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In re La Paloma Generating Company, LLC

United States District Court, D. Delaware

September 24, 2019

IN RE LA PALOMA GENERATING COMPANY LLC, et ah, Debtors.
v.
LNV CORPORATION, Appellee. AD HOC GROUP OF SECOND LIEN CREDITORS, Appellant,

          Glenn E. Siegel, Esq., Joshua Dorchak, Esq., and T. Charlie Liu, Esq. of MORGAN, LEWIS & BOCKIUS LLP, New York, NY.

          Jody C. Barillare, Esq., of MORGAN, LEWIS & BOCKIUS LLP, Wilmington, DE. Attorneys for Appellant Ad Hoc Group of Second Lien Creditors.

          Thomas E. Lauria, Esq., of WHITE & CASE LLP, Miami, FL.

          J. Christopher Shore, Esq. of WHITE & CASE LLP, New York, NY.

          Roberto J. Kampfher, Esq., of WHITE & CASE LLP, Los Angeles, CA.

          Jeffrey M. Schlerf, Esq., of FOX ROTHSCHILD LLP, Wilmington DE. Attorneys for Appellee LNV Corporation.

          MEMORANDUM OPINION

          STARK, U.S. District Judge:

         I. INTRODUCTION

         These appeals arise from a dispute under a Collateral Agency and Intercreditor Agreement, dated August 16, 2005 ("ICA"), among members of the Ad Hoc Group of Second Lien Creditors (together "2L Group")[1] and appellee LNV Corporation ("LNV").[2] On November 20, 2017, 2L Group appealed the order (B.D.I. 869)[3] ("Confirmation Order"), entered by the United States Bankruptcy Court for the District of Delaware ("Bankruptcy Court"), confirming the above-captioned debtors' plan of reorganization (Civ. No. 17-1697-LPS D.I. 1) ("Plan Appeal"). 2L Group contends that the Plan Appeal concerns whether the Bankruptcy Court had "the power to confirm a Chapter 11 plan to the extent it contained a provision that modified the relative rights between certain creditors under [the ICA]." (Id., D.I. 4) At the time of the Plan Appeal, the "relative rights between certain creditors under [the ICA]" ("Intercreditor Dispute") remained pending before the Bankruptcy Court, and the outcome of that dispute may have rendered the Plan Appeal moot. (Id., D.I. 15, 16) Therefore, at the parties' request, the Court deferred briefing of the Plan Appeal pending the Bankruptcy Court's adjudication of the Intercreditor Dispute. (Id., D.I. 17) On December 27, 2018, the Bankruptcy Court issued its opinion with respect to the Intercreditor Dispute. In re La Paloma Generating Co., et al, 595 B.R. 466 (Bankr. D. Del. 2018) ("ICA Decision").[4] On January 4, 2019, 2L Group appealed the ICA Decision. (Civ. No. 19-17-LPS D.I. 1) ("ICA Appeal")

         Thereafter, the Court entered a scheduling order to govern combined briefing on dispositive motions and the merits of both appeals. (See ICA Appeal, D.I. 20) LNV moved to dismiss both appeals as moot under 11 U.S.C. § 363(m) and the doctrine of equitable mootness. (Plan Appeal, D.I. 24; ICA Appeal, D.I. 12) ("Motions to Dismiss")[5] The Motions to Dismiss are fully briefed.[6] The merits of the appeals are also fully briefed.[7] No. party requested oral argument.

         On July 15, 2019, 2L Group filed a Notice of Withdrawal in each appeal (Plan Appeal, D.I. 41; ICA Appeal, D.I. 23) indicating that, pursuant to a Settlement and Assignment Agreement dated June 6, 2019, certain members of 2L Group had agreed to withdraw and participate no further in the appeals. Accordingly, the sole remaining member of 2L Group (and sole appellant in these appeals) is Solus Alternative Asset Management LP.

