Restructuring

This latest installment of our ongoing coverage of the Report of the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 discusses the Commission’s proposals regarding plan content, voting, confirmation issues, and exit orders (Report sections VI.E, F, and G). The recommendations are geared toward creating greater efficiencies in the plan process by reducing what the Commissioners view as opportunities for litigation and gamesmanship, and clarifying the permissibility of certain plan provisions and orders that have divided courts. Some of these recommendations, if adopted, would constitute significant changes to the Bankruptcy Code.
Today’s post highlights key proposals about plan voting, and a follow up post will discuss other key proposals regarding plan content, plan confirmation, and exit orders.
No Accepting Impaired Class for Cramdown
The Commissioners’ proposal to eliminate a key feature of the Bankruptcy Code – the requirement in section 1129(a)(10) of the Bankruptcy Code that at least one impaired creditor class vote in favor of a plan (not including the votes of any insiders) before it can be “crammed down” on classes that voted against the plan – is likely to generate the most controversy, especially among secured lenders. The Commissioners found that the claims voting provisions in the Bankruptcy Code, and, in particular, the cramdown requirement for at least one accepting impaired class of creditors, have resulted in “significant gamesmanship.” As an example, the Commissioners posit a case with a limited number of impaired creditor classes and a lender or other large creditor that purchases a sufficient number of claims in each class to control the plan vote. In such a scenario, the single creditor could vote against the plan in each of the classes and block a cramdown because there would be no accepting impaired class for purposes of section 1129(a)(10). On the flip side, the Commissioners also recognize that debtors may artificially impair or gerrymander a class to meet the requirements of section 1129(a)(10). The Commissioners ultimately determined that “the potential delay, cost, gamesmanship and value destruction attendant to section 1129(a)(10) in all cases significantly outweighs” the potential benefit of having a requirement that some impaired creditors support plan confirmation. As a result, they recommend eliminating section 1129(a)(10) in all chapter 11 cases.
It’s noteworthy that the Commissioners debated – but ultimately rejected – retaining section 1129(a)(10) in single asset real estate cases; the elimination of this requirement would make cramdown easier in SARE cases, where the debtor is usually dealing with one large creditor (a lender that may be undersecured) and may have a more difficult time effectuating a cramdown.
One Creditor, One Vote
In general, if a plan proposes to alter the rights of creditors, then those creditors are entitled to vote to accept or reject a plan (except if the class of creditors is receiving nothing under the plan, in which case they are deemed to reject the plan). Section 1126(c) of the Bankruptcy Code provides that a class of claims has accepted a plan if at least two-thirds in amount and one-half in number of the allowed claims that actually vote, excluding any entity whose votes were not cast in good faith, accept the plan. The latter requirement is commonly referred to as “numerosity.” The Commissioners propose replacing the numerosity requirement with a “one creditor, one vote” concept. This would require acceptance by over one-half of the creditors holding allowed claims (other than an entity whose votes were not cast in good faith), instead of a majority in number of claims. Creditors under common control (e.g., affiliated entities under common investment management, except where the affiliated entities have different decision-makers overseeing the claims being asserted against the estate) would count as one creditor for voting purposes, but a creditor holding claims in separate capacities (e.g., as a trustee and an individual creditor) would still get to vote in each capacity. The Commissioners were persuaded by anecdotal evidence that the numerosity requirement serves, at best, a nominal role in determining class support for a plan. In addition, the “one creditor, one vote” rule, in the eyes of the Commissioners, is less susceptible to abuse and gamesmanship than the current numerosity requirement.
Silence is Deemed Rejection
Section 1129(a)(8) of the Bankruptcy Code requires that each class of claims or interests accept the plan or remain unimpaired under the plan (in which case, the class is deemed to accept the plan). Some debtors propose a plan provision that treats classes of claims or interests where no creditors submit votes on the plan as accepting the plan. Courts disagree about whether this is permissible under the Bankruptcy Code.
The ABI Report recommends an amendment to the Bankruptcy Code to clarify that a chapter 11 plan cannot provide that a class that does not vote on a plan is deemed to accept the plan. As the Commissioners note, however, eliminating the accepting impaired class requirement for cramdown purposes (discussed above) may reduce the need for debtors to include deemed acceptance provisions in plans.
Hybrid Vote Designation Standard
Section 1126(e) of the Bankruptcy Code allows a court to disqualify a vote on a chapter 11 plan if such vote was not cast in good faith. The ABI Report recommends expanding the criteria for determining whether to designate votes. The Commissioners advocate a hybrid standard, whereby a court could designate a party’s vote if there is evidence presented at a hearing that the party (a) voted in a manner manifestly adverse to the economic interests of other creditors in the class or (b) did not act in good faith.
The Commissioners recognize that holding interests potentially in conflict with other creditors in the class or the debtor, and voting in a party’s self-interest, should not automatically disqualify a party’s vote, but argue that there is a point where that party’s self-interested conduct could delay or disrupt the case, or disadvantage the treatment of a particular class. The bad faith standard is a hard burden to meet, and it’s clear that the Commissioners want to make it easier for courts to extend section 1126(e) to provide a remedy in these scenarios.
It’s unclear how heavy a burden it will be to show that a creditor’s vote was “manifestly adverse” to the interests of the general creditors in the class, but it is almost certain to increase litigation over whether or not a vote should be designated under section 1126(e). Those who purchase claims in the secondary market or vote claims in multiple classes may be particularly vulnerable if this recommendation is adopted.
No Enforcement of Prepetition Voting Waivers
Intercreditor agreements or subordination agreements negotiated between secured creditors in respect of shared collateral may include provisions that, for example, assign or waive a junior creditor’s right to vote on a chapter 11 plan; such assignment can also occur outside of the subordination and intercreditor agreement context. Some courts decline to enforce assignments or waivers of voting rights, reasoning that only holders of claims (i.e., the junior creditors) can vote on the debtor’s chapter 11 plan and questioning whether parties can contractually waive rights created under federal bankruptcy law.
The Commissioners determined that contractual assignments or waivers of voting rights in favor of senior creditors should not be enforceable in bankruptcy. The Commissioners expressed discomfort with non-debtor parties being able to change the rights of the debtor and other stakeholders in a chapter 11 case.
Some of the Commissioners had argued that prohibiting voting assignments could give junior creditors greater bargaining power or control over the plan process but, ultimately, the Commissioners determined that preserving the agreed-to payment priority among creditors was the key consideration and would not be impacted by the Commissioners’ proposal.
The Commissioners further determined that the contractual assignment of voting rights in favor of an assignee or purchaser of a claim against the estate should be enforced only to the extent of the portion of the claim and economic interest also transferred to the assignee or purchaser – that is, voting and economic rights (in whole or in part) must be transferred as a package. The Commissioners agree that the holder of an assigned claim should be entitled to exercise any transferred voting rights and may agree to exercise its vote as directed by the beneficial holder.
Up Next
Stay tuned for Part II of this post, which will cover the Commission’s recommendations on exculpation and releases, settlements and compromises in a plan, and exit orders.