IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE ) ) ) ) ) ) ) ) )

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1 IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE In re: WASHINGTON MUTUAL, INC., et al., Debtors. ) ) ) ) ) ) ) ) ) Chapter 11 Case No (MFW) Jointly Administered Re: Docket No LIMITED OBJECTION OF NORMANDY HILL CAPITAL L.P. TO CONFIRMATION OF THE MODIFIED SIXTH AMENDED JOINT PLAN OF AFFILIATED DEBTORS PURSUANT TO CHAPTER 11 OF THE UNITED STATES BANKRUPTCY CODE Normandy Hill Capital L.P., ( Normandy Hill ) by and through its undersigned attorneys, Womble Carlyle Sandridge & Rice, PLLC and Halperin Battaglia Raicht, LLP, respectfully submits this Limited Objection (the Limited Objection ) to confirmation of the above-captioned Debtors 1 Modified Sixth Amended Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code (the Plan ). In support of its Limited Objection, Normandy Hill respectfully represents as follows: PRELIMINARY STATEMENT 1. Normandy Hill holds PIERS Claims. One issue for the Court to consider and determine in connection with confirmation of the Plan is whether the Debtors should be obligated to pay certain senior creditors interest at the Contract 1 Capitalized terms used but not defined herein have the meaning ascribed to them in the Plan. { \ }

2 Rate or the Federal Rate. In the Court s January 7, 2011 opinion denying confirmation of the Debtors Sixth Amended Joint Plan of Affiliated Debtors (the Confirmation Opinion ), the Court acknowledged the issue regarding interest rates, but declined at that juncture to rule on whether the equities of these cases mandated application of the lower Federal Rate of interest. 2. The Court s determination of the appropriate rate of interest in this case will raise genuine issues of interpretation of the subordination provisions in the Junior Subordinated Notes Indenture (the Indenture ). In short, if the Court determines that the Debtors obligation to pay interest during the pendency of these chapter 11 cases is limited to the Federal Rate, Normandy Hill posits that the correct interpretation of the Indenture is that the subordination of the recoveries of the holders of PIERS Claims to the holders of senior debt should likewise be limited to the Federal Rate. The Subordination Model annexed to the Plan and Disclosure Statement is inconsistent with the foregoing conclusion. 3. Rather, as discussed in detail herein, the Subordination Model proposed by the Debtors incorrectly allows senior creditors to recover Contract Rate interest, even should the Court award the Federal Rate. In addition to overcompensating senior creditors if the Court finds that the Federal Rate applies, this interpretation is inequitable because it allows for the very real possibility that equity would receive a distribution while recoveries to holders of PIERS Claims are unfairly and substantially reduced, even as to their pre-petition allowed claims. Indeed, as explained below, taken to the extreme this formula could result in equity { / } 2

3 recovering where the PIERS receive nothing. Such absurdity highlights the necessity of enforcing the Federal Rate in all circumstances. 4. Thus, consistent with the Plan, and in order to avoid any confusion after confirmation of the Plan, Normandy Hill respectfully requests that if the Court applies the Federal Rate, that the court also specify in its confirmation order that the Federal Rate applies for all purposes with respect to all allowed claims. LIMITED OBJECTION 5. The Plan provides, among other things, that: See 20.1 of the Plan at page 46. any distribution to holders of Allowed PIERS Claims of (a) Creditor Cash, (b) Cash received on account of Liquidating Trust Interests, and (c) Reorganized, Common Stock, shall be redistributed, subject to Bankruptcy Rule 3021 and subject to the lien or priority rights of the PIERS Trustee, in accordance with the Subordination Model attached to the Plan (except to the extent that the Subordination Model conflicts with the subordination and subrogation provisions in the applicable indentures, in which case the indentures shall control). 6. In addition, section of the Plan provides that: any disagreement with the priorities or distributions set forth herein or in the Subordination Model shall be raised prior to, and decided at, the Confirmation Hearing, and all issues with respect to contractual subordination and subrogation not resolved at the Confirmation Hearing shall be governed pursuant to the Subordination Model or, if the decision of the Bankruptcy Court at the Confirmation Hearing differs from the Subordination Model, then all issues with respect to contractual subordination and subrogation shall be governed pursuant to such decision. { / } 3

