Deploying a plan support agreement (PSA) has become an essential component of U.S. Chapter 11 bankruptcy proceedings, especially in larger, more complex reorganizations. Sophisticated debtors and creditors have effectively used PSAs to reduce the costs and risks associated with restructuring a distressed debtor and garner support for a new capital (typically provided through a rights offering). PSAs frame the material terms of the proposed restructuring, and by executing a PSA, a creditor agrees to vote for and support the terms of a restructuring plan that will be circulated to all creditors in the future. Creditors are often induced to sign on to a PSA in return for an enhanced recovery under the proposed plan of reorganization.
PSAs are generally negotiated between the debtor and key stakeholders (which often include the major lenders or bondholders that have significant claims against the debtor). For those creditors that do not participate in the negotiation of the PSA, it is especially important to understand the key legal provisions in the PSA and the implications of becoming a supporting creditor of the debtor’s plan of restructuring.
In this article we examine the language of certain key (sometimes overlooked) provisions typically found in a PSA, and provide a brief survey of provisions agreed to by debtors in bankruptcy proceedings, including: (1) representations made by each supporting creditor regarding their claim holdings, (2) the “fiduciary out” exercisable by the debtor, (3) the requirements for amending the PSA, (4) restrictions on buying and selling claims against the debtor, and (5) the creditor’s right to terminate its obligations under the PSA.
Claim Holder Representations
All PSAs include representations and warranties from each signing creditor that it owns and has the right to vote a specified amount and type of claims. These representations are fundamental because a PSA will have no purpose unless the creditors supporting the debtor’s plan have the right to the vote for that plan.
For creditors who buy and sell claims in the secondary trading market throughout a bankruptcy case, the representations and warranties regarding ownership and voting may need to address certain issues often not addressed. First, the representations normally do not expressly address open trades for the purchase or sale of claims which have not settled, but in some cases, the representation may specifically exclude previously confirmed trades [In re: Energy Future Holdings Corp., Case No. 14-10979 (Bankr. D. Del. 2014)]. Second, the representations typically do not address swaps and derivative exposure that a creditor may have with respect to claims against the debtor through total returns swaps or repurchase agreements. However, the debtor may want the claims that are beneficially owned through swaps or derivatives to be subject to the PSA and have assurances that the creditor has the right to direct voting on those claims [see In re: Energy Future Holdings Corp., Case No. 14-10979 (Bankr. D. Del. 2014) or In re: Verso Corp., Case No. 16-10163 (Bankr. D. Del. 2016)]. Lastly, it is important to confirm whether the legal entity signing the PSA is purporting to bind affiliates or other entities under common control. An investment manager of multiple affiliated funds or a bank representative should be mindful of this issue when executing a PSA because it may or may not bind other funds or divisions of the financial institution.
The obligations under a PSA could in theory limit or restrict the debtor’s ability to maximize the value of the debtor’s estate for all creditors, in violation of its fiduciary duties under applicable law. As a result, PSAs generally include a “fiduciary out” that provides a debtor with a limited right to enter into an alternative restructuring transaction if required to fulfill the fiduciary duties of the debtor’s board of directors. Alternatively, all obligations of the debtor under a PSA may be subject to its fiduciary duties.
The relative strength or weakness of a “fiduciary out” can vary. From the debtor’s perspective, a more permissive fiduciary out will be preferable. From the creditor’s perspective, an overly permissive fiduciary out may defeat the purpose of agreeing to support the debtor’s plan. PSAs may include reasonable constraints on the fiduciary out. For example, certain PSAs require a debtor to obtain a reasoned legal opinion to support its decision to exercise the fiduciary out [see In re: Optima Special Steel, Inc., Case No. 16-12789 (Bankr. D. Del. 2015)], or require the unanimous determination of the independent directors upon advice of outside counsel [see In re: Ultrapetrol (Bahamas) Limited, Case No. 17-22168 (Bankr. S.D.N.Y. 2017), or In re: Green Field Energy Services, Inc., Case No. 13-12783 (Bankr. D. Del. 2015)].
Generally, a PSA may be amended by creditors holding a majority or supermajority of the claims held by the creditors that are signatory to the PSA. For amendments that adversely and disproportionately affect one creditor compared to other creditors, the consent of that affected creditor is often required. In many cases, the disproportionate or adverse effect of the amendment is subject to a materiality threshold.
