Using the Doctrine of Abstention to Protect Your Consensual Restructuring

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Sep 2003

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Editor's Note:This is a new column that will focus on issues that arise in pre-packaged cases. It will provide aforum for practitioners—who frequently rely on anecdotal experience rather than case law in this area—to share their experiences.

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Practitioners planning to file a consensual chapter 11 proceeding (either as a pre-packaged or pre-arranged case) place
their clients in a uniquely vulnerable situation. Of course, the benefits of filing a consensual case are well-known:
certainty, speed and minimal impact on business operations, among others. There are, however, concomitant risks
associated with such a strategic decision. Most obvious is the fact that the restructuring is public long before the
company has the benefits and protections bestowed when a filing occurs. This period of active negotiations is
particularly challenging, as inevitably, dissenters seek to exert influence over the process—influence that will likely
dissipate upon a filing. Chief among the risks is an involuntary filing at a time and in a venue not determined by
the company.

The recent decision <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re NRG Energy Inc., 294 B.R. 71 (Bankr. D. Minn. 2003)</a>,<a href="#2" name="2a">2</a> provides a road map for
practitioners in developing a consensual plan while also minimizing the risk of an involuntary case. The NRG Energy court's decision to abstain from presiding over an involuntary case, even despite the absence of a formal
pre-arranged or pre-packaged plan, demonstrates that proper case evaluation, planning and progress may forestall
efforts by disgruntled creditors seeking to interfere with the preparations for a consensual restructuring.

In NRG Energy, former executives and officers of NRG Energy, a non-regulated power producer and marketing
subsidiary of Xcel Energy Inc., filed an involuntary bankruptcy petition against NRG Energy and its subsidiaries on
Nov. 22, 2002, pursuant to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §303(a)</a>.<a href="#3" name="3a">3</a> As terminated employees no longer receiving payments under
various employment agreements and non-qualified benefit plans, the original petitioning creditors alleged NRG
Energy "was not generally paying its debts as they became due."<a href="#4" name="4a">4</a> In response, NRG Energy filed an answer denying
the allegations, stated affirmative defenses and contested petitioners' standing to commence the case.<a href="#5" name="5a">5</a> NRG Energy
also included affirmative allegations that the original petitioners filed the involuntary petition in bad faith and may
have received transfers avoidable under the Bankruptcy Code, and that the court should abstain from jurisdiction
under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §305</a>.<a href="#6" name="6a">6</a> Together with its answer, NRG Energy filed a motion pursuant to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §§305(a)</a> and
303(j)<a href="#7" name="7a">7</a> seeking abstention and dismissal of the case.<a href="#8" name="8a">8</a>

After several months of discovery and settlement negotiations, NRG Energy resolved its disputes with the
original petitioning creditors, and the court conducted an evidentiary hearing on the abstention motion in
April 2003. NRG Energy and the sole creditor in interest opposing the motion, Shaw Constructors Group,<a href="#9" name="9a">9</a>
presented evidence at the hearing regarding NRG Energy's complicated debt structure and restructuring
efforts to date. NRG Energy acknowledged direct and subsidiary debt obligations of more than $11 billion
arranged in two tiers: (1) operating, revolving and note-holder obligations of NRG Energy totaling
approximately $5 billion and (2) project finance bond issues and bank loans for NRG Energy-related
subsidiaries of $5 billion to $6 billion. As the court noted, prior to the involuntary petition, NRG Energy
had taken substantial steps toward achieving a consensual restructuring.<a href="#10" name="10a">10</a> In this respect, NRG Energy was
already acting much like a debtor-in-possession. For example, NRG Energy had

<blockquote>
identified several constituencies among its creditors, groups of them that had common interests under similar forms
of financing or credit, and it enlisted members of these constituencies to form unofficial committees for the
purposes of communication and negotiation. In addition, it prevailed on these committees to hire counsel, financial
advisors and other professionals, and made their maintenance palatable by agreeing to pay the fees of such
professionals "in most cases."<a href="#11" name="11a">11</a>
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In the course of these negotiations, NRG Energy obtained general forbearances from its senior lenders in the form of
"collateral call extension letters" that enabled it to "use revenues for the maintenance of current operations, rather
than locking them into the illiquid form of supplementary collateral." Importantly, the court noted, "The
consequence of this arrangement is that NRG has had the benefit of a general forbearance by its major lenders, under
which none of them have taken any action that would affect any other's rights or those of the debtor."<a href="#12" name="12a">12</a>

<h3>Develop a Case Plan</h3>

Recognizing its authority to abstain under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §305</a> based on the "interests of creditors and the debtor" as
both "discretionary" and "extraordinary,"<a href="#13" name="13a">13</a> the court referred to such power as best exercised "by identifying the
practical benefits to all constituencies of resolving a debtor's financial distress under the respective legal regimes and
in their affiliated forums."<a href="#14" name="14a">14</a> Continuing, the court noted that "[s]ubstantial support by creditors for abstention and
a non-bankruptcy process is an important factor in the analysis."<a href="#15" name="15a">15</a> Such a flexible standard and the implicit need
for creditor support of a consensual restructuring emphasize the importance of case evaluation and planning. In
arranging a company's pre-filing restructuring efforts, an advisor must chart a course and timeline that accounts for
likely contingencies against the debtor, and act accordingly. NRG Energy succeeded in convincing the court to
dismiss the involuntary petition because its progress toward a possible consensual filing accounted for its own
interests as well as those of its senior creditors. Moreover, by obtaining forbearance agreements from its senior
lenders while engaging in restructuring negotiations, NRG Energy positioned itself for other negotiations vis-à-vis
its other creditors that it would otherwise not have been able to pay on a timely basis.

