Students interested in business bankruptcy often ask whether they should characterize themselves as transactional lawyers or litigators. Prepackaged chapter 11 cases illustrate why this question defies an easy response and invites inquiries into the nature of chapter 11's substance and procedure. The prepack seems to be a deal-making enterprise given that crucial aspects of the prepackaged process, such as negotiation and solicitation of votes, precede the bankruptcy filing. However, the prepack also ultimately requires the commencement of a chapter 11 case in the federal judicial system. The events and determinations in the case are supposed to adhere to bankruptcy law and rules of procedure and provide the requisite substantive and procedural protections on behalf of individual parties, classes of claims and interests, and arguably the bankruptcy system itself. Thus, party support resulting from negotiation may be necessary but not determinative of the outcome; U.S. Trustee objections and judicial determinations have the potential to "derail" the deal. Courts could and sometimes do find that the solicitations were inadequate, encourage competing plans or deny confirmation altogether. In other words, prepacks—and all chapter 11 cases, to a large extent—are supposed to be both negotiated business deals and formal judicial processes. The two sets of expectations do not necessarily coexist peacefully.

The deal-litigation tension is not new, but it may be growing. Rather than using prepacks principally for restructuring institutional debt, parties use prepacks in an ever-wider range of contexts, such as to implement mass-tort settlements² or to consummate sales or mergers.³ In addition, business bankruptcy has evolved through innovative transactions that rely more on parties exercising leverage and less on judicial determinations.⁴

Given this tension, judges and U.S. Trustees inherently walk a tightrope to find the right level of involvement. The challenge for government actors can be acute in pre-negotiated chapter 11 cases, in which the parties may conduct substantial negotiations prior to filing but do not formally solicit votes.⁵ The parties may have memorialized their understandings in voting agreements, which puts them more in the realm of contract and corporate law, only to be thrust later into a different set of requirements.⁶ Or the debtor may enter chapter 11 with intentions to effectuate a quick sale only to confront concerned parties in interest once they learn, among other things, that the stalking-horse bidder who wants a break-up fee also is a major creditor in the case.⁷

Monday morning quarterbacks, admittedly including the author, may be dissatisfied with the level of governmental intervention, or lack thereof, in instances such as these. Reactions are a bit like the story of Goldilocks and The Three Bears: The intervention is too much or not enough, but rarely just right.⁸ Sometimes, judges and U.S. Trustees appear to be overreaching when they disrupt the deal. Parties with actual economic interests are satisfied with the negotiation and resolution that culminated in voting agreements, for example, but the government actors persist in disqualifying the later votes. And yet, other times, when government actors do honor the deal, such as in permitting the requested break-up fee to the stalking-horse bidder/creditor, such actions might strike us as permissive, particularly when other creditors are complaining. Perhaps government actors in such cases see no better alternative for the creditors and shareholders. But holders of those claims and interests, not to mention would-be outside investors, may conclude that the bankruptcy system is a little too kind to the strongest inside players.

When parties and commentators react to government actor decisions, they generally focus on the merits and substantive arguments involved in each discrete circumstance. This is understandable and important, but one also should take a broader view. Even if consensus eventually develops on whether voting agreements violate §1125 or whether secured creditors ever deserve break-up fees, new issues undoubtedly will emerge, and complaints about overreaching and permissiveness by government actors will not subside. The more pervasive problem is that reasonable minds differ on how far to tip chapter 11's scales in favor of negotiation and deal-making vs. the judicial process.

Repeat institutional players and their legal and financial professionals have transformed chapter 11 into something that is cheaper, faster and less debtor-dominated, and this is largely thought to be a good thing. Increased pre-bankruptcy activity likely has played a significant role in this evolution. With that in mind, encouraging heavy governmental intervention in deal-making seems regressive and unwise.

Of course, a textbook discussion of this issue might remind us that chapter 11 cannot completely shed its judicial/litigation components. The system has an irreducible core of protections tied to the extraordinary benefits of the system (the ability to bind not only a dissenting minority but a rejecting class, avoidance powers, tax consequences) that make chapter 11 preferable to out-of-court workouts in some circumstances. The government cannot put its imprimatur on non-compliant deals, particularly when a true party in interest objects.

