In cramming down a plan on objecting equity holders, Bankruptcy Judge Philip Bentley of New York made two important holdings regarding Sections 1129(b)(1) and 1129(b)(2)(C):

(1)  A cramdown plan may not be confirmed merely because no inferior equity classes receive anything, and

(2)  the court is not required to hold a valuation hearing to determine the value of existing equity unless the opponent to confirmation demonstrates that the equity has value.

The corporate debtor operated a medical practice in New York. The debtor was wholly owned by a holding company. The chief executive of the debtor owned 15% of the holding company. The individual who would file a competing chapter 11 plan owned 70% of the holding company.

The 70% owner of the holding company proposed a competing plan designed to buy the debtor while giving nothing for the equity. Receiving nothing for her equity interest in the holding company, the CEO objected to confirmation, claiming that the equity had value and that the plan therefore failed the fair and equitable confirmation test for a cramdown plan.

In his September 8 opinion, Judge Bentley said that the case “raises the unsettled issue of what cram-down requirements protect equity holders when a plan of reorganization pays creditors in full and seeks to extinguish all equity interests for no consideration.” He added that the caselaw “is surprisingly sparse.”

The Competing Plans

Several months after the chapter 11 filing, the CEO was ousted when Judge Bentley granted motions by the majority equity holder and the U.S. Trustee for appointment of a chapter 11 trustee. For the debtor, the CEO had filed a proposed plan that seemed like a placeholder.

After exclusivity terminated, the majority equity holder filed a competing plan with full payment to holders of administrative and general unsecured claims. There were no secured claims. Existing equity was to be extinguished.

The majority equity holder was to receive all of the new equity in return for providing the reorganized debtor with $5 million in working capital and an undertaking to supply sufficient cash to pay claims in full on the effective date.

The plan filed by the former CEO was not ready for confirmation. At the hearing on confirmation of the plan proposed by the majority equity holder, the former CEO objected to the plan, contending that existing equity had value as shown by the plan she had filed for the debtor. Judge Bentley found that the former CEO was also a creditor and therefore had standing to object to the plan.

The majority equity holder was not required to file a disclosure statement, because, as Judge Bentley said, “no classes are entitled to vote; all classes either are unimpaired and deemed to accept under 1126(f) or are receiving nothing and deemed to reject under 1126(g).”

Fair and Equitable Is More than It Seems

After pages of analysis, Judge Bentley decided that the plan proposed by the majority equity holder satisfied all confirmation requirements other than Section 1129(a)(8), because existing equity holders were to receive nothing and were therefore deemed to have rejected the plan. As a cramdown plan, Judge Bentley was required to confirm under Section 1129(b)(1) “if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”

For cramdown, Section 1129(b)(2) says that “fair and equitable with respect to a class includes the . . . requirements” contained in Subsections 1129(b)(2)(C)(i) and 1129(b)(2)(C)(ii). [Emphasis added.]

For an objecting equity class, the plan is “fair and equitable” under Section 1129(b)(2)(C)(i) if equity receives “the value of such interest, or (ii) the holder of any interest that is junior to the interests of such class will not receive or retain under the plan on account of such junior interest any property.” [Emphasis added.]

Focusing on the word “or” in Section 1129(b)(2)(C), the plan proponent argued that the plan was confirmable simply because no class junior to equity was receiving anything under the plan, thus making the plan fair and equitable as a matter of law.

True, the plan satisfied Section 1129(b)(2)(C)(ii), but Judge Bentley said that “the absolute priority rule is only part of the fair and equitable standard; it is not the entirety of that standard.” As the basis for the conclusion, he pointed to the word “includes” in Section 1129(b)(2).

Given the word “includes,” Judge Bentley asked, “[W]hat requirements [does] the fair and equitable standard add[] to those imposed by the absolute priority rule?” In other words, does a cramdown plan that extinguishes equity for no consideration “potentially violate the fair and equitable test, even if the absolute priority rule is satisfied?”

In part, Judge Bentley found the answer in legislative history, where a House Report said that a plan would not be fair and equitable if equity were receiving nothing, but a senior class was receiving more than 100%. He held that a “plan that extinguishes valuable equity for no consideration over the equity class’s objection is anything but fair and equitable, in the ordinary sense of those words.”

When a plan gives nothing to an inferior class, Judge Bentley said that the plan proponent therefore need not offer “affirmative proof” that equity has no value. If an objector, on the other hand, produces “evidence that the equity has value,” he said that “the court must determine whether that is in fact the case and, if so, whether the extinguishment of equity for no consideration over the equity class’s objection is fair and equitable.”

Judge Bentley then turned to the question of whether the former CEO had presented sufficient evidence that the equity had value to require the court to conduct a valuation hearing.

As a standalone business without new capital, Judge Bentley said it was “clear” that existing equity had no value. However, the former CEO contended that equity had value to an acquiror because the former CEO’s plan would give $1 million to holders of existing equity. Judge Bentley decided that the former CEO’s competing plan was not confirmable for several reasons and therefore did not constitute evidence that existing equity had value.

Judge Bentley said he would confirm the competing plan proposed by the majority shareholder without conducting a valuation hearing, because the former CEO had not produced evidence to show that the existing equity had value.