Some judges have a way with words. Bankruptcy Judge Martin Glenn of New York is a prime example. He began his opinion on April 22 by saying:

A “lockup” agreement binding a significant group of creditors to a debtor’s plan that has yet to be filed, negotiated, or even contemplated through a disclosure statement can run afoul of section 1125 of the Bankruptcy Code. The consequences of violating section 1125 can be severe, including “designation” (disregarding) of votes, thus disenfranchising creditors . . . . The Code and caselaw encourage debtors and creditors to negotiate the terms of a plan and promise their support, and agreements to do so — often called Plan Support Agreements or Restructuring Support Agreements (“RSAs”) — are common. The provision at issue here is an impermissible lockup, not a common RSA.

The Debtor and the Lockups

The chapter 11 debtor was an airline that filed for reorganization in January. Three months later, the debtor filed motions to approve “settlements” with several aircraft and engine lessors.

The settlements called for modifying the leases and curing defaults. When the motions were filed, Judge Glenn said, “These cases [were] in their infancy . . . . [T]he Debtors are months away from filing a disclosure statement.”

The settlement agreements contained provisions that Judge Glenn called “lockup provisions.” The lockup provisions he quoted were almost a full page, single spaced.

Reduced to essentials, the lockups obligated the lessors to vote for any plan the debtor might file as long as a disclosure statement had been approved and the plan and disclosure statement were not inconsistent with the economic terms of the lease-modification agreements.

For the lockups to be binding, the debtor was required to have $500 million in liquidity and leverage of not more than 3.5:1 on the effective date. The lockups said nothing more about the reorganization plan.

The lockups also required the lessors to vote against any plan filed by anyone other than the debtor.

The U.S. Trustee and the official creditors’ committee did not object to the lease modifications, but they did oppose the lockups. Anticipating opposition, the debtor told Judge Glenn that he could approve the lease modifications if he were to uphold objections to the lockups.

The Lockups Don’t Fly

Judge Glenn recited the standards for approving settlements, including the business judgment rule. “But,” he said, “settlements cannot be allowed to trample on the rights and protections expressly created by section 1125 of the Bankruptcy Code.” Section 1125(b) provides:

An acceptance or rejection of a plan may not be solicited after the commencement of the case . . . unless, at the time of or before such solicitation, there is transmitted to such holder the plan or a summary of the plan, and a written disclosure statement approved, after notice and a hearing, by the court as containing adequate information.

RSAs have “become common practice” and are “generally approved in this district and others,” Judge Glenn said. He reviewed reported and unreported decisions from New York, Delaware and elsewhere regarding RSAs.

“In contrast to classic RSAs,” Judge Glenn said that lockups “bind creditors to vote in a particular way” but “are not per se improper.” He said that courts approve lockups if they have “sufficient information” about the plan and give creditors the ability to back out based on information that later becomes available.

In the case before him, Judge Glenn said that the lockups “contain[] neither (1) adequate (or any) information about the plan terms, nor (2) any evidence of meaningful choice.”

The lockups, Judge Glenn said, were “clearly” not “classic” RSAs because they do “not outline the broad structure or features of a plan.” There was more.

If the lockups were binding on the lessors, Judge Glenn said “that the Debtors may have bought the requisite votes to confirm a plan without input from, or regard for, any other creditors, essentially disenfranchising their votes at a nascent stage in these cases.” Moreover, he said that the lockups “mandate[] votes for any plan the Debtors may later propose, so long as it embodies the terms of the Stipulations [and] contain[] no meaningful ‘outs’ for creditors to void the blank check they are writing” [Emphasis in original.]

Judge Glenn elaborated on the open door to plan confirmation that the lockups would provide:

The Lockup Provision would grant the Debtors the votes needed to propose and confirm essentially any plan they wished as long as the Stipulation terms are included in the plan, obviating the need to deal with any other, smaller creditors. It would thus taint the voting process by effectively silencing the votes of all creditors besides the [lessors].

The debtor contended that the sophistication of the lessors obviated any objections to the lockups. Judge Glenn countered by saying that a “creditor’s sophistication is not an excuse to strip away provisions of the Bankruptcy Code which protect it.”

Judge Glenn approved the economic terms of the lease modifications but sustained the objections to the lockups.