The Challenge of Exclusivity Appeal of Original Equity Owners

By: Michael M. Harary

St. John's Law Student

American Bankruptcy Institute Law Review Staff 

In H.G. Roebuck & Son, Inc. v. Alter Communications, Inc.,[1] (“Roebuck”) the United States District Court for the District of Maryland reversed the bankruptcy court’s decision to grant the debtor, Alter Communications, Inc. (“Alter”), the exclusive right to file a plan of reorganization because the proposed plan violated the absolute priority rule.[2] H.G. Roebuck (“Roebuck”) sought to submit a competing plan, but was denied because the bankruptcy court determined that Alter’s plan satisfied the absolute priority rule and was confirmable. The court held that Alter’s prior equity holders, the Buerger family, could be granted the exclusive right to purchase shares in the reorganized company, even though the proposed plan provided for less than a 16% return to certain general unsecured claimants, including Roebuck.[3] Alter’s remaining unsecured creditors were to be paid in full.[4] The court reasoned that it was permissible to pay an old equity holder a greater return than certain unsecured claimants because the plan required the prior equity holders to contribute $34,850 in “new value” and therefore the “new value” exception to the absolute priority rule was satisfied.[5]

The district court addressed two issues in its decision: (i) whether the “new value” exception to the absolute priority rule applied and (ii) if not, what is the appropriate remedy. The absolute priority rule prevents confirming a plan if prior equity holders retain their equity interests “on account of” their pre-petition interests.[6] The Supreme Court held in Bank of Am. Natl. Trust & Savings Assoc. v. 203 North LaSalle Street P’ship (“LaSalle”)[7] that “new value” needed to be actually tested in market valuation or competitive bidding.[8] The Court determined that a market valuation requirement ensures that the former equity holders’ proposed contribution is the best obtainable price.[9] Here, the court found that Alter’s method of “testing” the market did not satisfy the LaSalle requirements because Alter’s valuation of its old equity was based solely on an expert’s valuation of the company and “eight bare-bones advertisements.”[10] As a result, the court held that the absolute priority rule was violated and the plan was unconfirmable.

The second issue was the appropriate remedy. The court determined that it could either terminate exclusivity and allow competing reorganization plans to be considered, or modify the original plan and allow competitive bidding.[11] The court held that the act of filing a new value plan along with Roebuck’s “expressed interest in acquiring . . . some of the reorganized” was sufficient cause to terminate exclusivity since the absolute priority rule was violated coupled with sufficient interest by the creditor.[12]

Roebuck will have an impact on other bankruptcy cases because it held that testing the market was defined literally. Even when other options exist to rectify the debtor’s failure to test the market, failure to comply will likely result in termination of exclusivity. In the interest of all parties and fairness, a plan that was deemed to have failed the market value test and perforce violated the absolute priority rule, no longer deserved the privilege of exclusivity and competing plans should be introduced.  Going forward debtors must carefully weigh their options and exercise caution when testing the market value in order to comply with the more rigid and technical requirement or risk having their exclusive right to propose a plan terminated. In addition it remains to be seen how this decision will affect the likelihood of old equity holders in retaining their interests in reorganized companies.

[12] Id.