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Lockups, Deathtraps and the Gifting Doctrine: A Discussion of Plan Confirmation Issues

Mark E. Andrews, Aaron M. Kaufman and M. Jermaine Watson Cox Smith Matthews Incorporated Dallas, Texas [email protected] Lisa G. Beckerman Akin Gump Strauss Hauer & Feld LLP New York, New York [email protected] James S. Carr and Stacia A. Neeley Kelley Drye & Warren, LLP New York, New York [email protected] Larry H. Lattig Mesirow Financial Consulting, LLC Dallas, Texas [email protected] The Honorable Brendan L. Shannon United States Bankruptcy Court for the District of Delaware Wilmington, Delaware


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I. II.

Introduction Unequal Treatment, Deathtrap, Waiver of Discrimination: Is Absolute Equality Required? A. B. C. D. Unequal Treatment Deathtrap Selective Waiver of Subordination Unfair Discrimination Subordination and Unfair


The Gifting Doctrine A. B. C. D. An Introduction to Gifting Gift Plans v. Gift Settlements Case Law Regarding Gifting The Importance of the Gifting Doctrine and Implications Going Forward


Prepacks and Prenegotiated Bankruptcies A. B. Prepack Bankruptcies Recent Trends


Other Confirmation Issues A. B. C. Pre-Confirmation Auctions Claim Preservation Non-Debtor Releases, Exculpatory Clauses and Injunctions



Appendix: Table of Gifting Doctrine Cases


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Introduction Section 1129 of the Bankruptcy Code contains the requirements for plan confirmation,

starting with the requirements that the plan "complies with all applicable provision of this title." A few common issues that arise in confirmation disputes, including the merits of "deathtrap" provisions and the "gifting doctrine," are addressed in this paper along with the related topics of improper classification, unequal treatment, unfair discrimination, and the absolute priority rule. Finally, this paper will discuss prearranged plans, prepetition lock-up agreements, credit bidding rights during pre-confirmation auctions, preservation of claims through a plan and the availability of non-debtor releases and protections through plans. II. Unequal Treatment, Deathtrap, Waiver of Discrimination: Is Absolute Equality Required? A. Unequal Treatment Subordination and Unfair

Section 1123(a)(4) of the Bankruptcy Code 1 requires that "a plan shall - . . . (4) provide for the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment of such particular claim or interest." Does Section 1123(a)(4) require that each member of the class receive identical treatment or does it merely require that each member of the class be offered the same choices as to its treatment? There is limited case law on this point and the decisions are divergent. Courts have held that section 1123(a)(4) gives parties in bankruptcy and the Courts some flexibility when faced with a complex reorganization. 2 If creditors in a class are given the same options as to treatment or the same elections, some Courts have held that there is no violation of section

1 2

11 U.S.C. § 101 ­ 1532 is referred to herein as the "Bankruptcy Code."

In re Joint E. & S. Dist. Asbestos Litig., 129 B.R. 710, 859 (E.D.N.Y. 1991), vacated and remanded on other grounds, 982 F.2d 721 (2d Cir. 1992).


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1123(a)(4) if the parties within the class do not all choose the same treatment option or make the same treatment election. 3 However, other Courts have held to the contrary. 4 B. Deathtrap

Can a plan of reorganization provide for a different treatment if the class votes to accept the plan? This type of "carrot and stick" provision is known as a "deathtrap." There are few reported decisions and there is a split in the Courts regarding deathtrap provisions. In Mcorp, 5 the Court denied confirmation of a plan of reorganization which authorized a possible payout to three classes of equity holders but only if certain classes of equity holders voted in favor of the plan of reorganization. That class voted against the plan and the debtor sought approval of the plan under section 1129(b) of the Bankruptcy Code. The Court in Mcorp expressed the view that since the two classes' fate was tied to the vote of the third class, such classes "not only lost any possible distributions, but also the right to vote effectively," 6 and that such classes were required to vote without adequate information to make an informed decision on the plan. Thus, the Mcorp Court denied confirmation of the plan of reorganization, finding that the plan did not satisfy the cramdown standards of section 1129(b). However, other Courts have approved plans with "deathtrap" provisions. In Zenith

Electronics Corp., 7 the plan of reorganization proposed a distribution to a class of bondholders

See King v. Dalkon Shield Claimants Trust (In re A.H. Robins Company), 219 B.R. 161, 175 (E.D. Va. 1998); In re Stolrow's Inc., 84 B.R. 167, 172 (9th Cir. BAP 1988); In re AOV Industries, 31 B.R. 1005 (D.D.C. 1993), affirmed in part and reversed in part, 792 F.2d 1140 (D.C. Cir. 1986). See ACC Bondholder Group v. Adelphia Communs. Corp. (In re Adelphia Communs. Corp.), 361 B.R. 337 (S.D.N.Y. 2007) (class members who voted in favor of the plan would receive broad releases and exculpations and those who did not vote in favor of the plan would not receive the same releases and exculpations which treatment violates section 1123(a)(4)).

5 6 7 4


In re Mcorp Fin., Inc., 137 B.R. 219 (Bankr. S.D. Tex. 1992) Id. at 236. In re Zenith Electronics Corp., 241 B.R. 92, 105 (Bankr. D. Del. 1999).


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that was not otherwise entitled to receive a distribution under the absolute priority rule but only if such class voted to accept the plan. The equity holders were not offered any distribution under the plan and objected to the bondholders receiving any distributions under the plan. The Court held that there is no prohibition in the Bankruptcy Code against a plan proponent offering different treatment to a class depending on whether it votes to accept or reject the plan. 8 "One justification for such disparate treatment is that, if the class accepts, the plan proponent is saved the expense and uncertainty of a cramdown fight. This is in keeping with the Bankruptcy Code's overall policy of fostering consensual plans of reorganization and does not violate the fair and equitable requirement of section 1129(b)." 9 As to the equity holders' objection that they were not offered a similar deal, the Court held that under the cramdown provisions of the Bankruptcy Code, the bondholders must be treated better than the shareholders and thus, "it is not fundamentally unfair" for the bondholders to have been offered a distribution under the plan in exchange for their acceptance even though the shareholders were not. In Drexel Burnham Lambert Group, Inc., 10 the Court held that a deathtrap provision was neither discriminatory nor violative of the absolute priority rule. Each of three classes of equity were offered warrants if the class voted in favor of the plan and nothing if each such class voted to reject the plan. First, the Court noted that "the only class that is affected by its negative vote is the class itself and not any junior class." 11 Additionally, the Court had "no conceptual problem with senior interests offering junior interests an inducement to consent to the Plan and waive whatever rights they have" and did "not view the carrot and the stick, . . . as forbidden by the

8 9

Id. Id.

In re Drexel Burnham Lambert Group, Inc., 138 B.R. 714 (Bankr. S.D.N.Y. 1992), aff'd, 140 B.R. 346 (S.D.N.Y. 1992)



Id. at 717.


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Code or any law." 12 The Court alternatively ruled that, even if the deathtrap provision was discriminatory, it nonetheless did not violate the absolute priority rule because (i) the equity holders were receiving exactly what their interest was worth ­ nothing, and (ii) no junior interests were receiving any property. 13 C. Selective Waiver of Subordination

Section 510(a) of the Bankruptcy Code provides that "a subordination agreement is enforceable in a case under the title to the same extent that such agreement is enforceable under applicable nonbankruptcy law." Courts have interpreted this provision as requiring a plan of reorganization not to impair the enforcement of contractual subordination provisions, whether in indentures, intercreditor agreements or other contracts. It is not uncommon for senior creditors that have the benefit of contractual subordination and who are not receiving payment in full under a plan of reorganization to agree to waive enforcement of subordination to allow junior creditors to retain distributions provided to them under the plan which would otherwise have to be turned over to the senior creditors under the terms of the indenture or intercreditor agreement. Recently, in some plans, enforcement of subordination has been used as a stick to encourage junior creditors to vote in favor of a plan of reorganization. An example of this is WCI Communities. 14 The plan of reorganization which was confirmed on August 26, 2009, contains the following provision: The Plan Distributions to the various classes of Claims hereunder shall not affect the right of any Person to levy, garnish, attach, or employ any other legal process with respect to such Plan Distributions by reason of any claimed subordination rights or otherwise. All such rights and any agreements relating thereto

12 13 14

Id. Id. In re WCI Communities, Inc., Case No. 08-11643 (KJC).


