The Aftermath of LaSalle The Question Is Not How to Apply the Decision But When
LaSalle failed, however, to give any guidance on how to satisfy the market-test requirement other than to suggest that the right to bid or to propose a competing plan may suffice. Although it is possible that simply terminating the debtor's exclusivity under §1121 is enough, in many instances it is likely that an auction will be necessary.
But the procedural and substantive mechanisms for the bidding process are subject to debate. Commentators have raised numerous questions. For example, does it matter that a creditor in effect recaptures its successful bid in satisfaction of its claim?2 If the bidder intends to liquidate the debtor, does it constitute bad faith? Must the court conduct an independent valuation as a check on the market?3
Nevertheless, a year and a half has passed since the Supreme Court handed down the decision and the courts have not even begun to address these questions and many others about how to apply LaSalle. Instead, the few reported cases have been bogged down in largely unanticipated issues surrounding the issue of when to apply the decision. First, is the LaSalle objection available only to unsecured creditors? Is it also available to interest holders under §1129(b)(2)(C) or to holders of impaired secured claims under §1129(b)(2)(A)? Further, can an impaired claim-holder raise a LaSalle objection when the debtor does not propose to retain an interest, but to sell the equity to an insider third party? Unfortunately, the cases provide very little in the way of clarity or uniformity. They are, however, instructive of how parties will try both to expand and to limit the Supreme Court's holding, and it is apparent that the issues raised by LaSalle are more numerous than perhaps earlier suggested.
The question of whether parties other than unsecured claim holders can invoke the LaSalle market-test requirement is addressed in In re Zenith Electronics Corp.4 and In re New Midland Plaza Associates.5 In Zenith, the debtor proposed a plan whereby LGE, its largest creditor and majority shareholder, received 100 percent of the equity in the reorganized debtor for a $60 million cash infusion and the release of a $200 million claim. LGE's acceptance was contingent upon a 50 percent reduction of outstanding bond debt and elimination of all shareholder interests. An ad hoc committee of minority shareholders objected on the basis that the adequacy of LGE's contribution of new value had not been subjected to a market test in accordance with LaSalle. But the Delaware bankruptcy court, in an opinion delivered by Judge Mary F. Walrath, ruled that because all classes of creditors had accepted the plan, the absolute priority rule as set forth in §1129(b)(2)(B) did not apply.6 It is beyond question that this conclusion is correct.
But the opinion went on to claim that LGE received the right to buy the equity in its capacity as creditor instead of as majority shareholder. The apparent point of the distinction was that even if there had been a dissenting creditor, §1129(b)(2)(B) would not have been violated. The basis for the determination that LGE received the opportunity to buy equity on account of its creditor status is not clear. Presumably, it was because forgiveness of debt made up the bulk of LGE's new value contribution. It is just as logical, however, to conclude that LGE received the right to purchase equity on account of its ability to control the debtor as majority shareholder. Thus, it seems that if a creditor had made an absolute priority rule objection in this case, it would have been unjust in light of LaSalle not to require a market test. Somewhat inexplicably, the court went on to state that giving the shareholders the right to bid in this instance "would present the same problem as the LaSalle plan did."7 But there is no reason why the minority shareholders would not have had that right if an auction had been necessary. LaSalle only held that the right to bid should not be given to old equity exclusively.
The most baffling part of Zenith, however, is its assertion that §1129(b)(2)(C), relating to interest-holders, was the applicable provision and that LaSalle does not apply to the absolute priority rule as set forth therein. Without more analysis, Judge Walrath states:
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 encompassed in §1129(b)(2)(B) is violated...8But there is no apparent reason why LaSalle would not require a market test in a situation where junior interest-holders receive the opportunity to purchase equity in the reorganized debtor over the objection of impaired senior interest holders. It would have been more accurate for Zenith to hold that the plan did not violate §1129(b)(2)(C) because there were no interests junior to the objecting shareholders. The opinion is confusing to say the least, and it runs counter to the reasoning adopted by the U.S. Bankruptcy Court for the Southern District of Florida in New Midland Plaza Associates.9
The New Midland court confirmed a debtor's plan that allowed its partners to hold on to their equity while significantly impairing the holder of an oversecured claim. Among its many objections to confirmation, the secured creditor asserted that the plan violated the absolute priority rule as described by LaSalle. The court had little difficulty in finding that a fully secured creditor does not have standing to assert a LaSalle objection. The basis for the holding was that whether a plan is fair and equitable with respect to a secured creditor depends on §1129(b)(2)(A). The court reasoned that Congress included the absolute priority rule in subsection (B) relating to unsecured creditors and in subsection (C) relating to classes of interest, but excluded it from subsection (A). According to New Midland's statutory analysis, a senior interest-holder would have standing to assert the LaSalle objection when a junior interest-holder receives or retains property on account of its interest in the debtor. After all, §1129(b)(2)(C) includes subsection (B)'s version of the absolute priority rule.
