Restructuring Support Agreement Upheld By Delaware Bankruptcy Court: Ruling Should Help Streamline the Chapter 11 Process
On January 31, 2013, the United States Bankruptcy Court for the District of Delaware issued an opinion in Indianapolis Downs, LLC confirming the debtors’ Chapter 11 plan of reorganization and denying a motion to “designate,” i.e., disqualify, the votes of certain creditors who were parties to a post-petition restructuring support agreement. This opinion provides guidance and support to parties seeking to streamline the restructuring process.
Ways to Streamline the Restructuring Process
In a traditional Chapter 11 case, the debtor negotiates a plan of reorganization with its principal constituencies, then seeks approval of a disclosure statement to accompany the plan, then solicits votes on the plan and then seeks confirmation of the plan. In fact, Section 1125(b) of the Bankruptcy Code provides that once a Chapter 11 case has been commenced, votes on a plan cannot be solicited until after the plan proponent has transmitted a court-approved disclosure statement to holders of impaired claims.1
Because a traditional Chapter 11 case can be time-consuming, difficult, expensive and unpredictable, parties have used various mechanisms to try to streamline the process, reduce costs and increase the odds of a successful outcome.2 One such mechanism is a prepackaged bankruptcy filing (referred to as a “prepack”) in which votes on a plan of reorganization are solicited before the debtor files Chapter 11. At the hearing on confirmation of a prepack, the plan proponent will request that the court find that either (1) the solicitation of acceptances was in compliance with applicable non-bankruptcy law, e.g., the securities laws, or (2) the pre-petition disclosure statement contained “adequate information.”3
Another method to streamline the process is a pre-negotiated Chapter 11, in which the parties agree pre-petition on the terms of a plan, but the plan proponent does not solicit votes pre-petition. Instead, the parties execute a pre-petition plan support agreement which effects a lock-up requiring the parties to support the agreed plan and no other plan. Then, with a deal in place, a plan and disclosure statement are filed with the petition or soon thereafter, and the plan proponent solicits votes post-petition after court approval of the disclosure statement.4
Some companies experiencing financial distress do not have the luxury of time required to negotiate and solicit votes on a prepack, which can take months, or even to reach a pre-petition agreement and lock-up on the material terms of a plan. In that case, one tool that participants can use to streamline the Chapter 11 process is a post-petition restructuring support agreement in which the debtor and certain of its principal constituencies agree on the material terms of a plan after the bankruptcy case is filed, and further agree to support that plan and no other plan.5 That is what Judge Shannon was faced with in the Indianapolis Downs case.
Facts in Indianapolis Downs
The debtors in Indianapolis Downs operated a racino in Shelbyville, Indiana and employed over 1,000 people. The debtors had $98 million in first lien debt, $375 million in second lien debt and $78 million in third lien debt. Prior to the petition date, after failing to pay interest on the second lien debt, there were negotiations among the debtors and certain holders of secured debt, but no deal could be reached. A substantial portion of the third lien debt, as well as some second lien debt, was held by Fortress Investment Group, LLC (“Fortress”). Fortress was an active participant in pre-petition and post-petition negotiations.
Confronted with the impending expiration of a forbearance period, the debtors filed Chapter 11 in April 2011. After months of post-petition negotiations, the debtors, an ad hoc committee of holders of second lien debt and Fortress reached agreement on a “parallel path” approach to the Chapter 11 case which envisioned that (1) the debtors would test the market to determine if a sale of assets would yield high enough prices to satisfy major constituencies, and (2) if the marketing effort failed, then the debtors would be recapitalized under the plan. This “parallel path” approach was memorialized in a restructuring support agreement (the “RSA”). The RSA also (1) specified treatment of creditors under the sale or recapitalization transactions, (2) obligated the debtors to propose a plan within an agreed time frame, (3) prohibited any party to the RSA from proposing, supporting or voting for a competing plan, and (4) required the parties to vote to accept a plan that complied with the RSA. The RSA was binding on the non-debtor parties upon execution and upon the debtors only upon court approval of a disclosure statement.
The RSA was filed with the court as soon as it was executed, along with a plan and disclosure statement, and the RSA was described at length in the disclosure statement. The disclosure statement was approved over the objection of the “Oliver Parties,” who included senior management and holders of debt and equity. Centaur LLC bid just over $500 million to purchase substantially all of the debtors’ assets, and so the debtors sought confirmation of their plan predicated on the sale track.
RSA Did Not Constitute Improper Solicitation of Votes
The Oliver Parties opposed confirmation of the plan arguing that the RSA constituted a wrongful solicitation of votes on the plan prior to court approval of the disclosure statement, and also moved to designate the votes of the creditor parties to the RSA. If such votes had been designated, then the plan would not have had sufficient acceptances to achieve confirmation. Section 1126(e) provides that: “On request of a party in interest, and after notice and a hearing, the court may designate any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.”6 The Oliver Parties did not argue a lack of good faith as a basis for designation. Instead, they argued that by executing the RSA, votes to accept the plan had been solicited before a disclosure statement had been approved in violation of section 1125(b).