         For ease of reference, however, the Court refers to appellant throughout as "2L Group." For the reasons stated below, the Court will deny the Motions to Dismiss and affirm the Confirmation Order and ICA Decision.

         II. BACKGROUND

         A. First Lien Obligations, Second Lien Obligations, and ICA

         Debtors owned and operated a natural gas fired power plant in McKittrick, California (the "Plant"). Prior to the commencement of the Chapter 11 cases on December 6, 2016 (the "Petition Date"), Debtors were indebted to LNV and 2L Group's members under certain credit agreements. On the Petition Date, La Paloma owed LNV approximately $330 million under two separate agreements dated February 20, 2014 (together, the "First-Lien Credit Agreements"): (i) a First-Lien Working Capital Agreement; and (ii) a First-Lien Credit Agreement.[8] LNV was the sole lender under the First-Lien Credit Agreements.[9] La Paloma's obligations under the First Lien Credit Agreements (the "First-Lien Obligations") were secured by a first priority lien on substantially all the Debtors' assets, pursuant to, among other documents: (i) a deed of trust and assignment of rents recorded as Kern County California instrument 000214020051 (the "Deed of Trust");[10] (ii) a First-Lien Security Agreement dated August 16, 2005 (the "First-Lien Security Agreement");[11] and (iii) a First-Lien Pledge Agreement dated August 16, 2005 (the "First-Lien Pledge Agreement").[12]

         La Paloma was indebted to 2L Group's members as lenders under a Second-Lien Credit Agreement dated February 20, 2014 (the "Second-Lien Credit Agreement"), under which approximately $110 million was outstanding on the Petition Date.[13] La Paloma's obligations under the Second-Lien Credit Agreement were secured by a second priority lien on substantially all the Debtors' assets pursuant to, among other documents: (i) the Deed of Trust; (ii) a Second-Lien Security Agreement dated August 16, 2005 (the "Second-Lien Security Agreement"); and (iii) a Second-Lien Pledge Agreement dated August 16, 2005 (together with the Deed of Trust, the First-Lien Security Agreement, the Second- Lien Security Agreement, and the First-Lien Pledge Agreement, the "Granting Documents").[14]

         Each security interest under each Granting Document was granted exclusively in favor of The Bank of New York Mellon as collateral agent (the "Collateral Agent") for the benefit of the lenders under the First-Lien Credit Agreement (LNV) and the lenders under the Second-Lien Credit Agreement (2L Group members). Each of those lenders and the Collateral Agent is a party to the IC A.[15]

         The ICA governs the parties' rights with respect to the "Collateral." As the recitals to the ICA state, the term "Collateral" embraces substantially all of the Debtors' assets.[16] Collateral is defined in the ICA as "all of the Property of the Grantors, whether real, personal or mixed constituting or intending to constitute all of the First-Lien Collateral [or] the Second-Lien Collateral..." (ICA §1.1 (A280)) "Property" is given its ordinary meaning and La Paloma is a "Grantor." (See id.) (A286, 290) First-Lien Collateral is defined by reference to other definitions, which, in turn, refer to the Property granted as security for the various First-Lien Obligations. (See id.) (A283, 285, 286) The Property pledged as First-Lien Collateral is described in the Deed of Trust and the First-Lien Security Agreement.

         The Deed of Trust subjects all of La Paloma's real property to liens, and does the same for "all rents, revenues, proceeds, issues, profits, royalties, income, and other benefits now or hereafter derived from [such] Property." (Deed of Trust, 4) (A356) The First-Lien Security Agreement subjects all of La Paloma's property, defined therein as "Pledged Collateral, " to a security interest. (A412, First-Lien Security Agreement, at Art. 111(a)) "Pledged Collateral" includes "general intangibles . . . and accounts of [La Paloma] constituting any right to the payment of money" (id. at Art. III(a)(iii)) (A413) and "all [of La Paloma's] other cash, products, offspring, rents, revenues, issues, profits, payment intangibles, royalties, income" (id. at Art. III(a)(xi)) (A414) and all proceeds thereof (id.). Pledged Collateral embraces all such property, "wherever located and now owned or hereafter acquired by [La Paloma] or in which [La Paloma] now has or at any time in the future may acquire any right, title or interest." (Id. at Art. 111(a)) (A412)

