Understanding The Ch. 11 Acceptance Process

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1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: Understanding The Ch. 11 Acceptance Process Law360, New York (August 14, 2013, 5:02 PM ET) -- A plan proponent generally negotiates its proposed Chapter 11 plan with as many constituencies as possible before soliciting acceptances in order to achieve a consensual plan. While the debtor may not be able to obtain the support of all its constituencies at this stage, the debtor may seek to begin soliciting acceptances while it continues to negotiate with classes in order to gain momentum for the plan and increase the pressure on the stakeholders. Even though, pursuant to Section 1125, a plan proponent may not solicit an acceptance or rejection of a plan without complying with certain disclosure obligations (which are discussed more fully below), a plan proponent is not precluded from negotiating with stakeholders to gain support of the plan. There can be, however, a lack of clarity between actions that constitute negotiation and actions that constitute solicitation. Generally, negotiations are understood to be a process during which a plan proponent and other parties-in-interest have discussions, exchange information and make tentative arrangements that may lead to the development of a plan and disclosure statement. See, for e.g., Century Glove Inc. v. First American Bank of New York, 860 F.2d 94, 101 (3d Cir. 1988) (rejecting a definition of solicitation that may cause the creditors to limit their negotiations, and reasoning that [t]he purpose of negotiations between creditors is to reach a compromise over the terms of a tentative plan. The purpose of compromise is to win acceptance for the plan ). A negotiation may even include a plan support agreement, whereby a party-in-interest agrees to support the general constructs of a plan so long as the plan submitted for confirmation adheres to the negotiated terms. Solicitation, on the other hand, is usually interpreted as the specific request for an official vote either accepting or rejecting the plan. A minority of courts, however, interpret solicitation more broadly to encompass, as an example, an oral statement by a creditor to another creditor of hope that the latter creditor would vote in favor of the debtor s plan. See In re Gilbert, 104 B.R. 206, (Bankr. W.D. Mo. 1989) (holding communication was solicitation under those facts). A plan proponent, therefore, should research the law in its jurisdiction to ensure compliance with disclosure obligations when soliciting votes on a plan.

2 Prepetition Disclosure and Solicitation In certain situations, a debtor may be able to minimize the amount of time spent in bankruptcy by negotiating the terms of a Chapter 11 plan and soliciting approvals for such plan prior to the commencement of the bankruptcy case. To facilitate this process, the Bankruptcy Code allows the debtor to prepare a plan and disclosure statement and solicit votes on that plan before the debtor files for bankruptcy. This type of plan is often referred to as a prepackaged plan or a prepack. Pursuant to Section 1126(b), the prepetition vote of a holder of a claim or interest will be a binding vote post-petition as long as the disclosure in connection with the prepetition solicitation complied with applicable nonbankruptcy law, rules or regulations regarding the adequacy of the disclosure. If there was no such nonbankruptcy law, rules or regulations, votes obtained through prepetition solicitation will be valid as long as the court subsequently determines that adequate information was provided to the holders of claims and interests in accordance with the same standards for plan and disclosure statements filed post-petition as set forth in Section 1125(a). In practice, a debtor will limit the classes it solicits for approval of a prepackaged plan to avoid any potential solicitation issues. To that end, a debtor will rarely seek a prepackaged plan where the main business issues it seeks to address in a bankruptcy involve burdensome contracts or leases to be rejected. Conversely, a situation ripe for a prepackaged plan would be if, for example, the debtor has just one, large secured creditor whose approval would be necessary for the plan s success and a few large unsecured creditors, or where the debtor seeks to reduce its bond debt while leaving its trade and other general unsecured creditors unimpaired. In addition, Section 1125(g) provides that the debtor may continue the solicitation of votes for a prepackaged plan post-petition as long as the solicitation complied with applicable nonbankruptcy law and the solicitation began prepetition. There are, however, certain risks associated with prepackaged plans. A proponent of a prepackaged plan may not have the protection of the safe harbor provision in Section 1125(e) (a more detailed discussion regarding this topic can be found under Safe Harbor Provision below) and cannot utilize the securities laws exemption under Section Additionally, the plan proponent may run the risk that the court will later find that the prepetition disclosure was inadequate, which would require the debtor to resolicit its plan and significantly extend the time spent in Chapter 11. As a practical matter, these risks are often dealt with by crafting a disclosure statement that is more comprehensive, with greater disclosure than is typically required by a bankruptcy court in a postpetition disclosure statement, and that resembles the type of document that might be filed with the U.S. Securities and Exchange Commission in a registered offering.

