Phil Anker Speaks on Exclusive Opportunism

From my perspective, two legal pillars frame the issue.  The first is the statute itself.  The Bankruptcy Code specifies that a Chapter 11 plan “shall†– i.e., must – “provide the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment of such particular claim or interest.† 11 U.S.C. § 1123(a)(4).  The second is the U.S. Supreme Court.  In construing the Code, it has held that the exclusive right to invest in the reorganized debtor, to finance its emergence from bankruptcy granted under a Chapter 11 plan, is a form of property – i.e., that exclusive right can amount to “treatment†under the plan, and if that preferential treatment afforded one party in interest but not another is contrary to the requirements for confirmation, the plan cannot be confirmed.  Bank of America Nat. Trust and Savings Assoc. v. 203 N. Lasalle St. P’ship, 526 U.S. 434 (1999). 

To be sure, the plan in Lasalle offered the debtor’s shareholders, not a subset of creditors in the same class, the exclusive right to invest in the reorganized debtor. And the question in Lasalle was whether the plan violated the “absolute priority rule†under Section 1129(b) after a senior class of impaired creditors voted to reject the plan, not whether the plan violated the “same treatment†requirement for claims in the same class under Section 1123(a)(4).  But there is nothing in the Supreme Court’s analysis in Lasalle that makes me think the case would have come out differently if the issue had arisen in the context of the “same treatment†requirement under Section 1123(a)(4).  Instead, as I read the decision, it holds that offering one party in interest (whether it is a creditor or an interest holder) the exclusive right to purchase equity in the reorganized debtor is a form of “property.† It therefore stands to reason that such an offer (or a similar offer to invest in equity or debt) can be “treatment†under a plan.  Accordingly, in my view, offering some but not all creditors in the fulcrum class the right to invest in the reorganized debtor (or the right to backstop an offering) under a plan can violate the “same treatment†requirement for confirmation.

Some of the arguments to the contrary that have been made by parties in leading cases seem to me to miss the mark.  For example, debtors will sometimes argue that they are offering the subset of creditors additional equity (or debt), not in consideration for the discharge of those creditors’ claims, but rather in exchange for those creditors’ agreement to help fund the debtors’ reorganization by investing in the reorganized debtor.  But the debtor and shareholders made essentially the same argument in Lasalle, and the Supreme Court rejected it.  The question is not whether the new equity (or debt) is in exchange for the creditors’ new money – it is; instead, the question is whether the option offered some but not all creditors in the same class to invest is in consideration of that subset of creditors’ claims (and in exchange for those creditors’ agreement to support the debtor’s plan).

So, too, I don’t see why it should make a difference if the debtor seeks approval for the investment agreement with the subset of creditors in advance of plan confirmation.  If that agreement is offered only to that select group of creditors, not to all creditors in the class, and it is offered to the favored creditors in order to obtain their support for the plan, it seems to me just as problematic whether, as a matter of timing and process, the offer is made in advance of or contemporaneous with plan confirmation.  Whether by invoking the sub rosa plan doctrine or by applying a different legal rubric, bankruptcy courts do not typically allow debtors prior to plan confirmation to make any distribution in respect of an impaired claim, let alone to offer one set of creditors preferential treatment over another, similarly situated group.

All this said, I also don’t think that every plan in which some, but not, all creditors in the same class get to invest in equity or debt issued by the reorganized debtor at emergence is unconfirmable.  For one thing, if the debtor offers the same opportunity to all creditors in the class and some elect to accept it whereas others do not, the disparate elections should not matter.  The “treatment†– the opportunity to invest – is the same, and the plan should pass muster under both Section 1123(a)(4) and Lasalle.  Indeed, Lasalle strongly suggests that if the debtor goes to market and simply accepts the highest bid for the equity it will issue upon its emergence from bankruptcy, the plan will be confirmable even if the highest bidder happens to be the existing equity holders (or a subset of creditors in the fulcrum class).  In this regard, a debtor could in effect conduct an auction open to all creditors in the class (as well, potentially, as third parties) and take the highest and best offer; in such a situation, no subset of creditors is receiving the “exclusive†right to invest or different “treatment†on their claims.

Even if the debtor does not offer all creditors in the class the right to invest and does not otherwise “market test†the opportunity, the debtor might have legitimate reasons for so proceeding, such that providing that opportunity to a subset of creditors in the class should not be viewed as offering them superior “treatment†on their claims as compared to the treatment afforded the other members of the class.  For example, the debtor might anticipate needing to lock-up a commitment to fund the plan for a long period, during which market conditions could change.  In such a situation, the debtor might have legitimate concerns that one group of creditors would present less “execution risk†as the “plan sponsor†than a different group might.  So, too, a debtor might have a legitimate concern that one group of creditors might be a better “business partner†than another group following plan confirmation.  For instance, if the plan funding is going to be in the form of debt, not equity, the debtor might conclude that one group is more likely to work “constructively†with the reorganized debtor if it trips a covenant in the future.

If the reason for the disparate opportunity to provide exit financing afforded different groups of creditors is not to “buy†their support for the plan by affording the favored group an attractive investment not afforded the rest of the class, a court might be able to conclude that the disparate opportunity does not amount to different “treatment†on the creditors’ claims.  But even if this is right as a matter of law, the debtor (or other plan proponent) bears the burden to prove that it has satisfied the requirements for plan confirmation, so it would need to show as a factual matter that a legitimate reason exists for why it is affording some, but not all, members of the class the opportunity to invest.  And, in my view, a bankruptcy court should have a healthy degree of skepticism about such a claim where the group that is offered the exclusive investment opportunity “just so happens†to have the votes to deliver the class and the group that is excluded does not.

One final point: Both on the law and the facts, I don’t think a debtor can justify affording some creditors in the affected class an exclusive investment opportunity by saying that, unfortunately, this is the price the debtor has to pay to obtain those creditors’ support so that the debtor can emerge from bankruptcy.  On the law, the Bankruptcy Code specifies that a plan can be confirmed “only if†it “complies with the applicable provisions†of the Code, one of which is that the plan “shall†provide the same treatment to all creditors in the same class (unless the subset receiving worse treatment so agrees).  11 U.S.C. §§ 1129(a)(1); 1123(a)(4).  Congress could have provided otherwise, but it did not.  On the facts, if a debtor is worth more reorganized than liquidated, then all creditors in the fulcrum class should support the debtor’s reorganization even if none can obtain a “premium†over others in the class.  To provide a simple example, assume that, if all creditors in the class are afforded the same treatment, they will receive 50 cents on the dollar if the debtor is reorganized, but only 40 cents on the dollar if instead the debtor is liquidated.  Yes, a subset of large and powerful creditors in the class might prefer to negotiate a sweetheart deal for themselves where they get 55 or 60 cents on the dollar under the debtor’s plan of reorganization, while other, less powerful creditors in the same class get less.  But if that option is not on the table, because the bankruptcy court holds that it runs afoul of the Code, the powerful creditors should still support the debtor’s reorganization since it will provide them a higher recovery than the debtor’s liquidation will – 50 cents on the dollar is better than 40.  There is every reason to think, therefore, that application of the “same treatment†requirement of Section 1123(a)(4) will, in most (if not all) cases, not stand in the way of the debtor’s reorganization and, indeed, may make such a reorganization simpler, quicker and less expensive by eliminating or at least reducing litigation over whether disparate treatment is, or is not, permissible.