4 See of the Plan at page The Indenture, by its terms, subordinates the PIERS Claims to Senior Debt (as defined in the Indenture) and to interest (notably undefined) on such Senior Debt. Accordingly, if the Court determines that interest on the Senior Debt accrues at the Federal Rate and not the Contract Rate, Normandy Hill respectfully requests a holding from this Court confirming that the senior creditors cannot collect the difference between the Federal Rate and Contract Rate of interest under the subordination provision of the Indenture. LEGAL ANALYSIS 8. It is a general tenet of bankruptcy law that interest on allowed claims does not accrue during the pendency of a bankruptcy case. In most bankruptcy cases, post-petition interest is disallowed if for no other reason than the practicalities of making distributions to creditors. Computations on interest-bearing claims must be made as of a fixed date and bankruptcy law selects the petition date as the correct point in time. As distributions in most cases are a fraction of the underlying debt, post-petition accruals of interest are academic. Section 502(b) of the Bankruptcy Code makes it express that the allowed amount of an unsecured claim does not include post-petition interest. 11 U.S.C. 502(b); see also, United Sav. Ass n v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 372 (1988) (unsecured creditors are not entitled to post-petition interest). { / } 4

5 9. It is equally uncontested, however, that in solvent debtor cases, creditors are entitled to post-petition interest and that interest accrues on the creditor s allowed claim. See In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 206 (3d Cir. 2003). Thus, the Third Circuit recognizes that post-petition interest is separate and apart from a creditor s allowed claim under section 502 of the Bankruptcy Code. The separate nature of allowance of post-petition interest supports the Court s flexibility in determining what rate of interest is equitable given the facts and circumstances of these cases. The Rule of Explicitness 10. Given the tension between a creditor s contractual right to interest and the fact that post-petition interest in generally disallowed in bankruptcy, substantial case law developed regarding interpretation of subordination provisions in indentures that purport to subordinate the recovery to junior creditors of their base claims to the post-petition interest of senior creditors. When reading an indenture to subordinate junior creditors to the recovery of post-petition interest by the senior lenders, the Third Circuit requires that the indenture explicitly provide for such an outcome. Absent explicitness in the indenture, consent of the junior creditors to such extreme subordination should not be inferred. This principle is commonly known as the Rule of Explicitness. See In the Matter of Time Sales Finance Corp., 491 F.2d 841 (3d Cir. 1974); In re Ionosphere Clubs Inc., et al., 134 B.R. 528 (Bankr. S.D.N.Y. 1991) (court declined to enforce subordination agreement that would pay postpetition interest to senior creditor due to lack of specificity in indenture, despite { / } 5

6 requirement of 510(a) to otherwise enforce such agreements in bankruptcy). When applied to the facts at hand, the Indenture fails to specify that junior creditors are subordinated to senior creditors until the senior creditors receive the full Contract Rate of interest on their allowed claims. Accordingly, the Rule of Explicitness mandates that such subordination not be inferred, as only express subordination of specific post-petition interest is contractually enforceable. part, as follows: 11. Article Eighteen (18) of the Indenture provides, in pertinent The Company covenants and agrees that anything in this Indenture or the Debt Securities of any series to the contract notwithstanding, the indebtedness evidenced by the Debt Securities of each series and any coupons appurtenant thereto is subordinate and junior in right of payment to all Senior Debt to the extent provided herein.in the event that the Company shall default in the payment of any principal of (or premium, if any) or interest on any Senior Debt when the same become due and payable then no direct or indirect payment shall be made or agreed to be made on account of the principal of (or premium, if any) or interest on any of the Debt Securities.In the event of bankruptcy all Senior Debt (including any interest thereon accruing after the commencement of any such proceedings) shall first be paid in full before any payment or distribution shall be made to any Holder of any of the Debt Securities. Indenture at p.75 (hereinafter the Subordination Provision ) (emphasis added). Further, the term Senior Debt is defined, in pertinent part, as follows: Senior Debt means any obligation of the Company to its creditors whether not outstanding or subsequently { / } 6