         The ICA provides that, together with the Granting Documents and other "Collateral Documents, " the parties intended that "the Liens securing the Second-Lien Obligations ... are subject and subordinate on terms contained in [the ICA] to the Liens securing the First-Lien Obligations." (ICA, § 2.1(2)) (A295) This priority is, as a matter of contract, unaffected by "the perfection of or avoidability 0/such Liens or claims secured thereby, " "any defect or deficiencies in, or failure to perfect, the Liens securing the First-Lien Obligations, " or "any other circumstances whatsoever." (Id. at § 2.1(b)) (A297) (emphasis added) The ICA bars the Second-Lien Claimholders[17] from "contesting] or supporting] any other Person in contesting, in any proceeding (including any Bankruptcy), the priority, validity or enforceability of a Lien held by or on behalf of any of any of the First-Lien Claimholders in the First-Lien Collateral." (Id. at §2.2(A298);§3.1(b)(1)(5)(A301))

         Given their subordination under the ICA, each Second-Lien Claimholder agreed not to "receive any Collateral or any proceeds of Collateral in connection with the exercise of any right or remedy ... with respect to any Collateral in its capacity as a creditor, unless and until the Discharge of First-Lien Obligations has occurred." (Id. at § 3.1(c)) (A301) The Second-Lien Claimholders' "sole right" with respect to the Collateral was to "receive a share of the proceeds thereof, if any, after the Discharge of the First-Lien Obligations has occurred." (Id.) As such, Second-Lien Claimholders "are required to pay over all Collateral and proceeds of Collateral to [LNV] until the First Lien Claims are paid in full." (ICA Appeal, D.I. 14, ¶ 34) (citing ICA, §§2.1, 3.1, 4.1, 4.2)

         B. Settlement and Plan

          At the outset of the Chapter 11 cases, Debtors noted that some of the liens under the Granting Documents were unperfected as of the Petition Date[18] due to the Collateral Agent's failure to continue certain UCC-1 financing statements.[19] This rendered those UCC liens potentially avoidable under 11 U.S.C. § 544(a). See, e.g., In re D'Angelo, 491 B.R. 395, 403 (E.D. Pa. 2013). Notwithstanding the UCC lapse, LNV asserted that Debtors' core assets -the Plant, associated fixtures, and their proceeds - remained subject to perfected liens under the Deed of Trust. Challenging market conditions and the regulatory environment limited Debtors' restructuring alternatives in bankruptcy. Debtors marketed their assets to potential buyers but received limited interest. LNV emerged as the most suitable purchaser of Debtors' assets, owing to its first lien position and right to credit bid its debt under § 363(k) of the Bankruptcy Code. Debtors and LNV engaged in settlement negotiations.[20] LNV reached a settlement with Debtors ("Settlement"), resolving numerous disputed issues, that was ultimately incorporated into a proposed plan of reorganization.

         Debtors argued that they could avoid LNV's lien in personal property that was not also covered by the Deed of Trust, although Debtors recognized that LNV had defenses and that avoiding those liens would not benefit their estates if it meant LNV was unwilling to bid in cash. As part of the Settlement, LNV agreed to credit bid $150 million of its debt to buy the assets -double the highest amount indicated by a potential third-party purchaser - and to make other amounts available for unsecured creditors. In exchange for those compromises, Debtors agreed to release all avoidance actions against the Collateral Agent and preserve the liens under the Granting Documents for LNV's benefit.

