LaSalle the Market Test and Competing Plans Still in the Fog
Editor's Note: This issue of the Journal debuts a new column: News at 11. The column is a project of ABI's Business Reorganization Committee. As the "11" in the title suggests, the column will focus on issues of interest to chapter 11 practitioners, whether attorneys, financial advisors, investment bankers or other professionals. As for the "news," the column will focus on what we hope are current and cutting-edge issues in chapter 11 law and practice, with an emphasis on thought- and debate-provoking commentary, as well as reporting on hot topics.
In its LaSalle decision,2 the U.S. Supreme Court held that a "new value" plan that vested equity in the reorganized business in the debtor's former equity interest-holders "without extending an opportunity to anyone else either to compete for that equity or to propose a competing reorganization plan" was not confirmable under §1129(b)(2) (B)(ii) of the Bankruptcy Code.3 According to the Supreme Court, it was "the exclusiveness of the opportunity, with its protection against the market's scrutiny of the purchase price by means of competing bids or even competing plan proposals," that rendered the old equity's right to purchase the equity a property interest extended "on account of" the old equity position and thus afoul of the Code.4 Assuming the "new value corollary" exists at all (an issue left undecided), a plan that allowed old equity to acquire shares in the reorganized entity "without paying full value" would be fatally flawed, and the preferred method of determining "full value" was a market test:
It would thus be necessary for old equity to demonstrate its payment of top dollar, but this it could not satisfactorily do when it would receive or retain its property under a plan giving it exclusive rights and in the absence of a competing plan of any sort. Under a plan granting an exclusive right, making no provision for competing bids or competing plans, any determination that the price was top dollar would necessarily be made by a judge in bankruptcy court, whereas the best way to determine value is exposure to a market.5
The court declined to decide 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..."6 Indeed, the decision leaves open the possibility that a judicial valuation might suffice when a form of market valuation is not available.7
Given the decision's lack of guidance on the point, the post-LaSalle commentary was understandably filled with debate over the proper means of conducting the "market test," with the pros and cons of the two suggested options—as well as others—amply aired. One commentator found both options flawed, but, using auction theory, also surmised that each was likely to generate roughly the same price for the equity of the reorganized debtor.8 A slight nod was given to competing bids vs. competing plans, since fewer procedural and structural problems were present with competing bids. Problems with the competing-plans option included the possibilities that the judge might have to choose one of several plans, that the plans might be so different that the judge and creditors would be forced to compare "apples and oranges," and that termination of exclusivity risked creditor liquidating plans, which might be worse for creditors than the debtor's new value plan. The major benefit to competing bids was that the judge would presumably not have to decide among multiple plans, but problems arose as to the procedures needed to insure a bid within the debtor's plan would generate a "proper market valuation."9
Prof. Markell wrote that terminating exclusivity to allow competing plans might not suffice to create a market in small and mid-sized chapter 11 cases (the bulk of chapter 11 cases in number). The cost to creditors of preparing and confirming a plan might be seen as a disincentive to bid for the equity. Moreover, the new-value plans might be hard to mirror or may contain built-in practical or business advantages for the proponents. However, allowing bidding within the debtor's plan was also seen as a potentially flawed approach.10 Still others suggested that termination of exclusivity to allow for competing plans whenever a new value plan was proposed might be inevitable after LaSalle.11
One argument for favoring termination of exclusivity to allow for competing plans is that §1129(c) provides for competing plans and provides some guidance to the court in choosing which plan to confirm. That section, and its accompanying decisional law, are seen as proving a process through which to conduct the market test.12
This article will briefly review the post-LaSalle case law regarding whether the lower courts have expressed a preference for the competing plans or competing bids option. To the extent that terminating exclusivity to allow for competing plans is the chosen option, the article will explore when exclusivity should be terminated to satisfy LaSalle, as far as the case law sheds light on that issue. Last, the article will briefly explore the §1129(c) case law to examine whether the Code's competing plan procedure, as it now exists, works to provide a workable "market test" mechanism or raises still more unanswered questions.
Post-LaSalle Decisions: Competing Plans or Bids?
The case law on how best to structure the "market test" is sparse at best. In In re CGE Shattuck LLC,13 the court found that LaSalle was implicated by a debtor's new-value plan that provided a right for old equity to acquire controlling interest in the reorganized debtor and also issued a portion of the equity to third parties, but did not subject the value of the new equity to any form of "competitive bid procedure or other market determination of value..."14 The court then invited the debtor and other plan proponents to amend the plan "to provide for a competitive market determination of the value of the new equity which satisfies the standards enunciated in LaSalle."15 In In re Minkoff,16 the court found that the debtors' plan failed to satisfy §1129(b)(2)(B)(ii), but allowed the debtors to amend the plan to provide for a bid procedure. Thus, both CGE Shattuck and Minkoff opted, at least in theory, for the competing-bids option, and permitted debtors to use bid procedures within the proposed plan.
