Overview of US Bankruptcy Law
J. Robert Stoll
Aaron Gavant
Mayer Brown LLP
Mayer Brown LLP
Visiting Professor
University of Belgrade Faculty of Law
U.S. Workout/Insolvency Law Course
University of Belgrade Faculty of Law
FALL 2015
Introduction
I.
II.
III.
IV.
V.
VI.
Statutory Framework / Key Players and Concepts
Overview of Asset Sales Under Section 363 of the
Bankruptcy Code
DIP Lending and Cash Collateral Financings
Recovery of Vendor Claims: From Reclamation to
Critical Vendor Programs
Avoidance Powers: Fraudulent Transfer and
Preference
Plan of Reorganization: Some Rules of the Road
1
Statutory/Judicial Framework:
Bankruptcy System for Business Entities
• US Has a National System of Bankruptcy Laws
– Provides a uniform set of laws (the Bankruptcy Code) and
procedures (the Bankruptcy Rules)
– Even so, regional differences exist – e.g., critical vendor
• Who May be a Debtor under the Bankruptcy Code?
– Almost all business entities qualify (e.g., corporations;
partnerships; individuals and sole proprietorships)
– Excludes entities subject to specialized regulatory schemes:
• Banks and insurance companies have separate regimes
2
Statutory/Judicial Framework:
Bankruptcy System for Businesses
• Other Eligibility Requirements are Modest:
– No requirement of insolvency: to encourage early resort to
bankruptcy when reorganization is possible
– Good faith is required: Must suffer from financial problems
justifying resort to bankruptcy laws
– Must have nexus to US – be a US entity; have assets or
principal offices in US
• Commencement of the Case
– Voluntary: order for relief is automatic upon filing
– Involuntary by creditors: order for relief is only after court
determines debtor is generally unable to pay its debts
3
Statutory/Judicial Framework:
Bankruptcy System for Businesses
• Types of Bankruptcy Code Cases:
– Chapter 7: Governs Liquidation Proceedings
• Trustee is always appointed to liquidate assets and distribute
proceeds to creditors in accordance with statutory priorities
– Chapter 11: Governs Reorganization Proceedings
• Goal is negotiation of a plan of reorganization
• Flexible process designed to preserve “going concern” value
• No automatic trustee appointment
– Chapter 9: Governs Reorganization Proceedings for
Municipalities and other Governmental Entities
– Chapter 12: Governs Reorganization Proceedings for
Farmers
– Chapter 15: Governs Foreign and Cross-Border Insolvency
Cases
4
Statutory/Judicial Framework:
Bankruptcy System for Businesses
• Federal Bankruptcy Court System
– Bankruptcy judges: Appointed to handle only bankruptcy
matters; have special expertise
– Expansive jurisdiction to consolidate all matters involving the
debtor and its property before the court
– Appeals go through the federal court system
• Venue
– Bankruptcy courts are in every state
– Favored venues for large cases: NY and Delaware
5
Initiation of Cases
• Voluntary: Commenced by filing of petition with the
bankruptcy court by the debtor
– There is no insolvency or other financial conditions requirement
• Involuntary: Commenced by filing of petition by creditors
against the debtor
– If the debtor has <12 creditors overall, only one creditor is required to
sign the petition, who must hold noncontingent, undisputed, and
unsecured claims that aggregate at least $15,325
– If the debtor has >12 creditors, the petition must be signed by three
creditors who hold noncontingent, undisputed, and unsecured claims
that aggregate at least $15,325
– An involuntary case may only be commenced under chapter 7 or chapter
11; a municipality cannot be the object of an involuntary petition in a
chapter 9 case
6
Key Players
• Debtor in Possession: Curse or Blessing?
– Pre-bankruptcy management remains in control in
Chapter 11 cases – philosophy is that they can best maximize
values
– Trustees can be appointed in cases of fraud, gross
mismanagement or other cause
– Trustees are rarely appointed in Chapter 11 – even in cases
of spectacular failures (Lehman and Enron)
7
Key Players
• Unsecured Creditors Committee – Chapter 11: Curse or
Blessing ?