         As part of the Settlement, the parties identified and valued assets that may have been subject to avoidable liens. These included cash and non-cash assets, most of which were covered by the expired UCC-1 financing statement. (A73-75) (Disclosure Statement) The estimated $63.3 million value of these assets is defined in the Plan as the "Unencumbered Amount." This amount was used to allocate distributions on account of the outstanding First-Lien Obligations and the Second-Lien Obligations. The Settlement and Plan earmarked cash in an amount equivalent to the ratable share attributable to Second-Lien Obligations - approximately $30 million - to be transferred to a liquidating trust ("Liquidating Trust") for distribution in accordance with the ICA ("Subject Fund"). (Id.) (A73-74) That cash is referred to in the Plan as the "Remaining Cash." (Plan, § 1.87) (A778) The source of the Remaining Cash was the Debtors' own cash accounts generated from operations.[21] According to LNV, the Debtors' transfer of such cash was made subject to "the Liens of the Collateral Agent for the benefit of the holders of the First Lien Claims and the Second Lien Claims to the extent necessary to enforce the Intercreditor Agreement, "[22] and the funds remain "Collateral or the proceeds of Collateral"[23]notwithstanding any transfer. (ICA Appeal, D.I. 21 at 12)

         2L Group was not satisfied with the Settlement negotiated by LNV under the terms of the ICA. 2L Group's claims were entirely unsecured because the value of the property subject to liens securing the First-Lien Obligations was less than the outstanding First-Lien Obligations.[24] In 2L Group's view, the Subject Fund should have been treated as unencumbered and distributed to 2L Group's members as unsecured creditors under their proofs of claim. 2L Group objected to confirmation of the Plan on several bases, including that the Settlement did not satisfy the Bankruptcy Rule 9019 standard. The Bankruptcy Court held a trial (A472, 10/30/17 Hr'g Tr.), overruled these objections, and entered the Confirmation Order (B.D.I. 869). The Plan deferred for later consideration "whether the holders of Second Lien Claims [2L Group] may receive distributions of Collateral or proceeds of Collateral (other than distributions of Second Lien Encumbered Cash) without violating the priority scheme provided for in the ICA." (Plan § 5.7(a)) Thus, the distributions that would theoretically go to 2L Group members on account of their unsecured claim (which is their entire claim) under the Plan were held in reserve with the Collateral Agent pending determination by the Bankruptcy Court as to whether the Second-Lien Lenders were entitled to such distribution in light of the ICA. (Plan § 4.4) The Plan also provided that the ICA "shall remain in full force and effect" and "shall be fully enforceable according to its terms." (Id. § 5.7(a))

         On November 20, 2017, 2L Group filed its appeal of the Confirmation Order. (Plan Appeal, D.I. 1). 2L Group identified as its sole issue whether the Bankruptcy Court had authority to modify the parties' rights under the ICA pursuant to the Plan. (Plan Appeal, D.I. 4 at 1) 2L Group did not seek a stay pending appeal. The Effective Date occurred and the Plan was substantially consummated on December 4, 2017 (the "Effective Date"). (A454; Plan § 13.2 (A110))

         B. ICA Decision

         On December 27, 2018, the Bankruptcy Court issued the ICA Decision. The ICA Decision determined that the ICA was not ambiguous and required the Subject Fund to be paid to LNV and not to the members of 2L Group. See La Paloma, 595 B.R. 466. In reaching its conclusion, the Bankruptcy Court relied on § 4.2(a) of the ICA. Section 4.2(a) requires Second-Lien Claimholders to turn over to LNV any Collateral or proceeds that they receive under the conditions specified therein. The Bankruptcy Court noted that 2L Group disputed that those conditions were satisfied with respect to the Subject Fund but did not dispute that the Subject Fund constituted Collateral or proceeds thereof. See Id . at 472. The Bankruptcy Court determined that the distribution of the Subject Fund pursuant to the Plan indeed constitutes Collateral or proceeds of Collateral. See Id . The Bankruptcy Court then proceeded to analyze the remaining elements of § 4.2(a) that the 2L Group argued were unsatisfied, such that its members could receive Collateral or its proceeds. Finding that each of these elements was satisfied under the circumstances, the Bankruptcy Court determined that 2L Group could not receive the Subject Fund.

