By the time restructuring and rescue reaches the bankruptcy court, a distressed company, in most circumstances, inevitably faces a change of control transaction. That economic posture often prompts investment in the company’s debt by sophisticated parties seeking to play an "outcome determinative" role in the reorganization by gaining control of the company. At times, a bankruptcy judge confronts a debtor controlled by equity that is clearly "out of the money" but that nevertheless attempts to advance equity’s interests rather than pursue the maximization of estate value. In a recent case, Castleton,1 Judge Frank H. Easterbrook once again confirms the view he expressed over 20 years ago in Kham & Nate’s Shoes,2 which demands that in bankruptcy, where value is the keystone, the market must serve as the true indicator of value and guardian of fiduciary principles.
Navigating from intervening decisions by the Supreme Court in N. LaSalle3 (setting forth the requirements for "out of the money" equity investing new value under a Chapter 11 plan to retain control of the reorganized debtor) and RadLAX4 (confirming that secured creditors have the right to credit bid on a sale of the debtor under a Chapter 11 plan), Easterbrook holds that a Chapter 11 plan relying upon new investment from an insider of the debtor must meet the same competitive bidding standard applicable to new-value plans premised upon investment by existing equity.
