The Aftermath of LaSalle The Question Is Not How to Apply the Decision But When

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Feb 2001

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In Bank of America National Trust and Savings Association v. 203 North LaSalle Street Partnership,<a href="#1" name="1a">1</a> the
Supreme Court held that if the new value corollary to the absolute priority rule survived the enactment of
the Bankruptcy Code, it is not satisfied when junior interest holders receive the exclusive opportunity to
purchase equity in the reorganized debtor. Instead, a market test is necessary to determine the adequacy of
the capital contribution.

LaSalle failed, however, to give any guidance on how to satisfy the market-test requirement other than
to suggest that the right to bid or to propose a competing plan may suffice. Although it is possible that
simply terminating the debtor's exclusivity under §1121 is enough, in many instances it is likely that an
auction will be necessary.

But the procedural and substantive mechanisms for the bidding process are subject to debate.
Commentators have raised numerous questions. For example, does it matter that a creditor in effect
recaptures its successful bid in satisfaction of its claim?<a href="#2" name="2a">2</a> If the bidder intends to liquidate the debtor, does
it constitute bad faith? Must the court conduct an independent valuation as a check on the market?<a href="#3" name="3a">3</a>

Nevertheless, a year and a half has passed since the Supreme Court handed down the decision and the
courts have not even begun to address these questions and many others about how to apply LaSalle. Instead,
the few reported cases have been bogged down in largely unanticipated issues surrounding the issue of when
to apply the decision. First, is the LaSalle objection available only to unsecured creditors? Is it also available
to interest holders under §1129(b)(2)(C) or to holders of impaired secured claims under §1129(b)(2)(A)?
Further, can an impaired claim-holder raise a LaSalle objection when the debtor does not propose to retain
an interest, but to sell the equity to an insider third party? Unfortunately, the cases provide very little in the
way of clarity or uniformity. They are, however, instructive of how parties will try both to expand and to limit
the Supreme Court's holding, and it is apparent that the issues raised by LaSalle are more numerous than
perhaps earlier suggested.

The question of whether parties other than unsecured claim holders can invoke the LaSalle market-test
requirement is addressed in In re Zenith Electronics Corp.<a href="#4" name="4a">4</a> and In re New Midland Plaza Associates.<a href="#5" name="5a">5</a> In
Zenith, the debtor proposed a plan whereby LGE, its largest creditor and majority shareholder, received 100
percent of the equity in the reorganized debtor for a $60 million cash infusion and the release of a $200
million claim. LGE's acceptance was contingent upon a 50 percent reduction of outstanding bond debt and
elimination of all shareholder interests. An ad hoc committee of minority shareholders objected on the basis
that the adequacy of LGE's contribution of new value had not been subjected to a market test in accordance
with LaSalle. But the Delaware bankruptcy court, in an opinion delivered by Judge Mary F. Walrath, ruled
that because all classes of creditors had accepted the plan, the absolute priority rule as set forth in
§1129(b)(2)(B) did not apply.<a href="#6" name="6a">6</a> It is beyond question that this conclusion is correct.

But the opinion went on to claim that LGE received the right to buy the equity in its capacity as creditor
instead of as majority shareholder. The apparent point of the distinction was that even if there had been a
dissenting creditor, §1129(b)(2)(B) would not have been violated. The basis for the determination that LGE
received the opportunity to buy equity on account of its creditor status is not clear. Presumably, it was because
forgiveness of debt made up the bulk of LGE's new value contribution. It is just as logical, however, to
conclude that LGE received the right to purchase equity on account of its ability to control the debtor as
majority shareholder. Thus, it seems that if a creditor had made an absolute priority rule objection in this case,
it would have been unjust in light of LaSalle not to require a market test. Somewhat inexplicably, the court
went on to state that giving the shareholders the right to bid in this instance "would present the same problem
as the LaSalle plan did."<a href="#7" name="7a">7</a> But there is no reason why the minority shareholders would not have had that right
if an auction had been necessary. LaSalle only held that the right to bid should not be given to old equity
exclusively.

