ResCap judge issues split ruling on first phase of junior notes trial

By Caroline Salls

Pittsburgh, Nov. 15 - Residential Capital, LLC's junior secured noteholders are undersecured by about $318 million, according to a ruling on the first phase of an adversary proceedings trial filed Friday with the U.S. Bankruptcy Court for the Southern District of New York.

Judge Martin Glenn said ResCap and its official committee of unsecured creditors are co-proponents of a reorganization plan that treats the junior secured noteholders as undersecured, but would pay them the face amount of all principal and pre-bankruptcy interest of $2,222,000,000, less $1.1 billion repaid after ResCap's bankruptcy filing.

The junior secured noteholders voted against and oppose confirmation of the plan.

Glenn said the noteholders contend they are oversecured and entitled to post-bankruptcy interest at the default rate and fees.

The judge said the noteholders also contend they are entitled to recover an adequate protection claim of $515 million based on alleged diminution in value of their pre-bankruptcy collateral used during the case under a series of consensual cash collateral orders.

The noteholders also argued that their collateral should be increased as the result of an "all assets" pledge, which attaches to the ResCap debtors' assets that were once excluded from the "all assets" pledge but no longer are, were released from the noteholders' liens but were subsequently reacquired by the debtors or were never properly released from the liens at all.

Meanwhile, the company and the committee contend that noteholders are undersecured and, therefore, not entitled to post-bankruptcy interest and fees, the noteholders' collateral has not declined in value since the bankruptcy filing date, meaning the noteholders cannot assert an adequate protection claim and the noteholders' collateral should be reduced from lien challenges to deposit accounts and real estate owned assets.

Glenn said plaintiffs ResCap and the committee also argued that transfers of $270 million of collateral to the undersecured noteholders in the 90 days before bankruptcy are avoidable preferences, and the principal amount of junior secured noteholders' claim must be reduced by $386 million for unmatured interest arising from original issue discount (OID) created as part of the debtors' "fair value" debt-exchange offer in 2008.

"The swing between the [junior secured noteholders'] projected recoveries under the proposed plan and their ask is at least $350 million, or perhaps more," the judge said in Friday's ruling.

"In other words, the parties are fighting about a lot of money."

Phase one results

Glenn said the results of the phase I trial can be viewed as a split decision, with some issues resolved in favor of the company and committee and some in favor of the noteholders.

Subject to the outcome of the second phase of the trial, the judge concluded that the noteholders' claim should not be reduced for unmatured OID, that the noteholders have failed to establish that they are entitled to recover an adequate protection claim and that the noteholders have liens on some contested collateral, including intangible assets, but do not have liens on the full extent of the collateral claimed.

Meanwhile, Glenn said ResCap and the committee have failed to establish that noteholders received avoidable preferences during the preference period and that the noteholders are undersecured and not entitled to post-bankruptcy interest and fees.

According to the ruling, the trial was bifurcated into two phases because some issues involve only the plaintiffs and defendants, while other issues potentially involve other creditor constituencies in the case.

The phase II trial will be part of the contested plan confirmation hearing scheduled to begin on Nov. 19.

Noteholder conduct

Despite the split ruling, Glenn did chastise the noteholders for their conduct in ResCap's bankruptcy case.

"The [junior secured noteholders] have pursued from the start a strategy where they contest everything and concede nothing (even when the court has questioned whether they are acting in good faith)," the judge said.

"The [junior secured noteholders] have made clear that they will continue to follow the same strategy in the phase II trial and contested confirmation hearing.

"The court will continue to decide all issues fairly (the [junior secured noteholders] did prevail on some of the important issues in the phase I trial), but it should not be lost on anyone that the [junior secured noteholders] stand virtually alone in this case in failing to reach a consensual agreement to resolve their issues.

"The result has been protracted proceedings that have burdened the estate and reduced funds available to satisfy creditor claims. That is unfortunate!"

Residential Capital, a New York-based mortgage originator and servicer, filed for bankruptcy on May 14, 2012. Its case number is 12-12020.

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