Other post-LaSalle decisions prefer—or mandate—termination of exclusivity to allow for competing plans as the mechanism to satisfy the "market test" requirement. In In re Situation Management Systems Inc.,17 the debtor filed a new value plan that included a provision for competing bids for the new equity, including specific bid procedures and a minimum overbid, with the court to approve the highest and best bid. The court held that the inclusion of bid provisions constituted cause for termination of exclusivity, finding that "the debtor's exclusive right to propose and gain acceptance of a plan has been effectively forfeited because any party can bid on the debtor's equity interest and assume control of the debtor if the bidder is successful."18 The court also found that where there is another party interested in acquiring the debtor, the opportunity to offer a competing plan was a preferable procedural mechanism to an auction because the requirement of a disclosure statement would allow creditors to make an informed choice: "Because an approved disclosure statement is a prerequisite to the circulation of a plan and the solicitation of votes, creditors will be able to choose which plan they prefer after having been provided with adequate information..."19 Having an informed expression of choice would assist the court in its §1129(c) determination of which plan to confirm.20 The court noted that some pre-LaSalle case law, commentators and the National Bankruptcy Review Commission report favored termination of exclusivity as a response to a debtor proposing a new value plan.21 The other court to address the issue, while not prejudging which of the two alternatives must be followed in the case, nonetheless refused to extend exclusivity further in the face of a new value plan found to implicate LaSalle.22
One circuit court found that neither option was required when the issue was whether or not old equity could receive releases of causes of action when senior classes were not paid in full. In In re PWS Holding Corp.,23 the court found that the releases were not received on account of the old equity position, but rather because the causes of action released were without merit and valueless, as determined by the investigation of a court-appointed examiner, and because, in the opinion of the plan proponents, extinguishing the claims was likely to provide the greatest addition to the bankruptcy estate. Acknowledging that the releases were not subjected to a formal market test as may be required by LaSalle, the court found that—in the limited circumstances of the case—the examiner's finding of little or no value to the claims was "an appropriate surrogate for a market test and an acceptable safeguard."24
Thus, the post-LaSalle case law is hardly determinative of the method required for satisfying the "market test." Combined with the earlier decisions and commentary, such authority as exists may suggest a preference in practice for terminating exclusivity to allow for competing plans. One question, however, is when in the process exclusivity should end in the face of a new value plan.
The Timing of Loss of Exclusivity: Avoiding Premature Termination
As noted above, the Situation Management Systems opinion implies that merely proposing a new value plan, including one with a bidding provision, is cause for termination of exclusivity, a position adopted by certain pre-LaSalle decisions, commentators and the Review Commission report. However, LaSalle clearly does not require this approach. As discussed above, the decision did not favor exclusivity termination over other market approaches and does not mandate that the "price of admission" for filing a new value plan is loss of exclusivity.
First, LaSalle is a decision about the application of §1129(b)(2)(B), the cramdown provision. As the court emphasized in In re Zenith Electronics Corp.,25 regardless of whether old equity receives or retains any property, LaSalle is not implicated if all impaired classes accept the plan and §1129(a)(8) is satisfied.26 The Zenith court noted that the restriction on the debtor's right to propose a plan contained in LaSalle should be limited to the facts of that case, where the absolute priority rule of §1129(b)(2)(B)(ii) is violated, and LaSalle does not apply where all creditor classes have accepted the plan.27 Moreover, LaSalle is similarly not implicated where, based on the valuation of the enterprise, value otherwise distributable only to senior classes is being voluntarily allocated by such senior classes to old equity and management (who may be the same people) to provide an incentive to remain with the company. The senior classes are free to allocate their property as they wish without violating the absolute priority rule.28 Thus, an enterprise valuation might be required in the case to determine if LaSalle is triggered.
