Confirming a Plan

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Dec/Jan 2004

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<blockquote>
Editor's Note:

The ultimate objective of a chapter 11 case is confirmation of a plan. The plan is the document that sets forth the terms of the reorganization. It is the "contract" that rewrites the relationship between the debtor and its creditors and shareholders (and often other parties). The plan process can be very complicated. Here, we try to simplify it somewhat by providing a short outline of what you need to do to get a plan confirmed.

</blockquote>

Chapter 11 plans come in all shapes and sizes:

<ul>
<li>There are pre-packaged plans, pre-arranged plans and "regular" plans;

</li><li>There are plans of reorganization and plans of
liquidation;

</li><li>There are consensual plans and non-consensual
plans;

</li><li>There are plans that effect a particular
transaction, like a sale or a merger; and

</li><li>There are plans proposed by a debtor, a
committee or another party.

</li></ul>

When drafting a plan, it makes sense to start with one
or more precedent plans (why re-invent the wheel?). Ideally, the precedent
you use will have some things in common with your plan. It is also very
helpful to have an outline or term sheet of some sort that delineates the
key business points to be included in the plan. Without this, trying to
draft a plan is akin to trying to hit a shadow: A plan merely memorializes
the deal. The client (with our input) needs to decide how it wishes to
group creditors and equity owners and how much (and how) it wants to pay
them. Our job is to try to effectuate the client's goals and to
advise the client if any of its goals are unlikely to be achievable. Here
is a short lesson on how to confirm a plan under chapter 11.

First, look at Bankruptcy Code §1121 to see
whether your client can propose a plan. Part of this will depend on whether
the "exclusive period" has expired. Debtors have the exclusive
right to propose a plan for the first 120 days of the case (or longer, if
extended—and the period often is extended). After exclusivity
expires, the door is open to other parties who may want to propose a
plan.

Then turn to Code §1122. This deals with
classification of claims and interests. It says you can only classify
claims together if they are "substantially similar." It
doesn't say what "substantially similar" means, and it
doesn't say whether you can classify claims that are
"substantially similar" in separate classes—which is
often helpful in trying to achieve the required votes—so that's
all left to the case law (of which there's a lot). Section 1122 also
permits what are referred to as "convenience
classes"—something like "all unsecured creditors whose
claims are less than $5,000, or who agree to reduce their claims to $5,000,
get paid in full."

The next section, 1123, deals with what can go in a
plan. The first part, subsection (a), outlines what a plan must contain.
Always use this section as a checklist to make sure you have done
everything you are required to do. Subsection (b) lists provisions that a
plan may contain.

Code §1124 defines what constitutes
"impairment" of a class of claims or interests. This is
important because "impaired" classes get to vote on the plan. A
basic oversimplification is this: If the plan alters the rights you would
otherwise have, you are impaired.

Code §1125 deals with requirements for a
disclosure statement. The Code provides that we cannot solicit acceptances
of our plan until we have provided the creditor with a "disclosure
statement" sufficient to enable him to cast a rational vote. Think
"securities prospectus." No, try not to think "securities prospectus." The
drafters pretty clearly intended that the disclosure statement be something
more informal than a full-fledged S-1. Indeed, §1125(e) provides a
"safe harbor" from the registration and solicitation provisions
of the securities laws, as well as the anti-fraud provisions, for the
proponents of plans providing for the issuance, purchase or sale of
securities if the proponents complied with the requirements of the Code,
including §1125, and solicited acceptances of the plan in good faith.
In order to get to the confirmation hearing, you need to have your
disclosure statement approved by the court. Parties are permitted to object
to the disclosure statement, and the court will conduct a hearing on its
adequacy. Often the objections do not really go to disclosure, but are
instead disguised (sometimes very thinly disguised) objections to the plan
itself. The practical result is that the hearing on the disclosure
statement can become kind of a preview of the plan confirmation battle.

Code §1126 deals with who has accepted and who
has rejected a plan. More about that below.