Unfortunately, we do not get very far by concluding merely that government actors should permit dealmaking when it complies with bankruptcy law. In all but the most extreme instances, people reasonably can disagree on if a deal complies. Neither the Bankruptcy Code nor existing case law explicitly and definitively answers every pressing question. Whether the deal is compliant and warrants a hands-off approach sometimes depends on whether one believes the deal or the judicial process should have the upper hand in bankruptcy.

Therefore, as people continue to study the discrete issues in prepacks and the related decisions of government actors, the bigger-picture tension warrants a greater focus. In the meantime, one can expect that government actors will face continued "Three Bear" accusations—namely, that they do too much, and too little. As for my students seeking ready characterizations of bankruptcy practice, I look forward to learning from their own observations of the deal-litigation tension.

Footnotes

¹ The author is grateful to Gerald F. Munitz and Ronald Barliant for their comments and discussion. Return to article

² Two examples are Congoleum (www.congoleum.com/ investor_relations/49471_TRI_STATE.PDF) and various Halliburton entities (http://www.halliburton.com/ir/asbestos_update.jsp) (reporting filing of pre-packaged chapter 11 on Dec. 16, 2003). Return to article

³ Two examples are Aurora Foods (http://www.aurorafoods.com/news/ 2003_13.asp) (announcing filing of plan on Dec. 13, 2003, in furtherance of merger with Pinnacle Foods) and Champion Auto Racing Teams, (http://www.cart.com/News/Article.asp?ID=7441) (announcing buyout by Open Wheel Racing Series that requires filing of chapter 11) (Dec. 16, 2003). See, generally, Baird, Douglas G., and Rasmussen, Robert K., "The End of Bankruptcy," 55 Stan. L. Rev. 751 (2002). Return to article

⁴ See, e.g., Skeel, David A. Jr., "Creditors' Ball: The 'New' New Corporate Governance in Chapter 11," 151 U. Pa. L. Rev. (forthcoming). Return to article

⁵ This distinction sometimes is characterized as "pre-voted" and "post-voted," and the distinction matters in terms of the time taken in chapter 11 once formally initiated. See, e.g., Tashjian, Elizabeth, Lease, Ronald C., and McConnell, John J., "Prepacks: An Empirical Analysis of Prepackaged Bankruptcies," 40 J. Fin. Econ. 135, 142 (1996). Return to article

⁶ See, e.g., In re Stations Holding Co., 2002 Bankr. Lexis 1617, 02-10882 (Bankr. D. Del. Sept. 30, 2002) (explaining that votes were designated and disqualified for those who had executed post-petition voting agreements); In re NII Holdings Inc., et al., No. 02-11505 (transcript Oct. 25, 2002) (designating and disqualifying votes by noteholders who formally executed voting agreements post-petition); In re NII Holdings, et al, 02-11505 (MFW), 2002 WL 31946083 (Bankr. D. Del. Oct. 28, 2002) (confirming plan in cramdown). Commentators diverge on the appropriateness of this result. Cf. Deutsch, Douglas E., "Ensuring Proper Bankruptcy Solicitation: Evaluating Bankruptcy Law, the First Amendment, The Code of Ethics and Securities Law in Bankruptcy Solicitation Cases," 11 Am. Bankr. Inst. L. Rev. 213, 259 -261 (2003), with Keach, Robert J., "A Hole in the Glove: Why 'Negotiation' Should Trump 'Solicitation,'" 22-Jun. Am. Bankr. Inst. J. 22 (2003). In a significant recent decision, however, the Delaware Supreme Court has told us that lockups are not always appropriate under corporate law either. See Omnicare Inc. v. NCS Healthcare Inc., 818 A.2d 914 (Del. 2003). Return to article

⁷ See, e.g., In re Cannondale Corp., 03-50017, Motion for Two-week Continuance of Bidding Procedures Motion (Docket #16) (Bankr. D. Conn.); Objection by Unsecured Creditors' Committee (Docket #16) (Bankr. D. Conn. Feb. 11, 2003). The creditors' committee was successful in getting a continuance, but ultimately the court approved the break-up fee and bidding procedures and approved the sale to the stalking-horse bidder. See In re Cannondale Corp., 03-50117, Order Approving Sale of Substantially All Assets, (Bankr. D. Conn. April 7, 2003). Return to article

⁸ If pressed, Monday morning quarterbacks might acknowledge that the level is "just right" most of the time. Even so, the more controversial determinations inevitably get the most attention, shape the discourse and sometimes even lead to reform efforts. Return to article