A written tour of business bankruptcy and its alternatives.
This is the latest in the series, Dealing with Distress for Fun & Profit, which you can read from the beginning if you like. Our last two installments focused on the basics of confirming a plan, followed by specific plan confirmation issues to address with individual classes of creditors. In this installment, our fearless authors take on a discussion of a less frequently used, yet highly effective means of confirming plans–plan support agreements and restructuring support agreements.
Welcome back, dear readers! As you may recall, in our last two installments we discussed methods by which Chapter 11 plans are confirmed, whether all creditors like it or not. Those installments presupposed that the plan proponent wouldn’t garner the necessary support to be confirmed until after the plan is filed. But taking a step back, one might ask—is there a more efficient way to get a Chapter 11 case where it needs to go ahead of time?
The answer (in some cases) is yes. Parties can come together and negotiate a “restructuring support agreement” (a/k/a “plan support agreement,” referred to henceforth as an “RSA”).
An RSA is a contract a debtor enters into (either pre- or post-petition) with its most sophisticated creditor constituencies. Under the terms of an RSA, certain of the debtor’s creditors agree to support a proposed Chapter 11 plan. When entered into pre-petition, an RSA acts as the document that memorializes a prepackaged bankruptcy.
An RSA can help expedite the reorganization process. In addition, an RSA can help minimize the “soft costs,” of Chapter 11 (i.e. negative publicity and loss of key employees, suppliers, and customers). The RSA shows the outside world that the debtor has already set itself up to successfully reorganize and exit Chapter 11. There is also risk associated with negotiating and entering into an RSA if some significant stakeholders are left out of negotiations or are unwilling to participate in them, because these circumstances may be followed by litigation.
For example, in In re Innkeepers USA Trust, the bankruptcy court denied the proposed assumption of an RSA that had been entered into pre-petition. The debtor entered into the RSA with only one creditor, had excluded most of its creditor-constituents from the negotiating process and did not adequately “shop” the RSA before entering into it. 442 B.R. 227, 236 (Bankr. S.D.N.Y. 2010). Based on these facts, the Innkeepers court (Bankruptcy Judge Chapman) concluded that the debtor had not acted in good faith when entering into the RSA because it had failed to consider alternative structures or agreements, among other issues identified. Id. at 233-34. In stark contrast, in In re Genco Shipping & Trading Ltd., Bankruptcy Judge Lane stated that assumption of a prepetition RSA should be analyzed under a deferential “business judgment,” standard. 509 B.R. 455, 462-63 (Bankr. S.D.N.Y. 2014).
At the core of an RSA is the agreement between the debtor and its key creditors that the creditor-parties to the RSA will bind themselves to support a plan as outlined in the RSA. As such, a debtor will likely want creditors agreeing to enter into the RSA to agree to the following, at the very least:
In addition to these key terms, debtors commonly seek to incorporate additional provisions that protect them from losing creditor support for the plan and incentivize creditors to abide by the terms of the RSA. These provisions may include:
A properly drafted “fiduciary out” clause enables the debtor, as a fiduciary of its bankruptcy estate in Chapter 11, to terminate the RSA in the event that the debtor determines the plan outlined in the RSA is not in the best interests of the estate and creditors. See, e.g., In re Genco, 509 B.R. at 464.
Because an RSA is ultimately a consensual agreement between a debtor and those creditors who agree to it, creditors typically have considerable leverage in negotiating its terms and may be able to extract significant concessions from the debtor or other creditors under the terms of an RSA.
Specifically, creditors can work to ensure that the RSA sets the pace for the Chapter 11 case by:
As explained above, an RSA is a contract. When executed prepetition, an RSA is like any other executory contract in bankruptcy: the debtor will need to assume it post-petition under Bankruptcy Code § 365 for the RSA to remain effective. See, e.g. In re Genco, 509 B.R. at 462. The debtor, therefore, will likely file a motion in the first days of its Chapter 11 case seeking court authority to assume the RSA. See, e.g. In re Lombard Public Facilities Corporation, Case No. 17-22517, Dkts. 54-55 (Bankr. N.D. Ill. August 7, 2017), In re Hexion Holdings, LLC, et al., Case No. 19-10684, Dkt. 198 (Bankr. D. Del. April 25, 2019).
