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September 20‚ 2011
Holders of “Dirt Bonds” May Lack Plan Voting
Rights in Developer Bankruptcies
By William W. Kannel and Ian A. Hammel
In a decision that may have implications for holders of
community development district bonds and other similar “dirt bonds,” a
Florida bankruptcy court has ruled that holders of community development
district bonds do not always have plan voting rights when the underlying
developer — as opposed to the development district itself — is the
bankruptcy debtor. The decision, In re Fiddler’s Creek, LLC,1 determined that holders of bonds
issued by two community development districts to finance roadway and other
infrastructure at a Florida residential development lacked standing to vote
for or against the plans of reorganization proposed in the bankruptcies of
the project developer and its affiliates. The bankruptcy court came to this
conclusion over the bond trustee’s objections and even though the
bankruptcy plans sought to modify the debtors’ obligations to pay the
special assessments that were the primary means for the payment of debt
service on the associated bonds.
Fiddler’s Creek is a residential development project on
Florida’s gulf coast with more than 1,700 existing homes and plans for up
to 6,000 residences over 4,000 acres, including golfing, spa, tennis, and
related amenities. To finance infrastructure associated with the project, the
developers formed two community development districts (“CDDs”) that
collectively issued more than $100 million of bonds. Each CDD is governed
by a board of trustees, initially appointed by the developer, and later, by
landowners within the CDD. Payment on the bonds is secured by special
assessments levied on the real property situated within the CDDs but not by
the real property itself or any assets of the developers. The landowners
within the CDDs (including the developer) have no direct obligations to the
bond trustee or bondholders.
The developer and a number of its affiliates sought
bankruptcy protection in February 2010, and in due course filed plans of
reorganization and a joint disclosure statement that proposed to
restructure the developer/debtors’ obligations to pay the assessments
needed to timely service the CDD bonds. The plan specifically proposed to
capitalize unpaid interest on the assessments and to defer certain payments
on the special assessments. Under the debtors’ projections, these changes
would provide for payment of the assessments in full and with interest,
though perhaps not in the amounts necessary to ensure timely payment of
debt service on the bonds. Despite the direct impact of these plans on
bondholders’ interests, the debtors argued that bondholders did not have
direct claims or liens in the bankruptcy proceedings and therefore could
not vote. The debtors instead asserted that their obligations ran to the
CDDs, and that the two CDDs were the appropriate parties to vote on the plans.
Under this framework, bondholders and the bond trustee would need to rely
on their rights with respect to the CDDs as set forth in the trust
indentures and related bond documents. The CDDs, which according to the bond
trustee remained heavily influenced by the developers, voted to accept the
plans. By its ruling in the Fiddler’s Creek case, the bankruptcy
court adopted the developer/debtors’ position that the bond trustee was “a
creditor of a creditor” and therefore the bondholders could not vote on the
plan.
The bond trustee has appealed the decision in Fiddler’s
Creek to the United States District Court for the Middle District of
Florida. Pending disposition of that appeal, it remains to be seen whether
parties with similarly structured bond obligations will attempt to use this
decision to exclude bondholders from voting on bankruptcy plans that
effectively restructure bond obligations. The decision reinforces the
importance of understanding the legal structures associated with municipal
bond transactions and understanding the extent to which bond trustees have
been assigned sufficient rights to establish privity with the conduit
obligor.
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If you have any questions about
rights holders of municipal bond debt may have in a bankruptcy case or the
potential impact of the Fiddler’s Creek decision on a particular
municipal bond, please let us know.
Click here to view Mintz Levin’s Bankruptcy,
Restructuring & Commercial Law attorneys.
1 See
Memorandum Opinion and Order Confirming the Debtors’ Second Amended Plans of
Reorganization, as Modified, Case No., 8:10-bk-03846, August 29, 2011
(available at www.flmb.uscourts.gov).
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