Opinion ID: 791129
Heading Depth: 1
Heading Rank: 1

Heading: The X-Clause

Text: 6 Before the bankruptcy, appellants purchased various Metromedia notes (the Notes) governed by an indenture agreement that subordinated the rights of the note holders to those of other creditors (the Senior Indebtedness) as follows: 7 Upon the payment or distribution of the assets of [MFN 1 ] of any kind or character ... to creditors upon any dissolution, winding-up, liquidation or reorganization of [MFN] ... any payment or distribution of assets of [MFN] of any kind or character ... to which the Holders [of the Notes] or the Trustee on behalf of the Holders would be entitled ... shall be paid or delivered ... to the holders of the Senior Indebtedness.... 8 However, a so-called X-Clause exempted from subordination: 9 securities of [MFN] as reorganized or readjusted, or securities of [MFN] or any other Person provided for by a plan of reorganization or readjustment, junior, or the payment of which is otherwise subordinate, at least to the extent provided in this Article 12, with respect to the Notes, to the payment of all Senior Indebtedness. 10 The Notes were outstanding when Metromedia filed for relief under Chapter 11. The Plan provided in relevant (small) part that [i] on account of the Notes, appellants were to be paid a combination of cash, common stock in the Reorganized Debtors, and five- and seven-year warrants to purchase additional common stock at specified prices; but [ii] under the terms of the subordination agreement described above, appellants' entire distribution would be reallocated to the Senior Indebtedness. 11 Appellants concede that the Plan properly reallocated the cash and stock to the Senior Indebtedness; but they argue that the X-Clause allowed them to keep the stock warrants. 12 The stock warrants are covered by the X-Clause if they are junior, or if their payment ... is otherwise subordinate... with respect to the Notes, to the payment of all Senior Indebtedness. But the text is not self-reading; the applicability of the clause in a specific case is not readily apparent; and the parties have submitted no evidence as to the drafters' intentions. Still, such clauses seem to be common in the industry. See In re Envirodyne Indus., 29 F.3d 301, 306 (7th Cir.1994). 13 Helpful guidance is found in the American Bar Foundation's Commentaries on Model Debenture Indenture Provisions (1971) [hereinafter Commentaries ]. 2 In a nutshell, when subordinated and senior note holders are given securities under a plan of reorganization, an X-Clause allows the subordinated note holder to retain its securities only if the securities given to the senior note holder have higher priority to future distributions and dividends (up to the full amount of the senior notes). This provides for full payment of the senior notes before any payment of the subordinated notes is made. In such a case, the senior note holder enjoys unimpaired the priority to payment that it had under its notes, i.e., payments on the subordinated note holder's securities are subordinate ... to the payment of all Senior Indebtedness. See Commentaries, supra, § 14-5, at 570 (X-Clause is triggered where mortgage bonds, preferred stock or similar higher class security are provided to senior note holders and common stock is provided to subordinated note holders because this kind of distribution gives practical effect to the subordination and therefore turnover is not required) 3 ; Ad Hoc Committee for Revision of the 1983 Model Simplified Indenture, Revised Model Simplified Indenture, 55 Bus. Law. 1115, 1221 (2000) (If Senior Debt were to receive preferred stock and the subordinated debt were to receive common stock, for example, where the preferred stock precluded distributions to common stockholders until the preferred stock was redeemed, the X-Clause would permit that distribution.). This approach assures that the junior creditor remains fully subordinated without requiring it to yield assets that are not required for full payment of the senior creditor and that would therefore make a round-trip to the senior creditor and back, with the attendant delay, friction, and transaction cost. 14 The caselaw on X-Clauses is consistent with this approach. The Seventh Circuit considered an X-Clause virtually identical to the X-Clause in this case, and construed it to exempt from subordination securities allocated to junior creditors that are subordinated to the claims of the senior creditors, and which therefore do not erase the priority of the senior class. Envirodyne, 29 F.3d at 303, 306; see also In re PWS Holding Corp., 228 F.3d 224, 244-45 (3d Cir.2000) (X-Clause allows securities to be retained if they are subordinated to the same extent as the existing subordinated debt (quotation omitted)). 15 The question thus presented is whether appellants can keep the stock warrants without impairing the priority assured to the Senior Indebtedness by the subordination agreement. The answer is no. Under the Plan, the Senior Indebtedness received cash, common stock, and warrants identical to those at issue here. It is undisputed that the Senior Indebtedness did not receive full payment for its debt under the Plan. If appellants can keep their warrants, they would be able to buy the same class of common stock allocated to the Senior Indebtedness, giving appellants and the Senior Indebtedness equal priority to any future distribution. Therefore, allowing appellants to retain the warrants would effect an impairment of seniority.