Code §1127 deals with modification of a plan.
The important rules here are (1) you can't modify a plan so that it
fails to comply with the requirements for a confirmable plan and (2) if you
modify a plan in a material way after creditors have voted, then you are
likely to have to re-solicit—that is, tell the creditors about the
change and give them a chance to change their vote, if they want to do so.

Code §1128 says the court will hold a hearing to
consider confirmation of the plan, and that parties can object to
confirmation if they want to do so. That takes us to the heart of the
matter—§1129—the Code section that sets the criteria for
confirmation.

Start with the "general" requirements of
§1129—those that apply to the plan itself, as opposed to the
acceptance of the plan by, and treatment of, particular classes of
creditors. Those general requirements are found in subsections 1129(a)(1)
through (a)(6), and (a)(11) through (a)(13). Some of these are specific
requirements, such as the requirement that the plan proponent disclose the
identity of and compensation to be paid to any insider who will be retained
by the reorganized debtor. Some are more general, such as the requirement
that the plan be proposed "in good faith"—a judgment call
for the court.

One of these requirements that deserves special note
is the "feasibility" test of §1129(a)(11). The proponent
must show that the plan is not likely to be followed by a liquidation or
further reorganization of the reorganized debtor.

Then turn to the sections that deal with the
treatment of classes of creditors. With respect to each class of creditors
and interest-holders, the proponent should ask: Can I meet the confirmation
requirements? If the answer is "no," go back to the drawing
board. If your answer is "yes" with respect to all classes,
then you are pretty much done. With respect to any particular class, how do
you get to "yes?" There are three ways.

<ul><li>Leave the class
"unimpaired." If the class is
unimpaired, it is deemed to accept the plan, and for most purposes, you
don't have to worry about them any more.

</li><li>Get their votes. If you get the right number of votes, you can confirm
with respect to a class. More important, you can impose the plan on
dissenters within a class. Indeed, this rule is the linchpin of chapter
11—something vital that you can do under the Code that you cannot do
outside bankruptcy. There is only one important catch; we'll explain
it later.

</li><li>Cram them down. Finally, even if the class is impaired, and even
though you don't have the votes, you may still be able to
confirm—to impose the plan on the dissenting class over its
objection. You do it under the "fair and equitable" rule of
§1129(b), more commonly (if less elegantly) known as the
"cramdown." We consider each of these in turn.
</li></ul>

<h4>Leaving the Class Unimpaired</h4>

Code §1129(a)(8)(B) provides that we need not
obtain the acceptance of an unimpaired class (and §1126 instructs us
that we need not even solicit the votes of creditors in an unimpaired
class, as such creditors are conclusively presumed to accept the plan).

<h4>Getting the Votes</h4>

If the claims (or interests) in a class are impaired,
then the debtor needs to rely on §1129(a)(8)(A) and solicit votes of
the class members. You can confirm with respect to a voting class if you
get the votes of:

<ul><li>a majority in number and
</li><li>two-thirds in amount.
</li></ul>

Note that these numbers are of those voting (not "of
all creditors").

So, if there are 200 creditors in a class and only 10
cast ballots, you have a majority in number if you have six votes. Also, if
claims total $1 million and only claims aggregating $100,000 return
ballots, then you have two-thirds in amount if you get the votes of claims
aggregating $67,000. See Code §1126.

Once you have the votes, you can impose the plan on
dissenters in the class. There is only one important exception to this
important rule: A dissenting creditor (even one in a consenting class) may
defeat confirmation if he can show that he would receive less under the
plan than in a chapter 7 liquidation. This is the "Best
Interest" test of Code §1129(a)(7), sometimes also known as the
"liquidation test." Most courts will insist that you provide a
"liquidation analysis" in the disclosure statement,
accompanying your plan, to show whether the plan passes the liquidation
test.

For example, suppose we have a class of claims
aggregating $100,000 that would get $20,000 in a liquidation. We propose to
pay them $10,000 next year and $10,000 more the following year. Can we
confirm with respect to this class? Probably not. Money now is worth more
than money later. If the relevant interest rate is anything greater than
zero, then two (deferred) payments of $10,000 do not have a (present) value
of $20,000, and the creditor class is getting less than it would get in a
chapter 7.

