The expense, disruption and value deterioration inherent in sustained Chapter 11 proceedings have in recent years led to faster paced cases which are often, if not prepackaged, at least pre-negotiated (or pre-arranged). Debtors and sophisticated stakeholders are increasingly using plan support agreements (PSAs), also known as restructuring support agreements, to provide structure to a Chapter 11 case and set forth the pre-negotiated terms of a Chapter 11 plan. A PSA is pre- or postpetition contract entered into by the debtor and certain significant creditors, usually right before the bankruptcy filing, pursuant to which the debtor and its creditors agree to support a proposed Chapter 11 plan, subject to specific terms or conditions. PSAs may help to reduce the cost, length and negative publicity associated with a bankruptcy filing by assuring the market, including prospective lenders or investors, that the debtor will exit bankruptcy without causing too much disruption to employees, customers or partners of the debtor. At the same time, if a debtor enters into a PSA with less than all of its significant stakeholders, it could be a recipe for litigation.
Benefits to Debtor
The heart of a PSA is the creditors’ pledge of support for the plan which typically is comprised of provisions requiring that such creditors (1) may not delay confirmation of a plan, (2) are required to support and vote in favor of a plan that is consistent with the terms of the PSA, and (3) may not assign claims that are subject to the PSA (unless the assignee agrees to sign onto the PSA and be bound by its terms). See Restructuring Support Agreements in Bankruptcy, Practice Law Bankruptcy and Practice Law Finance, at 3-4 (2018) (hereinafter, “Restructuring Support Agreements”). Other terms beneficial to the debtor that are commonly included in a PSA are (a) specific performance as a remedy for breach, (b) termination provisions upon certain events of default, and (c) a so-called “fiduciary out” for the debtor. Id. A fiduciary out is particularly important because it ensures the debtor is able to terminate the PSA and propose a different plan if the debtor determines that the agreement is no longer in the best interests of its estate. See, e.g., In re Genco Shipping & Trading Ltd., 509 B.R. 455, 464 (Bankr. S.D.N.Y. 2014) (“[T]he [PSA] provides a fiduciary out that gives the Debtors the ability to receive, review and negotiate unsolicited proposals for any better alternative transaction.”).
Benefits to Creditors
In addition to the benefits that PSAs confer upon the debtor, creditors may receive concessions from the debtor to encourage their participation, such as (i) milestones for achieving important Chapter 11 events, such as approval of post-petition financing, approval of a disclosure statement or confirmation of a plan, (ii) favorable payment terms, interest rates or payment schedules, (iii) debt-to-equity conversions, and (iv) liability releases, as well as more certainty regarding a restructuring timeline and outcome. See Restructuring Support Agreements, at 35. Other possible concessions could include lenders’ consent to debtor’s use of cash collateral or to post-petition DIP financing with priming liens. Id. Debtors may also agree to pay the legal and financial advisors of lenders and/or groups of creditors who agree to sign on to the PSA. Id.
Assumption of the PSA
For PSAs entered into pre-petition, a debtor would typically file a motion with the court seeking to assume the agreement as an executory contract under section 365 of the Bankruptcy Code. A court reviewing the PSA would approve the assumption of the PSA “upon a showing that the debtor’s decision to take such action will benefit the debtor’s estate and is an exercise of sound business judgment.” In re Genco, 509 B.R. at 462. While courts generally will not second-guess the debtor’s business judgment, the involvement of insiders will trigger heightened scrutiny. 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.”). There have been some recent instances in which a debtor has entered into a pre-petition PSA but does not seek to assume it. In such a case, creditors would be bound by the terms of the PSA but the debtor technically would not. See 11 U.S.C. §365.
A PSA entered into after the bankruptcy case has been filed is subject to review under Bankruptcy Code section 363, which requires a debtor to seek court approval of any transaction that uses, sells or leases property of the estate and would occur “other than in the ordinary course of business.” 11 U.S.C. §363(b). The enforceability of a post-petition PSA requires a fact-intensive analysis and may be problematic because of potential violations of the Bankruptcy Code, particularly with respect to the requirements of section 1125(b), which prohibits solicitation of votes on a plan before the court approves a disclosure statement. As noted above, some of the more significant benefits of a PSA are the ability to announce to the market the support of creditors for the debtor’s plan and to be assured a path towards an exit at the time of commencement of the case. Since these benefits are not as pronounced when an agreement is entered into after the filing, it is more common for a debtor to enter into a pre-petition PSA
PSAs are treated differently by different courts, so practitioners should consider how such agreements will be viewed and whether the terms will be acceptable in the particular jurisdiction. Courts have evolved in their approach to PSAs over the past 15-20 years as PSAs have become a more common feature in large Chapter 11 cases.
For example, in Genco, the court approved the pre-petition agreement under the business judgement test. In In re Residential Capital, Case No. 12-12020, 2013 WL 3286198 (Bankr. S.D.N.Y. June 27, 2013), notwithstanding the involvement of an insider (Ally Financial) and the presence of affiliate releases, the court also approved the post-petition PSA under the business judgment test because the PSA “resulted from a months-long, court-supervised mediation involving numerous parties” and “contain[ed] numerous proposed compromises and settlements of billions of dollars of claims,” and “the negotiations were conducted in good faith, with the debtors represented by…an unconflicted fiduciary who is not beholden to [the insider].” Id. at *19.
In In re Innkeepers USA Trust, 442 B.R. 227, 236 (Bankr. S.D.N.Y. 2010), the court considered a pre-petition PSA that was filed with “the support of only one creditor among the critical mass of creditors needed to support a successful restructuring in these cases.” While the court noted that the heightened scrutiny/entire fairness standard may apply due to the involvement of an insider, it concluded that “the debtors have failed to meet their burden for assumption of the PSA under either ‘heightened scrutiny’ or under the less stringent ‘business judgment’ test.” Id. at 231. The court found significant that the proposed deal was not “shopped” and that most constituents were excluded from the process. Id. at 231-32. The debtor was found not to have acted in good faith because, among other things, it failed to consider alternatives. Id. at 233-34.
Other factors that the court found important in Innkeepers were that the objecting creditors were not an out of the money constituency which was objecting to the PSA for hold-up value but rather had real economic value at stake, id. at 236, and that the debtors made no attempt to value the equity preserved for an affiliate, id. at 232.
In summary, PSAs can be very useful to a debtor in organizing its constituents to support a restructuring plan and reduce dissent in a bankruptcy case. From these cases, it is apparent that courts will approve a PSA if it is the product of good faith efforts to reorganize, is not intended to preclude alternatives and is consistent with the value maximizing directives of the Bankruptcy Code. Elements like a robust marketing process, a fiduciary out and support from the debtor’s principal creditors are clearly important. PSAs are a useful tool to bring certainty and order to the process but they are still subject to the substantive requirements of the Bankruptcy Code and the appropriate exercise of a debtor’s fiduciary duties.
Thomas R. Califano and Rachel Ehrlich Albanese are partners in the Restructuring Practice Group at DLA Piper.