Restructuring

Contributed by Doron P. Kenter.
A critical step in confirming a plan of reorganization is the solicitation of creditors votes in favor of, or opposed to, the proposed plan.  Over the years, some parties have been reluctant to share draft plans or otherwise solicit support for their contemplated plan, lest they run afoul of the strict requirements of the Bankruptcy Code and compromise their ability to confirm what would otherwise be a confirmable plan.  This concern has been particularly pronounced in Delaware for the past ten years, as a result of two orders entered in the chapter 11 cases of Stations Holdings and NII Holdings, in which Judge Walrath suggested that postpetition “lockup agreements” may violate section 1125 of the Bankruptcy Code and might result in a designation of the votes of the parties agreeing to support the plan.  In that situation, the restructuring support agreement would have the opposite of its intended effect, making it less (and not more) likely that a plan that has the support of major creditors in a chapter 11 case will be accepted.  A recent case from Judge Shannon in the District of Delaware, however, may signal that the bankruptcy judges in Delaware bankruptcy court are ready to adopt a more flexible position about using restructuring support agreements during a case to garner early support for proposed plans of reorganization.
In In re Indianapolis Downs, LLC, after months of negotiations and “occasional litigation,” the debtors, together with certain holders of second and third lien debt, ultimately agreed upon a process that provided for a “parallel path” to the debtors’ reorganization.  That parallel path contemplated (i) an effort to complete a sale of substantially all of the debtors’ assets, or (ii) a recapitalization transaction.  In connection with that agreement, the debtors and these creditors entered into a “Restructuring Support Agreement” (RSA), which provided the terms of this dual approach, prohibited the plan supporters from supporting or accepting any competing plans, and bound these “RSA Parties” to vote in favor of any plan that comported with the terms of the RSA.
Immediately after the RSA was executed, the debtors filed the RSA and a disclosure statement with the bankruptcy court.  Proceeding on the dual path, the debtors’ marketing efforts succeeded, resulting in a $500 million bid for substantially all of the debtors’ assets.  The debtors then sought approval of the sale and confirmation of a plan of reorganization predicated upon that sale.  At confirmation, a group opposing the debtors’ plan argued (among other things) that the entry by the debtors and the plan supporters into the RSA constituted a wrongful postpetition solicitation of votes prior to the bankruptcy court’s approval of the disclosure statement in connection with the plan, in violation of section 1125(b) of the Bankruptcy Code.  As a result, the objectors argued that the plan supporters’ votes should be designated (i.e., not counted) pursuant to section 1126(e) of the Bankruptcy Code.
Section 1125(b) of the Bankruptcy Code provides that “[a]n acceptance or rejection of a plan may not be solicited after the commencement of [a bankruptcy case] from a holder of a claim or interest with respect to such claim or interest, unless, at the time of or before such solicitation, there is transmitted to such holder the plan or a summary of the plan, and a written disclosure statement approved, after notice and a hearing, by the court as containing adequate information.”  In turn, section 1126(e) of the Bankruptcy Code provides that “the court may designate any entity whose acceptance or rejection of such plan [i] was not in good faith, or [ii] was not solicited or procured [a] in good faith or [b] in accordance with the provisions of this title.”  Accordingly, because the RSA Parties (without whose votes the plan could not be confirmed) were not solicited in accordance with section 1125(b), the objectors argued that the bankruptcy court should designate those votes and deny confirmation of the debtors’ plan.
Judge Shannon was not persuaded by the objectors’ reliance on the decisions to designate votes in Stations Holdings and NII Holdings.  The objectors argued that in those cases, Judge Walrath designated creditors’ votes because they had entered into postpetition lockup agreements (pursuant to which they committed their votes after the commencement of the chapter 11 cases), in violation of section 1125(b).  They argued that postpetition “lockup” or “restructuring support” agreements are impermissible postpetition solicitations, and that any votes obtained as a result must therefore be designated.  Judge Shannon rejected that argument, noting that the designation in Stations Holdings and NII Holdings took place in prepackaged bankruptcy cases presenting “markedly different factual and procedural context[s]” and that designation in those cases took place simple via two-page orders, without any legal analysis, which “are of only the most limited (if any) precedential value.”
