Restructuring

Contributed by Conray C. Tseng
As we noted in our previous post, the United States Court of Appeals for the Second Circuit issued a one-page decision in December stating that the bankruptcy court had erred in confirming the chapter 11 plan of DBSD North America, with a full written opinion to follow.  Yesterday, the Second Circuit issued the much-anticipated written opinion, In re DBSD N.A., Inc., __ F.3d __ (2d Cir. 2011).  We plan to post more blog entries on the interesting and important decision in the days to come, but today we provide a quick summary.
Two creditors appealed confirmation of DBSD’s plan:  Sprint, a litigation creditor holding an unliquidated and disputed general unsecured claim, and DISH, a competitor of DSBD that had acquired significant portions of DBSD’s first and second lien debt in an attempt to control the company.
The Second Circuit’s opinion is most noteworthy for its impact on three key issues arising in bankruptcy cases:  (i) whether a senior creditor may “gift” recoveries to junior creditors/interest holders over the dissent of an intermediate class, (ii) whether an “out-of-the-money” creditor with an unliquidated and disputed claim has standing to appeal confirmation of a plan, and (iii) on what basis may a court “designate” (i.e., disregard) a plan vote as not being in “good faith.”
First, can a chapter 11 plan “gift” a recovery from a senior creditor to junior creditors/interest holders over a dissenting intermediate class despite the absolute priority rule?  The Second Circuit answered a resounding “No” and adopted a strict reading of the absolute priority rule.  The Second Circuit cited the plain language of section 1129(b)(2)(B) of the Bankruptcy Code (commonly known as the “absolute priority rule”), which provides that a plan is not “fair and equitable” with respect to a dissenting class of creditors unless the creditors in the class are paid in full or no junior creditor or interest holder receives or retains property under the plan.  In so ruling, the Second Circuit sided with the Third Circuit and its 2005 Armstrong decision and against several courts that had upheld gifting.  Although the court left for another day the question of whether gifting outside of a plan is proper, this opinion will have a significant impact on the negotiating and structuring of plans in future cases in the Second Circuit, which includes the popular Southern District of New York.
Second, does an out-of-the-money creditor with an unliquidated and disputed claim have standing to appeal a confirmation order?  The Second Circuit held that it does, adopting a broad view of the standing of creditors to appeal a confirmation order, including, in this case, Sprint.  As an aside, one of the judges on the panel dissented in this part of the opinion, noting that she did not believe a creditor with an unliquidated claim with questionable validity should have standing to appeal a confirmation order.
Third, under what circumstances can a bankruptcy court “designate” the plan vote of a creditor under section 1126(e) of the Bankruptcy Code as being “not in good faith”?  The Second Circuit upheld the bankruptcy court’s designation of DISH’s vote against DBSD’s plan, noting that while having ulterior motives in voting on a plan is not per se improper, certain motives rise to the level of not being good faith.  Based upon the facts before it, including that DBSD had purchased its claims after DISH proposed a plan and did so in an attempt to control the company, the court found designation warranted.  The court stated, however, that the same view might not apply to preexisting creditors.  Because any designation determination is highly fact-specific, it is difficult to predict how this decision will apply to other factual circumstances. 
For more detail and analysis on the Second Circuit’s decision, keep an eye on this blog in the days to come.