In Bank of America National Trust and Savings Association v. 203 North LaSalle Street Partnership, __ U.S. __, 119 S.Ct. 1411, __ L.Ed.2d __ (1999), the U.S. Supreme Court addressed the long-debated issue of whether the new value exception to the absolute priority rule survived the enactment of the U.S. Bankruptcy Code. LaSalle fell short of a definitive answer, however, as the court stated that the issue was "not to be decided here." Instead, the court held that the debtor's proposed plan of reorganization was not confirmable regardless of the validity of the new value exception. LaSalle at 1411, 1422-23.

Specifically, the court held that old equity holders could not, over the objection of a senior class of impaired creditors, contribute new value and receive ownership interests in the reorganized debtor without allowing others to either (a) compete for that equity or (b) propose a competing plan of reorganization. LaSalle at 1422-23. The court then specifically set forth a new unresolved issue by holding that "whether a market test would require an opportunity to offer competing plans, or would be satisfied by a right to bid for the same interest sought by old equity, is a question we do not decide here." Id. at 1424. Thus, as Justice Thomas stated in his concurring opinion, "the approach taken today only thickens the fog." Id. at 1426.

The Thickening of the Fog

By now, every chapter 11 practitioner is aware of the LaSalle ruling, but perhaps not the additional unresolved issues raised therein.

LaSalle, in addition to not resolving the new value problem, raised many other issues. Specifically, although LaSalle held that old equity cannot contribute new value and retain or receive equity interests in a reorganized debtor without first offering others a chance to purchase equity or propose a competing plan, the court did not address whether: (1) an offer to bid suffices, as opposed to an actual auction; (2) third parties may bid, or only existing creditors; (3) an auction must occur if the equity involved is publicly traded; (4) an auction must occur if the debtor proposes its plan after exclusivity terminates; and (5) whether the termination of exclusivity suffices if no creditor files a competing plan.

Fortunately, even though the Supreme Court failed to address these issues, certain pre-LaSalle case law discusses the equity interest sale issues. Though prior to LaSalle, these holdings shed light upon the proper procedure. Much like fog lights in deep fog, however, these cases only allow the practitioner to see a short distance ahead.

Pre-LaSalle Case Law

Though the LaSalle opinion is very recent, the burdens imposed therein are not new to all bankruptcy practitioners as certain bankruptcy courts previously set forth similar holdings, along with the additional necessary guidance. Not all issues raised herein, however, were previously addressed.

For example, in In re Bjolmes Realty Trust, 134 B.R. 1000 (Bankr. D. Mass. 1991), which is perhaps the most widely cited pre-LaSalle case, the court closely examined the issue of whether a new value contribution was the reasonable equivalent of the equity interests received or retained. Specifically, Bjolmes focused on (1) the propriety of seeking capital from stockholders, without exploring other sources and (2) valuing the equity interest retained or received. Bjolmes Realty Trust, 134 B.R. at 1008-10. In examining these issues, Bjolmes concluded that the only proper method of determining the value of the equity interests retained or received was to measure market forces, when the equity is not publicly traded, by offering the equity interests for sale. Id. at 1010.

Thus, Bjolmes held that when a creditor opposes a plan of reorganization, and that creditor is a likely buyer of equity interests, an auction must be held among the debtor's shareholders and any creditors interested in purchasing equity interests. Where creditors were not interested in bidding or lacked funds to bid, however, equity interests "must presumably be placed on the market in order to encourage third-party buyers." Bjolmes at 1010. Thus, Bjolmes proposes a two-step auction offer—first to creditors and then to third parties.

Other courts, however, have held that merely giving notice of old equity's proposed new value contribution is sufficient, and that only upon objection should the debtor auction equity interests. In re Ropt Ltd. Partnership, 152 B.R. 406, 412 (Bankr. D. Mass. 1993); BT/SAP Pool C Associates v. Coltex Loop Central Three Partners L.P., 203 B.R. 527, 535-36 (S.D.N.Y. 1996), aff'd, 138 F.3d 39 (2d Cir. 1998); but, see In re Homestead Partners Ltd., 197 B.R. 706, 719 (Bankr. N.D. Ga. 1996) (where the court adopted the Bjolmes approach). Ropt and Coltex, therefore, offer a streamlined process whereby an auction occurs only upon objection.