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shall remain in full force and effect, except as otherwise compromised and settled pursuant to the Plan. If Class 4 ­ Unsecured Claims votes to accept the Plan, the Prepetition Lenders and the Prepetition Agents shall not enforce any of their contractual subordination rights against any holder of an Allowed Prepetition Note Claim or against any Plan Distributions received by any holder of an Allowed Unsecured Claim, and shall waive and expressly release any deficiency claims under section 506(a)(1) of the Bankruptcy Code. If Class 4 ­ Unsecured Claims votes to reject the Plan, the Plan is confirmed and the Effective Date occurs, the Prepetition Lenders and the Prepetition Agents (a) shall enforce their contractual subordination rights against any holder of an Allowed Prepetition Note Claim who voted to reject the Plan or against any Plan Distributions received by any such holder, (b) shall not enforce their contractual subordination rights against any holder of an Allowed Prepetition Note Claim who did not vote to reject the Plan or against any Plan Distributions received by any such holder, and (c) do not waive and release any deficiency claims under section 506(a)(1) of the Bankruptcy Code; provided, however, that the Prepetition Lenders and the Prepetition Agents shall only receive recoveries on account of such deficiency claims through the enforcement of any contractual subordination rights against holders of Allowed Prepetition Note Claims who voted to reject the Plan and against any Plan Distributions received by such holders and shall not be entitled to any other recoveries on account of such deficiency claims. 15 In situations like WCI, the senior creditors use their ability to waive the enforcement of contractual subordination to encourage junior creditors to vote in favor of the plan of reorganization and to discourage junior creditors from voting against the plan of reorganization by providing for adverse economic consequences. "If subordination agreements were not

waivable under a plan of reorganization acceptable to the senior creditor, the section would prevent just what Congress envisioned: that senior creditors may compromise with junior

creditors in order to confirm a plan." 16 Even though the waiver of enforcement of subordination

15 16

Id. Collier on Bankruptcy, ¶ 510.03[3] (16th ed. 2009).


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is clearly permissible, it is unclear whether selective enforcement of contractual subordination within a class is permissible under section 1123(a)(4) of the Bankruptcy Code. 17 D. Unfair Discrimination

If a plan of reorganization is being confirmed under section 1129(b) of the Bankruptcy Code, the cramdown standards, the Court must find that "the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan." The case law regarding unfair discrimination generally applies one of two standards. The majority of Courts apply a four factor test: "(1) whether the discrimination is supported by a reasonable basis; (2) whether the debtor can confirm and consummate a plan without the discrimination; (3) whether the discrimination is proposed in good faith and (4) the treatment of the classes discriminated against." 18 A minority of Courts follow a more conservative approach to § 1129(b)(1) that shifts the burden and typically bars discrimination regardless of whether it is fair or reasonable. 19 The Court in Dow Corning held that: a rebuttable presumption that a plan is unfairly discriminatory will arise when there is: (1) a dissenting class; (2) another class of the same priority; and (3) a difference in the plan's treatment of the two classes that results in either (a) a materially lower percentage recovery for the dissenting class (measured in terms of net present value of all payments), or (b) regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution. 20

See In re Piece Goods Shops Co., L.P., 188 B.R. 778, 789-90 (Bankr. M.D.N.C. 1995) (Court held that there was no violation of Section 1123(a)(4) when the enforcement of inter-creditor agreements may result in parties within the same class retaining different consideration). Liberty National Enterprises v. Ambanc La Mesa Ltd. Partnership (In re Ambanc La Mesa Ltd. Partnership), 115 F.3d 650, 656 (9th Cir. 1993); In re Snyders Drug Stores, Inc., 307 B.R. 889, 896 (Bankr. N.D. Ohio 2004).

19 20 18


In re Dow Corning Corp., 244 B.R. 705 (Bankr. E.D. Mich. 1999). Id. at 710.


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Courts that apply the four factor balancing test will be more likely to approve a plan of reorganization which discriminates against a class if there is a rational basis for the discrimination. Such courts will also be more likely to uphold a deathtrap or class skipping arrangement in gifting plans if the class would otherwise not be entitled to a distribution on an absolute priority basis. III. The Gifting Doctrine A. An Introduction to Gifting

One of the most well recognized tenets of bankruptcy law is the absolute priority rule. The absolute priority rule establishes a priority scheme that mandates payment in full to secured creditors prior to distributions being made to unsecured creditors. 21 The gifting doctrine seeks to circumvent the absolute priority rule by enabling a senior creditor to "gift" a portion of its distribution to a junior creditor 22 despite the fact that a creditor with the higher priority has not been paid in full. The rationale behind this practice is that a secured creditor, who has a lien on all of a debtor's assets, may "gift" a portion of its recovery to whomever it wants, including junior creditors who might otherwise receive nothing in a bankruptcy case. 23 B. Gift Plans v. Gift Settlements

There are numerous contexts in which a senior creditor may gift a portion of its recovery to junior creditors. The two most common are the gift plan and the gift settlement.

21 22

11 U.S.C. § 1129(b)(1).

This applies equally to equity holders who may receive a gift from senior creditors notwithstanding that junior creditors have not been paid in full. See, e.g., In re DBSD North Am., 419 B.R. 179 (Bankr. S.D.N.Y. 2009). See Hugh M. Ray and John W. Daly, Reverse Cramdown: The Senior Creditor's Tip to the Lower Classes, "A Plan Too Far" and Other Confirmation Controversies.



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Gift Plans

A gift plan is a plan of reorganization that grants distributions to junior creditors even though creditors with a higher priority have not received a full distribution on account of their claims. The following is a classic example of a gift plan: A hypothetical chapter 11 plan contains three classes of creditors. First, there is a senior class comprised of a secured creditor with a lien on substantially all of the debtor's assets. This creditor is under-secured and accordingly, entitled to receive all of the proceeds of its collateral in a liquidation. The plan calls for 95% of distributions to be used to satisfy the senior creditor's claim. Second, there is an intermediate class comprised of holders of subordinated debt. The plan does not provide for distributions to these claimants. Third, there is a class of trade creditors. The plan provides for these creditors to receive the remaining 5% of distributions to which the senior creditor would otherwise be entitled. The 5% distribution is a "gift" to the trade creditors from the senior secured creditor. These gifts are not ones of beneficence. Often, gift plans are designed to hasten a debtor's emergence from chapter 11 by accelerating plan confirmation and avoiding protracted litigation through a gift to junior creditors. Proponents of gift plans recognize that junior creditors may hold up confirmation by voting "no" on a plan of reorganization, thereby forcing a cram down of their class. To avoid this result, a senior creditor may agree to share a portion of its recovery under the plan with junior creditors in exchange for a "yes" vote on the plan. Gift plans are problematic vis a vis certain plan confirmation provisions of the Bankruptcy Code. For example, section 1129(b)(1) limits cram downs to those situations where a plan does not "unfairly discriminate" and is found to be "fair and equitable" with respect to


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each class of impaired claims or interests that has not accepted the plan. 24 Fair and equitable is a euphemism for the absolute priority rule. Given that gifting is an attempt to circumvent this rule, it is no surprise that some bankruptcy courts have denied confirmation of gift plans. 2. Gift Settlements

A gift settlement is the functional equivalent of a gift plan except that the gift is embodied in a settlement agreement rather than a plan of reorganization. Approval of a gift settlement is sought pursuant to Federal Rule of Bankruptcy Procedure 9019. 25 Gift settlements are sometimes favored over gift plans because, on its face, Rule 9019 does not take the absolute priority rule into account. However, parties that object to a gift settlement often do so on the ground that a gift settlement is an end-run around section 1129 and, therefore, should not be permitted. C. Case Law Regarding Gifting

To understand how case law on gifting has developed, one must start at the beginning: the 1993 decision of In re SPM Manufacturing Corp. 26 In this case, a senior secured creditor entered into an agreement with the unsecured creditors' committee to cooperate in formulating a plan of reorganization and share any proceeds received as a result thereof. 27 When attempts at


11 U.S.C. § 1129(b)(1). Section 1129(b)(1) states in pertinent part: "...if all of the applicable requirements of subsection (a) of this section, other than paragraph (8) are met with respect to a plan, the court, on request of the proponent of the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan."

