Corinne Ball ()
A competitor’s attempt to take over a debtor through its debt may be subject to judicial scrutiny, as discussed in the bench, and subsequent written, decision issued by Bankruptcy Judge Shelley C. Chapman in the LightSquared case.1 Such scrutiny extends to the classification of debt purchased by a competitor, treatment accorded that debt under a plan of reorganization and the competitor’s ability to vote its claim because these are plan-related activities that effect a change of control through Chapter 11. In prosecuting its third amended plan, LightSquared argued that separate classification of a competitor’s claims is appropriate, the rejection vote of the competitor’s class should be designated and, in the event the rejection vote was recognized, that the Plan should still be confirmed under the “cram-down” provisions of the Bankruptcy Code. Chapman concluded that separate competitor classification was appropriate, but denied designation and confirmation. The court reaffirmed that the competitor’s conduct merited equitable subordination appropriate to redress injury to innocent creditors, but again deferred ruling on the extent of subordination.
A few months ago, Charles Ergen, the founder, chairman of the board of directors and controlling shareholder of DISH Network, was the focus of bankruptcy court scrutiny due to his conduct in acquiring senior secured claims against LightSquared (the Ergen claims). His heavily litigated takeover attempt, in which he amassed what appeared to be a control position of having close to $1 billion of the outstanding $1.5 billion in senior secured debt, resulted in the determination to equitably subordinate his claims to an extent to be determined at a later date.2 Critically, the Ergen claims were all acquired before a plan was filed. An auction for the assets of LightSquared, premised upon a stalking horse proposal from DISH-related entities, followed. There were no competing bids, but the purchase agreement was terminated by DISH for failure to meet various agreed milestones.
Following the failed auction, the Debtors, supported by various parties in interest, proposed and prosecuted a stand alone Plan, which provided for 16 classes of claims and equity interests. Claims under the $1.5 billion senior secured credit agreement were divided into two classes. The Ergen claims were classified separately from the other first lien lender claims. Under the Plan, a seven-year, third priority lien note was to be distributed in full satisfaction of the Ergen claims, while other lenders under the credit facility were being paid in cash in full upon confirmation. The Plan was accepted by every voting class except the Ergen class. If the Ergen rejection vote was designated, the Plan could be confirmed without meeting the “cram-down” requirements of the Bankruptcy Code. If the rejection vote was recognized, the Plan could only be confirmed through a “cram-down” establishing that it was fair and equitable and did not unfairly discriminate against Ergen.
Undoubtedly, a prior ruling designating DISH’s vote in another debtor takeover influenced the Debtors’ response to Ergen’s rejection.3 The Debtors moved to designate the vote cast by Ergen alleging that his rejection was not motivated by an assessment of creditor recovery, but rather in furtherance of his design to acquire LightSquared at a lesser cost. Alternatively, if the rejection was recognized, the Debtors sought confirmation of the Plan on a cram-down basis, arguing that the Plan was fair and equitable because it provided Ergen with the indubitable equivalent of his claims. Indubitable equivalence was the only standard available to the Debtors to establish that the Plan was fair and equitable because Ergen, a secured creditor, did not retain his first lien under the Plan, but instead received a silent third lien. While Ergen’s motives and conduct informed the court’s decision on the issue of designation, the court primarily focused on the valuation of the reorganized LightSquared in analyzing the issue of indubitable equivalence. Ergen challenged the separate classification, opposed the motion to designate his vote and opposed confirmation of the Plan arguing that it discriminated unfairly against the Ergen claims and failed to provide the indubitable equivalent.4
Classification, Designation, And Cram-Down
The Debtors’ prosecution of the Plan presented three key questions. On classification, the court ruled in the Debtors’ favor because separate classification of a strategic competitor was a reasonable justification under the circumstances. Second, the court ruled that the Ergen’s rejection vote should not be designated under §1126(e) of the Bankruptcy Code because (1) the rejection was premised upon common sense and economics given the Plan’s unfavorable treatment of their claim, and (2) despite the allegations of “bait and switch” to lower the cost of acquiring LightSquared, there was insufficient evidence to bring the DISH affiliates within the proscription of In re DBSD N. Am. and In re Allegheny Int’l.5 Finally, the plan proponents failed to establish that the Plan’s treatment of the Ergen claims provided the indubitable equivalent and fairly discriminated against Ergen.
