+1 212 318 2000
Europe, Middle East, & Africa
+44 20 7330 7500
+65 6212 1000
By Judge D. Michael Lynn, U.S. Bankruptcy Court for the Northern District of Texas
A couple of months ago I wrote about valuation. This month I want to address the use of tools afforded practitioners by the Bankruptcy Code that can be useful in negotiating a plan in a Chapter 11 case.1 The relationship between value and negotiation of a plan is obvious: the value of a debtor's estate in liquidation and as a going concern forms the better part of the factual framework for negotiation, and an understanding of value is a necessary prerequisite for any competent negotiation.
Another necessity for negotiating is to identify the parties that must participate in the negotiation process. The usual suspects—the debtor, any committees and the debtor's principal lenders—will usually be necessary to negotiations, but there may be other entities to be identified as negotiating partners as well. What other parties will be necessary negotiating partners will vary from case to case. Some typical specially situated entities that may have to be satisfied with (or forced to acquiesce in) any plan include a large judgment creditor (as with Pennzoil in the Texaco case), a franchisor or other necessary contractual counterparty, one or more unions, regulators, a prospective purchaser, or key members of management. Basically any party whose relationship with the debtor is essential to the debtor's rehabilitation should have a seat at the table.
The prospective negotiator must also identify what is necessary to performance of a plan and what is not necessary—and so may be used in negotiation as consideration to the various creditor constituencies. The first of these categories includes both what is necessary to get out of Chapter 11—e.g., cash requirements that must be met at confirmation—and what assets are necessary to survival of the reorganized debtor.2 The reorganized debtor will need to retain sufficient capital for post reorganization operations and will need certain property—manufacturing equipment or retail outlets, for example—to carry on its business following consummation of a plan. In some instances, a debtor may have an excess of what is necessary in a given category: only five stores will be operated by the reorganized debtor, but the debtor presently owns or leases eight locations. This obviously provides potential added negotiating leverage for the plan proponent: a landlord will be more willing to make concessions to keep the debtor as a tenant if it is competing with other landlords.
As to the assets that are not necessary to the reorganized debtor's future, some of these will be burdensome—losing contracts, over-liened property, assets the value of which is insufficient to justify their associated costs. These assets will be abandoned under Section 554 of the Bankruptcy Code or—if contracts—will be rejected. Other unnecessary assets, though, may have realizable value. A debtor often downsizes during a Chapter 11 case. Land or other property intended for expansion may be available for sale. Leases that are unnecessary for future operations may be saleable to assignees. One category of asset that is usually not required for the debtor's future success is litigation. While sometimes a law suit may be a key element for the future, often suits, including voidable transfer actions, may be transferred to a creditor-controlled entity for pursuit for the benefit of creditors. These rights of action can be an important part of the consideration given creditor classes. It may be that potential litigation against a specially situated party like a franchisor can become an important counter in negotiations with that party: a release by the debtor may have real value.
Another question that must be addressed before negotiating a plan is whether there are any so-called “gate-keeper” issues. These are issues that are independent of negotiations that must be resolved before the factual and legal parameters of a plan may be established. For example, if ownership of a key asset is in doubt or a debtor's ability to satisfy regulators is unclear it may be that the value of the debtor and its estate is so problematic that negotiations could not be productive absent resolution of that issue. Such gate-keeper issues are especially critical now that there are absolute time limits on lease assumption and exclusivity:3 an inability to resolve one or more gate-keeper issues in a timely fashion may force a decision prematurely on leases or even lead to dismemberment of an enterprise through creditor sponsored plans.
These four elements: value, negotiating parties, assets necessary to plan feasibility and any gate-keeper issues will typically be the determinants of the factual setting for negotiations. There may, however, be other important considerations in a given case—tax issues, for example, not only of concern to the debtor but those relevant to other interested parties. It is counsel's job to identify not only the pieces that make up the four areas I have discussed, but also any other factor significant to a reorganization's impact on the debtor, its creditors and other parties in interest.
Having defined the playing field, the next step is to decide how best to use the tools the Code and Federal Rules of Bankruptcy Procedure provide to move negotiations toward the goal of a confirmable plan satisfactory to the plan proponent. In considering these tools, I will adopt the debtor's perspective. Not only is the debtor (at least in the absence of a trustee) the most common plan proponent. It is also the proponent Congress anticipated would be the usual architect of its own reorganization.