Fed. R. Bankr. P. 9019. Rule 9019(a) states in pertinent part that "[o]n motion by the trustee and after notice and a hearing, the court may approve a compromise or settlement." Rule 9019(b) states that "[a]fter a hearing on such notice as the court may direct, the court may fix a class or classes of controversies and authorize the trustee to compromise or settle controversies within such class or classes without further hearing or notice."

26 27


984 F.2d 1305 (1st Cir. 1993). Id. at 1308.


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reorganization failed, the debtor's case was converted to chapter 7 and its assets were sold for less than the amount of the senior secured creditor's claim. 28 The senior secured creditor and the unsecured creditor's committee sought to have the sale proceeds distributed in accordance with their agreement; the debtor objected, arguing that the proposed distribution would violate the absolute priority rule by permitting general unsecured creditors to receive a distribution while priority tax claimants received nothing. 29 The First Circuit approved the distribution scheme and found that the sale proceeds were the property of the senior secured creditor which was free to distribute those proceeds in any manner it chose, including to junior creditors over the objection of an intermediate class. 30 Since SPM Manufacturing, a number of courts have approved plans of reorganization involving gift distributions, including courts in New York, Delaware, Texas, and Ohio. 31 In these cases, two factors are commonly present: (1) the gifted property is not property of the debtor's estate but rather belongs to a senior under-secured creditor and (2) there exists a strong and credible business justification for the gift (i.e., preserving the enterprise value of a reorganized debtor). Conversely, courts have refused to uphold gift distributions to junior creditors where at least one of the factors listed above was missing. For instance, in In re Snyder Drug Stores, 32 certain favored classes, including reclamation claimants and trade creditors, were to receive an

28 29 30 31 32

Id. at 1308-09. Id. Id. at 1313-14. See Appendix. 307 B.R. 889 (Bankr. N.D. Ohio 2004)


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enhanced recovery while general unsecured creditors would receive nothing. 33 The enhanced value was comprised of proceeds from avoidance actions and other value that would have otherwise gone to the debtor's secured lenders. 34 In defending the plan, the debtors argued that because the senior lenders were under-secured and would not be paid in full, the objecting creditors were not entitled to receive anything under the plan and in addition, the special treatment to favored creditors was justified by the debtor's post-reorganization business needs. 35 The court refused to confirm the plan, finding that the avoidance actions were property of the estate rather than property of the lenders and there was not sufficient evidence that the favored creditors would have refused to do business with the reorganized debtor in the absence of the gift. 36 The oft-cited decision In re Armstrong World Indus., Inc. 37 also appears to be grounded in part on the "strong business justification" factor. In rejecting a plan that would have provided new warrants to certain equity holders, the district court for the District of Delaware held that the plan was not "fair and equitable" because equity holders were receiving a distribution even though unsecured creditors had not been paid in full. 38 The court went on to hold that "to accept the [secured lender's] argument that [it] can, without any reference to fairness, decide which creditors get paid and how much those creditors get paid is to reject the historical foundation of receiverships and to read the § 1129(b) requirements out of the Code." 39 The court rejected the

33 34 35 36 37 38 39

Id. at 892. Id. Id. at 894. Id. at 894-95. 320 B.R. 523 (D. Del 2005), aff'd 432 F.3d 507 (3d Cir. 2005). Id. at 525-26, 536. Id. at 540 (citing to In re Sentry Op. Co. of Tex., Inc., 264 B.R. 850, 865 (Bankr. S.D. Tex. 2001)).


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gift because there was no adequate business justification (the value of the warrants far exceeded the value of the claims that the recipients were releasing in exchange for the gift) and the gift was from unsecured asbestos claimants (thus not making it a "true gift"). 40 Armstrong World is an important decision in gifting jurisprudence because it is the only decision that has been affirmed by a circuit court and, notably, it comes from the Third Circuit. 1. Table of Gifting Decisions

In the Appendix to this paper, there is a chart summarizing gifting decisions reported in the last 25 years. Opinions approving gift provisions are listed first, followed by opinions denying gift provisions. The third section of the chart lists unreported opinions in which a bankruptcy court approved a gift plan or gift settlement but did not publish an opinion with respect to its decision. This list is by no means exhaustive, but rather reflects a few of the bankruptcy cases in which the authors have been involved. 2. Recent Case Law

Since the 2005 Armstrong World decision, there have been eight reported decisions regarding gifting to a junior class. Notably, six of these decisions approved a gift, including two bankruptcy courts in the District of Delaware. First, in In re World Health Alternatives, the Delaware bankruptcy court approved a gift settlement within the context of 363 sale where the gift resulted "in global peace among the Debtors, the Committee and [the gift giver]." 41 The court held that the gift was not problematic because its source was a secured lender's collateral which would not otherwise be available to the objecting party. 42

40 41 42

Id. at 536. 344 B.R. 291, 296 (Bankr. D. Del. 2006). Id. at 297.


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More recently, in In re TSIC, the Delaware bankruptcy court approved a gift settlement within the context of a 363 sale. 43 The court found that the gift settlement, which provided for a cash gift to unsecured creditors over the objection of the Internal Revenue Service, did not violate the absolute priority rule because the source of the gift was funds held by a stalking horse bidder rather than the estate. The fact that the IRS, as a priority tax claimant, would not receive a distribution from the sale proceeds was not relevant to the court's decision. In rendering its opinion, the court stated that the logical starting point was Armstrong World, but found Armstrong World to be inapplicable because the settlement in question involved payment by a non-debtor to junior creditors outside of a plan of reorganization. 44 The court reached a similar conclusion in World Health Alternatives, finding that the absolute priority rule did not apply to a 9019 settlement. 45 These cases are perfect examples of why gift

settlements (and not gift plans) are likely to become the preferred method of gifting. What does this mean for the future of gifting? We will likely see more and more bankruptcy courts approve gift settlements (or gift plans) for the reasons discussed herein. However, it is important to note that there may not be many reported decisions on this topic because gifting objections are often consensually resolved before a judge has to issue a ruling. D. The Importance of the Gifting Doctrine and Implications Going Forward It provides a

Gifting is an important development in bankruptcy jurisprudence.

mechanism by which parties may settle disputes, thereby assisting a debtor in emerging from chapter 11 as quickly as possible. In the context of a chapter 11 reorganization, this may result in an enhanced enterprise value and to some degree, the preservation of jobs.

43 44 45

In re TSIC, 393 B.R. 71 (Bankr. D. Del. 2008). Id. at 75-77. In re World Health Alternatives, 344 B.R. at 297.


