language of their agreement.”[28]
[1]See In reEnergy Future Holdings Corp., No. 17-1958, 2018 WL 3752231, at *6 (3d Cir. Aug. 7, 2018).
[2]See id.at *1. Appellants are Marathon Asset Management, LP; Polygon Convertible Opportunity Master Fund; and Polygon Distressed Opportunities Master Fund. See In reEnergy Future Holdings Corp., No. BR 14-10979-CSS, 2017 WL 1170830, at *1 (D. Del. Mar. 28, 2017).
[3]See In re Energy Future Holdings Corp., 2018 WL 3752231, at *1.
[4]See In reEnergy Future Holdings Corp., 548 B.R. 79, 82–83 (Bankr. D. Del. 2016). The three credit facilities were: (1) a $20.55 billion term loan; (2) a $2.7 billion revolving line of credit arrangement; and (3) a $1.25 billion Deposit Letter of Credit Facility. Id.
[5]See id. at 83.
[6]See In re Energy Future Holdings Corp., 2018 WL 3752231, at *1.
[7]See id.at *1 (“Deposit letter of credit is backed by a cash deposit used to reimburse the letter of credit bank”).
[8]See In re Energy Future Holdings Corp., 548 B.R. at 80. The Appellants cash deposit is placed in a Collateral Account, where funds can be drawn as needed. Id.
[9]See id. at 83. These nine lenders were also TCEH’s first lien creditors. Id. at 80.
[10]See In re Energy Future Holdings Corp., 2018 WL 3752231, at *1 (stating that Chapter 11 bankruptcy relief was filed in the United States Bankruptcy Court for the District of Delaware).
[11]See id. at *2. The “Other Lenders” did not fund the Deposit Letter of Credit Facility but funded one or both of the other two credit facilities. See In re Energy Future Holdings Corp., 548 B.R. at 80.
[12]See In re Energy Future Holdings Corp., 2018 WL 3752231, at *1. Here, Appellee is Wilmington Trust, acting in its capacity as first lien Collateral Agent. See In re Energy Future Holdings Corp., 548 B.R. at 82 (explaining that Wilmington Trust was only named nominal Defendant because Plaintiffs–Appellants are not seeking monetary recovery or action from Wilmington Trust).
[13]See In re Energy Future Holdings,2018 WL 3752231, at 2* (highlighting that all nine lenders are entitled to the remaining portion of the deposit because TCEH granted all of them a security interest in the Collateral Account and its cash proceeds).
[14]See id.
[15]See id. at *2. The five tiers are as follows: (1) financing fees owed to the Deposit Letter of Credit Issuer; (2) unreimbursed amounts on Deposit Letters of Credit already issued; (3) any lender’s advances or payments of fees owed to the Deposit Letter of Credit Issuer by TCEH and notreimbursed; (4) all other Deposit Letter of Credit Obligations; and (5) any remaining amounts are distributed pro rata to the lenders. Id. In the fourth tier, the Deposit Letter of Credit Obligations are equal to the aggregate stated amount of all outstanding Deposit Letters of Credit plusthe aggregate principal amount of all unpaid drawings under all Deposit Letters of Credit. Id.at *3.
[16]See id. at *2.
[17]See id.at *5.
[18]See id. at *6.
[19]See id.
[20]See id. at *4.
[21]See id. at *6.
[22]See id.(holding that interpretation of Section 3.9 of the Creditor Agreement implies that priority is only given to the issuer).
[23] See id.
[24]See id.
[25]See id.
[26]See id.
[27]See id. at *7.
[28]See id.; Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., N.A., 773 F.3d 110, 113–114 (2d Cir. 2014).