7 incurred other than other than (i) any obligation as to which, in the instrument creating or evidencing the same or pursuant to which the same is outstanding, it is provided that such obligation is not Senior Debt, (II) obligations evidenced by the Debt Securities, and (III) obligations that are expressly stated in the terms of the Debt Securities (or in this Indenture ) not to be Senior Debt. Indenture at p. 7. Though the Indenture contemplates various definitions regarding interest and the timing of payment thereof, the Subordination Provision is clear on its face that the Debt Securities such as the PIERS Claims are subordinated to the Senior Debt and interest not Contract Interest. Thus, if this Court determines the Federal Rate of interest is the equitable accrual of interest on post-petition claims, then that is the rate to which the junior creditors agreed to be subordinate. If there had been an intent to subordinate recoveries of junior creditors until senior creditors recovered post-petition interest at the Contract Rate, as opposed to the actual rate of interest held to accrue post-petition on senior claims, the drafters of the Indenture could have easily defined interest as being at the Contract Rate in the Subordination Provision. Given the lack of explicit subordination in the Indenture to the higher Contract Rate of interest, the Rule of Explicitness governs and such an extreme subordination should not be inferred. 12. The Rule of Explicitness is supported by the equities of the cases in this matter. In circumstances where the Court finds that there are equitable considerations mandating application of the lower Federal Rate of interest instead of { / } 7

8 the Contract Rate, there would also be equitable reasons to favor a like interpretation of the Indenture. 13. Independent of the Rule of Explicitness, it should be noted that a plain reading of the Indenture does not provide that holders of PIERS Claims must subordinate recoveries to senior creditors until such time as the senior creditors have recovered interest at the Contract Rate the Indenture subordinates recoveries to holders of PIERS Claims until senior creditors have recovered the Senior Debt and interest. Thus, under general contract law, if the Court determines that the appropriate rate of post-petition interest is the Federal Rate, the Contract Rate on the Senior Debt did not accrue and, therefore, may not be recovered, whether from the Debtors estates or from junior creditors through subordination. 14. Whether due to application of the Rule of Explicitness or due to basic interpretation of the Indenture under contract law, to allow senior creditors to recover Contract Rate interest via subordination if the Court holds that the Federal Rate is applicable would yield an unintended and inequitable result. In such circumstances, senior creditors would be grossly overcompensated at the expense of junior creditors such as Normandy Hill (i.e. holders of PIERS Claims), as is revealed by the Debtors disclosures themselves, addressed below. THE LIQUIDATION ANALYSIS AND THE SUBORDINATION MODEL 15. The Debtors Revised Supplemental Disclosure Statement for the Plan (the Disclosure Statement ) provides a liquidation analysis (see Disclosure { / } 8

9 Statement, Exhibit D, pp. 4-5, hereinafter the Liquidation Analysis, annexed hereto for the Court s ease of reference) that allegedly describes the flow of funds should the Court determine that the Contract Rate of interest applies (page 4), versus the Federal Rate of interest (page 5). This is also referred to in the Plan as the Subordination Model. However, the Subordination Model is inconsistent with the subordination provisions of the Indenture when describing the flow of funds in the event the Federal Rate of interest applies (page 5). The Plan is clear that the Indenture should control distributions in these cases, not the Subordination Model (see 20.1 of the Plan). 16. If the Contract Rate of Post-Petition interest applies, the Subordination Model reveals that Senior Notes and Senior Subordinated Notes would earn $426,000,000 and $320,000,000 in post-petition interest, respectively (page 4). In comparing the post-petition interest should the Federal Rate apply, the Subordination Model shows that Senior Notes and Senior Subordinated Notes should earn $229,000,000 and $96,000,000 in post-petition interest. However, at the bottom of page 5 the model that purports to apply the Federal Rate of interest along with contractual subordination, the Debtor s Liquidation Analysis improperly reverts to recoveries of Contract Rate interest on Senior Notes and Senior Subordinate Notes (i.e. accruals of $426,000,000 and $320,000,000 in post-petition interest, respectively). This model is inconsistent with both the Indenture and with the Court s (hypothetical) determination that the Federal Rate of interest should apply. { / } 9