<h3>Identify Objectives, Initiate Restructuring Efforts and Make Tangible Progress</h3>

Tangible restructuring efforts may assist a debtor greatly in continuing a path of its own choosing. The NRG
Energy court commented, "Clearly, the presentation of a pre-packaged plan in a bankruptcy case is the contingency
against which NRG's bid for abstention must be evaluated."<a href="#16" name="16a">16</a> In reviewing this contingency, the court viewed
favorably the efforts of NRG Energy to address its debt structure and exercised its discretion to abstain in deference
to NRG Energy's objectives, stating "[t]he real question is whether NRG should be required to go forward in the
confirmation process now in this case, at a time not quite of its own choosing, and before it has achieved a
comfortable breadth of resolution and accord."<a href="#17" name="17a">17</a> The court relied heavily on evidence presented by NRG Energy of
the time and expense associated with the initiation of formal proceedings under the Bankruptcy Code.<a href="#18" name="18a">18</a> The court
noted the irony of an abstention motion: "NRG's management professes to be willing to leave its shelter under the
bankruptcy jurisdiction, and to expose NRG to unrestrained creditor action, to avoid an immediate assumption of
the transactional costs of a chapter 11 case."<a href="#19" name="19a">19</a>

<h3>Account for the Interests of Creditors</h3>

While the NRG Energy court was deferential to the evidence presented by the alleged debtor as to its own
objectives, the interests of creditors in general remained central to its decision to abstain.<a href="#20" name="20a">20</a> The court noted,
"[t]he question posed by this motion, then, is whether this outcome scenario, coupled with the prospect of a
return to a chapter 11 on a voluntary basis at some future date, is more in the interests of creditors and NRG
than leaving NRG in chapter 11 here, in this case."<a href="#21" name="21a">21</a> In considering the "interests of creditors and the
debtor," the court observed that such interests coincide with the values of the Bankruptcy Code and:

<blockquote>
include a level playing field among creditors similarly situated under non-bankruptcy law, in which no single one
gets an undue advantage over others; an orderly administration of the value inherent in current assets or future
revenue, and the preservation of as much of that value as possible during that administration; and the assurance of a
responsible distribution to creditors, prioritized rateably in accordance with the expectancies each constituency
properly had before the debtor's financial distress began.<a href="#22" name="22a">22</a>
</blockquote>

NRG Energy's success in securing forbearance agreements from its senior lenders, as well as its ability to
pay its trade-creditor obligations on a generally timely basis, may have been determinative in the court's
review of the interests of creditors. NRG Energy's efforts as to both groups of creditors allowed the court to
comment determinatively:

<blockquote>
There is just too much in the record to indicate that progress in negotiations would be set back by days-to-weeks,
were NRG locked into bankruptcy in this case. There is much more to establish that the transactional costs would
be markedly greater than those for the completion of an out-of-court process, even were its results segued into a
second chapter 11 case.<a href="#23" name="23a">23</a>

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Additionally, the efforts directed to satisfying creditors were themselves a factor favoring abstention, "[b]eyond
these specifics of cost in dollars, there is a more intangible aspect that goes to the efficacy of the process: the
complex pace and momentum of settlement negotiations that are going on simultaneously on many different fronts,
all focused back in on NRG directly or indirectly."<a href="#24" name="24a">24</a> As noted by the court, "NRG has made substantial progress
toward the milestones of a reorganization plan; it would not be starting from scratch in this case or [in another
forum]."<a href="#25" name="25a">25</a> Together, the decreased transactional costs associated with consensual negotiations<a href="#26" name="26a">26</a> coupled with a
demonstration that the interests of creditors were the focus of NRG Energy's general attention persuaded the court
that the involuntary petition should be dismissed, even in the face of Shaw's arguments that dismissal would
promote forum-shopping.<a href="#27" name="27a">27</a>

<h3>Conclusion</h3>

NRG Energy ultimately filed a non-consensual case in another forum. Such a filing, however, does not limit the
broad application of NRG Energy. NRG Energy confirms several central tenets essential to planning and preparing a
consensual case: (1) evaluate a client's debt structure and develop a case-management strategy well in advance of
filing preparations; (2) obtain forbearance and financing arrangements sufficient for a debtor to pay debt obligations
as they become due, and particularly debts to those not involved in the restructuring process; and (3) conduct
meaningful restructuring negotiations, even to the point of bearing the associated costs. Such a course of action will
optimize the likelihood (by managing associated risks) of a consensual restructuring even in the face of an
involuntary petition.