While the Zenith and New Midland cases are inconsistent only in their rationale, the next two post-LaSalle decisions stand in direct contradiction to one another. These cases disagree on whether LaSalle is applicable to a debtor's private sale of equity to insiders. Beal Bank S.S.B. v. Waters Edge Ltd. Partnership10 involved the typical single-asset case scenario. The debtor limited partnership owned a $16.6 million apartment complex that had failed to generate enough income to service the lending bank's $29.5 million mortgage. The plan, confirmed by the bankruptcy court in an unpublished opinion, proposed to satisfy the secured portion of the bank's claim with deferred cash payments, while paying 0.1 percent of its $12.9 million deficiency claim on the effective date. All of the equity in the reorganized debtor would be sold for $1.3 million to the son-in-law of the partner that owned a 99.5 percent interest. The bank objected to confirmation on the grounds that an insider sale of ownership in a single-asset debtor without a market test was equivalent to a sale of its collateral, entitling it to credit-bid against its secured claim. But the court summarily refused to characterize the transaction as such, insisting that the sale of equity did not improperly frustrate the bank's credit-bid rights.11
The bank next argued that the plan violated the absolute priority rule by essentially permitting the original partner to retain his interest by means of the insider sale. The court refused to accept this de facto retention argument absent proof that the insider was acting as a "straw man" for the original partner. The court concluded that the new value corollary as described in LaSalle did not prohibit a private sale of the debtor's equity to anyone other than an existing owner. It also acknowledged, however, that "an auction of the equity interest...would have been preferable here" but that "the issue was not pressed below."12 LaSalle had not been decided at the time of the 1998 confirmation hearing from which the bank appealed. It is possible that the result would have been different if the bank had had the benefit of LaSalle from the outset.
Judge Walrath's opinion in In re Global Ocean Carriers Ltd.13 stands in direct contradiction to Beal Bank, and despite her statement in Zenith that "it is not appropriate to extend the ruling of [LaSalle] beyond the facts of that case," she did just that in Global Ocean. Similar to Beal Bank, the debtor in Global Ocean proposed a plan transferring all of its stock to an insider, the majority shareholder's daughter, in return for a $10 million capital contribution. The plan slightly impaired the secured claim of Credit Lyonnais and provided for a 50 percent payout to unsecured noteholders. Credit Lyonnais accepted the plan, but the noteholders argued that it ran afoul of the mandate in LaSalle due to the private sale of stock to an insider. The debtor countered, relying on Beal Bank, that there was no absolute priority rule violation because the stock was not being retained by an existing shareholder, and that the insider was not in fact receiving the shares on behalf of old equity. But Global Ocean refused to address the debtor's contention:
We do not find it necessary to decide this issue because we disagree with the conclusion of the Beal Bank court. We believe that the Supreme Court decision in [LaSalle] cannot be read as narrowly as Beal Bank suggests.14After carefully analyzing the rationale in LaSalle, Judge Walrath ruled that the exclusive right to determine who buys the stock and at what price constituted the "property" that the majority shareholder retained on account of its equity interest. Accordingly, the debtor had to subject that "exclusive opportunity" to the market:
Thus we conclude that the debtor's plan violates the absolute priority rule by allowing the existing controlling shareholder to determine, without the benefit of public auction or competing plans, who will own the equity of Global Ocean and how much they will pay for it.15The broad language of the court's conclusion makes no effort to limit its holding to an insider sale. It seems to require a market test any time the debtor has the exclusive right to control the sale. But directly after the court concludes that Beal Bank read LaSalle too narrowly, it continues:
In fact, among numerous predictions of plans which may avoid the result in LaSalle, we have found none to suggest that a plan which gives the equity to the largest shareholder's daughter can pass muster.16This statement supports a narrow reading of Global Ocean, as it clearly gives some weight to the fact that the third party was an insider. Ultimately, it is unclear whether the case applies equally to sales to non-insiders.
Questions regarding the scope of LaSalle remain after Global Ocean, Beal Bank, Zenith and New Midland. It is likely that dissenting claim-holders will assert new arguments to extend the market-test rationale beyond the facts of LaSalle. It is just as likely that debtors will find creative ways to avoid the market-test requirement. Additionally, the cases decided so far are subject to conflicting interpretations. More issues will arise with respect to the applicability of the Supreme Court's holding. It is also apparent that LaSalle's legacy will become even more uncertain as other courts address the scope of the decision. The only certainty is that more litigation will follow.