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Chapter 11 Confirmation Issues

The goal of Chapter 11 is reorganization through confirmation of a Plan of Reorganization. There are three steps toward confirming the Plan: (1) obtaining court approval of a disclosure statement, whose purpose is to provide adequate information about the Plan so that creditors can vote; (2) obtaining the consent of a requisite (by number and amount) of the creditors through balloting; and (3) obtaining court approval of the Plan at a confirmation hearing.

A. Disclosure Statement.

Before soliciting consents to the Plan, a Disclosure Statement must be approved by the Bankruptcy Court. 11 U.S.C. section 1125 provides that the Disclosure Statement must contain “adequate information” which is defined as:

“[I]nformation of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the Debtor and the condition of the Debtor’s books and records that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the Plan, but adequate information need not include such information about any other possible or proposed plan.”

Courts consider the creditors’ ability “to obtain such information from other sources than the Disclosure Statement.” 11 U.S.C. section 1125(a)(2)(c); In re Copy Crafters Quickprint, Inc., 92 Bankr. 973, 979 (Bankr. N.D.N.Y. 1988). In applying the typical investor standard, legalese should be avoided. In re Stanley Hotel, Inc., 13 Bankr. 926, 935 (Bankr. Co., 1981).

In general, a Disclosure Statement should include the following:

  1. An Executory Summary of the Plan
  2. Background Information About the Debtor
  3. Significant Events Precipitating the Chapter 11 Case
  4. Significant Events During the Case
  5. The Classification and Treatment of Parties Under the Plan
  6. Time of Performance
  7. Estimated Distributions to Creditors
  8. Means for Implementing the Plan
  9. Financial Projections of Future Operations
  10. Who Will Manage the Debtor and their Compensation
  11. Default Provisions
  12. Income Tax Consequences
  13. Risk Factors Concerning the Plan
  14. An Analysis of the Return to Creditors if the Debtor was Liquidated
  15. Future Litigation Against Others

See In re Metro Craft Publishing Serv., Inc., 39 Bankr. 567 (Bankr. N.D.Ga. 1984).

B. Obtaining Consents.

One goal of the proponent of a Plan and Disclosure Statement is to obtain the consent of at least one class of creditors who is impaired or affected by the Plan. As a practical matter, this means that the Disclosure Statement should also contain the Debtor (or other proponent’s) request that creditors vote for the Plan. Often, the Disclosure Statement becomes so bulky that no one (other than the lawyers) wants to read it. The Proponent should call or write creditors asking them to vote for the Plan. Similarly, the Official Creditors’ Committee should be asked to send a letter urging a yes vote. Such solicitations, however, should be done with great care, as there is no exemption from the anti-fraud provisions of the securities laws for such efforts.

Section 1126(e) permits the court to invalidate votes cast in bad faith. While there is little case law on what constitutes bad faith for this purpose, the legislative history and prior law indicate that bad faith would include: extortion, a desire to take over or eliminate a business competitor, or pursuing a noncreditor strategy. Moreover, “insider” votes are not counted when determining whether a class has accepted the Plan.

C. Confirming A Plan.

After balloting, the Court will conduct a hearing to determine if the Plan meets the requirements of 11 U.S.C. section 1129. These require findings that:

