Substantial increases in the cost of administering Chapter 11 cases over the years resulted in new strategies to advance more efficient restructurings. The negotiation of pre-packaged and pre-negotiated reorganization plans as part of pre-bankruptcy discussions among the various stakeholders is now commonplace. These restructuring dialogues are followed by Chapter 11 filings and the filing of plans of reorganization in the early stages of the case. Often, plan support agreements are executed by significant creditors involved in the negotiations. These agreements typically provide for the filing of a plan within a specified time, the treatment of the creditors’ claims, and a commitment the creditors will support the plan when voting occurs and not support any competing plan.
Post-bankruptcy filing plan support agreements have been criticized as an attempt by the debtor to solicit acceptance of a plan before solicitation is authorized by the bankruptcy court. Key constituents in Chapter 11 reorganizations who wish to enter into such agreements after the bankruptcy filing may breathe a little easier following a recent decision by U.S. Bankruptcy Judge Brendan Shannon of the District of Delaware in In re Indianapolis Downs LLC, No. 11-11046 (BLS) (Jan. 31, 2013). In the opinion, Shannon declined to designate, or disallow, the votes of several large creditors who signed a plan support agreement after the bankruptcy filing providing they would vote in favor of the debtors’ plan of reorganization. The dissenting stakeholders alleged the creditors and the debtors violated the solicitation provisions of the Bankruptcy Code by entering into an agreement whereby the creditors were bound to vote for a plan of reorganization before a disclosure statement containing information about the debtor and the plan was approved by the court.
Indianapolis Downs and Its Creditors’ Negotiations
According to the opinion, the debtors, Indianapolis Downs LLC and Indiana Downs Capital Corp., operate a "racino," which combines a horse racing track and casino, along with an assortment of other wagering games. The debtors had three levels of prepetition secured debt in an aggregate amount in excess of $551 million. The second and third lien debt, which accounted for approximately $453 million, was guaranteed by the debtors and secured by their assets. The opinion describes that in late 2010, the debtors failed to make a required interest payment on the second-tier secured debt. The debtors and several of the second- and third-tier secured creditors attempted to negotiate a restructuring without success. In April 2011, the opinion states that "faced with the expiration of a forbearance period, the debtors commenced Chapter 11 cases with the hope of brokering a financial restructuring."
After the bankruptcy filing, the debtors and certain secured creditors spent several months negotiating possible plans of reorganization. Ultimately, the parties agreed to a deal and entered into a restructuring support agreement (RSA) that provided for two possible paths to reorganization: The debtors would test the market to see if a sale at an appropriate price was possible, but if not, the debtors would recapitalize the enterprise. In addition to terms related to the two reorganization paths and treatment of creditors thereunder, the RSA prohibited the parties from supporting competing reorganization plans and required the creditor parties to vote in favor of a reorganization plan that complied with the RSA. The RSA was binding on the non-debtor parties upon execution, and binding on the debtors upon court approval of a disclosure statement.
The RSA and proposed disclosure statement and plan of reorganization were filed with the court in April 2012. The court approved the disclosure statement. The marketing efforts ultimately proved successful, and substantially all of the debtors’ assets were to be sold for approximately $500 million. Confirmation of the plan was conditioned on the sale, which the court later approved. In addition to other objections to confirmation raised by certain debt and equity holders, the objecting parties argued that the negotiation and execution of the RSA constituted an impermissible vote solicitation and the non-debtor parties to the RSA should not be permitted to vote on the proposed plan. If their votes were disallowed, the plan would fail.
RSA Parties did not Engage in Vote Solicitation
Section 1125 of the Bankruptcy Code provides that votes in favor of a plan of reorganization may only be solicited following court approval of a disclosure statement. Section 1126(e) provides that interested parties whose votes are not solicited in compliance with the requirements of Section 1125 may designate votes submitted by a designated party are not counted for purposes of plan confirmation. In this case, designation of the non-debtor parties to the RSA would have resulted in the debtors lacking sufficient votes to confirm the plan.