Because of such considerations, the court in In re Annicott Excellence LLC,29 faced with a motion for relief from stay, refused to find a plan, which allegedly did not comply with LaSalle, patently unconfirmable. The court agreed that the objection was premature, because the new value corollary of §1129(b)(2)(B)(ii) does not come into play until a debtor attempts a cramdown of a rejecting class of impaired, unsecured creditors. "Until such time as an impaired, unsecured class actually rejects the plan, triggering a cramdown, the rule of [LaSalle] need not be considered.30 The court also found that it could not conclude that the moving creditors could establish a blocking position with respect to the debtor's plan.31
Annicott Excellence suggests the proper approach to timing if competing plans are used to satisfy the market test. Unless an objecting creditor or creditors can establish possession of a blocking position with respect to confirmation of a debtor's plan allowing for retention or receipt of property by old equity, and the plan is not otherwise infirm, exclusivity need not be terminated—at least to satisfy LaSalle—until the debtor has been allowed to solicit votes and has failed to satisfy §1129(a)(8). Blocking positions may be evident early in single-asset or individual chapter 11 cases, but will be hard to establish and maintain in more complex business reorganization cases of operating enterprises, including small or mid-sized cases. Premature termination of exclusivity may unfairly tip the negotiating balance in such cases, making it harder to achieve any form of plan. Moreover, creditors are perhaps less likely to file competing plans in such cases, given issues of management retention and various operational issues, particularly in smaller cases, as Prof. Markell suggested. Courts should be sure that LaSalle is at issue before pulling the plug on exclusivity.
The §1129(c) Process as the "Market"
If competing plans are chosen as the means to insure the market, §1129(c) of the Code provides—minimally—the process the court should follow in selecting which plans to confirm. That section simply provides:
Notwithstanding subsections (a) and (b) of this section and except as provided in §1127(b) of this title, the court may confirm only one plan, unless the order of confirmation in the case has been revoked under §1144 of this title. If the requirements of subsections (a) and (b) of this section are met with respect to more than one plan, the court shall consider the preferences of creditors and equity security-holders in determining which plan to confirm.32
The court, at the first step in the process, must first find that each of the multiple plans is confirmable under §1129(a) or, if necessary, by resorting to §1129(b).33 If the plan is a cramdown plan, the court must find that all necessary elements of §1129(b) are present, including that the plan is fair and equitable. If one of the plans under consideration is a new value plan requiring consideration under §1129(b), the court—at least prior to LaSalle—considered whether all of the elements of the new value corollary were satisfied, i.e., that the offered value was (1) new, (2) substantial, (3) money or money's worth, (4) necessary for a successful reorganization and (5) reasonably equivalent to the value or interest received.34 The court proceeds to the next step in the §1129(c) analysis only if two or more plans are found confirmable under §§1129(a) and (b).
In step two of the process, the court then determines which of multiple confirmable plans to confirm. In making this decision, courts consider the following factors: (1) the type of plan, (2) the treatment of creditors and equity security-holders, (3) the feasibility of the plan and (4) the preferences of creditors and equity security-holders.35 The first factor looks at whether the plan is a liquidating plan or a reorganization plan that will continue the debtor in business. The second factor looks at the amount to be received by both creditors and old equity. The third factor focuses on relative feasibility: Which of the plans—all of which must be feasible under §1129(a)(11)—is most feasible and has the greatest likelihood of successful consummation. The fourth factor embodies the "popularity contest;" in a multiple-plan vote, the ballot (usually a single ballot for all plans) will ask creditors which plan they prefer among the plans they accept. None of the factors is determinative, but the court must balance all of the relevant factors in choosing which plan to confirm.36
The courts favor debtor reorganization plans over creditor liquidating plans.37 Other factors—such as relative feasibility—may tip the balance to a creditor's liquidating plan that promises a higher return to creditors.38 Relative feasibility is an important factor, other factors being equal.39 The preferences of creditors and equity security-holders as expressed during the plan balloting process—particularly the preferences of non-insider creditors (other than the proponent creditor and affiliates)—carry great weight.40 However, the court is not bound by the expressed preference of either group.41 A plan preferred by creditors and equity security-holders was held to prevail over a creditor plan that paid more, suggesting that the highest payout to creditors was not—at least prior to LaSalle—a deciding factor.42
How, post-LaSalle, should a court apply the §1129(c) process when competing plans are used to satisfy the "market test"? In applying step one, threshold confirmability, questions arise in determining whether §1129(b) has been satisfied by the debtor's new value plan. Given the Supreme Court's disdain for judicial valuation, should (can) the bankruptcy court determine "reasonable equivalence" at all, or has this element been replaced by the "market test"? In other words, does the debtor need to establish equivalence through evidence, or is it enough that exclusivity has been terminated and competition for the equity is underway? Reflecting on the Supreme Court's discussion about the need for old equity to pay "full value" or "top dollar," can the new-value plan be determined confirmable (and thus advance beyond step one of the analysis) if the price to be paid for the new equity is not, on its face, equal to or higher than that offered by the competing plan proponent? If LaSalle requires that old equity pay "top dollar," the answer is in the negative. If, on the other hand, LaSalle simply requires that creditors have the opportunity to choose "top dollar" or not, then a new value plan that pays less than the competing purchase price should at least survive to step two of the §1129(c) analysis.