         On January 4, 2019, 2L Group filed its appeal of the ICA Decision. (ICA Appeal, D.I. 1)

         III. JURISDICTION

         The Court has jurisdiction over all final judgments, orders, and decrees pursuant to 28 U.S.C. § 158(a)(1). In conducting its review of the issues on appeal, this Court reviews the Bankruptcy Court's findings of fact for clear error and exercises plenary review over questions of law. See Am. Flint Glass Workers Union v. Anchor Resolution Corp., 197 F.3d 76, 80 (3d Cir. 1999). The Court must "break down mixed questions of law and fact, applying the appropriate standard to each component." Meridian Bank v. Alten, 958 F.2d 1226, 1229 (3d Cir. 1992).

         IV. CONTENTIONS

         A. Motions to Dismiss

          LNV moves to dismiss the appeals as moot pursuant the doctrine of equitable mootness and § 363(m) of the Bankruptcy Code. With respect to equitable mootness, LNV argues that no review of the ICA Decision is permissible because the 2L's Group's requested relief would upset the terms of the Debtors' substantially consummated Plan. (ICA Appeal, D.I. 12 at 13-19) According to LNV, the Plan embodies a comprehensive settlement between LNV, the Debtors, and the Official Committee of Unsecured Creditors appointed in the Chapter 11 cases. This settlement was "the heart of Plan and, in exchange for many concessions from LNV, the Debtors agreed to release all avoidance actions against the Collateral Agent under the Granting Documents, meaning that all liens of the Collateral Agent were preserved for the benefit of LNV and would be "valid, binding, and unavoidable." (Id.) (citing A87, Plan § 5.5) The Debtors further agreed that any distributions payable to Second Lien Claimholders from the $30 million Subject Fund would be and remain "Collateral or the proceeds of Collateral." According to LNV, 2L Group's appeals could only succeed if the Debtors' estates held unencumbered cash not subject to the ICA, and according to LNV, no such assets exist. Granting any relief to 2L Group would fatally scramble the Plan, invalidating the releases granted, liens preserved, and collateral determinations made in the Plan as part of the Settlement, and 2L Group's appeals should be dismissed as equitably moot.

         2L Group, of course, disagrees. 2L Group argues that the ICA Decision merely addressed a bilateral dispute over escrowed funds expressly contemplated by the Plan. As such, reversal of the ICA Decision would not even modify - let alone "fatally scramble" - the Plan or harm third parties. (ICA Appeal, D.I. 17 at 6-11)

         With respect to statutory mootness under § 363(m), LNV contends that 2L Group did not obtain a stay of the Confirmation Order and argues that the relief sought in the appeals threatens the validity of the sale. (ICA Appeal, D.I. 12 at 19-21) According to LNV, the sale to LNV was inseparable from the Settlement, as LNV was only able to credit bid for the Debtors' assets as a consequence of the Settlement preserving all liens under the Granting Documents; likewise, the amount of its credit bid was a key settlement term. LNV contends that invalidating the avoidance actions releases and liens would impact the validity of the sale as it would erode the value of the consideration that LNV received in the transaction. (Id. at 20-21)

         Again, 2L Group disagrees, arguing that LNV's argument under § 363(m) fails for the same reasons its equitable mootness argument fails. (ICA Appeal, D.I. 17 at 11) The sale cannot moot the appeals, according to 2L Group, because 2L Group does not seek to interfere with the sale any more than it seeks to interfere with the Settlement, which preserved the Intercreditor Dispute for later determination and escrowed the funds at issue. Moreover, 2L Group argues, even if the Court were to construe the Subject Fund as proceeds of the sale, § 363(m) preserves the validity of the sale and does not address the disposition of the proceeds of a sale. (Id.)

