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  • Release of Security Pursuant to The Terms Of The Equal and Ratable Clause of The Indenture Shortly Prior to Bankruptcy Filing Does Not Violate The Covenant of Good Faith and Fair Dealing

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Release of Security Pursuant to The Terms Of The Equal and Ratable Clause of The Indenture Shortly Prior to Bankruptcy Filing Does Not Violate The Covenant of Good Faith and Fair Dealing

May 29, 2007

Wilmington Trust Company v . Solutia Inc., Ad. No. 05-01843 (PCB) (Bankr. S.D.N.Y. 5/1/07). Interpreting the “equal and ratable” clause in the Indenture for Solutia’s Notes, Bankruptcy Judge Prudence Carter Beatty rejected the Noteholders’ claim that the Debtors improperly caused the release of the lien securing the Noteholders’ claims shortly before the bankruptcy case was filed. She also held that, as used in a default clause “corporate action” in furtherance of a bankruptcy case required the adoption of a corporate resolution authorizing the filing of a bankruptcy case.

The Solutia Indenture required that the Notes be equally and ratably secured if the Debtors incurred debt secured by in excess of 15% of its consolidated net assets. The Notes were unsecured when issued in 1997.  When the Debtors were able to refinance their principal credit agreement in 2002 only by granting security in excess of the 15% threshold, the Notes were secured by the collateral securing the credit agreement pursuant to an  Intercreditor and Collateral Trust Agreement. 

Faced with mounting liabilities relating to PCB contamination at one of its facilities, the Debtors were actively considering restructuring options in the spring of 2003.  In August, the Debtors incorporated a shell subsidiary in New York that was ultimately used as the basis for venue for the bankruptcy cases in New York.   In October the Debtors were able to refinance their credit agreement with another institution that did not require security in excess of the threshold. Upon the closing of the new financing, the Debtors delivered an Officer’s Certificate and Opinion of Counsel that the conditions for the release of the lien securing the Notes, including the absence of any default, were met. When the Debtors were then unable to negotiate satisfactory terms to address its PCB liabilities, they filed a chapter 11 cases six weeks after the release of the liens. The debtor in possession financing obtained after the bankruptcy cases were filed was secured by collateral that would have required equal and ratable security for the Noteholders.

Judge Beatty found that the conditions under the Indenture for the release of the lien were met and that the implied covenant of good faith and fair dealing was not violated by the Debtor’s actions in strict compliance with the terms of the Indenture. 

Relying on her 1985 opinion in In re Revere Copper & Brass, Inc. 60 B.R. 887 (Bankr. S.D.N.Y. 1985) and Union Bank of Switzerland v. Deutsche Fin. Servs. Corp, 2000 WL 178278 (S.D.N.Y. 2/16/2000), Judge Beatty ruled that the steps taken by the company in contemplation of a bankruptcy did not amount to “corporate action” in furtherance of a bankruptcy case which is limited to a formal corporate resolution authorizing the filing of a bankruptcy case.

Contributed by James Gadsden, Carter Ledyard & Milburn LLP in New York, gadsden@clm.com



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