  1. The Plan complies with the requirements of Title 11.
  2. The Proponent of the Plan complies with the applicable provisions of the Bankruptcy Code.
  3. The Plan has been proposed in good faith and not by any means forbidden by law. Good faith means that there is a reasonable likelihood that the Plan will achieve a result consistent with the objectives and purpose of the Bankruptcy Code. In re Nite Lite Inns, 17 Bankr. 367, 370 (Bankr. S.D. Cal. 1982). This is different than the test for when a case should be dismissed or stay relief granted as a bad faith filing. In re Stolrow’s Inc., 84 Bankr. 167 (9th Cir. BAP 1988). The most important inquiry is the terms of the Plan. In re Madison Hotel Assoc., 749 F.2d 410, 425 (7th Cir. 1984).
  4. Any payment made or to be made by the Proponent, by the Debtor, or by a person issuing securities or acquiring property under the Plan, for services or for costs and expenses in connection with the case, or in connection with the Plan and incident to the case, has been approved by, or is subject to the approval of, the Court as reasonable.
  5. The Proponent of the Plan has disclosed the identity and affiliations of any individual proposed to serve, after confirmation of the Plan as a director, officer, or voting trustee of the Debtor, an affiliate of the Debtor participating in a joint plan with the Debtor or a successor to the Debtor under the Plan; and that the appointment to, or continuance in, such office of any such individual is consistent with the interests of creditors and equity security holders and with public policy.
  6. The Proponent of the Plan has disclosed the identity of any Insider that will be employed or retained by the reorganized Debtor, and the nature of any compensation for such Insider.
  7. No governmental regulatory commission exists with jurisdiction, after confirmation of the Plan, over the rates of the Debtor.
  8. With respect to each impaired class of claims or interests, each holder of a claim or interest voting will receive or retain under the Plan an account of such claim or interest property of a value, as of the effective date of the Plan that is not less than the amount that such holder would so receive or retain if the Debtor were liquidated under Chapter 7 of the Bankruptcy Code. This means that creditors will receive at least what they would get if the Debtor were liquidated. This test, commonly known as the “best interests of creditors” applies only to claims or interests that are impaired by the Plan. 11 U.S.C. Section 1129(a)(7).
  9. Each holder of a secured claim will receive or retain under the Plan an account of such claim property of a value, as of the effective date of the Plan, that is not less than the value of such holder’s interest in the estate’s interest in the property that secures such claims.
  10. Except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the Plan provides for full payment of certain administrative and priority claims on the effective date of the Plan.
  11. Unless the Plan proposes for liquidation of the assets of the Debtor, confirmation of the Plan is not likely to be followed by the liquidation, or the need for further financial reorganization of the Debtor or any successor to the Debtor under the Plan.
  12. The Plan provides for the payment of all fees payable under section 1930 of the Bankruptcy Code on the effective date of the Plan, and for the payment of retiree benefits, as that term is defined in section 1114 of the Bankruptcy Code.
  13. The Plan does not discriminate unfairly with respect to any impaired class of claims or interests.
  14. The Plan is fair and equitable with respect to each impaired class of claims or interests.
  15. The Plan provides that each holder of a Secured Claim receive an account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the Plan, of at least the value of such holder’s interest in the estate’s interest in such property; or provides for the realization by each holder of a Secured Claim of the indubitable equivalent of such claims.

D. The Absolute Priority Rule.

The Absolute Priority Rule requires that the holders of equity interests receive nothing on account of their interests under the Plan unless creditors receive payment in full with interest. 11 U.S.C. section 1129(b)(2)(B). Under the prior Bankruptcy Act, the requirement was found by the Courts as part of the requirement that a plan be “fair and equitable.” The prior practice, however, included a corollary to the rule known as the “New Value Exception.” Where equity proposed to provide substantial new value, the equity holders could retain an interest even though other creditors were not paid in full. A nationwide dispute has centered on whether the New Value Exception remains a part of the Bankruptcy Code. The Absolute Priority Rule was expressly codified in section 1129(b); the New Value Exception was not (although section 1129 retained the test that the Plan be “fair and equitable.” Although the United States Supreme Court ultimately sidestepped the question, the Ninth Circuit Court of Appeals has found that the New Value Exception applies in bankruptcy. Bonner Mall Partnership v. U.S. Bancorp Mortgage Partnership, 2 F.3d 899 (9th Cir. 1993); Bank of America NTSA v. 203 N. LaSalle St. Partnership, 526 U.S. 434 (1999)(assuming that New Value Exception exists, Debtor cannot propose a Plan in which only equity has the right to bid for the new interests).

To meet the New Value Exception, the value contributed by the equity holders must be: (1) new; (2) substantial; (3) money or money’s worth (not personal services); (4) necessary for a successful reorganization; and (5) reasonably equivalent to the value or interest received. Bonner Mall, supra at 907. Other creditors must either have a right to bid for the equity interests or the bankruptcy court must determine the “market” value for the new equity interests. Bank of America NTSA, supra, at page 1423.