Our last installment focused on what we called the “mundane” middle of a chapter 11 case. You can read it here. This time we discuss something a bit more exciting: confirmation.
Here is the basic chronology leading up to confirming a plan, for those of you with a short attention span or a need for immediate gratification:
There is an old saying, “a little learning is a dangerous thing,” and the summary above is a good example of this saying in action. You cannot get away with reading just the summary above if you want to understand even the most basic elements of the chapter 11 plan process.
Orchestrating the timely confirmation of a plan requires the plan proponent to determine exactly what it wants from the reorganization (or liquidation) and how, from a business perspective, it plans to achieve it.
The debtor has the sole right to propose a plan during the “exclusive period” (generally, the first 120 days of the case) but after the exclusive period expires other parties may propose a plan. Such other parties include a creditors’ committees, secured lenders, and other parties. Whoever proposes a plan is a “plan proponent.”
Plans may, and frequently do, provide for comprehensive changes in the financial and business structure of the debtor. Examples include sales of assets and cancellation or refinancing of debt (or conversion of debt to equity). Bankruptcy courts have confirmed plans with repayment periods of up to 20 years or longer.
Investors and would-be acquirers can use chapter 11 to gain control of a debtor-corporation, buy its assets, or otherwise act in ways that would be more difficult outside of bankruptcy. For example, articles of incorporation can be amended in a plan to change the voting rights of different issues of shares or to modify anti-takeover measures.
A plan cannot be solicited for acceptance without a court approved “disclosure statement” to allow voters to “make an informed judgment about the plan.” See Bankruptcy Code§1125(a)(1). The hearing on a disclosure statement typically becomes the first point of contact between the plan and the court.
At this point, there may be opposition from opposing counsel. Objections to disclosure statements, however, can commonly be resolved by the plan proponent agreeing to add additional disclosures or to include an alternative perspective on the disclosures the plan proponent has included.
Compliance with the disclosure statement requirements creates a limited safe harbor from certain securities laws requirements that would otherwise apply. See Bankruptcy Code §1145.
The plan proponent solicits votes on a class-by-class basis. In order for a class to be deemed to have accepted a plan, the plan must be accepted by a majority in the number of creditors who vote, and those who accept must hold at least two-thirds of the debt held by voting creditors in that class. For these purposes, the claims of insider creditors don’t count, nor do those that have been objected to, unless the court temporarily allows such claims for purposes of voting.
If every impaired class of creditors votes to accept the plan, the court may confirm the plan. If no impaired class votes to accept the plan, then the plan is dead on arrival and the proponent must come up with something else. If some impaired classes vote to accept and others vote to reject, then the proponent may seek to “cramdown” the dissenting classes.
Upon receipt of the necessary acceptances, the plan proponent will request the bankruptcy court to confirm the plan at the confirmation hearing.
Section 1129 of the Bankruptcy Code requires the bankruptcy court to make a number of specific findings to “confirm” (approve) a plan and make it binding on all parties. They include determinations that the plan complies with all applicable law and has been proposed in good faith. See §1129(a)(1)-(3). The bankruptcy court must also determine that the plan is feasible (i.e., that confirmation is not likely to be followed by liquidation). See §1129(a)(11).
If any individual creditor votes against the plan, then the plan must also pass the “best interests of creditors” test, which requires the court to determine that the dissenting creditors or shareholders are receiving under the plan at least as much (in present value) as they would receive if the debtor were instead liquidated under chapter 7. See §1129(a)(7). To do this, the court must compare (1) the probable distribution to the dissenting creditors or equity-holders if the debtor were liquidated with (2) the present value of the payments or property to be received or retained by the same creditors or equity-holders under the plan.
If a class of creditors votes to reject the plan, it may, nevertheless, be imposed on the class (“crammed down”) if (1) at least one impaired class has voted to accept the plan, (see §1129(a)(10)), and (2) the court finds that the treatment provided for objecting classes under the plan satisfies the “fair and equitable” test (see §1129(b)(1)).
The prohibition against “unfair discrimination” means that, ordinarily, similar claims or equity interests must be treated in like manner. There can be “fair” discrimination, however.
Cramdown of a secured class will be permitted if the plan provides one of the following three things: (1) that the objecting secured creditor class will retain a lien to the extent of its secured claim and will receive deferred cash payments that have a present value equal to at least the value of the creditor’s interest in the collateral, (2) for the sale of the secured creditor’s collateral with the creditor’s lien attaching to the proceeds, or (3) for the realization by the secured class of the “indubitable equivalent” of its secured claim.
The fair-and-equitable test for unsecured claimants and shareholders is much simpler. Generally speaking, a class of unsecured claims holders, or equity security holders, can be crammed down if the plan provides either that the creditors in such class receive (over time) cash payments equal to the present value of their unsecured claims (i.e., payment in full) or that junior classes (such as subordinated creditors or stockholders) receive nothing under the plan.
Plan Confirmation represents a significant achievement in a chapter 11 case, but does not end the case. Confirmation represents consummation of the business “deal” among the relevant parties. Often, a number of important tasks remain to be completed after confirmation.
NEXT INSTALLMENTS: Our next couple of installments will look at a chapter 11 case from the perspective of a secured creditor. After that we will spend several columns taking a deeper dive on some of the subjects and concepts we have touched on in earlier installments.
To read other installments in this series, click here.
For a great discussion on insolvency, we recommend this webinar and this webinar. You can also learn about federal equity receiverships here, and get advice on what to do when your business is struggling here.
Prior to joining the faculty in 2000, Professor Kuney was a partner in the San Diego office of Allen Matkins Leck Gamble & Mallory LLP where he concentrated his practice on insolvency and reorganization matters nationwide. Before that he received his legal training with the Howard, Rice and Morrison & Foerster firms in his hometown…
Jonathan Friedland is a principal at Much Shelist. 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 Magazine; Smart Business Magazine; The M&A…
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