10 17. As discussed above, it was never contemplated by the parties to the Indenture that junior claimants such as holders of PIERS Claims would be forced to make senior claimants whole as to any amounts above and beyond the Senior Debt with interest whatever that rate of interest may be found just and proper in this Court. Stated differently, the parties intended, and the Indenture is clear on its face, that the PIERS Claims are subordinated to the senior creditors, but only as to and through whatever rate of interest is found to apply to the Senior Debt. In the event this Court were to determine that the Federal Rate applies, then the scenario incorrectly contemplated in the Liquidation Analysis at the bottom of page 5, would yield an unintended result whereby innocent parties such as Normandy Hill (i.e. holders of PIERS Claims) would directly foot the bill for the Court s determination that the Federal Rate of interest is appropriate in these circumstances As further evidence that the Subordination Model allegedly applying the Federal Rate is fundamentally flawed, Normandy Hill asks the Court to consider recoveries to the various creditor constituencies should the value of the estates exceed the value hypothesized in the Liquidation Analysis. There are real and foreseeable circumstances in these cases whereby the value of the estates exceeds the value ascribed in the Liquidation Analysis. In such circumstances, 2 If the facts and equities are such that the Court finds that the Contract Rate of interest applies to accruals of post-petition interest on allowed claims, Normandy Hill does not dispute that the Indenture provides that recoveries to it are subordinated to the senior creditors both as to the Senior Debt and post-petition interest. That scenario is reflected on the lower half of page 4 of the Liquidation Analysis. In such circumstances, holders of Senior Notes and Senior Subordinated Notes have allowed claims of $4,559,000,000 and $1,986,000,000 respectively, and receive a 100% recovery on allowed claims. Holders of PIERS Claims have allowed claims of $987,000,000 and recover 34% of their allowed claims. { / } 10

11 holders of PIERS Claims would not be effectively compensated in full (indeed, they would not even recover full principal on their claims), yet equity would receive a preferred distribution, which could even exceed in total the value received by the PIERS Claims. Further, under this model, if the cases had run longer and the gross difference between interest sums due had been greater, the PIERS Claims would be deemed satisfied in full, but they would effectively receive less recovery that equity due to being forced to compensate senior creditors for post-petition Contract Rate interest even if the Debtors liquidation values were perfectly on target. Indeed, taken to the extreme, one could construct a scenario under this model whereby the PIERS would receive nothing, yet preferred equity would receive a distribution. This absurdity is further evidence that the Subordination Model in applying the Federal Rate of interest is flawed by, in fact, allowing senior creditors to recover interest at the Contract Rate. Contract Rate Versus Federal Rate of Interest 19. As the Court is aware, there is flexibility in determining what interest rate should accrue on allowed claims post-petition, given the equities of these cases. It is noteworthy that nowhere in the Indenture is the Contract Rate required, as opposed to the Federal Rate of interest. In considering application of the Federal Rate of interest, it is notable that courts in other cases have lowered applicable interest rates on various equitable grounds. In In re W.R. Grace, Bankr. D. Del. Case No (JKF), recommending confirmation of the debtors First Amended Joint Plan of Reorganization as Modified Through December 23, 2010 { / } 11

12 (Docket No , Exhibit A), Judge Fitzgerald declined to apply the contractual default rate of interest on several classes of bank debt in favor of the lower nondefault rate, despite the fact that the debtors were not current in payment, as well as the fact that equity retained an interest in the reorganized business post-confirmation. Further, in overruling the objections of at least one class of claims regarding entitlement to a specific application of interest, Judge Fitzgerald held, all class 7A Claimants will be paid 100 percent of the allowed amount of their claims and if the court determines that interest is appropriate, the PD Trust will pay it. Memorandum Opinion on Confirmation dated January 31, 2011, Docket No (emphasis added). See also, In re Sylmar Plaza, L.P., 314 F.3d 1070 (9th Cir. 2002) (a plan can be specifically crafted to deny a secured creditor contractual default rate of interest); In re Urban Communicators PCS Limited Partnership, et al., Bankr. S.D.N.Y., Case No (REG) (court lowered secured creditor s contractual interest rate, that otherwise provided for both a default rate and compound interest on installment payments, weighing, among other things, the equities of making distributions to other classes of claims). 3 Equitable Subordination 3 Though Normandy Hill does not believe it is necessary for the Court to decline to enforce the Subordination Provision in order to apply the Federal Rate of interest, it is noteworthy that courts in other cases have declined to enforce contractual subordination agreements in a variety of circumstances. See HSBC Bank USA, Nat l A ssn v. Bank of New England Corporation, et al., 364 F. 3d 355 (1st Cir. 2004) (court declined to enforce subordination agreement otherwise entitling senior creditor to post-petition interest because to do so would deprive subordinated creditors their equitable distribution of the bankruptcy estate); In re Kingsboro Mortgage Corp., 514 F. 2d 400 (2d Cir. 1975) (denying postpetition interest to senior creditors in favor of recoveries to junior creditors due to lack of specificity in indenture); In the Matter of King Resources Co., 528 F.2d 789 (10th Cir. 1976) (affirming disallowance of postpetition interest to senior creditors). { / } 12