3 This approach attempts to avoid a scenario in which the court holds that the debtor did not adequately disclose certain information. If the court comes to that conclusion, the debtor must restart the process anew, which defeats the purpose for initially pursuing a prepackaged plan. A debtor should take into account the following considerations when contemplating a prepackaged plan: Are there business issues and reasons to pursue or avoid a prepackaged plan? 1. Will the restructuring be a simple balance sheet adjustment? 2. Are there a number of unexpired leases to reject? 3. Are there a number of material executory contracts to reject? 4. Are there significant assets to sell? Can the debtor limit solicitation to those classes that are necessary to have the requisite support for the prepackaged plan? 1. Are there only a few classes necessary to have the requisite support or are there many classes necessary to have the requisite support? Are there any exemptions to the securities laws that allow the debtor to solicit those classes without a registered offering? If so, what is the scope of the exemptions? Post-Petition Disclosure and Solicitation Before a plan proponent can solicit votes, the disclosure statement must be approved by a court, after notice and a hearing, as containing adequate information as defined by Section 1125(a). Under Section 1125(c), the plan proponent may send different disclosure statements to different classes of claims or interests. However, the plan proponent must send the same disclosure statement to all of the holders of the claims or interests within the same class. This section permits a plan proponent to tailor the amount, detail and type of disclosure to each class and allows for flexibility in the creation and distribution of copies of the disclosure statements, which may save in printing and shipping costs. A plan proponent may want to prepare different disclosure statements where, for example, one class requires limited disclosure, and a second class requires extensive disclosure.

4 Plan proponents, however, rarely distribute more than one disclosure statement, particularly in large cases, because of the high cost of preparing multiple disclosure statements. Multiple disclosure statements may also cause unnecessary complication at the disclosure statement hearing. In any event, as mentioned above, the debtor must distribute the disclosure statement, as approved by the court as containing adequate information, to each holder of a claim or interest entitled to vote before soliciting a vote on the plan from that holder. Safe Harbor Provision Section 1125(e) provides a safe harbor for parties that have either: (1) solicited votes on a plan; or (2) participated in the offer, issuance, sale or purchase of a security offered or sold under a plan from liability for violation of any applicable law, rule or regulation governing the solicitation of a plan or the offer, issuance, sale or purchase of securities. The safe harbor applies as long as the party acted: (1) in good faith and (2) in compliance with the Bankruptcy Code. This provision generally means that the plan proponent may solicit votes from shareholders and bondholders without complying with the specific processes required by securities laws. A more detailed discussion regarding this topic with regard to prepackaged plans can be found under Prepetition Disclosure and Solicitation above. Good Faith Requirement The plan proponent must solicit and procure votes on the plan in good faith and in accordance with the Bankruptcy Code. Pursuant to Section 1126(e), a party-in-interest can request that the court, after notice and a hearing, designate (or disqualify) the vote of any party whose acceptance or rejection of the plan was not solicited or procured in good faith or in accordance with the Bankruptcy Code. A vote, for example, will be disallowed as having been cast not in good faith: If the claimant is using obstructive tactics and holdup techniques to extract better treatment for its claim than the treatment afforded to the claims of other holders within the same class; If the holder of the claim casts its vote for the ulterior purpose of securing some advantage to which it would not otherwise be entitled; or When the motivation for the vote is not consistent with the creditor s protection of its selfinterest.

5 Situations that support a finding of a lack of good faith may include: Pure malice Strikes Blackmail Purposeful destruction of a debtor s business For example, a court designated the vote of a creditor for lacking good faith where the creditor was employed by a competitor of the debtor and it appeared from the creditor s stance in the bankruptcy case that the creditor cast its vote with the ulterior purpose of destroying or injuring the debtor s business so that the competitor s business would benefit. See In re MacLeod Co., 63 B.R. 654, (Bankr. S.D. Ohio 1986). As another example, a court designated the vote of a senior creditor that was also the debtor s competitor and that acquired its claims during the Chapter 11 case because it was attempting to obtain some benefit to which [it was] not entitled by buying a blocking position with the intention of using its status as a creditor to vote against any plan that did not give it a strategic interest in the reorganized company. DISH Network Corp. v. DBSD North America Inc. (In re DBSD North America Inc.), 634 F.3d 79, 102 (2d Cir. 2011). In addition to designating a vote cast in bad faith, the court can also take other action against such a party, including denying any motion by that stakeholder to terminate exclusivity or finding that any plan proposed by that stakeholder is not proposed in good faith and cannot be confirmed. It is important to note that a creditor or interest holder is entitled to act in its own self-interest and that doing so does not mean that the creditor is not acting in good faith. A creditor, for example, may take a blocking position with respect to the plan, or purchase claims or the vote of a deficiency claim to block confirmation of a plan without acting in bad faith. However, a creditor must always be cognizant of the risk of vote designation. That risk increases if the creditor acquires its claims during the Chapter 11 case and is particularly acute if the creditor is a competitor or has a significant stake in a competitor of the debtor. --By Gary L. Kaplan, Fried Frank Harris Shriver & Jacobson LLP Gary Kaplan is a bankruptcy and restructuring partner resident in Fried Frank's New York office. This article is excerpted from Lexis Practice Advisor, a comprehensive practical guidance resource providing insight from leading practitioners on the topics critical to attorneys who handle transactional matters. For more information on Lexis Practice Advisor or to sign up for a free trial please click here. Lexis is a registered trademark of Reed Elsevier Properties Inc., used under license. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. All Content , Portfolio Media, Inc.