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The gifting phenomenon appears to have grown alongside pre-packaged bankruptcies. This makes sense given that gift provisions are sometimes critical to the success of a prepackaged chapter 11 plan. To the extent gifting were to disappear, we would likely see a fall in the number of pre-packaged bankruptcies as well. While the utility of pre-packaged plans is outside the scope of this paper, it is worth noting that pre-packaged bankruptcies tend to result in significant savings to both a debtor and its stakeholders. One of the more interesting facets of the gifting doctrine is its impact on other Bankruptcy Code provisions. Although an in-depth discussion on this topic is outside the scope of this paper, there are two issues worth mentioning. a. 363 Sales and Sub Rosa Plans. 46 New authority has emerged in recent years

approving arrangements in section 363 sales for the carving out or gifting of certain sale proceeds from a secured lender's collateral. The carve-outs are for the benefit of the debtor's unsecured creditors and may often provide the best or only realistic recovery for these claimants where the debtor's secured lenders are under-secured. These arrangements typically are styled as gift settlements to be approved under Rule 9019. The use of gifting in 363 sales raises the question of whether these settlements are merely sub rosa plans designed to avoid the absolute priority rule. Courts are split on this issue. For example, in In re World Health Alternatives, the bankruptcy court approved a gift from a stalking horse bidder to general unsecured creditors in exchange for the creditors' support of the 363 sale. 47 Conversely, in On-Site Sourcing Inc., the bankruptcy court for the Eastern District of Virginia denied a similar gift on the ground that it

For more information on this topic, see Richard L. Ferrell, Gifting Carve-Outs in Asset Sales under § 363 Still Controversial, 28-9 ABIJ 16 (November 2009).



344 B.R. 291 (Bankr. D. Del. 2006).


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contravened the absolute priority rule because unsecured creditors would be paid at the expense of priority creditors. 48 b. Pay to Play. 49 "Pay to play" is a term of art used to describe situations where a

secured lender finances a bankruptcy case so that it may collect the proceeds of its collateral. In essence, the bankruptcy case is being run for the benefit of the lender and, in exchange, the lender shares a portion of its recovery with junior creditors. "Pay to play" takes different forms, including professional fee carve-outs, claw-backs and carve-outs for committee investigations into the legitimacy of a secured lender's liens, 506(c) surcharges, and most importantly for purposes of this paper, gift plans and gift settlements. Going forward, we may start to see written decisions where the "pay to play" doctrine is used to justify gifting. Given the status of current case law, there appear to be three main factors to consider in connection with a gift plan or gift settlement: a. Jurisdiction. To the extent a gifting proponent has control over jurisdictional

issues, careful consideration should be given to the locale of the bankruptcy case. For example, courts in the Second Circuit, and particularly in the Southern District of New York, have embraced the gifting doctrine. 50 Notwithstanding the Third Circuit's opinion in Armstrong World, Delaware bankruptcy courts appear to be embracing the doctrine by factually


2009 WL 1789331 (Bankr. E.D. Va. 2009).

For more information on this topic, see Andrew L. Turscak Jr. & Alan R. Lepene, Must a Secured Creditor "Pay to Play" in Chapter 11?, 28-2 ABIJ 36 (March 2009). See, e.g., In re Iridium Op., 478 F.3d 452 (2d Cir. 2006); In re DBSD North Am., 419 B.R. 179 (Bankr. S.D.N.Y. 2009); In re Journal Register Co., 407 B.R. 520 (Bankr. S.D.N.Y. 2009).




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distinguishing Armstrong World from the case presently before them. 51 Bankruptcy courts in the Fifth Circuit appear to be evenly divided on the issue. 52 b. Source of gift/identity of gift giver. The gift should come from a senior secured

creditor which is under-secured based on the current value of its collateral. Gifts from unsecured creditors 53 or the debtor itself 54 do not work. c. Is there a substantial business justification for the gift? Courts are less likely to

approve gifting provisions where there is little to no evidence of a substantial business justification for the gift 55 or where it appears that the gift is being given to gerrymander votes. 56 Conversely, gifting provisions have been approved where there is sufficient evidence that the advantaged class is critically important to the success of the reorganized debtor. 57 Other factors to be considered include (a) whether the gift is inter-priority or intrapriority (which may raise unfair discrimination issues), (b) whether the gift will be distributed as part of a chapter 11 plan or at a later date after the gift giver has received its distribution, and (c) the disparity of treatment between the advantaged class and the disadvantaged class.

See In re World Health Alternatives, 344 B.R. 291 (Bankr. D. Del. 2006) and In re TSIC, 393 B.R. 71 (Bankr. D. Del. 2008). See, e.g., In re IDEARC, Inc., 2009 Bankr. LEXIS 4202 (Bankr. N.D. Tex. 2009) (approving gifting provision); In re OCA, 2006 WL 3833929 (Bankr. E.D. La. 2006) (denying gifting provision); In re Sentry Op. Co. of Tx., 264 B.R. 850 (Bankr. S.D. Tex. 2001) (denying gifting provision); In re MCorp. Fin. Inc., 160 B.R. 941 (S.D. Tex. 1993) (approving gifting provision). See, e.g., In re Snyder Drug Stores; In re AWECO, 725 F.2d 293 (5th Cir. 1984) (holding that debtor could not transfer estate assets to unsecured creditor as part of 9019 settlement without first satisfying priority tax claims).

54 55 56 57 53 52


See, e.g., In re Armstrong World Indus., Inc. See, e.g., In re Snyder Drug Stores. See, e.g., In re Sentry Op. Co. of Tex. See, e.g., In re Union Fin. Svcs. Group, 303 B.R. 390 (Bankr. E.D. Mo. 2003).


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Prepacks and Prenegotiated Bankruptcies A. Prepack Bankruptcies

Pre-packagaged ("Prepack") chapter 11 bankruptcy cases 58 are used to minimize costs, provide greater flexibility to the debtor corporation and reduce uncertainty especially in situations where the debtor has a simple capital structure. 59 Prepack and pre-negotiated chapter 11 bankruptcy cases are authorized under section 1126(b) of the bankruptcy code, which allows creditors and equity holders to vote on a reorganization plan prepetition if: · The debtor's solicitation of votes on the proposed plan complies with applicable nonbankruptcy laws, rules or regulations governing the adequacy of the solicitation; or The disclosure statement contains adequate information to allow such creditors and equity holders to vote on the plan. 60


Depending on the purpose of the restructuring effort, debtors typically seek out either a stalking horse bidder or a DIP lender prior to soliciting votes from creditors and equity. The debtor then negotiates with creditors and equity holders. Depending on the debtors' capital structure, this process can become untenable as the number of creditors increases. In some instances, a relatively small creditor constituency can derail the entire process by refusing to negotiate for less than the full amount of their claims. 61

A prepack is a type of pre-negotiated bankruptcy case whereby the debtor negotiates the key terms of a plan and solicits votes prior to filing a chapter 11 petition. A prepack is extremely useful in that it minimizes disruption to the debtor's business, which allows flexibility to restructure, reorganize or seek new purchaser without the disruption (and publicity) of a bankruptcy proceeding. Michael L. Bernstein, Jonathan Friedland and Prof. John D. Ayer, Out-of-court Workouts, Prepacks and Pre-arranged Cases: A Primer, 24-3 AM. B. INST. J. at 16 (Apr. 2005).

60 61 59


See 11 U.S.C. § 1126(b) (2010). Bernstein, supra note 2, at 16.


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Assuming the debtor obtains the necessary votes to approve the reorganization plan, the debtor then circulates the plan, disclosure statement and ballots to creditors to consider. 62 The creditors typically have a deadline to return their ballots to the debtor. Provided that sufficient votes exist to approve the plan, the debtor then files a petition, plan and disclosure statement at the same time. Subject to court approval, the debtor may reorganize its business or sell its assets under the terms of the plan. However, the debtor may still be subject to objections from a dissenting creditor challenging the disclosure statement or the solicitation of votes. If the court sustains the objection, the debtor may have to resolicit votes. 63 B. Recent Trends 1. Pre-negotiated Bankruptcies

There is a recent trend towards pre-negotiated bankruptcies, which some commentators describe as: A reorganization or restructuring that is, prior to the commencement of the bankruptcy, (1) negotiated with representatives of the most significant constituencies that are expected to be impaired and whose acceptance is sought or needed for confirmation, (2) agreed to by those representatives, and (3) memorialized in a written agreement containing the basic terms of a reorganization plan (a "lock up agreement"). 64 A "lock-up" refers to an agreement between a creditor and a debtor (or prospective debtor) which legally binds the creditor to vote for the reorganization plan subject to certain terms and conditions defined in the agreement. 65 Thus, the key distinction between a prepack

62 63 64 65

Id. Id. at 56. Id. Official Comm. of Unsecured Creditors v. New World Pasta Co., 322 B.R. 560, 568 (M.D. Pa. 2005).


