A Special Purpose CDO, an Involuntary Filing and a Single Lien Structure — Can an Investor “Create” an Unsecured Claim?

December 20, 2017

The U.S. Bankruptcy Court for the Southern District of New York recently addressed whether secured noteholders against a CDO can waive their entitlement to a portion of the collateral securing all notes issued under an indenture, such that they can file an involuntary petition against the CDO as holders of unsecured claims. Noting the novel issues involved, the Bankruptcy Court answered the question in the negative, at least at the motion for summary judgement stage. In re Taberna Preferred Funding IV, LTD., No. 17-11628-mkv (Bankr. S.D.N.Y. November 27, 2017). 


Three petitioning creditors filed an involuntary chapter 11 petition against Taberna Preferred Funding IV, Ltd. (“Taberna”), a structured-finance entity known as a collateralized debt obligation or a “CDO.” Pursuant to an indenture, Taberna issued eleven classes of notes in descending priority, and used the funds generated by the notes to purchase securities issued by third parties. The purchased securities serve as collateral for the notes. The Indenture provided that the collateral was to be held in trust for the benefit of and as security for all of the noteholders. 

The petitioning creditors held 100% of the most senior class of notes (the “A-1 Notes”) and approximately 34% of the second-priority notes (the “A-2 Notes”). As holders of the most senior notes, the petitioning creditors realized that they may not qualify for filing the involuntary petition, since the Bankruptcy Code requires petitioning creditors to hold unsecured claims. In order to avoid the issue, pre-petition each petitioning creditor executed a partial waiver that provided that “to the extent that there is any question that the petitioning creditor is not a qualified creditor pursuant to Bankruptcy Code section 303(b) with respect to the secured or unsecured status of its claims, the petitioning creditor hereby waives its right to benefit from the security interests in any assets of the Debtor solely on account of its ownership interests in the Class A-2 Notes up to, but not to exceed, the amount of US$5,259.00.” Hence the question, in a single lien structure does this work? 


As mentioned, the Indenture provided for one lien, granted to the trustee for the collective benefit of all noteholders. The petitioning creditors argued that, notwithstanding the single lien structure, they can waive their own personal entitlement to a portion of the collateral such that a portion of their claims is unsecured. In support, they cited a number of cases finding that secured creditors may waive a portion of their security interest in order to qualify as unsecured creditors, eligible to file an involuntary petition. 

The Bankruptcy Court found, however, that none of these cases involved a single lien structure granted to the trustee for the benefit of several tranched series of notes: “[None of the cases cited] support the argument that a secured creditor may waive a security interest held by a third party-in trust for the benefit of multiple parties-in order to create an unsecured claim….” 

The petitioning creditors’ alternative argument, referred to by the parties as the “common lien argument”, was that because all of the notes were secured by a single lien on common collateral, the court should compare the aggregate outstanding amount owing on all of the notes (US$530 million) to the value of the collateral (US$444 million) to determine that all noteholders are unsecured. Further, they argued that since they hold US$154 million in notes, they are unsecured to the tune of US$24 million. But the Bankruptcy Court noted that the argument has been previously rejected in the Eastern Airline case, where it was held that “separate classes of certificate holders do not hold individual claims under an indenture that provides for only one lien simply because such holders are entitled to separate priority ….” 

In any event, the court found that the fundamental flaw in the petitioning creditors’ argument is that they failed to demonstrate that they are the holders of the claim and the lien under the Indenture. Looking at the Indenture’s grant clause, the court noted that it strongly suggests that the trustee, and not the petitioning creditors, would be the holder of such claim, for the benefit of all noteholders. 

Accordingly, the court denied the petitioning creditors’ motion for summary judgement. 


Secured creditors are often able to waive a security interest in collateral in order to qualify as petitioning creditors under section 303(b) of the Bankruptcy Code. As the Taberna opinion shows, however, the issue is not that simple when dealing with a single or common lien structure where the lien is held by the trustee for the collective benefit of senior and junior creditors. The case is clearly one of first impression, and the Court’s ruling was made in the summary judgement stage. Nevertheless, it could chart the course for other courts to follow, or distinguish, in the future. 

Read the opinion »

Subscribe to Dechert Updates