13 20. Normandy Hill recognizes that there is substantial case law supporting the general enforceability of subordination agreements, and Normandy Hill does not ask the court to decline to enforce the Subordination Provision. However, Normandy Hill does ask this Court to enforce them in accordance with applicable law, and recognize that the senior creditors may not imply subordination of junior creditors in order to receive post-petition Contract Rate interest should the Court find that the Federal Rate is appropriate. 21. If the Court were to apply the Federal Rate of interest but find (contrary to the arguments made herein) that the Subordination Provision did, by its terms, entitle senior creditors to collect the balance of interest up to the Contract Rate from junior creditors through subordination, Normandy Hill respectfully requests that the Court to apply section 510(c) of the Bankruptcy Code to equitably subordinate the interest to senior creditors in excess of the Federal Rate. To do otherwise would render the relief granted by applying the Federal Rate to allowed claims meaningless as such parties would be shifting the burden of their own conduct (the very conduct that mandated application of a lower interest rate) onto other innocent creditors. 22. Section 510(c) of the Bankruptcy Code provides the Court with one avenue to subordinate all or part of the interest due to senior creditors, if appropriate. Section 501(c) provides, in relevant part: Notwithstanding subsections (a) and (b) of this section, after notice and a hearing, the court may (1) under principles of equitable { / } 13

14 subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest; or (2) order that any lien securing such a subordinated claim be transferred to the estate. 11 U.S.C. 510(c). 23. It is statutorily clear that though the Bankruptcy Code generally supports enforcement of subordination agreements that are otherwise enforceable under applicable nonbankruptcy law, the Bankruptcy Code also empowers the Court to equitably subordinate the recoveries of parties who are found to have acted inequitably to those of other creditors. Of course, this subordination is only necessary to the extent the Court determines that the term interest as used in the Subordination Provision somehow entitles senior creditors to a higher rate of interest than whatever rate the Court determines is just and proper given the equities of these cases. It remains Normandy Hill s position that it only agreed to be subordinated to Senior Debt plus interest as is deemed to have accrued by the Court of appropriate jurisdiction. CONCLUSION 24. Section of the Plan requires a determination at confirmation as to how the Subordination Model applies if there is a conflict between the model and the Indenture. Normandy Hill respectfully requests that the Court consider its position that allowing a technical application of the Federal Rate of interest on allowed claims, while enabling senior creditors to effectively recover { / } 14

15 interest up to the Contract Rate through an inconsistent application of the subordination provisions on the Indenture, would be improper, unintended, and unjust. If the Federal Rate of interest is found to apply, Senior Notes and Senior Subordinated Notes should not then recover the exact amount they would should the Contract Rate have applied, at the expense of innocent junior creditors. To allow such a result would render meaningless the determination that the lower Federal Rate of interest should apply (whether based upon inequitable conduct of senior creditors, or mere equities of the cases). WHEREFORE, Normandy Hill respectfully requests that, to the extent the equities of the cases mandate application of the lower Federal Rate of interest, the Court specify in its Order confirming the Plan, and direct the Debtors and holders of senior claims accordingly, that the Subordination Provision in the Indenture limits interest recoveries on all claims to accruals at such Federal Rate; and (B) grant such other and further relief as is just and proper. [Signature page follows.] { / } 15

16 Dated: May 13, 2011 Wilmington, DE WOMBLE CARLYLE SANDRIDGE & RICE, PLLC /s/ Thomas M. Horan Steven K. Kortanek (DE Bar No. 3106) Thomas M. Horan (DE Bar No. 4641) 222 Delaware Avenue, Suite 1501 Wilmington, DE Telephone: (302) Facsimile: (302) and- HALPERIN BATTAGLIA RAICHT LLP Alan D. Halperin Julie D. Dyas 555 Madison Avenue, 9 th Floor New York, New York (212) Counsel for Normandy Hill Capital L.P. { / } 16 WCSR v2

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44 To view the full exhibits, click here.