|
Smoothing the Way
Pre-packaged Chapter 11 cases remain an extremely popular method for restructuring troubled companies
Neil Cummings
The Deal
April 9, 2002
But a relative newcomer, the pre-negotiated Chapter 11 case is growing in popularity. It combines the advantages of a pre-bankruptcy negotiation with creditors with the benefits of a post-bankruptcy solicitation of votes on a plan. A pre-negotiated case allows the company and the important players -- usually the banks and/or a bondholders' committee -- to privately negotiate the terms of the proposed restructuring away from the spotlight of a bankruptcy, and to avoid premature disclosure of the company's financial condition before the automatic stay under the U.S. Bankruptcy Code is in place. More important, the company will find it easier to comply with the federal securities laws in a pre-negotiated case.
The tradeoff is that, in a pre-negotiated case of a public company, creditors may be unable to trade in the company's securities for a month or more after they would have been free to buy or sell those securities in a pre-packaged case.
The key structural difference between a pre-negotiated and a pre-packaged Chapter 11 proceeding is the time at which the company solicits votes on the plan of reorganization.
In a pre-packaged bankruptcy, this is done pre-bankruptcy, and the company will not file for Chapter 11 protection until the required votes are obtained in favor of the plan.
In contrast, in a pre-negotiated plan, the company commences its Chapter 11 case as soon as practicable after the company and the key players have reached agreement on the terms of the restructuring. Votes on the plan are not solicited until the bankruptcy court has approved both the plan and the disclosure statement.
Why is the timing of the solicitation important? And why are companies and creditors better off using a pre-negotiated plan?
First, it is easier to comply with federal securities laws in a pre-negotiated case than in a pre-packaged case, due to various provisions in the Bankruptcy Code and the federal securities laws.
Under the Securities Act of 1933, if securities are to be issued under the plan in either a pre-negotiated or a pre-packaged bankruptcy, the company will need to file a registration statement with the Securities and Exchange Commission covering the solicitation of votes on the plan and the issuance of those securities, unless there are available exemptions from registration.
The preparation of a registration statement reflecting the detailed line-item disclosure called for under the Securities Act is time-consuming. And, even with limited SEC review, the registration process can take several months -- and is invariably costly -- at a time when the company's financial resources are limited and management's attention is already stretched.
As a result, the availability of exemptions from registration can mean the difference between an out-of-court restructuring and a traditional Chapter 11 bankruptcy proceeding for the company.
In a pre-negotiated case, § 1145 of the Bankruptcy Code provides a broad exemption for the company's solicitation of votes on, and the issuance of securities under, the plan. More importantly, under § 1145 the securities issued under the plan are deemed to have been issued in a public offering and are freely tradable by their holders, so long as they did not, in effect, act as professional underwriters in respect of the securities and are not affiliates of the issuer. In most pre-negotiated restructurings, most creditors will receive freely tradable securities.
In a pre-packaged case, it is harder to find exemptions from registration. Section 1145 does not apply to the pre-bankruptcy solicitation of votes under a pre-packaged plan. And although the Securities Act contains a number of exemptions from registration, they may not apply to the company's vote-solicitation efforts in a pre-packaged plan.
For example, the exemption in § 3(a)(9) of the Securities Act that permits exchange offers is lost if financial advisers are paid to solicit votes. Many companies are reluctant, or ineligible, to go through the fairness hearing called for under the exemption in
§ 3(a)(10) of the Securities Act.
And the private-placement exemption in § 4(2) can't be used if any of the creditors whose votes are being solicited is unsophisticated in financial and business matters.
A second advantage of a pre-negotiated plan is that, prior to the bankruptcy filing, the company doesn't have to publicly disclose its financial condition. That allows the company to run its operations as smoothly as possible in the pre-filing period.
Even if the company is subject to the reporting requirements under the Securities Exchange Act of 1934, under Regulation FD, it doesn't have to publicly disclose material non-public information about itself that it shares with its creditors during the restructuring discussions, so long as those creditors sign confidentiality agreements.
In contrast, in a pre-packaged case, during the pre-bankruptcy solicitation period the company is left in a different and more difficult position. Its financial condition is publicly detailed in the disclosure statement, but until the Chapter 11 case is commenced it doesn't have the benefits of the automatic stay under the Bankruptcy Code.
There is one potential disadvantage for creditors with a pre-negotiated plan.
If the company is a reporting company under the Exchange Act, creditors who receive material non-public information about it are liable under insider-trading laws if they trade in its securities before that information becomes immaterial or public.
It is extremely unlikely all the information disclosed during the negotiations will become immaterial. In practice, those creditors will only be free to buy or sell the company's securities when the information becomes public, which won't happen until the company solicits votes on the plan and files the related 8-K with the SEC or otherwise makes the information public.
In a pre-packaged plan, the vote solicitation will take place and the SEC filing will be made promptly after the company and the key players have struck a deal on the terms of the restructuring.
However, under the bankruptcy rules, in a pre-negotiated case the earliest the vote solicitation can begin is usually a month or more after the company files for bankruptcy. This leaves affected creditors unable to trade in the company's securities during this gap period, unless the company publicly discloses the non-public information. But creditors shouldn't count on this disclosure because it is rarely in the company's interests.
Neil Cummings is a corporate partner in the Los Angeles office of Latham & Watkins, www.lw.com.
|
Latham & Watkins' Neil Cummings |