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and a pre-negotiated bankruptcy is that solicitation occurs after the bankruptcy is filed and after the court has approved a disclosure statement. 66 2. Pre-negotiated Sale of Debtor's Assets to Insiders Approved

In Summit Global Logistics, a parent corporation and its affiliates filed chapter 11 bankruptcy petitions in a consolidated proceeding after several unsuccessful attempts to reorganize their debt structure.


The debtors faced a liquidity crisis arising out of several

acquisitions, which saddled the debtors with a $65 million senior revolving credit facility and $85 million in convertible bonds. The debtors retained Gordian Group, LLC ("Gordian") as its investment banker to help facilitate a pre-negotiated plan. 68 The debtors' management team formed an entity, TriDec Acquisition Company ("TriDec"), for the sole purpose of acquiring the debtors' assets. Under the terms of the prenegotiated sale, TriDec would acquire the debtors' assets; management would infuse $8 million in cash to reduce the DIP facility with $3 million remaining in working capital; a post sale transaction 69 would proceed; the bondholders would receive 25% of the common stock 70 in TriDec; the remaining portion of the revolver would be satisfied from the sale proceeds; TriDec

66 67

Bernstein, supra note 9, at 56.

In re Summit Global Logistics, et al., No. 08-11566, 2008 Bankr. LEXIS 896, at *9-10 (Bankr. D. N.J. Mar. 26, 2008). Id. at 12. Gordian approached Fortress Credit, the senior lender, to finance TriDec as the stalking horse bidder for the contemplated sale, which resulted in DIP financing and an asset purchase agreements. Id. at 14. An investor reached an agreement with TriDec whereby TriDec would complete the purchase of the debtors' assets, the investor would help TriDec refinance its senior secured debt and fund a later merger with another entity. Id. at 17. Although the bondholders were impaired under the proposed scheme and initially objected to the DIP financing and proposed sale, TriDec and the bondholders later reached a settlement whereby the bondholders would receive 25% of the common stock in TriDec after the sale. Id. at 19-20.

70 69 68


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would not acquire any potential avoidance actions 71 later brought against insiders; and all executory contracts would be assumed and assigned to TriDec. 72 Since a rapid sale was contemplated, no unsecured creditors' committee was appointed. The United States Trustee moved for and the court approved the appointment of an examiner to evaluate the debtors' prepetition sales effort to address the sale of the debtors' assets to management. The examiner analyzed the debtors' sale process and filed a report, which determined that the contemplated sale was extensively marketed both prepetition and postpetition in good faith. The terms of the plan, among other things, included the sale of the debtors' China operations to TriDec. One of the unsecured creditors, Hecny, a direct competitor of the debtors, objected to the sale of stock in the debtors' China subsidiary. 73 The court overruled Hecny's objections and approved the sale of assets to TriDec. The court noted that the debtors

demonstrated sound business judgment in the formation of the proposed transaction given their liquidity crisis and the vast amount of secured indebtedness under the revolver and convertible bonds. The court further noted that the proposed transaction was fair and open and maximized the value of the estate. 74 3. No Duty to Disclose Pre-Negotiated Bankruptcy

In Beleson v. Schwartz, Loral Space & Communications, Ltd. ("Loral"), a satellite communications company began experiencing financial difficulties. 75 Intelsat, Ltd. ("Intelsat")



72 73 74 75

The U.S. Trustee insisted that any potential avoidance actions against insiders remain with the debtors' Id. at 21-22. Id. at 24-25. Id. at 43. Beleson v. Schwartz, 599 F. Supp. 2d 519, 521 (Bankr. S.D.N.Y. 2009).


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approached Loral about purchasing six of its satellites. Initially, Intelsat did not require a bankruptcy proceeding to consummate the proposed transaction, but later demanded that Loral file a bankruptcy petition to ensure the safe passage of title to the satellites. Loral issued two press releases related to the favorable settlement of pending litigation and a large performance payment under one of its contracts on June 30, 2003. Moreover, Loral's CEO was quoted in two news articles discussing two lucrative financial transactions on July 1, 2003 and July 8, 2003. On July 14, 2003, the parties reached a deal and Loral's board of directors approved the transaction along with the bankruptcy petition. The next day, the parties signed an asset purchase agreement in which Intelsat agreed to pay $1.06 billion for the satellites and Lorel filed a chapter 11 petition. On August 11, 2003, plaintiffs filed a class action lawsuit under federal securities laws against the CEO alleging that four fraudulent statements were made during the class period, which led to a precipitous decline in the price of Loral's common stock after the bankruptcy petition was filed. The CEO filed a motion for summary judgment, which the court later granted. 76 The court held that Loral had no duty to disclose its proposed bankruptcy filing. 77 The court noted that there was sufficient public information available from Loren's federal securities filings and press releases to alert the public that Loren was experiencing financial difficulties. The court further noted that any attempt to mandate contingent bankruptcy planning would unduly burden corporations and their officers. 78

76 77 78

Id. at 527-528. Id. at 525. Id. at 527.


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Other Confirmation Issues Whether caused by the current economics and lack of available financing in the market,

or simply because of the strict time constraints imposed by the Bankruptcy Code, 79 many chapter 11 cases have resulted in liquidating plans. However, as discussed below, not all liquidating plan are the same. One trend discussed below is a pre-confirmation auction to determine who will acquire substantially all of the debtor's assets through the liquidating plan. While the structure of these plans may help to avoid GM and Chrysler like concerns of early bankruptcy sales, it raises interesting issues, including what protections are available for auction participants and what rights the lenders have during the auction process. Below are a few issues seen in recent bankruptcy cases. Also discussed below are the ever popular issues regarding claim preservation in plans, and non-debtor and third party releases under plans A. Pre-Confirmation Auctions

In Philadelphia Newspaper, 80 the debtors proposed a plan under which their assets would be sold to a successful bidder, to be determined through a pre-confirmation auction process. Within a week of filing a plan and disclosure statement, the debtors filed a motion to approve bid procedures. 81 Among other things, the procedures expressly denied the rights of the senior secured lenders to credit bid at the auction.82 The bankruptcy court denied the motion, holding that there could be no auction process for a sale to close through a plan without providing the

79 80 81

See 11 U.S.C. § 1121(c)&(d) (2010). In re Philadelphia Newspapers, LLC, 418 B.R. 548 (E.D. Pa. 2009). Id. at 553-54.

82 Id. at 555 (quoting the motion, "The Plan sale is being conducted under section 1123(a) and (b) and 1129 of the Bankruptcy Code, and not section 363 of the Bankruptcy Code. As such no holder of a lien on any assets shall be permitted to credit bid pursuant to section 363(k) of the Bankruptcy Code.").