The first tool—weapon—the Code gives a debtor in plan negotiations is control. Because under Section 1121 the debtor is given the exclusive right for a time (120 days plus extensions up to a total of 18 months) within which to propose a plan, it begins with an advantage over other plan proponents as well as having control over the plan process. In addition, sections 1107 and 1108 give the debtor control over its estate and the operation of its business; these circumstances discourage the possibility of an unfriendly plan proponent horning in on the process.4
Among the most important tools for the debtor-plan proponent are those that allow confirmation of a plan over dissent. The reason out-of-court workouts often fail is that there is no way to bind the dissenters to the terms of a plan. Chapter 11 gives a debtor means to lock dissenters in to a plan, and the threat of use of these tools will be a key to negotiations.
To begin with, a debtor in default may not (beyond the ambit of the parties' agreement) force cure on a creditor out of court. In Chapter 11, by curing most (but not all5) defaults, a debtor may leave a creditor (or class of creditors) unimpaired and so neutralize the party's dissent.
Even more significant is the ability to bind dissenters through the requisite majorities specified in Section 1126(c). If the requisite majorities of those voting accept the plan, it is binding on those who voted to reject or did not vote. In conjunction with the classification under Section 1122, which can be used to submerge potential dissenters in an accepting class or divide creditors into classes such that at least one class satisfies Section 1129(a)(10), Section 1126(c) allows design of a facially confirmable plan. In negotiations, having such a plan on the table not only is a starting point for deal-making, but also is a tool for persuading.
The ultimate tool for dealing with dissenters is Section 1129(b). The ability to cramdown a class of creditors constitutes a powerful tool for negotiation. Like unimpaired treatment and the binding effect of majority votes, cramdown provides both a measure and a weapon that will facilitate negotiations.
Another tool available to the plan proponent is the claims adjudication process. Not only does Section 502(b) of the Code together with Federal Rule of Bankruptcy Procedure 3007 provide a method for contesting claims that otherwise might impede a plan, but Section 502(c) allows for estimation of claims, even for purposes of distribution. See In re Wallace's Bookstores Inc. 317 B.R. 720, 724 (Bankr. E.D. Ky. 2004) (discussing the bankruptcy court's power to estimate claims under Section 502(c) including for purposes of distribution); In re Continental Airlines, Inc., 57 B.R. 842, 844-45 (Bankr. S.D. Tex. 1985) (utilizing the Section 502(c) claims estimation process because it was “the most effective method to accomplish the statutory purpose in bankruptcy of advancing a ratable distribution of assets among the creditors” as to a large class of employee claims). The ability to use these tools encourages settlements between creditors and a plan proponent to facilitate plan confirmation.
In a given case other tools provided by the Code and Rule may assist a plan proponent in persuading one or more constituencies to agree to given treatment (e.g., Section 524(g) in asbestos cases)—and other provisions—for example Section 1129(a)(9)(C) and (D) may assist in assessing what constitutes acceptable treatment for a given class of claims. Similarly, the facts faced may affect what plan is confirmable: can a celebrity debtor's plan be confirmable if the celebrity refuses to work to fund it? In negotiations, therefore, the plan proponent will negotiate with constituencies based on facts and law relevant to the case—and the law provides important tools for pursuing those negotiations.
D. Michael Lynn has served as United States Bankruptcy Judge for the Northern District of Texas in Fort Worth since 2001. During his tenure on the bench, he has presided over such large Chapter 11 cases as Texas Rangers Baseball Partners, Mirant Corporation, and Pilgrim's Pride Corporation, as well as thousands of consumer cases. Prior to his appointment to the bench, he spent 29 years practicing bankruptcy law, specializing in corporate reorganizations. Judge Lynn was a Visiting Professor of Law at Southern Methodist University's Dedman School of Law for 15 years and now serves as Adjunct Professor of Law at Texas Wesleyan University, where he teaches courses in corporate reorganization law, legal drafting, and legal ethics. He has served as a contributing author for Collier on Bankruptcy and the Collier Bankruptcy Practice Guide and as co-author of The Collier Handbook for Trustees and Debtors in Possession, and has spoken frequently at continuing legal education events. He can be reached at firstname.lastname@example.org.
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
Notify me when updates are available (No standing order will be created).