The most baffling part of Zenith, however, is its assertion that §1129(b)(2)(C), relating to
interest-holders, was the applicable provision and that LaSalle does not apply to the absolute priority rule
as set forth therein. Without more analysis, Judge Walrath states:

<blockquote>
The restriction on the debtor's right to propose a plan contained in [LaSalle] should be limited to
the facts of that case—where the absolute priority rule encompassed in §1129(b)(2)(B) is violated...<a href="#8" name="8a">8</a>
</blockquote>
But there is no apparent reason why LaSalle would not require a market test in a situation where junior
interest-holders receive the opportunity to purchase equity in the reorganized debtor over the objection of
impaired senior interest holders. It would have been more accurate for Zenith to hold that the plan did not
violate §1129(b)(2)(C) because there were no interests junior to the objecting shareholders. The opinion
is confusing to say the least, and it runs counter to the reasoning adopted by the U.S. Bankruptcy Court for
the Southern District of Florida in New Midland Plaza Associates.<a href="#9" name="9a">9</a>

The New Midland court confirmed a debtor's plan that allowed its partners to hold on to their equity
while significantly impairing the holder of an oversecured claim. Among its many objections to
confirmation, the secured creditor asserted that the plan violated the absolute priority rule as described by
LaSalle. The court had little difficulty in finding that a fully secured creditor does not have standing to
assert a LaSalle objection. The basis for the holding was that whether a plan is fair and equitable with
respect to a secured creditor depends on §1129(b)(2)(A). The court reasoned that Congress included the
absolute priority rule in subsection (B) relating to unsecured creditors and in subsection (C) relating to
classes of interest, but excluded it from subsection (A). According to New Midland's statutory analysis,
a senior interest-holder would have standing to assert the LaSalle objection when a junior interest-holder
receives or retains property on account of its interest in the debtor. After all, §1129(b)(2)(C) includes
subsection (B)'s version of the absolute priority rule.

While the Zenith and New Midland cases are inconsistent only in their rationale, the next two
post-LaSalle decisions stand in direct contradiction to one another. These cases disagree on whether LaSalle

is applicable to a debtor's private sale of equity to insiders. Beal Bank S.S.B. v. Waters Edge Ltd.
Partnership<a href="#10" name="10a">10</a> involved the typical single-asset case scenario. The debtor limited partnership owned a $16.6
million apartment complex that had failed to generate enough income to service the lending bank's $29.5
million mortgage. The plan, confirmed by the bankruptcy court in an unpublished opinion, proposed to
satisfy the secured portion of the bank's claim with deferred cash payments, while paying 0.1 percent of
its $12.9 million deficiency claim on the effective date. All of the equity in the reorganized debtor would
be sold for $1.3 million to the son-in-law of the partner that owned a 99.5 percent interest. The bank
objected to confirmation on the grounds that an insider sale of ownership in a single-asset debtor without
a market test was equivalent to a sale of its collateral, entitling it to credit-bid against its secured claim. But
the court summarily refused to characterize the transaction as such, insisting that the sale of equity did not
improperly frustrate the bank's credit-bid rights.<a href="#11" name="11a">11</a>

The bank next argued that the plan violated the absolute priority rule by essentially permitting the
original partner to retain his interest by means of the insider sale. The court refused to accept this de facto
retention argument absent proof that the insider was acting as a "straw man" for the original partner. The
court concluded that the new value corollary as described in LaSalle did not prohibit a private sale of the
debtor's equity to anyone other than an existing owner. It also acknowledged, however, that "an auction
of the equity interest...would have been preferable here" but that "the issue was not pressed below."<a href="#12" name="12a">12</a>

LaSalle had not been decided at the time of the 1998 confirmation hearing from which the bank appealed.
It is possible that the result would have been different if the bank had had the benefit of LaSalle from the
outset.