American Bankruptcy Institute

right of the secured lenders to credit bid the face value of their secured claim. The bankruptcy court's decision was based on the debtors' inability to meet the "fair and equitable" standard of cramdown over objecting secured lenders if the lenders were denied the right to credit bid at the auction. 83 The bankruptcy court concluded that section 1129(b)(2)(A)(ii) required the debtors to allow a credit bid if they proposed to sell the lenders' collateral through the plan. 84 The debtors appealed the decision to the district court. Noting the popularity of this types of liquidating plans, 85 the district court concluded that a plan could meet the "fair and equitable" standard of section 1129(b)(2)(A) through any one of the three prongs--not all of which provided the secured lenders' right to credit bid. Specifically, the third "indubitable equivalent" prong did not require the allowance of a credit bid, provided that the sale would produce a return for the lenders which accurately reflected the value of the collateral. 86 Because the bankruptcy court failed to consider this possibility, the district court found that the bankruptcy court erred in denying the bid procedures motion without considering this prong. 87 The district court remanded the matter to the bankruptcy court to reconsider the bid procedures motion consistent with the interpretation of 1129(b)(2)(A). In remanding, the district

Case No. 09-11204 (Bankr. E.D. Pa. Oct. 8, 2009) [Doc. No. 1234], available at

84 85 86 83

Id. In re Philadelphia Newspapers, LLC, 418 B.R. at 561.

See id. at 567-68 (quoting In re Pacific Lumber Co., 584 F.3d 229, 246-47 (5th Cir. 2009) ("Whatever uncertainties exist about indubitable equivalence, paying off secured creditors in cash can hardly be improper if the plan accurately reflected the value of the collateral.")). In Pacific Lumber Co., certain secured noteholders appealed a confirmation order which proposed to pay them only to the extent of their judicially determined value, without providing them a credit bid right. The plan proponents argued that the plan provided for a transfer, not a sale, of the noteholders' collateral and, thus did not need to comply with section 1129(b)(2)(A). In re Pacific Lumber Co., 584 F.3d at 245. The Court of Appeals rejected this argument, holding instead that the transaction was a sale, but that where the plan offered to pay the noteholders in cash, section 1129(b)(2)(A)(iii) afforded a distinct basis for confirming a plan without allowing secured creditors to credit bid. Id. at 247.



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court was explicit that its decision was "limited to the application of the unadorned statutory language of section 1129(b), which standing alone does not provide a right to credit bid." 88 The decision was also "limited in effect to a pre-confirmation auction." 89 Before the bankruptcy court could reconsider its prior decision, the lenders appealed the decision to the Court of Appeals for the Third Circuit. As of the submission of this paper, the matters had been briefed and argued, and are awaiting a decision from the Third Circuit. 90 In the meantime, the auction and plan confirmation process have been stayed. B. Claim Preservation

In light of the trend of chapter 11 plans involving a liquidating or litigation trust, there has also been a special emphasis on the requirements for a debtor or trustee to properly preserve claims under a plan. There is no question that claims may be preserved for prosecution following the confirmation of a plan. 91 However, agreement among courts and practitioners breaks down from there. Courts disagree about whether a plan must reserve claims by reference and specificity, or if a blanket reservation is sufficient to preserve claims for later enforcement. 92 While the majority of courts agree that some specificity is required, they diverge on the amount of

88 89 90

In re Philadelphia Newspapers, LLC, 418 B.R. at 574. Id.

See Philadelphia Newspapers, LLC, et al. v. Steering Group of Prepetition Lenders and Citizens Bank of Pennsylvania, as Agent for the Prepetition Lenders (In re Philadelphia Newspapers, LLC), Case No. 09-4266, pending before the Court of Appeals for the Third Circuit. See 11 U.S.C. § 1123(b)(3)(B) (" . . . a plan may provide for the retention and enforcement by a debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interest"). Compare Browning v. Levy, 283 F.3d 761, 775 (6th Cir. 2002) ("[The Debtor's] blanket reservation was of little value to the bankruptcy court and the other parties to the bankruptcy proceeding because it did not enable the value of [the Debtor's] claims to be taken into account in the disposition of the debtor's estate. Significantly, it neither names [the Defendant] nor states the factual basis for the reserved claims. We therefore conclude that [the Debtor's] blanket reservation does not defeat the application of res judicata to its claims against [the Defendant].") with In re Bleu Room Experience, Inc., 304 B.R. 309, 314 (Bankr. E.D. Mich. 2004) (requiring only that the debtor or trustee reserve the right to assert claims or object to claims).

92 91


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specificity required. 93

Further, courts disagree over the legal rationale for requiring such

specificity. 94 And where it is a close case, some but not all courts consider disclosure statements and other plan documents to determine if a claim has been sufficiently preserved for enforcement by an agent appointed under a confirmed plan. 95 While proper preservation of claims under a plan rarely presents a bar to confirmation of that plan, the failure to get it right before confirmation could undermine the time, money and effort spent obtaining confirmation of a plan. 96 Even further complicating concerns over proper claim preservation is the impact of a post-confirmation default and the conversion of a case to chapter 7. In one case, a bankruptcy court held that all property not actually disposed of during chapter 11 case revested in the chapter

While not practical in larger cases, one way to avoid the issue of specificity is to file the claim objection or adversary proceeding before the plan is confirmed. See In re Goodman Bros. Steel Drum Co. v. Liberty Mutual Insurance Co. (In re Goodman Bros. Steel Drum Co, Inc.), 247 B.R. 604, 613 (Bankr. E.D.N.Y. 2000) (holding that the plan agent had standing and was not barred from continuing an action against the debtor's insurer, which had been filed pre-confirmation, but was not expressly referenced or preserved by the plan); see also P.A. Bergner & Co. v. Bank One, N.A. (In re P.A. Bergner & Co.), 140 F.3d 1111, 1117-1118 (7th Cir. 1998) (holding that pending litigation was not waived when the plan was confirmed, despite the lack of reference to the actual pending actions). Some courts find that the failure to list claims in the plan acts as res judicata against the debtor's successor in future litigation. See, e.g., United Operating, LLC, 540 F.3d 351 (5th Cir. 2008) (finding that the plan proponents failed to "specifically and unequivocally" enumerate the claims to be preserved). Other courts find that section 1123(b)(3) of the Bankruptcy Code requires a listing of claims to be pursued for the benefit of creditors who may wish to share in those recoveries. See Harstad v. First Am. Bank, 39 F.3d 898, 903 (8th Cir. 1994) (concluding that the debtor forfeited its rights to pursue preference actions in the two-and-a-half years before confirmation, not because it failed to give notice to creditors in its plan of the potential preference actions); Katz v. I.A. Alliance Corp. (In re I. Appel Corp.), 300 B.R. 564, 570 (S.D.N.Y. 2003) (finding unvalued claims against unspecified defendants were sufficient to notify the creditors of the potential recoveries). See, e.g., Rifken v. CapitalSource Finance, LLC (In re Felt Mfg. Co.), 402 B.R. 502, 518-19 (Bankr. D.N.H. 2009) (holding that the liquidating plan agent was not barred from bringing a surcharge action against the secure lenders, even though the plan did not expressly preserve the potential surcharge action, nor was it listed in one of the six enumerated categories of preserved claims, reasoning that the disclosure statement contained sufficient language to put the secured lenders on notice of the potential surcharge action); see also Fleet Nat'l Bank v. Gray (In re Bankvest Capital Corp.), 375 F.3d 51, 59 (1st Cir. 2004). See, e.g., Manchester, Inc., Slip op., 2009 WL 2243592, 2009 Bankr. LEXIS 2003 at *14 n.6, 51 B.C.D. 262 (Bankr. N. D. Tex. July 16, 2009) (Houser, B.J.) (concluding that certain significant claims were not "specifically and unequivocally" preserved under the confirmed plan, but acknowledging the absurdity of this result in light of the circumstances surrounding the case, and urging the Court of Appeals for the Fifth Circuit to reconsider its holding in United Operating).