         B. Merits

         2L Group argues that the ICA Decision must be reversed because: (i) the filing of a proof of claim was not the exercise of a right or remedy in contravention of the ICA, since the ICA expressly permits such an action; (ii) the Subject Fund is not Collateral or "intended" to be Collateral under the ICA, since it is comprised entirely of Avoidance Proceeds, which cannot be Collateral or "intended" to be Collateral under the ICA, since such avoidance actions are not property of the Debtors; and (iii) the ICA provides for only lien subordination and not payment subordination.

         LNV responds that 2L Group has completely changed its legal strategy. (ICA Appeal, D.I. 21 at 16) According to LNV, 2L Group argued to the Bankruptcy Court that it could receive the Subject Fund, even if the fund constituted Collateral, because some of the other conditions of ICA Section 4.2(a) had not been met. (Id.) (citing B.D.I. 695, ¶¶ 16-24 (A226-30)) On appeal, however, 2L Group concedes that it cannot receive the Subject Fund if it is Collateral but argues that the Subject Fund is not Collateral because it constitutes the proceeds of an avoidance action. (ICA Appeal, D.I. 14 at ¶¶ 20-31) LNV argues that 2L Group's approach narrows, if not eliminates, the issues in the appeals, "as the plain terms of the ICA and the Plan make clear that the Subject Fund constitutes Collateral." (Id.) As such, LNV contends, the Subject Fund cannot be paid to 2L Group, and the ICA Order should be affirmed.

         V. DISCUSSION

         A. Equitable Mootness

         Equitable mootness is a judge-made abstention doctrine which can be applicable in the context of an appeal following the confirmation of a plan of reorganization by a bankruptcy court. See In re SemCrude, 728 F.3d 314, 317 (3d Cir. 2013). "Once effective, reorganizations typically implement complex transactions requiring significant financial investment." Id. Notwithstanding an aggrieved party's statutory right to appeal, and a federal court's "virtually unflagging obligation" to exercise the jurisdiction conferred on it, Colo. River Water Conservation Dist. v. United States, 424 U.S. 800, 817 (1976), in some circumstances granting the relief requested in the appeal "would disrupt the effected plan or harm third parties, " SemCrude, 728 F.3d at 317.

         Parties seeking to dismiss an appeal as equitably moot contend that "even if the implemented plan is imperfect, granting the relief requested [in the appeal] would cause more harm than good." Id. In light of the responsibility of federal courts to exercise their jurisdictional mandate, the Third Circuit has cautioned that an appellate court must "proceed most carefully before dismissing an appeal as equitably moot." Id. at 318. "Before there is a basis to forgo jurisdiction, granting relief on appeal must be almost certain to produce a perverse outcome - chaos in the bankruptcy court from a plan in tatters and/or significant injury to third parties. Only then is equitable mootness a valid consideration." Id. at 320 (internal citations and quotation marks omitted).

         To determine whether to dismiss an appeal of a bankruptcy order as equitably moot, the court undertakes a two-step inquiry. See In re Tribune Media Co., 799 F.3d 272, 278 (3d Cir. 2015). The Court must assess: "(1) whether a confirmed plan has been substantially consummated; and (2) if so, whether granting the relief requested in the appeal will (a) fatally scramble the plan and/or (b) significantly harm third parties who have justifiably relied on plan confirmation." SemCrude, 728 F.3d at 321.

         LNV, as the party seeking dismissal of the appeal on equitable mootness grounds, bears the burden of proving that, weighing these factors, dismissal is warranted. See Id . Because dismissal of an appeal over which the Court has jurisdiction "should be the rare exception and not the rule, " any such dismissal must "also be based on an evidentiary record, and not speculation." Id.

         1. ...


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