Judge Walrath's opinion in In re Global Ocean Carriers Ltd.<a href="#13" name="13a">13</a> stands in direct contradiction to Beal
Bank, and despite her statement in Zenith that "it is not appropriate to extend the ruling of [LaSalle] beyond
the facts of that case," she did just that in Global Ocean. Similar to Beal Bank, the debtor in Global Ocean

proposed a plan transferring all of its stock to an insider, the majority shareholder's daughter, in return for a
$10 million capital contribution. The plan slightly impaired the secured claim of Credit Lyonnais and provided
for a 50 percent payout to unsecured noteholders. Credit Lyonnais accepted the plan, but the noteholders
argued that it ran afoul of the mandate in LaSalle due to the private sale of stock to an insider. The debtor
countered, relying on Beal Bank, that there was no absolute priority rule violation because the stock was not
being retained by an existing shareholder, and that the insider was not in fact receiving the shares on behalf
of old equity. But Global Ocean refused to address the debtor's contention:

<blockquote>
We do not find it necessary to decide this issue because we disagree with the conclusion of the Beal
Bank court. We believe that the Supreme Court decision in [LaSalle] cannot be read as narrowly as

Beal Bank suggests.<a href="#14" name="14a">14</a>
</blockquote>
After carefully analyzing the rationale in LaSalle, Judge Walrath ruled that the exclusive right to determine
who buys the stock and at what price constituted the "property" that the majority shareholder retained on
account of its equity interest. Accordingly, the debtor had to subject that "exclusive opportunity" to the
market:

<blockquote>
Thus we conclude that the debtor's plan violates the absolute priority rule by allowing the existing
controlling shareholder to determine, without the benefit of public auction or competing plans, who
will own the equity of Global Ocean and how much they will pay for it.<a href="#15" name="15a">15</a>

</blockquote>
The broad language of the court's conclusion makes no effort to limit its holding to an insider sale. It seems
to require a market test any time the debtor has the exclusive right to control the sale. But directly after the
court concludes that Beal Bank read LaSalle too narrowly, it continues:
<blockquote>
In fact, among numerous predictions of plans which may avoid the result in LaSalle, we have found
none to suggest that a plan which gives the equity to the largest shareholder's daughter can pass
muster.<a href="#16" name="16a">16</a>
</blockquote>
This statement supports a narrow reading of Global Ocean, as it clearly gives some weight to the fact that
the third party was an insider. Ultimately, it is unclear whether the case applies equally to sales to
non-insiders.

Questions regarding the scope of LaSalle remain after Global Ocean, Beal Bank, Zenith and New
Midland. It is likely that dissenting claim-holders will assert new arguments to extend the market-test
rationale beyond the facts of LaSalle. It is just as likely that debtors will find creative ways to avoid the
market-test requirement. Additionally, the cases decided so far are subject to conflicting interpretations.
More issues will arise with respect to the applicability of the Supreme Court's holding. It is also apparent
that LaSalle's legacy will become even more uncertain as other courts address the scope of the decision.
The only certainty is that more litigation will follow.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… S.Ct. 1411 (1999)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> See ABI Real Estate Committee, "A Roundtable Discussion: The Supreme Court Decision 203 N. LaSalle St. Partnership," 7 ABI
L. Rev. 1, 3 (1999). <a href="#2a">Return to article</a>

<a name="3">3</a> White, Bruce H. and Medford, William L., "Conducting Equity Auctions Under LaSalle—The Fog Thickens," ABI Journal (Oct.
1999). <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 92 (Bankr. D. Del. 1999)</a>, aff'd. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 207 (D. Del. 2000)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 877 (Bankr. S.D. Fla. 2000)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 241 B.R. at 106</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; (emphasis added). <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 877 (Bankr. S.D. Fla. 2000)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 668 (D. Mass. 2000)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 679-80</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Bank, 248 B.R. at 680</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 31 (Bankr. D. Del. 2000)</a>. <a href="#13a">Return to article</a>

<a name="14">14</a> Global Ocean at 48. <a href="#14a">Return to article</a>

<a name="15">15</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 49</a>. <a href="#15a">Return to article</a>

<a name="16">16</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#16a">Return to article</a>

<hr>

Journal Authors

William M. Reid

Journal Date

Thursday, February 1, 2001 - 12:00

Bankruptcy Rule

2001