Sid Levinson Speaks on Exclusive Opportunism
Payment of backstop fees, like many of the other non-statutory creatures of restructuring that the Creditor Rights Coalition has explored (third party releases, independent directors, etc.), is a valuable tool for debtors that is also subject to abuse.
On the one hand, obtaining a backstop commitment (whether from an existing creditor or a third-party) to fully subscribe a rights offering better ensures full subscription, and thus provides debtors with a more certain path to confirmation. That backstop commitment has independent value to the debtor, and cannot be obtained without compensating the backstop party for the financial risk associated with making such a commitment. On the other hand, backstop fees have been used to provide majority groups of creditors with outsized consideration at the expense of minority creditors who are not offered the same opportunity, which implicates Section 1123(a)(4)’s prohibition on different treatment of claims in the same plan class.
In situations where an RSA provides for payment of backstop fees to creditors who provide both (1) a backstop commitment and (2) an agreement to vote their existing claim in favor of a chapter 11 plan, it is difficult to determine what portion of the backstop fees are attributable to the value of the backstop commitment itself versus the commitment to support the debtor’s treatment of the existing claim under the plan.
From a legal standpoint, the cleanest solution to the above dilemma would be to require debtors to offer all creditors of a given class the opportunity to participate in the backstop, but imposing that requirement would undoubtedly diminish the appetite of larger creditors to provide any upfront backstop commitment under an RSA, thereby depriving the debtor of an important and valuable restructuring tool. Given that reality, one theoretical legal solution would be to use the market test requirement imposed by 203 N. LaSalle as a guide to isolating the “new value” attributable to the backstop. This would involve requiring a debtor to shop the backstop opportunity to third parties who are not creditors and thus indifferent to treatment of their claim under a plan. But running such a process for backstop fees may not be practicable for a variety of reasons including timing concerns, securities law compliance, and the risk that non-creditors will attribute lower value to the new securities than creditors who have skin in the game.
Alternatively, the Supreme Court could, with appropriate input, prescribe a new bankruptcy rule, similar to FINRA Rule 5100 (which governs underwriting terms and arrangements), establishing guidelines (whether presumptive or fixed) for bankruptcy courts (and parties-in-interest) to determine if particular backstop fees are reasonable or unreasonable. While not a perfect solution to isolate the value of the backstop commitment, such a bankruptcy rule could at least minimize the abuse that can result when no guardrails exist.