While the court reviewed the statutory language, distinguished cases denying classification schemes based on an intent to gerrymander the vote to gain at least one impaired class of claims6 and cited cases in which courts allow separate classification of similar classes based on a reasonable business justification, the court’s reasoning regarding separate classification of a competitor’s claim merits attention.7 The court found that separately classifying a competitor’s claim is justifiable because competitors have diverging interests from the interests of other creditors. The court reasoned that Ergen’s interest differed from other creditors, due to his relationship with DISH, a direct competitor of LightSquared, and stated, “it is not hard to conjure a set of facts and circumstances in which [Ergen] personally would benefit more from LightSquared’s failure than its success.”8 Thus, because of Ergen’s competitor relationship to LightSquared, the court held that the Debtors had a reasonable business justification for separately classifying the claims under §1122 of the Bankruptcy Code. However, the court made clear that, while separate classification of the Ergen claims was permissible, it was not necessarily required.
Votes cast in the context of an attempted takeover, especially by a strategic competitor, have been scrutinized. While §1126(e) of the Bankruptcy Code provides that a bankruptcy court may designate a vote that is not cast “in good faith,” courts have recognized that the statute “provides no guidance about what constitutes a bad faith vote” and agree that it requires more than a creditor’s “self-interested promotion of their claims.”9 For example, in In re DBSD N. Am., the court designated DISH’s vote, in part, for buying claims above par and after a plan had been proposed by the debtor, in an effort to block a plan that did not give DISH a strategic interest in the debtor.
The Debtors argued that Ergen’s vote was not cast in good faith and should be designated due to: (1) conduct in acquiring the Ergen claims that led the court to equitably subordinate its claims, and (2) activities of Ergen, DISH and affiliates in the failed auction characterized as a “bait and switch” by offering a high bid price and later withdrawing the offer when the bid was unchallenged with the intent to thereafter purchase the assets at a lesser cost. However, the court rejected these arguments, pointing out that the vote designation analysis, unlike the equitable subordination analysis, focuses on voting conduct and the Plan, concluding that the evidence in the context of the Plan’s treatment of the Ergen claims did not establish an improper motive. Indeed, as the court explained, it was “not at all surprising” that Ergen declined to accept the treatment of its claim, which was “virtually indistinguishable from equity interests.”10 Thus, because Ergen had a valid business reason for voting against the Plan, even though the rejection was consistent with Ergen’s other self-interested motivations, Ergen’s vote could not be determined to have been cast in bad faith.
Plan Did Not Provide Indubitable Equivalent
Once the vote was recognized, the Debtors prosecution of the Plan could only proceed on a “cram-down” or nonconsensual basis. The court found that the Plan did not treat Ergen’s claims fair and equitably because the Ergen claims did not retain first priority liens on the collateral and were not otherwise provided with the “indubitable equivalent.”11 In assessing indubitable equivalence, the court reasoned that the term, tenor and lien priority of the Ergen claims (four years, cash interest, and first priority on all assets) were relevant in comparison to the proposed treatment under the Plan (seven years, PIK interest and silent third lien).
The Debtors relied heavily upon the value of the collateral, arguing that because the value of the collateral assured full payment, the Plan under these circumstances provided the indubitable equivalent. In support of its argument, the Debtor relied on its financial advisor and pointed to the high valuation used by Ergen in internal presentations to his board during the failed auction process, suggesting that LightSquared offered synergistic value to DISH not available to other bidders. Ergen offered conflicting expert testimony. The court declined to accept any particular valuation. Instead, the court observed that LightSquared’s reorganization value was subject to a ruling by the FCC on various spectrum rights of LightSquared. Although the parties disagreed as to what the FCC might do, it was virtually uncontested that the value of the third lien position on the collateral would be impacted, if not dependent upon, the future regulatory action by the FCC. Hence, given the uncertainty, payment was not assured. Thus, the court determined that the Plan was not fair and equitable because Ergen neither retained a first lien nor received the indubitable equivalent under the Plan.
