Contributed by Damon P. Meyer
Section 1129(b) of the Bankruptcy Code, grants authority for a non-consensual chapter 11 plan to be “crammed down” on a dissenting class of claimants or interest holders, and begins with the words “[n]otwithstanding section 510(a) of this title….” Section 510(a) provides, generally, for the enforceability of contractual subordination in bankruptcy, to the same extent the subordination would be enforceable under nonbankruptcy law. Although the cramdown power is frequently used, the interplay between section 510(a) and section 1129(b) is not often an issue. Therefore, few cases have discussed the precise meaning of the carve out of section 510(a) from section 1129(b). In In re Tribune Company, however, Judge Carey in the Bankruptcy Court for the District of Delaware was faced with this exact question.
One of the requirements of section 1129(b) is that, in order for a chapter 11 plan to be confirmed despite a dissenting class, the plan not “discriminate unfairly … with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.” Although unfair discrimination is not defined in the Bankruptcy Code, it is generally accepted to mean that a dissenting class must receive relative value equal to the value given to all other similarly situated classes and cannot bear disproportionate risk as compared with other similarly situated classes. As Judge Carey and other courts have noted, though, section 1129(b) allows “discrimination” that is not “unfair.”
In Tribune, a class of senior noteholders enjoyed the benefit of a subordination agreement pursuant to which distributions that otherwise would be made to a class of junior creditors were to be paid, instead, to the senior creditors. Under section 510(a), this contractual subordination of the junior creditors was enforceable in the bankruptcy case. The chapter 11 plan, however, provided the senior noteholders and a class of general unsecured creditors with equivalent distributions, essentially allowing the general unsecured creditors to reap the benefit of the contractual subordination, which the senior noteholders argued violated the requirement that the plan not “discriminate unfairly.”
Specifically, the senior noteholders asserted that section 1129(b) should be read “as requiring that a plan must not unfairly discriminate, even before giving effect to third party contractual rights embodied in a subordination agreement.” In other words, similarly situated classes must receive equivalent distributions under a plan prior to giving effect to any contractual subordination. In support of their argument, the senior noteholders pointed to the legislative history of section 1129(b), which seemingly addresses the precise situation confronted in Tribune, and states that a plan that does not provide that senior creditors receive the full benefit of a contractual subordination agreement would violate section 1129(b).
The Court, however, held that the legislative history was not determinative in deciding the issue and looked instead to recent cases that addressed the meaning of the phrase “notwithstanding section 510(a).” Based on this, Judge Carey found that the inclusion of this phrase in section 1129(b) required that section 1129(b) be applied “without prevention or obstruction of any applicable subordination agreements.” Therefore, the Court analyzed simply whether, based on the recoveries under the plan, the plan satisfied the unfair discrimination requirement of section 1129(b).
Because there is no definition of “unfair discrimination” in the Bankruptcy Code, the Court adopted the “rebuttable presumption test,” which states that “unfairness is presumptively present if the plan specifies materially different percentage recoveries for two classes having the same priority … [or contains] risks materially greater [for one class] than those assumed under the plan by other similar assenting classes.” In Tribune, there was no issue of disparity of risk, and the only issue was whether the plan’s equal treatment of the senior noteholders and the general unsecured creditors, as opposed to the senior creditors receiving the full benefit of the subordination, resulted in a materially lower recovery for the senior noteholders.
There is no benchmark for what is a material difference, so Judge Carey looked to other courts that had considered the issue. These courts rejected chapter 11 plans where the difference in recoveries was 50% or greater and confirmed plans where the difference in recoveries was 4% or less. In Tribune, the difference in recoveries to the senior noteholders resulting from the plan’s equal treatment of the general unsecured creditors was less than 4% in percentage recovery and approximately 6.5% in amount. The senior noteholders asserted that the difference in recoveries to the general unsecured class was significantly greater (approximately 50%) however, the Court held that “the analysis for determining whether the discriminatory treatment is unfair should be viewed by its effect on the dissenting class.” Therefore, the “discriminatory effect on the dissenting class is immaterial and, therefore, no rebuttable presumption of unfair discrimination” arose under the plan.
It is worth noting that, even though Judge Carey concluded that section 1129(b) does not require consideration of contractual subordination provisions, his analysis of unfair discrimination specifically addressed the recovery that senior noteholders would have received if the plan gave full effect to the subordination. Because the recovery would be less than 4% higher, Judge Carey concluded that the plan met the unfair discrimination test. Notwithstanding the bankruptcy court’s conclusion that section 510(a) was irrelevant to the unfair discrimination analysis, it will be interesting to see how the issue plays out in another case in which the effect of not expressly enforcing the contractual subordination creates a greater disparity in recovery for senior creditors.