Newsflash: Subordination Agreement Prevents Rule 2004 Examination

April 17, 2019

Bankruptcy Rule 2004 allows the examination of any entity with respect to various topics, including conduct and financial condition of the debtor and any matter that may affect the administration of the estate. Does a subordination agreement that is silent on the use of Rule 2004 prevent the subordinated creditor from taking a Rule 2004 examination of the senior creditor? Yes, says an Illinois bankruptcy court.

The subordination agreement in question provided that the subordinated creditor was prohibited, prior to the payment in full of the senior creditor, from foreclosing upon, taking possession of or otherwise attempting to realize on the collateral, or from proceeding in any way to enforce any claim it had against the obligor. The court viewed this provision as a “silent second” provision aimed at preventing obstructionist behavior and going well beyond simply establishing lien priorities.

The bankruptcy court viewed the attempt to take discovery of the senior lender under Rule 2004 as “a calculated, if intermediate act, to enforce claims that [the seconds] have against [the debtor].” Viewed in this light, the bankruptcy court held that the subordination agreement prevented the subordinated lender from using the bankruptcy process to obtain discovery from the senior lender with respect to the senior lender’s claim against the debtor.

This decision should cause lenders to pause and consider some likely unintended consequences of their subordination agreements: should they specifically address the ability to utilize Rule 2004 as against each other? As against the borrower? How does this case impact the standard provision allowing a subordinated secured creditor to take all actions available to a general, unsecured creditor? Food for thought.

Read the opinion >> 

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