As an independent basis to deny confirmation, the court also considered whether the Plan discriminated unfairly against the Ergen claims.12 To determine whether the plan unfairly discriminates, the court considered whether: (1) there is a reasonable basis for discriminating, (2) the debtor can consummate the plan without the discrimination, (3) the discrimination is proposed in good faith, and (4) discrimination is in direct proportion to its rationale.13 With regard to (1) above, the Debtors argued that the basis for discriminating was Ergen’s purchase of debt with the intent to acquire the debtor and the other alleged bad acts that led to equitable subordination.
While the court agreed that “some discrimination in [the] case may be necessary to address the non-creditor/competitor interest of [Ergen],” the Plan’s treatment “far exceed[ed] those necessary to address the legitimate concerns attendant to its competitor status and connections to DISH.”14 Thus, while the court indicated that it was willing to accept some discrimination against the Ergen claims, the court held that the level of discrimination against Ergen under the Plan did not “pass muster.”15
At every juncture, the court has stated that (1) the purchase of claims by a strategic competitor, standing alone, is not disqualifying or meriting of less favorable treatment, and (2) the status of being a competitor that stands to benefit from the economically efficient acquisition of a debtor or its failure is a reasonable justification for some differing consideration, notably classification and potentially differing treatment under a plan. These two statements are not inconsistent. While there were allegations of “bait and switch” and related misconduct in connection with the failed auction, as well as differing views of valuation, the Plan itself, as opposed to the competitor’s conduct, was the dominant factor in this decision. For every proffered improper motive, there was an equally plausible motive that the Plan treatment did not reflect the value and rights attributable to the Ergen claims without regard to DISH’s status as a competitor. This decision suggests that while differences for competitors may be permissible, the extent of differing treatment, especially for a competitor that has purchased claims prior to a plan being filed, are limited by, among other things, the protections the Bankruptcy Code extends to a dissenting class in requiring a plan to be fair and equitable.
Currently, two plans are pending before the bankruptcy court. It remains to be seen which plan will be prosecuted to confirmation. Perhaps, there will be litigation over competing plans. This story isn’t finished.
1. See Corinne Ball, “Bankruptcy Court Foils Competitor’s Attempted Takeover,” N.Y.L.J., June 26, 2014, http://www.newyorklawjournal.com/id=1202660599515/Bankruptcy-Court-Foils-Competitors-Attempted-Takeover.
2. LightSquared LP v. SP Special Opportunities (In re LightSquared) (LightSquared I), 511 B.R. 253, 345-46 (Bankr. S.D.N.Y. 2014).
3. In In re DBSD N. Am., the Second Circuit affirmed the designation of DISH’s vote in a takeover situation where DISH bought a blocking position after a plan was filed. 634 F.3d 79 (2d Cir. 2011).
4. See 11 U.S.C. §1129(b).
5. In re DBSD N. Am., 634 F.3d at 79; In re Allegheny Int’l, 118 B.R. 282 (Bankr. W.D. Pa. 1990).
6. Section 1122 of the Bankruptcy Code provides that “a plan may place a claim or an interest in a particular class only if such claim or interest is substantially similar to the other claims or interests of such class.” 11 U.S.C. §1122.
7. Section 1129(a)(10) of the Bankruptcy Code requires “at least one class of claims that is impaired under the plan [to have] accepted the plan, determined without including any acceptance of the plan by any insider.” 11 U.S.C. §1129(a)(10).
8. In re LightSquared (LightSquared II), 513 B.R. 56, 74 (Bankr. S.D.N.Y. 2014).
9. Id. at 85.
10. Id. at 89
11. Section 1129(b) of the Bankruptcy code, when applicable, requires that the proposed plan provide creditors with fair and equitable treatment. With regards to a secured creditor, fair and equitable treatment includes retaining a lien on the collateral and receiving a stream of payments having a present value equal to the value of its collateral, or receiving the “indubitable equivalent.” See 11 U.S.C. §1129(b)(2)(A)(i) and (iii).
12. The second requirement under section 1129(b) of the Bankruptcy Code is that the plan not unfairly discriminate against a creditor’s claims. See 11 U.S.C. 1129(b)
13. LightSquared II, 513 B.R. at 115 (citing In re WorldCom, Case No. 02-13533, 2003 Bankr. LEXIS 1401, at *174-75 (Bankr. S.D.N.Y. Oct. 31 2003)).
14. Id. at 117.
15. Id. at 118.