As with any other executory contract, the bankruptcy court’s standard for deciding whether to approve the assumption motion will generally be deferential, requiring only that the court determine that the debtor’s decision to assume the RSA is an exercise of sound business judgment. See In re Genco, 509 B.R. at 462. To the extent insiders of the debtor are parties to the RSA, however, a higher level of scrutiny will apply to the court’s analysis before approving the debtor’s proposed assumption. See 7 Collier on Bankruptcy ¶ 1108.07 (Richard Levin & Henry J. Sommer eds., 16th ed. 2015) (“[c]ourts have employed what has been described as a ‘sliding scale’ of scrutiny, with the most searching standard of review being accorded to…transactions in which there is a potential for managerial self-dealing.”).
But what if the RSA is not finalized until after the debtor files for bankruptcy? Does the same analysis still apply?
Simply put—no. When a Chapter 11 debtor enters into a new contractual relationship outside the ordinary course of its business dealings on a post-petition basis, Bankruptcy Code § 363 will be triggered, and the debtor will have to seek approval of the transaction under § 363 (as opposed to assuming the RSA as an executory contract under § 365). The bankruptcy court will likely undertake a much more intense analysis of the facts surrounding an RSA entered into post-petition to ensure the debtor has not violated other provisions of the Bankruptcy Code.
Controversy surrounding approval of a post-petition RSA will often center around whether the proposed agreement (sometimes presented to bankruptcy courts as a settlement) violates § 1125(b) as an improper solicitation of a Chapter 11 plan. For example, in In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013) the debtor negotiated the terms of a dual track reorganization plan with numerous creditors, memorialized in an RSA. Id. at 292. Among the relevant terms in the RSA, creditors who signed onto the RSA were required to cast votes in favor of a plan that complied with its terms; the RSA would not be binding until court approval of a disclosure statement and contained fiduciary out provisions for creditors.
The court ultimately held that the RSA did not violate the Bankruptcy Code, partly because it chose to narrowly interpret the definition of “solicitation,” under § 1125, stating that “[c]ongress intended that creditors have the opportunity to negotiate with debtors and amongst each other; 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.” Id. at 295. The court also placed importance on the fact that the creditors participating in the RSA were sophisticated, represented by counsel, and not the types of creditors Congress intended to protect under § 1125. Id. at 296; see also Douglas G. Baird, Bankruptcy’s Quiet Revolution, 91 Am. Bankr. L.J. 593, 605 (2017) (stating that courts considering RSAs often read § 1125 in light of its purpose to protect uninformed outside investors and not sophisticated parties); see also In re Kellogg Square Partnership, 160 B.R. 336, 339-40 (Bankr. D. Minn. 1993) (holding that post-petition RSA did not violate solicitation provisions of the Bankruptcy Code because the debtor was still required to present creditors with a court-approved disclosure statement before ballots would be cast and because policy grounds favored allowing the debtor to engage in negotiations with creditors that would foster a consensual plan process).
RSAs are just one more tool in a debtor and creditor’s toolbox when considering the best, most effective means of achieving desired results in a distressed situation. When implemented properly, RSAs can provide significant savings to a debtor’s estate, ensure creditor-consensus for the administration of a Chapter 11 proceeding, and give certainty to parties when entering an otherwise uncertain situation.
To learn more about the basics of bankruptcy, please read the other installments in this series.
Check out these related webinars, which can be taken for Continuing Legal Education (CLE) credit, or simply for practical and entertaining education for business owners, Accredited Investors, and their legal and financial advisors, Contesting Confirmation and The Nuts and Bolts of a Chapter 11 Plan.
Jonathan Friedland is a senior partner in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized as a “SuperLawyer”, by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has received numerous other accolades. He has been profiled, interviewed, and/or quoted in publications such as Buyouts…
Jack O’Connor is an associate in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He has been recognized repeatedly as a “Rising Star” by SuperLawyers Magazine in the area of Bankruptcy & Creditor/Debtor Rights and has been named an “Emerging Lawyer,” by Leading Lawyers Magazine.
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