Restructuring

Contributed by Sara Coelho
Every reorganization plan is premised on the valuation of claims and assets, and support of any plan by the debtor, creditors and new investors depends upon each of these parties accepting the accuracy and fairness of these values.  A recent decision in the SCOPAC case by the Court of Appeals for the Fifth Circuit stands as a stark reminder, however, that substantial administrative expenses may be allowed post-confirmation, and even post-emergence, leaving a reorganized debtor with liabilities not contemplated in the plan.

In SCOPAC, after the debtors’ exclusivity period expired, certain creditors proposed a plan that would satisfy the first lien claims held by a bank and would pay noteholders holding a junior lien on the same collateral cash equal to the value of the collateral securing their claims.  At confirmation, the noteholders challenged the plan proponents’ valuation of the collateral, which was primarily timberland owned by one of the debtors and to which the debtors ascribed a value substantially lower than the amount of the noteholders’ claims.  The noteholders had also previously filed a motion seeking allowance of a superpriority administrative expense pursuant to section 507(b) of the Bankruptcy Code equal to the amount of the diminution in the value of their timberland collateral used by the debtors during the chapter 11 cases.
As part of its findings of fact and conclusions of law on the plan, the bankruptcy court determined the value of the timberland at the time of confirmation and, as a result, set the value that the noteholders were entitled to receive under the Plan.  It delayed entering a confirmation order, however, to consider the noteholders’ section 507(b) claim and heard evidence on that motion.  The court determined that there had been no diminution in the value of the timberland since the petition date, but found that the noteholders were entitled to receive an additional approximately $3.6 million to account for certain non-timber collateral securing their claims.  The plan proponents revised the plan to provide for recoveries to noteholders consistent with the values determined by the court, and the court confirmed the plan and denied the section 507(b) motion.
The noteholders filed separate notices of appeal challenging the confirmation order and the order denying their 507(b) claim.  The district court initially dismissed the appeal of the 507(b) order, holding that the Fifth Circuit’s consideration of the confirmation order on a direct appeal divested it of jurisdiction over an appeal from the 507(b) order.  The Fifth Circuit ruled on the confirmation order in September of 2009, largely upholding it, and this month issued a decision on the appeal of the 507(b) order.
In deciding whether an appeal of the 507(b) order could have been heard separately from an appeal of the confirmation order, the Fifth Circuit considered whether separate consideration of the 507(b) issue would “interfere with or allow the circumvention of” the confirmation order appeal.  It found that separate appeals were permissible because appeal of the 507(b) order did not challenge the plan or its valuation of the noteholders’ claim, but rather challenged the bankruptcy court’s ruling on the diminution in value of the noteholders’ secured claim and the noteholders’ entitlement to certain sale proceeds of collateral, which it found rested on “independent factual inquiries, unrelated to confirmation.”  It stated that the court and parties treated the 507(b) issues separate from confirmation, with separate hearings and briefs on the 507(b) issues and a separate order.  It also found that the appeal of the 507(b) order raised issues and sought relief that could not be raised or sought on appeal of the confirmation order and that the appeal of the 507(b) order could not have interfered with or circumvented the appeal of the confirmation order.  Although it did not view the consideration of the 507(b) claim to be a confirmation issue, the Fifth Circuit did state that all parties were on notice of the requirement to pay administrative expenses under the plan and, therefore, were on notice of the potential financial effect of the noteholders’ claim on confirmation.  As a result of this analysis, the Fifth Circuit found that the district court had jurisdiction to consider the appeal of the 507(b) order.
The Fifth Circuit went on to uphold the bankruptcy court’s valuation of the noteholders’ collateral, finding that the noteholders failed to demonstrate clear error and that the evidence on which the bankruptcy court made its determination was similar to the evidence underlying the confirmation order appeal.  It also held, however, that the bankruptcy court erred in failing to include $29.7 million in proceeds from timber sales as part of the noteholders’ collateral.  As a result, it found that the noteholders held a $29.7 million administrative expense that was payable by the reorganized debtor.
To be sure, reorganization plans often leave administrative expenses and other claims unquantified at the time of confirmation, with resolution coming only after months or sometimes years of claims litigation.  Typically, the size of claims remains within the parameters anticipated by drafters of the plan and investors in the reorganized debtor.  One of the lessons of SCOPAC is that where plan proponents are aware of large, disputed claims, or any dispute that could result in a significant liability surviving the reorganization case, they should consider building resolution of the claims or dispute into the plan and confirmation order.  While a bankruptcy court’s determination in the confirmation order may be overturned on appeal, incorporating such determinations into the plan and confirmation order serves finality by minimizing the possibility that appeals on issues bearing on the economic constructs underlying a plan will proceed separately from appeals of the confirmation order.