<h4>Cramming Down</h4>

Even if a class is impaired, and even if you
don't have the votes, you still may be able to cram down under
§1129(b). Suppose the debtor owes $1 million to the creditor under a
contract providing for payment in annual installments over 10 years, with
interest at 10 percent (the payment pencils out at about $162,000 a year).
The debt is secured by Blackacre, which, luckily, is worth $1
million—exactly the same amount as the debt.

The creditor has made it clear that he favors no
resolution except payment in full immediately. Your client certainly
can't do that; indeed, he can't even meet the installments.

But he could pay a lower installment. You fire up the
spreadsheet and determine that if you strung the loan out from 10 to 20
years at the same rate of interest, then the payment would fall to around
$127,000. Your client figures he could pay $127,000.

Can you impose this deal under the cramdown rule?
Let's say it's a close call. The rule provides that we can
impose the plan if the creditor gets a payment stream with a present value
equal to the amount of its secured claim. Indeed, we are proposing to give
him a payment stream with a value equal to his claim—if 10 percent is the right
interest rate.

The creditor will say that a 20-year loan is riskier
than a 10-year loan and so he has a right to a higher interest rate. But if
the interest rate is higher than 10 percent, a stream of 20 payments of
$127,000 has a present value that is less than $1 million. So we may be
heading for a fight over the question of what the right interest rate is.

In Till v. SCS Credit
Corp., 124 S. Ct. 1951 (2004), the
Supreme Court very recently adopted the "formula approach" for
determining the appropriate interest rate to be used to determine the
present value of a stream of payments. Under this approach, the national
prime rate is used as a starting point and is increased based on the risk
of default in the particular case. The Court rejected the "coerced
loan," "presumptive contract rate" and "cost of
funds" approaches for determining an interest rate.

While Till v. SCS Credit
Corp. involved payments to a secured
creditor under a chapter 13 plan, the Court suggests that the same approach
should be used in chapter 11 wherever the Code requires a plan to provide a
secured, priority or unsecured creditor with payments having "a
value, as of the effective date of the plan, equal to" the allowed
amount of its claim (or, for purposes of satisfying the best-interests
test, the amount the creditor would have received under chapter 7).

If we change the hypothetical, and the collateral
value is less than
the amount of the debt, then the plan will treat the claim as two
claims—one secured and one unsecured. For example, if the creditor
has a debt of $50 million secured by collateral with a value of $35
million, then, pursuant to §506(a), it has a $35 million secured claim
and a $15 million unsecured deficiency claim. Its claim is
"bifurcated" into those two parts. Let's say the $50
million debt carried a 13 percent interest rate and was scheduled to mature
six months after the bankruptcy petition was filed. The plan can cram down
the secured claim by giving the creditor a stream of payments with a
present value of $35 million, just as the creditor in the prior
hypothetical was entitled to a stream of payments with a present value of
$1 million. As a result, this secured creditor may find himself with a new
note that has a smaller principal balance than his original note, an
extended maturity and perhaps a lower interest rate, as well.

If the plan proponent seeks to cram down a class of
unsecured creditors (or a secured lender with a deficiency claim—as
in the example above—since the deficiency claim is treated as an
unsecured claims), then no junior class can receive anything on account of its
pre-bankruptcy claim unless the plan provides that each holder in the class
"receive or retain an account of such claim property of a value, as
of the effective date of the plan, equal to the allowed amount of such
claim." Again, this implicates Till v.
SCS.

This last limit is important: It means that the
equity class will ordinarily not support a cramdown plan unless the plan
pays the whole of the cramdown debt; if it fails to do so, equity (a junior
class) cannot receive anything.

There is yet one more limit on the cramdown plan: If
we propose to impose the plan on a dissenting class of claims, then we must
show that at least one impaired class of claims has voted to accept the
plan. See Code
§1129(a)(10). Think of this as the
"somebody-has-to-like-it" rule.

Journal Authors

John D. Ayer

Jonathan P. Friedland

Michael L. Bernstein

Journal Date

Wednesday, December 1, 2004 - 12:00

Bankruptcy Rule

2004

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