Unfortunately, none of these cases demonstrate why an auction between old equity and existing creditors should prevail over an offer to sell the equity interests to third parties, other than perhaps limiting the number of potential purchasers. Indeed, equity interests in a reorganized debtor are property interests, much like equipment and inventory, whose sales are more often than not open to any purchaser, not just creditors. Thus, while Bjolmes and other pre-LaSalle case law gives guidance, perhaps future equity interest sales should modify this approach and simply treat the sale of equity interests as the sale of any property of the estate.

While these cases focus on the sale of equity interests to demonstrate the necessity of new capital contributions and to prove market value, they follow LaSalle's reasoning and offer guidance as to the proper procedure for the sale of equity interests.

Other issues remain, however, as pre-LaSalle case law does not discuss the effect of filing a plan after exclusivity terminates, except for Homestead, which rejects the exclusivity termination option.

See Homestead, 197 B.R. at 719. Further, these cases, as well as LaSalle, fail to recognize the potential conflicts with non-bankruptcy law that equity interest sales may create, i.e., securities regulation violations.

Securities Regulations and Equity Interest Sales

Though the sale of equity interests appears to be a good solution to what many consider an otherwise unfair domination of a reorganized debtor, problems persist. Specifically, securities regulations may prohibit the exact type of equity interest sales that the Supreme Court now requires. See In re Homestead Partners Ltd., 197 B.R. 706, 717-18 (Bankr. N.D. Ga. 1996). Particularly, the Securities Act of 1933, as well as many state statues, contains certain registration requirements with potentially cost-prohibitive requirements. See 15 U.S.C. 77e. Failure to comply with these registration requirements could lead to serious civil and criminal consequences from either the Securities and Exchange Commission or purchasing creditors claiming fraud.

These registration requirements can be avoided, however, for certain equity interest sales because the 1933 Act exempts "transactions by an issuer not involving any public offering," a.k.a. the private placement exemption. 15 U.S.C. 77d(2). The private placement exemption focuses on the qualitative characteristics of the offeree group, specifically whether the prospective purchasers need the protections of the registration process. Mark v. FSC Securities Corp., 870 F.2d 331, 333 (6th Cir. 1989) (citing Securities & Exchange Commission v. Ralston Purina Co., 346 U.S. 119, 125, 73 S.Ct. 981, 984-85, 97 L.Ed. 1494 (1953) (a non-public offering is "[a]n offering to those who are shown to be able to fend for themselves")). Accordingly, transactions involving a limited group of sophisticated investors with independent access to the kind of financial information disclosed by registration are not "public offerings" and may be exempt from registration requirements. United States v. Lindo, 18 F.3d 353, 358 (6th Cir. 1994); Ackerberg v. Johnson, 892 F.2d 1328, 1337 (8th Cir. 1989).

Therefore, theoretically, the chapter 11 process, with its plan submission and disclosure statement requirements, sufficiently informs participating creditors of the debtor's financial affairs and intentions, perhaps even more than a registration and prospectus would inform a normal investor. Homestead at 706, 718-19. Thus, by confining an auction to existing creditors, with pre-existing contacts and familiarity with the debtor's affairs, as well as a degree of business sophistication, might qualify as an exempt private placement. Id.

On the other hand, not all equity interest sales will qualify as an exempt private placement, an issue the reorganized debtor may not discover until after the initiation of civil or criminal proceedings. Nor does Homestead address the effect of proposing an equity interest sale when the debtor is a publicly traded company. These issues, among others, remain outstanding and are potentially devastating. Consequently, the attentive practitioner must beware as potential problems, far outside the scope of this article, lurk in the fog.

Conclusion

Equity interest sales, therefore, are not the simple bidding procedure that the Supreme Court suggests. In fact, an equity interest sale might result in a heavy burden for the debtor, possibly undermining the debtor's reorganization efforts. The unresolved issues raised and implied by LaSalle increase this burden. Unfortunately for all, these issues are but forthcoming as the constitutional "case or controversy" requirement is an ever-present obstacle to full resolution.

Thus, although LaSalle addressed the new value exception to the absolute priority rule, the bankruptcy community is again left questioning its existence, as well as how to apply its newly imposed burden. While certain pre-LaSalle case law gives guidance, treacherous roads lie ahead in the ever-thickening fog.

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Footnotes

¹ The authors thank Laura Braasch, a third-year law student at Southern Methodist University, for her contribution in researching and writing this article. Ms. Braasch clerked at Patton Boggs this summer and will join the firm in September 2000. Return to article