To no one’s surprise, a district court in Delaware held that so-called horizontal gifting does not offend the chapter 11 confirmation standards.
In his August 21 opinion, District Judge Richard G. Andrews reached the merits of gifting after ruling that the appeal from confirmation was equitably moot.
The debtor had $500 million in secured debt and a business concededly not worth more than $300 million. The prepackaged chapter 11 plan called for converting secured debt to equity. The secured creditors made what is known as a gift to unsecured creditors in the form of cash and stock to holders of unsecured notes worth no more than 6% of the claims in the class. Trade and other unsecured creditors were to be paid in full.
The noteholder class voted against the plan, but Bankruptcy Judge Kevin J. Carey confirmed the plan last year. A holder of about $500,000 in unsecured notes appealed from the confirmation order and unsuccessfully sought a stay pending appeal.
The noteholder argued that the appeal was not equitably moot because the appellate court could order payment of its claim in full without upsetting the plan as a whole.
Judge Andrews rejected the argument, saying there was no method under the Bankruptcy Code to permit paying the appellant in full without paying all other noteholders in full. Paying one creditor in the noteholder class, he said, would offend Section 1123(a)(4) and its requirement of making identical payments to all creditors in a class.
Judge Andrews declined to expand In re Tribune Media Co., 799 F.3d 272 (3d Cir. Aug. 19, 2015), where the Third Circuit declined to dismiss an appeal for equitable mootness because it would not be unfair if one class were forced to pay back $30 million.
Even if he could pay one noteholder and not the others, Judge Andrews said it was “unclear which party the court may order to fund such a recovery.” He distinguished Tribune by saying it was an intercreditor dispute involving a reallocation between two classes that would not upset the overall plan. Unlike Tribune, he said there was no readily identifiable set of creditors against whom disgorgement could be ordered.
Judge Andrews concluded that the appeal was equitably moot because he could not give the appellant a higher recovery than other noteholders “within the confines of the Bankruptcy Code”; paying noteholders the same as trade creditors “would require undoing the plan and would necessarily harm third parties”; and there was no other “practicable relief” the court could grant.
Although finding the appeal to be equitably moot, Judge Andrews analyzed the merits and upheld confirmation.
The appealing noteholder argued that the plan unfairly discriminated and thus violated Section 1129(b)(1).
Like Delaware District Judge Gregory M. Sleet in Law Debenture Trust Co. of New York v. Tribune Media Co. (In re Tribune Media Co.), 12-1072, 2018 BL 269729 (D. Del. July 30, 2018), Judge Andrews applied the so-called Markell test to determine whether there was unfair discrimination. The test raises a rebuttable presumption of unfair discrimination if a similar class receives “a materially lower percentage recovery.” To read ABI’s discussion of Tribune Media, click here.
Although Judge Andrews noted that the Markell test says nothing about gifting, he said the bankruptcy court properly applied the test and found no improper discrimination. He said that In re Genesis Health Ventures Inc., 280 B.R. 339 (D. Del. 2002), presented “virtually identical facts” involving horizontal gifting, where a senior creditor makes a gift to an inferior class.
Judge Andrews said that Genesis I found that gifting rebuts the presumption of unfair discrimination when senior lenders redirect a portion of the recovery to which they otherwise would have been entitled.
Judge Andrews also ruled that the appealing noteholder was not harmed as a consequence of the larger recovery by trade creditors because “all unsecured creditors did significantly better than they would have outside of chapter 11 or under a plan of liquidation.”
Judge Andrews said that the case on appeal was not a prohibited form of so-called vertical class-skipping because there was no distribution to a class junior to the bondholders.