The Indianapolis Downs court began its analysis with the Third Circuit’s decision in In re Century Glove,7 where, after approval of a disclosure statement, a major creditor (“FAB”) contacted other creditors urging them to vote to reject the debtor’s plan and provided them with a copy of FAB’s draft plan which was not part of the court-approved solicitation materials. In Century Glove, the Third Circuit held that solicitation must be read narrowly to avoid inhibiting creditor negotiations. Judge Shannon also noted that Congress intended that debtors and creditors have the opportunity to negotiate, and “to the extent that those negotiations bear fruit, a narrow construction of ‘solicitation’ affords these parties the opportunity to memorialize their agreements in a way that allows a Chapter 11 case to move forward.”
Designation of the votes of the RSA parties would have been inconsistent with the purposes of the Bankruptcy Code because (1) creditor suffrage is a bedrock component of Chapter 11, and (2) the interests that Section 1125 are designed to protect were not at risk in Indianapolis Downs. Specifically, the RSA parties were all sophisticated financial players represented by experienced professionals. Requiring approval of a disclosure statement before these sophisticated parties committed to a deal would have been elevating form over substance. Moreover, the right to vote on a plan is a fundamental component of the Chapter 11 process, and the party seeking to strip a creditor of its vote bears a heavy burden.
Finally, Judge Shannon noted that the filing of a Chapter 11 case is an invitation to negotiate, and “courts must be chary of construing these disclosure and solicitation provisions in a way that chills or hamstrings the negotiation process that is at the heart of Chapter 11.”
The decision in Indianapolis Downs provides some welcome guidance on restructuring support agreements. In fact, the agreement before Judge Shannon went further than many such agreements in that it not only obligated the creditor parties to support the agreed plan and no other plan, but also expressly obligated them to vote to accept a plan that complied with the RSA. Traditionally, many such agreements stop short of obligating actual voting to avoid running afoul of the prohibition in Section 1125(b) on soliciting votes post-petition prior to approval of a disclosure statement. Yet, Judge Shannon recognized that sophisticated parties negotiating plan treatment of their claims probably have done sufficient due diligence to have at least as much information (if not far more) as would be contained in a disclosure statement. Thus, they should not be inhibited in their negotiations because of a rule designed to protect less sophisticated creditors.
If followed by other courts, this ruling will facilitate plan negotiations. Absent a lock-up agreement, even if major players have agreed on the terms of a plan, the plan is not binding until it is confirmed. Because it generally takes two to three months from the time a plan is filed until it is confirmed, there are ample opportunities for the deal to unravel. In fact, if major players cannot be bound during that two to three month time frame to the deal they negotiated, then there will be less incentive for parties to negotiate a consensual resolution of the Chapter 11 case and a greater likelihood that parties will grow disillusioned with the deal. For instance, circumstances in the industry, economy or financial markets may change. Moreover, in today’s marketplace, hedge funds trade in and out of various tiers of debt on a daily basis and the new holders of the debt may have different ideas about plan treatment. Thus, an agreement that binds the debtor and its principal creditors at an earlier stage will likely streamline the Chapter 11 process, thereby saving time, reducing costs and increasing the odds of a successful outcome. Best practice militates in favor of promptly disclosing and seeking court approval of the RSA.
For More Information
For more information on how these issues may affect your rights, contact Nicholas F. Kajon at 212.537.0403.
This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.
1 11 U.S.C. § 1125(b).
2 For a general discussion of factors militating against traditional Chapter 11 filings, see Prepackaged Bankruptcy Filings: A Harbinger of Practice Under the New Law, June 6, 2006.
3 11 U.S.C. § 1126(b) (validating pre-petition plan solicitation provided one of the two tests is satisfied). “Adequate information”is defined in 11 U.S.C. § 1125(a).
4 Other alternatives include Section 363 sales, friendly foreclosures and other out-of-court procedures. See generally Friendly Foreclosure Sales and Other Alternatives to Traditional Chapter 11 Restructurings, September 1, 2010.
5 Ideally, the creditor parties to the restructuring support agreement will hold claims sufficient to assure acceptance of the plan by all or most impaired classes of claims (or at least all classes that are not clearly out of the money). A majority of creditors holding two-thirds of the debt are required for a class of claims to accept a plan. 11 U.S.C. § 1126(c).
6 11 U.S.C. § 1126(e) (emphasis supplied). For a discussion of designation for not acting in good faith, see Second Circuit Holds “Gifting” Plan Violates Absolute Priority Rule and Disregards Blocking Vote Cast by Competitor Attempting to Take Control of Debtor, February 17, 2011.
7 860 F.2d 94 (3d Cir. 1988).