According to the opinion, the objecting parties argued that by negotiating and executing the RSA, the non-debtor parties’ votes had been improperly solicited prior to court approval of the disclosure statement. The debtors countered by arguing that the term "solicitation" should be narrowly construed, and vote designation is a harsh remedy that should be rarely used. The court agreed with the debtors and declined to designate the non-debtor parties’ votes, and confirmed the reorganization plan.
After reviewing the relevant statutory provisions, the opinion discussed In re Century Glove, 860 F.2d 94 (3d Cir. 1988). In that case, a creditor had discouraged other creditors from voting for the debtor’s proposed plan of reorganization and shared a "draft" plan of its own. The bankruptcy court designated the creditor’s vote. The district court reversed, finding, among other things, that the creditor’s actions "were more accurately characterized as ‘negotiations’ rather than as a solicitation of votes." The U.S. Court of Appeals for the Third Circuit affirmed the district court’s decision, and endorsed this narrow reading of solicitation under Section 1125. The Third Circuit found that a broad reading of solicitation would seriously inhibit creditor negotiations.
Shannon found that in this case, designation of the non-debtor parties to the RSA would be inconsistent with the purposes of the Bankruptcy Code. The court wrote: "First, creditor suffrage is a bedrock component of Chapter 11; it would indeed be anomalous, in the absence of a showing of bad faith or wrongful conduct, to discount or ignore the votes of the overwhelming majority of the creditors and stakeholders, and thereby deny confirmation of a plan that has been laboriously (and expensively) developed and has won broad support."
Second, the court observed that the interests that Section 1125 was designed to protect were not at risk in this case. The court reasoned the Bankruptcy Code’s disclosure statement requirements were designed to prevent solicitation of votes by creditors who were too ill-informed to act capably in their own interests. In this case, the parties to the RSA were sophisticated financial players ably represented in negotiations by an array of capable professionals.
The opinion also addressed two 2002 rulings by the Delaware Bankruptcy Court where creditor votes had been designated due to improper solicitation following execution of plan support agreements. The opinion acknowledged that creditor votes had been designated in the two pre-packaged Delaware bankruptcy cases where the votes had been received by the debtor after the filing of the bankruptcy petition. Though not discussed in the opinion, the 2002 cases caused some commentators to express concern that post-petition lock-up agreements would expose the contracting parties to vote designation. Shannon noted that, in addition to being factually and procedurally distinguishable, the orders in those cases did not provide legal analysis. The court concluded the 2002 cases had limited, if any, precedential value.
Win for Post-Petition Plan Bankruptcy Negotiations
The court concluded: "The filing of a Chapter 11 petition is an invitation to negotiate. Congress has carefully calibrated the Chapter 11 process — using the automatic stay, exclusivity, the right of secured creditors to adequate protection and a host of other statutory provisions — to provide stakeholders with leverage or bargaining chips to advance their respective agendas. The purpose, at bottom, is to permit parties to have a voice and to make their own economic decisions." The court allowed the votes to stand, overruled the other objections, and confirmed the plan. The Indianapolis Downs decision provides some comfort to sophisticated creditors who actively participate in the restructuring process and enter into post-petition plan support agreements. That being said, careful attention should be paid to the creditors involved and drafting of these agreements to ensure that they do not attempt to replace the Section 1125 solicitation process. We expect more on this issue in contested cases in the future. •
Andrew C. Kassner is the chair of the corporate restructuring practice group of Drinker Biddle & Reath, practicing in the firm’s Philadelphia and Wilmington, Del., offices. He can be reached at firstname.lastname@example.org or 215-988-2554.
Joseph N. Argentina Jr. is an associate in the firm’s corporate restructuring practice group in the Philadelphia and Wilmington offices. He can be reached at email@example.com or 215-988-2541.