n In re Global Ocean Carriers Ltd., 251 B.R. 31 (Bankr. D. Del. 2000), the bankruptcy court examined the relationship between insiders and the new value exception to the absolute priority rule and came to a surprising conclusion: The process was more important than the participants. The bankruptcy court denied confirmation of Global Ocean's modified plan of reorganization for itself and 15 wholly owned affiliates, sustaining the objection of a small noteholder and minority shareholder based on the absolute priority rule.

Global Ocean and its affiliates are involved in the international shipping industry. Global Ocean is a publicly traded company whose stock was registered on the American Stock Exchange until shortly before the bankruptcy filing, with the Tsakos family controlling more than 50 percent of its shares. Global Ocean issued $126 million in unsecured notes, which were subordinated to $51 million in senior secured debt.

After negotiations with an ad hoc committee of noteholders, the debtors filed a reorganization plan and disclosure statement on the day the case was filed. The plan provided for a 50 percent cash payment to the noteholders, all other creditors were to be paid in full in accordance with their normal terms, and the existing shareholders would be eliminated. All of the new stock in the reorganized Global Ocean would be issued to a company owned by Maria Tsakos in exchange for new capital of up to $10 million. Maria Tsakos is the daughter of Capt. Panagiotis Tsakos, the largest and controlling shareholder. Global Ocean was to retain ownership of the other debtors.

After voting on the plan, the note-holders, the only impaired class, rejected it under the numerosity test. The plan was also opposed by Arabella, an investment company that had purchased a small number of shares and notes at steep discounts. Thereafter, the debtors filed the modified plan, which changed the treatment of the senior secured creditor in a manner the debtors assert impaired it. The senior secured creditor then voted to accept the modified plan, thereby providing the debtor with one impaired accepting class.

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Following Global Ocean's call for a broad reading of 203 North LaSalle, the need for market testing would be no less necessary where the new equity is being sold to existing shareholders as where it is being sold to existing creditors...

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Arabella objected to confirmation on the grounds that the modified plan violated the absolute priority rule. This was because, among other things, the equity of the reorganized Global Ocean would be issued to a company owned by Maria Tsakos. Global Ocean asserted that this did not violate the absolute priority rule because the new equity was not being retained by an existing shareholder; in fact, it was being sold to a non-shareholder. In support of its position, Global Ocean relied on Beal Bank v. Waters Edge Limited Partnership, 248 B.R. 668 (D. Mass. 2000), in which the district court had upheld confirmation of a plan providing for the private sale of the reorganized debtor's equity to the existing shareholder's son-in-law. The Beal Bank court concluded that unless the buyer was acting merely as a straw party for an existing shareholder, the sale of equity in the reorganized debtor to anyone other than an existing shareholder was not prohibited by the absolute priority rule. 248 B.R. 680.

In denying confirmation of the modified plan, the bankruptcy court determined it unnecessary to decide whether Maria Tsakos was acting as a straw party for her father because it disagreed with the conclusion of the Beal Bank court. Instead, the bankruptcy court focused on how the modified plan determined who would own the equity of the reorganized Global Ocean, as opposed to the identity of the entity selected and its relationship to the old equity-holders.

The bankruptcy court determined that the fundamental flaw in the modified plan was not that Maria Tsakos was the straw party for the largest shareholder (although it found evidence to support Arabella's contention that she was); rather, it was the deeper structural problem of how the selection of the new equity-holder was made. Turning to Bank of America v. 203 North LaSalle Street Partnership, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed. 2d 609 (1999), the bankruptcy court determined that the absolute priority rule was violated because the "exclusiveness of the opportunity, with its protection against the market's scrutiny of the purchase price by means of competing bids or competing plan proposals, rendered the [controlling shareholders'] right a property interest extended 'on account of' the old equity position and therefore subject to an unpaid senior creditor class's objection." 251 B.R. at 49 (quoting 203 North LaSalle, 526 U.S. at 456, 119 S.Ct. 1411).

The bankruptcy court concluded that essentially the same structural flaw that rendered the plan in 203 North LaSalle unconfirmable was also present in the modified plan. Global Ocean's controlling shareholder determined, without the benefit of a "new value auction" or a termination of exclusivity, exactly who would own the equity of the reorganized Global Ocean as well as the price to be paid. It was the ability of Capt. Tsakos to exercise this control, solely "on account of" his position as controlling shareholder of Global Ocean, that caused the modified plan to violate the absolute priority rule. The bankruptcy court stated that this fundamental flaw could only be cured by testing the market for the "exclusive opportunity" by either terminating exclusivity and allowing others to file a competing plan or allowing others the right to bid for the new equity—neither of which the modified plan provided.

In rejecting the Beal Bank relationship test and what the bankruptcy court characterized as a narrow reading of 203 North LaSalle, Global Ocean raised an important question: Does 203 North LaSalle require market testing in every chapter 11 reorganization case in which creditors get less than payment in full and old equity is replaced by new equity? A fair reading of Global Ocean suggests that it does.

By focusing on the structural determination of whether the sale of the equity in the reorganized debtor has been appropriately market tested (i.e., whether by terminating exclusivity or conducting a "new value auction"), Global Ocean suggests that 203 North LaSalle is implicated every time a plan provides for a reorganization in which creditors' claims are compromised and old equity is replaced with new equity. Indeed, unless exclusivity is terminated or a "new value auction" is held, the "exclusive opportunity" will necessarily persist in every case where the debtor alone determines to whom the new equity will be sold and the price that will be paid. This is so regardless of whether the "exclusive opportunity" is exercised by a controlling individual shareholder in a closely held corporation, a general partner in a general or limited partnership or the management of a publicly held company (acting derivatively for shareholders)—and regardless of the identity of the purchaser (keeping in mind that sales to insiders and straw parties might be subject to special scrutiny).

If the relationship of the new equity-holder to the old equity-holder is overshadowed by the structural aspects of the decision, as Global Ocean states, market testing should not necessarily be confined to those cases in which old equity-holders have simply arrogated unto themselves the "exclusive opportunity" to subscribe to new equity. Moreover, if economic competition for the new equity is the touchstone of the new value exception to the absolute priority rule, then Global Ocean suggests that market testing is required at every point along the continuum of reorganization possibilities. Following Global Ocean's call for a broad reading of 203 North LaSalle, the need for market testing would be no less necessary where the new equity is being sold to existing shareholders as where it is being sold to existing creditors in, for example, a typical "stock-for-debt" plan. The ability of a single dissenting creditor or shareholder to raise this confirmation objection suggests that it is a test that may have to be routinely satisfied.

Time will tell whether the legacy of Global Ocean will be to force earlier terminations of exclusivity and infuse the bankruptcy marketplace with a new intensity of economic competition.