Creditor choice should prevail in this circumstance. Since the "reasonable equivalence" test was designed to insure that old equity was paying "market value" or close to it for new equity, this safeguard is arguably now replaced by LaSalle's competitive bidding requirement. A debtor plan that meets the other elements of the new value test, but has a lower initial "offering price" for the equity, should be compared—in step two of the §1129(c) analysis—to a competing plan, thus allowing the court to examine critical issues of creditor preference and relative feasibility. If creditors want a lower payout—after examining all other factors—and the debtor plan is sufficiently feasible, why should a competing, higher-paying plan be forced upon them?
At lease one commentator has suggested that after LaSalle, a court applying §1129(c), would be hard-pressed not to confirm the plan that paid the highest price for the new equity.43 However, if LaSalle is fundamentally about insuring creditor choice, as opposed to merely a required method of valuation, the selection of a preferred, lower-paying plan should be possible. Moreover, factors such as certainty of payment and the possibility of future business are relevant to creditors, not just dividend size in the abstract. However, the Supreme Court's language about plans that do not pay "top dollar" being fatally flawed is nonetheless troubling in this respect.
The post-LaSalle case law has provided little guidance as to the method to be used to satisfy the "market test" requirement suggested by the Supreme Court's decision. Questions remain as to whether terminating exclusivity to permit competing plans is the best approach, and if so, as to when exclusivity should be ended for this purpose. How prior jurisprudence under §1129(c) will be applied in this context is far from clear. The extent that LaSalle is a factor beyond individual or single-asset cases remains to be seen, but clarity in applying the decision must await further development in the case law.
1 Shareholder, Bernstein, Shur, Sawyer & Nelson, P.O. Box 9729-5029, 100 Middle Street, Portland, ME 04104-5029, [email protected]. Board-certified in business bankruptcy by the American Board of Certification. Return to article
8 Hoang, Hieu T., "The New Value Exception to the Absolute Priority Rule after In re 203 N. LaSalle Street Partnership: What Should Bankruptcy Courts Do, and How Can Congress Help?," 149 U. PA. L. REV. 581, 610 (December 2000). Return to article
10 Markell, Bruce A., "LaSalle and the Little Guy: Some Initial Musings on the Ultimate Impact of Bank of America NJ & SA v. 203 North LaSalle Street Partnership, 16 Bankr. Dev. J. 345, 354 (2000). Return to article
11 See, e.g., Miller, Harvey R., Rapisardi, John S., and Greene, Reginald A., "Leaving Old Questions Unanswered and Raising New Ones: The Supreme Court Furthers the New Value Controversy in Bank of America National Trust & Savings Ass'n v. 203 North LaSalle Street Partnership, 30 U. MEM. L. REV. 553, 590 (Spring 2000); Brunsted, G. Eric, and Sigal, Mike, "Competitive Choice Theory and the Broader Implications of the Supreme Court's Analysis in Bank of America v. 203 North LaSalle Street Partnership, 54 BUS. LAW. 1475, 1544 (August 1999) ("Competitive Choice"). Return to article
28 In the Matter of Genesis Health Ventures Inc., 266 B.R. 591, 618 (Bankr. D. Del. 2001). See, also, In re SPM Manufacturing Corp., 984 F.2d 1305 (1st Cir. 1993) (senior secured debt could give up value to unsecured debt without violating Code's priority scheme). Return to article
31 Id. at 285. A blocking position would usually be obtained when an objecting creditor (or group of creditors) holds more than one-third in dollar amount of the claims in a class. 11 U.S.C. §1126(c). Return to article
33 See, e.g., In re Valley View Shopping Center L.P., 260 B.R. 10 (Bankr. D. Kan.), at *15(“The court’s starting point is to determine whether either or both of the plans presented are confirmable.”); In re Holley Garden Apartments Ltd., 238 B.R. 488, 493 (Bankr. M.D. Fla. 1999) (“The first step at a confirmation hearing on competing plans is to determine whether one or more of the plans are confirmable.”); In re Cellular Information Systems Inc., 171 B.R. 926, 928 (Bankr. S.D.N.Y. 1994).. Return to article
37 See, e.g., Holley Garden Apartments, 238 B.R. at 495; Valley View Shopping Center, 2001 Bankr. LEXIS 174 at *75; In re Patrician St. Joseph Partners L.P., 169 B.R. 669 (D. Ariz. 1994); In re Oaks Partners Ltd., 141 B.R. 453(N.D. Ga. 1992).. Return to article
43 Miller, Judith Lunstron, and Murray, John C.,“The ‘New Value’ Exception: Myth or Reality after Bank of America National Trust & Savings Association v. 203 North LaSalle Street Partnership?,” 104 COM. L.J. 147, 162 (Summer 1999).. Return to article