96 95 94



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7 estate upon a post-confirmation default and conversion. 97 Thus, the chapter 7 trustee in that case had standing to pursue all causes of action belonging to the estate as of the petition date, even if the confirmed chapter 11 plan did not properly preserve them. C. Non-Debtor Releases, Exculpatory Clauses and Injunctions 98

In Ingersoll, Inc., 99 the Seventh Circuit upheld non-debtor releases contained in chapter 11 liquidating plan. The release provisions in that case purported to bar actions related to, or arising out of, two specific pieces of litigation involving the non-debtor principals of the familyowned debtors. 100 The bankruptcy court confirmed a liquidating plan containing a provision purporting to release the non-debtor family from liability arising from failed pre-petition actions. Once the plan was confirmed, the non-debtor family moved the bankruptcy court to enjoin the law firm's continued collection actions, which the bankruptcy court did under section 105(a) of the Bankruptcy Code. The district court then affirmed, and the matter was appealed to the Seventh Circuit. 101 The Seventh Circuit agreed that the releases were "an essential component of the plan, the fruit of long-term negotiations and achieved by the exchange of good and valuable

See Spicer v. Laguna Madre Oil and Gas II, LLC (In re Tex. Wyoming Drilling, Inc.), Slip Op., 2010 Bankr. LEXIS 125, Bankr. Case No. 07-41650 (Bankr. N.D. Tex. Jan. 20, 2010). See also Murdock v. Holquin, 323 B.R. 275 (N.D. Cal. 2005) (finding the exit loan to be a dischargeable claim against the chapter 7 estate). While not restricted to liquidating plans, non-debtor releases and protections have come up in at least two circuit court opinions this past year. The following section discusses those opinions briefly.

99 98


In re Ingersoll, Inc., 562 F.3d 856 (7th Cir. 2009).

One of those lawsuits involved a dispute between the family and a law firm retained well before the chapter 11 proceedings in an attempt to enjoin the sale of the debtors' "crown jewel" asset. After the prepetition injunction efforts failed and the crown jewel assets were sold, the family caused the debtors to commence bankruptcy proceedings. On the initial appeal, the district court remanded to get a better understanding of the bankruptcy court's rationale for the injunction, which the bankruptcy court provided by explaining that the non-debtor releases were needed to "ensure the success of the bankruptcy plan."




American Bankruptcy Institute

consideration by the [non-debtor family] that will enable unsecured creditors to realize the distribution in this case." 102 Back in Pacific Lumber, however, the Fifth Circuit reversed a confirmation order, in part, concluding that the broad exculpation provided under the plan to the certain non-debtor plan proponents were overly broad and could not be squared with the Bankruptcy Code. 103 Unlike the Ingersoll case, where the exculpees were co-obligors or guarantors, the exculpees in Pacific Lumber were not on the hook for the debtors' prepetition obligations. The Pacific Lumber provisions simply exculpated for negligence arising out of the reorganization. The Fifth Circuit struck those releases, concluding that "[t]he fresh start § 524(e) provides to debtors is not intended to serve this purpose." 104 VI. Conclusion As may be apparent from the foregoing discussion, confirmation in chapter 11 is no easy business. Appeasing one group of constituents may mean including a deathtrap provision to the detriment of others. Implementation of a plan under the gifting doctrine, in turn, could lead to the denial of confirmation for violation of the absolute priority rule. Prearranged plans could

Id. at 865. The court made clear that this holding was not an expansion of the powers of bankruptcy courts to discharge non-debtors' co-obligations. Instead, the court likened the releases at issue in this case to the "narrowly tailored and critical" releases accepted by the Seventh Circuit in In re Airadigm Communications, Inc., 519 F.3d 640 (7th Cir. 2008), and distinguished from the releases described in In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005), noting that the releases in this case shielded the non-debtors from a narrow set of claims held by individuals who were not creditors of the bankruptcy estates, but without whom the plan would not have been successful. Id. at 864-65. For a good description of the circuit split regarding non-debtor releases and injunctions, see In re Mercedes Homes, Inc., 2009 LEXIS 4265, Bankr. Case No. 09-11191-pgh (Bankr. S.D. Fla. Sept. 18, 2009) (citing, inter alia, In re Dow Corning, Corp., 280 F.3d 648, 658 (6th Cir. 2002)). Some courts have held that temporary injunctions are distinguishable from broad releases. See, e.g., In re Regatta Bay, LLC, 406 B.R. 875 (Bankr. D. Az. 2009) (declining to stay a confirmation order pending appeal, concluding that the appellant creditor was unlikely to succeed on the merits of its argument that a two-and-a-half year delay in the creditor's ability to collect on a judgment against the debtor's two individual owners was not a non-debtor discharge prohibited by 11 U.S.C. § 524(e)).

103 104


In re Pacific Lumber Co., 584 F.3d at 252-53. Id.


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lead to unenforceable lock-up agreements. While the issues discussed here are only a survey of the issues that arise in confirmation disputes, it is clear that confirmation issues are difficult to predict and even more difficult to resolve. By understanding the state of the law in a given jurisdiction and the types of plan provisions that may be tolerated without offending general bankruptcy policies, confirmation disputes may be minimized and, hopefully, avoided.


American Bankruptcy Institute

Appendix: Table of Gifting Doctrine Cases


28th Annual Spring Meeting


Case Name

Context of Gift

Gift Giver

Advantaged Class

Disadvantaged Class

Approved by Court?


Cases Approving Gift Provisions: Secured creditor Yes General unsecured creditors IRS and insiders liable to IRS Debtor's case converted to ch. 7 and assets sold for less than secured creditor's claim. Secured creditor sought to share sale proceeds with unsecured creditors while IRS remained unpaid. Court authorized settlement agreement on ground that sale proceeds belonged to secured creditor who could distribute as it saw fit Yes Debtor proposed plan in which senior bondholder gifted a portion of its claim to fund settlement between debtors and FDIC while junior bondholders received nothing. Court held that "the seniors may share their proceeds with creditors junior to

In re SPM Mfg. Corp. 984 F.2d 1305 (1st Cir. 1993)

R. 9019 settlement

American Bankruptcy Institute

In re MCorp. Fin. Inc. 160 B.R. 941 (S.D. Tex. 1993)

Ch. 11 plan

Senior bondholders


Junior bondholders




Gift Giver the juniors, as long as the juniors continue to receive at least as much as what they would without the sharing" Court approved gifting provision because source of gift was sale proceeds that belonged to secured creditor and "creditors are free to do what they want with dividends received including sharing them with other creditors" Yes Plan was approved because value distributed to junior creditors was property of senior lenders and senior subordinated debt holders were not entitled to a distribution under the plan even without the gift Advantaged Class Disadvantaged Class Approved by Court? Notes Secured creditor Yes Second class of unsecured creditors 28th Annual Spring Meeting Senior lenders One class of unsecured creditors (secured creditors guaranteed 10% dividend to this particular class of unsecured creditors) Subordinated debt holders Senior subordinated debt holders

Case Name

Context of Gift

In re Parke Imperial Canton 1994 WL 842777 (Bankr. N.D. Ohio 1994)

Ch. 11 plan/§ 363 asset sale

In re Genesis Health Ventures 266 B.R. 591 (Bankr. D. Del. 2001)

Ch. 11 plan


Case Name Court approved gift because it came out of cash collateral of lenders and the advantaged class was important to the success of the reorganized enterprise Approved gifting because it resulted in "global peace among the Debtors, the Committee and [the DIP Lender]" and because the source the of gift was lender's collateral Yes, but remanded to bankruptcy court to determine validity of secured creditor's liens Set the standard in the 2d Cir. for approving gift settlements that deviate from the absolute priority rule if the settling parties can present "specific and credible grounds to justify th[e] deviation"

In re Union Fin. Svcs. Group 303 B.R. 390 (Bankr. E.D. Mo. 2003)

Context of Gift Ch. 11 plan

Gift Giver Secured lender and DIP lenders

Advantaged Class Unsecured trade creditors

Disadvantaged Class Unsecured nontrade creditors

Approved by Court? Yes


In re World Health Alternatives 344 B.R. 291 (Bankr. D. Del. 2006)

§ 363 asset sale/ R. 9019 settlement Asset purchaser (stalking horse bidder was DIP lender) General unsecured creditors Priority tax claimants Yes

American Bankruptcy Institute

In re Iridium Operating 478 F.3d 452 (2d. Cir. 2006)

R. 9019 settlement

Secured creditor

General unsecured creditors

Administrative claim holder (former Parent co.)