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<h3>Footnotes</h3>

<a name="1">1</a> Anup Sathy is a partner in the Chicago office of Kirkland & Ellis LLP in the Restructuring, Workout & Bankruptcy practice group. The author acknowledges the contributions of Thomas J. Augspurger in developing this article. <a href="#1a">Return to article</a>

<a name="2">2</a> Kirkland & Ellis LLP represented NRG Energy Inc. and its affiliates in the proceedings discussed in this article and in the proceedings now pending before the U.S. Bankruptcy Court for the Southern District of New York. <a href="#2a">Return to article</a>

<a name="3">3</a> See, generally, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §303</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re NRG Energy Inc., 294 B.R. 71, 73 (Bankr. D. Minn. 2003)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> Section 303(d) specifies that "the debtor...may file an answer to a petition under this section." <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 73</a>. Section 305(a) of the Bankruptcy Code provides:

<blockquote>
(t)he court, after notice and a hearing, may dismiss a case under this title or may suspend all proceedings in a case
under this title, at any time if—(1) the interests of creditors and the debtor would be better served by such dismissal
or suspension.... <a href="#6a">Return to article</a>

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<a name="7">7</a> Section 303(j) provides that "[o]nly after notice to all creditors and a hearing may the court dismiss a petition filed
under this section—(1) on the motion of a petitioner, (2) on consent of all petitioners and the debtor or (3) for want
of prosecution." <a href="#7a">Return to article</a>

<a name="8">8</a> NRG Energy moved in the alternative for a court order requiring the original petitioning creditors to post a bond
pursuant to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §303(e)</a> for amounts alleged due under §303(i). <a href="#8a">Return to article</a>

<a name="9">9</a> In August 2002, Shaw sued NRG Energy and its subsidiary LSP-Pike Energy LLC, alleging breach of contract and
other theories in the U.S. District Court for the Southern District of Mississippi. <a href="#9a">Return to article</a>

<a name="10">10</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 71</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 76</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 77</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 80</a>. <a href="#13a">Return to article</a>

<a name="14">14</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 80</a>, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Spade, 269 B.R. 225, 227 (D. Colo. 2001)</a>. Additionally, the court
noted that a seven-factor test has evolved over time in considering the application of the court's discretion:
<ol>
<li>the economy and efficiency of administration
</li><li>the availability of another forum, or the actual pendency of an insolvency proceeding in one
</li><li>the essentiality of federal jurisdiction to a just and equitable resolution

</li><li>the availability of alternative means for an equitable distribution of assets and value
</li><li>the lesser cost of a non-bankruptcy process that would serve all interests as well
</li><li>the possibility that commencing administration in bankruptcy would duplicate previous effort toward a workout in a non-bankruptcy setting and
</li><li>the purpose for which bankruptcy jurisdiction was sought by petitioners.
</li></ol>
294. B.R. 80, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re Fax Station Inc., 118 B.R. 176, 177 ( Bankr. D. R.I. 1990)</a>. <a href="#14a">Return to article</a>

<a name="15">15</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 81</a>. <a href="#15a">Return to article</a>

<a name="16">16</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 82</a>. <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 82</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 83-84</a>. <a href="#18a">Return to article</a>

<a name="19">19</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 83</a>. <a href="#19a">Return to article</a>

<a name="20">20</a> Only Shaw presented evidence in opposition to the motion seeking abstention, and the absence of any evidence in
objection from other creditors may have influenced the court's decision on this issue. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… B.R. at 74-75</a>. <a href="#20a">Return to article</a>

<a name="21">21</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 83</a>. <a href="#21a">Return to article</a>

<a name="22">22</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 81</a> (citations omitted). <a href="#22a">Return to article</a>

<a name="23">23</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 85</a>. <a href="#23a">Return to article</a>

<a name="24">24</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 85</a>. <a href="#24a">Return to article</a>

<a name="25">25</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 83</a>. <a href="#25a">Return to article</a>

<a name="26">26</a> The court observed:
<blockquote>
The transactional costs—professional compensation, noticing expenses, the quarterly fee to the U.S. Trustee System
Fund, among others—would be large. Many of them would be directly attributable to the presence in chapter 11,
rather than to the general effort to adjust the terms of the debtor-creditor relationships.
</blockquote>
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 83</a>. <a href="#26a">Return to article</a>

<a name="27">27</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Energy, 294 B.R. at 85</a>. The court noted:

<blockquote>
If abstention is appropriate on the merits recognized by Congress, the result cannot be unseated by the prospect of a
voluntary refiling for the very same relief in another forum. That has to be so [that] even if the successor forum
turns out to be one to which a debtor is less "connected" in the maintenance of physical assets, the degree of local
investment, the extent of creditor, management or employee presence locally, or any way other than the attenuated
link of situs of incorporation.
</blockquote>
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 86-87</a>. <a href="#27a">Return to article</a>

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