There is some variation on how the amendments provision protects individual or sub-groups of creditors. In some cases, a creditor may only have a consent right to the extent the amendment adversely affects “economics rights” [see In re: SH 130 Concession Company, Zachry Toll Road–56 LP Cintra Texas 56 LLC, Case No. 16-10262 (Bankr. W.D. Tex. 2016)] or adversely and disproportionately affects “legal rights” [see In re: New WEI, Inc., Case No. 15-02741 (Bankr. N.D. Ala. 2015)]. Even more specifically, the affected creditors may only have a consent right if the amendment modifies such creditors’ entitlements to distributions on the claims [see In re: Dex Media, Inc., Case No. 16-11200 (Bankr. D. Del. 2016)]. Each creditor may want the ability to prevent the broadest range of amendments or have the broadest right to terminate its obligations under the PSA if the proposed amendment adversely affects such creditor. However, this must be balanced with the need to ensure that the other creditors will continue to support the PSA if certain material amendments, which are necessary to consummate the restructuring, are supported by a majority or supermajority of creditors.
Claim Transfer Restrictions
The existence of a secondary trading market for claims throughout a bankruptcy case means that the composition of the creditor group can change over time. This raises concerns for a debtor because a PSA entered into with one group of creditors may be abandoned by new creditors. In order to address this concern, a PSA will include transfer restrictions that prohibit the transfer or sale of a supporting creditor’s claims unless the transferee or buyer agrees to be bound by the PSA by signing a joinder. Any additional claims purchased by a supporting creditor will automatically become subject to the PSA.
As a general matter, the secondary trading market for claims is riddled with operational and legal complexity. For distressed investors that actively trade claims, it is important to closely review the details of the transfer provisions, as the failure to satisfy technical requirements could result in a transfer being deemed void. For example, in the secondary trading market for claims, it is often the case that a PSA is negotiated after a “trade” is executed, but before the trade is closed due to the ordinarily long time for trade settlement for claims. Generally, creditors should exclude pending trades because the buyer in the pre-existing trade may refuse to sign onto the PSA. Additionally, it is often unclear on whether specific timing requirements for providing notices or signing a joinder is timed off the trade date or the settlement date.
Creditor Termination Provisions
Creditors have the right to terminate the PSA upon the occurrence of certain events. In general, typical creditor termination events include the following: (i) a failure to meet milestones in the bankruptcy proceedings, (ii) an outside date by which the PSA may be terminated, (iii) the debtor’s material breach of PSA, (iv) adverse events in the bankruptcy proceedings, such as dismissal of the case or conversion to a chapter 7 proceedings, (v) the final plan of restructuring materially differing from the PSA term sheet, (vi) an acceleration or a termination of any post-petition financing, and (vii) a material adverse effect on the financial condition of the debtor.
Termination of the PSA generally requires the approval of some majority of the supporting creditors. In limited cases, each individual creditor may have the right terminate its own obligations under a PSA separately from the other creditors [see In re: Eagle Bulk Shipping Inc., Case No. 14-12303 (Bankr. S.D. NY 2014)]. However, even where a PSA may allow each individual creditor to terminate its own obligations under the PSA upon the occurrence of certain termination events, such as a material amendment of the final restructuring plan documents, such termination event can be waived by some majority of creditors [see In re: EMAS Chiyoda Subsea Limited, Case No. 17-31146 (Bankr. S.D. Tex. 2017)]. . Therefore, an individual creditor may not be able to exercise its right to terminate its own obligations, if the group of creditors that has a controlling vote under the PSA has diverging incentives.
PSAs have become a mainstay in the Chapter 11 restructuring process, and it is therefore vital for distressed investors and other creditors to have a clear understanding of the legal terms of a contemplated PSA. Distressed investors and other creditors will be well advised to become more familiar with how certain provisions in a PSA can be addressed, and how such provisions have been addressed by debtors and creditors in other bankruptcy proceedings.
Gregory G. Plotko is a partner in the Corporate Department of Richards Kibbe & Orbe, specializing in Bankruptcy. Richard J. Lee is counsel at the firm, also in the Corporate Department.