Gift Giver Asset purchaser Absolute priority rule not violated by a carveout of non-estate funds by a non-estate creditor (the stalking horse bidder) to be paid exclusively to unsecured creditors even if senior claimants will not be paid first with such funds Court approved gifting of stock to equity holders over objection of unsecured creditor because gift did not injure junior creditors Advantaged Class General unsecured creditors Disadvantaged Class IRS Approved by Court? Yes Notes 28th Annual Spring Meeting Second lien debt holders Equity holders General unsecured creditors Yes Secured lender General unsecured creditors Unsecured note holders Yes Gifting approved because source of gift was lenders' collateral and slight discrimination between advantaged class and disadvantaged class did not run afoul of § 1129(b)

Case Name

In re TSIC 393 B.R. 71 (Bankr. D. Del. 2008)

Context of Gift § 363 asset sale/ R. 9019 settlement

In re DBSD North Am. 419 B.R. 179 (Bankr. S.D.N.Y. 2009)

In re IDEARC Inc. 2009 Bankr. LEXIS 4202 (Bankr. N.D. Tex. 2009)

Ch. 11 plan with support agreement between debtors, equity holders and second lien debt holders Ch. 11 plan/ R. 9019 settlement


Case Name

In re Journal Register Co. 407 B.R. 520 (Bankr. S.D.N.Y. 2009)

Context of Gift Ch. 11 plan

Gift Giver Secured lenders

Advantaged Class Unsecured trade creditors

Disadvantaged Class Unsecured nontrade creditors

Approved by Court? Yes

Notes Approved gifting because it was property of the senior lenders, the lenders' liens were unchallenged, lenders were not paid in full and unsecured nontrade creditors would receive the same distribution regardless of the gift

Cases Denying Gift Provisions: Debtor IRS Single unsecured creditor No Holding that the absolute priority rule applies to Rule 9019 settlements and that debtor could not transfer estate assets to unsecured creditor as part of settlement without satisfying the priority claim of the IRS Significance of the case is that it is the first holding applying the

American Bankruptcy Institute

In re AWECO 725 F.2d 293 (5th Cir. 1984)

R. 9019 settlement




Gift Giver absolute priority rule to R. 9019 settlements Although recognizing that gift was technically not a part of the plan, the court held that "the economic substance and effect of the [gifting] would be to sanction a distribution scheme that discriminates between creditors in the same class" No Court did not approve gifting which would have resulted in 100 percent recovery for trade creditors and 1 percent recovery for non-trade creditors because debtor failed to show that trade creditors were instrumental in preserving value of reorganized entity Advantaged Class Disadvantaged Class Approved by Court? Notes Certain unsecured creditors Remaining unsecured creditors No 28th Annual Spring Meeting Secured lender Unsecured trade creditors Unsecured non-trade creditors

Case Name

Context of Gift

In re CGE Shattuck 254 B.R. 5 (Bankr. D. N.H. 2000)

Side Secured agreement lender between secured lender and certain unsecured creditors (agreement not embodied in ch. 11 plan)

In re Sentry Op. Co. of Tx. 264 B.R. 850 (Bankr. S.D. Tex. 2001)

Ch. 11 plan


Case Name No Source of gift was twofold: lender's collateral and recovery from avoidance actions; court held that debtor could not gift proceeds from avoidance actions because proceeds were property of the estate and available for distribution to all unsecured creditors; also, debtor did not proffer sufficient evidence to establish need for critical vendor status No Denied gifting from unsecured creditors to equity holders because it violated the absolute priority rule and "would undermine Congress' intention to give unsecured creditors bargaining power in this context" Court distinguished its holding from that of

In re Snyder Drug Stores, Inc. 307 B.R. 889 (Bankr. N.D. Ohio 2004)

Context of Gift Ch. 11 plan

Gift Giver Secured creditor/ debtor

Advantaged Class Reclamation claimants and unsecured trade creditors

Disadvantaged Class Unsecured non-trade creditors

Approved by Court?


American Bankruptcy Institute

In re Armstrong World Indus., Inc. 320 B.R. 523 (D. Del. 2005), aff'd 432 F.3d 507 (3d Cir. 2005)

Ch. 11 plan

Asbestos claimants

Equity holders

General unsecured creditors




Gift Giver SPM because SPM was a ch. 7 liquidation Plan called for senior secured creditor to waive its rights to up to 15% of the new common stock in favor of equity holders; court denied gifting provision because although a creditor may do whatever it likes with its distribution upon receipt of same, it may not gift assets within the context of a plan over the objection of other creditors No Although court approved asset sale, it would not approve gifting which "effectively evaded the carefully-crafted scheme of the Chapter 11 plan confirmation process" Advantaged Class Disadvantaged Class Approved by Court? Notes Secured creditor No Equity holders General unsecured creditors 28th Annual Spring Meeting Purchaser of assets (stalking horse bidder was DIP lender) General unsecured creditors Priority creditors

Case Name

Context of Gift

In re OCA 2006 WL 3833929 (Bankr. E.D. La. 2006)

Ch. 11 plan

In re On-Site Sourcing Inc. 2009 WL 1789331 (Bankr. E.D. Va. 2009)

§ 363 asset sale/ R. 9019 Settlement


Case Name

Context of Gift

Gift Giver

Advantaged Class

Disadvantaged Class

Approved by Court?


Decisions Approving Gifting Where No Formal Written Opinion Has Been Published: Secured creditors Holders of preferred stock Yes General unsecured creditors and holders of common stock

In re Granite Broadcasting Corp. Case No. 0612984 (Bankr. S.D.N.Y. 2007) Second lien bondholders General unsecured creditors N/A Yes

Ch. 11 plan

American Bankruptcy Institute

In re U.S. Shipping Partners, L.P. Case No. 0912711 (Bankr. S.D.N.Y. 2009)

Ch. 11 plan

The second lien bondholders gave a cash payment to the general unsecured creditors, who were directly beneath them in terms of priority, and therefore, no class was disadvantaged as a result N/A Yes Secured lenders gifted a portion of their recovery to senior note holders and unsecured creditors in exchange for their support of plan; to the extent senior note holders and/or unsecured

In re SemCrude LP Case No. 0811525 (Bankr. D. Del. 2009)

Ch. 11 plan/ R. 9019 settlement

Secured lenders

Senior note holders and general unsecured creditors




Gift Giver creditors rejected the plan, the gift would be returned to the secured lenders Advantaged Class Disadvantaged Class Approved by Court? Notes Secured lenders Subordinated note holders Yes General unsecured creditors 28th Annual Spring Meeting Secured lenders Equity holders Secured lenders Pre-packaged plan filed on petition date; confirmation has not yet occurred Plan was part of contested confirmation hearing; as of March 10, 2010, no decision had been made on confirmability of plan Under the terms of the Beal/Icahn plan, if the competing plan of the ad hoc committee of noteholders does not get to confirmation, both second lien noteholders and general unsecured claims would receive a pro rata distribution of a cash gift Senior secured lenders Second lien Ad hoc noteholders and committee of general noteholders unsecured claims

Case Name

Context of Gift

Ch. 11 plan

Ch. 11 plan

In re Dayton Superior Corp. Case No. 0911351 (Bankr. D. Del. 2009) In re Regent Communications, Inc. Case No. 1010632 (Bankr. D. Del. 2010) In re TCI 2 Holdings, LLC (Trump) Case No. 0913654 (Bankr. D. N.J. 2010)

Ch. 11 plan of Beal Bank/Icahn Partners



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