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, 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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