Ruling in favor of the plan proponents, the bankruptcy court expressly noted that section 1126(e) is permissive (i.e., even if solicitation had been premature, the court may, but need not designate votes that are obtained after an improper solicitation), but it did not stop there.  Instead, Judge Shannon focused his analysis on what constitutes “solicitation” pursuant to section 1125.  Relying on the Third Circuit’s decision in Century Glove and Chief Judge Houser’s decision in the Heritage Organization case, the court held that “solicitation” should be construed very narrowly, in deference to the “clear legislative policy encouraging negotiations among creditors and stakeholders in Chapter 11 cases.”  For the court, the impact of a narrow construction of “solicitation” meant that the debtors and the RSA Parties did not act improperly in committing to vote in favor of a plan that conformed to the terms of the RSA.
In reaching this conclusion, the court first observed that “creditor suffrage is a bedrock component of Chapter 11” and that it would be manifestly unfair to deprive creditors of their votes in the absence of a showing of bad faith or wrongful conduct – especially where designation of those votes would deny confirmation of a plan that “has been “laboriously (and expensively) developed and has won broad support.”  Second, the court observed that section 1125 of the Bankruptcy Code and the requirement to obtain court approval for a disclosure statement before commencing solicitation are premised on a desire to prevent plan proponents from soliciting votes from creditors before the creditors have an opportunity to become adequately informed, so that they are able to “act capably in their own interests.”
After pointing out both of these core principles of the bankruptcy law, the court (citing to Adelphia), observed that vote designation is a drastic remedy and one that should be the exception, rather than the rule.  Though the decision to designate votes requires a case-by-case factual inquiry, the court echoed Judge Gerber’s sentiment that designation may not be appropriate where creditors have acted out of pure self-interest – even where the creditors’ actions have been “distasteful” and “heavy-handed.”
In light of this analysis, the court found that the RSA Parties were simply seeking to maximize their own recoveries, while at the same time advancing the debtors’ reorganization process.  The court further observed that, in any event, the RSA Parties had simply committed themselves to support an eventual plan conforming to the RSA – after court approval of an appropriate disclosure statement – rather than committing to a premature plan.  Because “the filing of a Chapter 11 petition is an invitation to negotiate,” and the existing bankruptcy laws provide the various stakeholders with sufficient tools to advance their respective agendas, the court concluded that parties must be given an opportunity to make their own economic decisions and that designation was therefore inappropriate.  In Judge Shannon’s words, “When a deal is negotiated in good faith between a debtor and sophisticated parties, and that arrangement is memorialized in a written commitment and promptly disclosed, § 1126 will not automatically require designation of the votes of the participants.”
Though the court never decided whether execution of the RSA actually constituted a solicitation, it held that where creditors are “sophisticated financial players” and are “represented by able and experienced professionals” (as the RSA Parties were), vote designation would “elevate form over substance” and defeat the purposes of the Bankruptcy Code and its requirements for plan confirmation.  The bankruptcy court’s strong statements should help to reduce any trepidation that sophisticated stakeholders may have in connection with negotiating pre-plan “lockup” or “plan support” agreements, and will help debtors to “lock in” definitive support for prospective plans of reorganization.
The lack of a bright line test, coupled with the risk of such severe penalties if another court exercises its discretion to hold otherwise, raises other questions:

• Does postpetition entry into a “restructuring support agreement” (or “lockup agreement” or “plan support agreement”) constitute impermissible solicitation in the first place?
• Which types of agreements run afoul of section 1125(b), and which agreements do not?
• Does it make a difference if a creditor agrees to “support” a plan as opposed to “vote to accept” a plan?
• Should a creditor that has agreed to support a plan prior to court approval of a disclosure statement have the right to change its mind after approval of the disclosure statement?
• What are the debtor’s rights if a creditor breaches a “restructuring support agreement”?
• If the Indianapolis Downs court’s analysis holds true, when would it be appropriate for a court to designate votes because a debtor has, in fact, solicited votes without first obtaining approval of a disclosure statement?
• If designation is only appropriate in the presence of bad faith (or where a plan proponent has taken advantage of an unsophisticated party by distributing a misleading disclosure statement – which might constitute bad faith in its own right), what is the purpose of the last clause of section 1126(e), which allows courts to designate votes that were not solicited or procured “in accordance with the provisions of [the Bankruptcy Code]?”

In any event, parties should still take care to consider any unexpected repercussions of their actions, especially where votes are on the line.