– Selected from largest unsecured creditors, unless adverse
interest
– Active player on all major issues – DIP financing; assets sales;
reorganization plans; litigation against other creditors
– Acts to protect interests of unsecured creditors as a whole
– Professionals of the UCC are paid by the estate
8
Key Players
• Secured Creditors
– Often the key constituency – control access to financing
– Rarely have official committees for secureds
• Bankruptcy Judges
– No direct managerial involvement in debtor; rule on matters
requiring court approval or adversary proceedings
– Rules prohibit “ex parte” communications; still, often
perceived as having “pro-debtor” tendency
9
Key Players
• US Trustee: Intended as a Watchdog
– Governmental Appointees
– Acts to protect the integrity of the bankruptcy system, but
sometimes seen as inflexible
– Handles administration: Select trustees; Appoints
committees
10
Key Concepts: Automatic Stay
• Upon filing, creditors are stayed from collecting claims,
from taking possession or control of property, or from
taking setoffs
• Purpose is to protect the estate from dismemberment and
to give DIP/Trustee a breathing spell
• Stay can be lifted for cause – e.g., to allow setoff or if
collateral is not “adequately protected”
• A number of actions are exempt from the stay
– Swaps; repos; securities contracts can be closed out
– Exercise of police power – e.g., environmental laws are
enforced
11
Key Concepts: Who Trumps Whom – Priority
Scheme in Bankruptcy – Claims and Interests
• Secured Creditors (DIP lenders and pre-bankruptcy lenders)
– get highest priority but only to extent of the
proceeds/value of collateral
• Administrative Expense Claims
– First to DIP lender with superpriority
– Second to post-bankruptcy claimants (vendors; professionals;
obligations under assumed contracts) and to some prebankruptcy vendor claims
– But, then give priority to subsequent Chapter 7 creditors
12
Key Concepts: Who Trumps Whom – Priority
Scheme in Bankruptcy
• Pre-bankruptcy claims
– First, to priority claims (taxes; employees priority; deposits)
– Second, to general unsecured claims (trade; deficiency claims
of secureds; rejection claims)
– Third, to subordinated creditors
– Fourth, to equity holders (together with any litigation claims
based on equity)
13
II. Claims and Interests (cont’d)
• Trading/Sale of Claims: Substantial market for trading of
claims; particularly in large cases
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Validity/Enforceability
Original Issue Discount
Setoffs/Preferences
Subordination Risks
Warranties/Reps in Assignment/Sale Documents
Disclosure Issues: Bankruptcy Rule 2019 may require certain
disclosure of information
14
Key Concepts: Executory Contracts and Leases –
a Brief Overview
• DIP/Trustee has right to assume or reject contracts
– Decision is left to DIP/Trustee’s business judgment
– Some exceptions: e.g., agreements to make loans
• Pending decision, non-debtor must generally perform if
paid currently for its performance
• Assumption, requires DIP/Trustee to cure all defaults, and
give adequate assurance; and then must perform going
forward
• Can also assume and assign
• Rejection relieves debtor from all obligation to perform, but
gives non-debtor a claim for damages; special rules cap
damage claims for leases
15
Key Concepts: Asset Sales
Under Section 363 of the Bankruptcy Code
• Section 363(b) of the Bankruptcy Code authorizes a debtor
to sell property of the estate outside of the ordinary course
of the debtor’s business with the prior approval of the
bankruptcy court
– Sales or dispositions of property that are in the ordinary
course do not require court approval
– 363 sales are increasingly common for various reasons,
including the speed and finality with which they enable a
debtor to monetize its business assets on a going concern
basis and the fact that there are increasingly fewer successful
reorganizations in Chapter 11
16
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• 363 sales provide important protections and related
benefits to buyers that acquire assets
– Assets sold under Section 363 of the Bankruptcy Code are
transferred “free and clear” of interests claimed by third
parties
– Typically, claims or interests of third parties will attach to the
proceeds of the sale, and the amount and relative priority of
such claims and interests can be determined at a later date
after the sale has closed
17
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• Ability to sell assets subject to third party claims and
interests is not unlimited; sale must satisfy one or more of
the following five requirements:
– Applicable non-bankruptcy law permits sale of such property
free and clear of interests
– Entity claiming an interest consents to the sale free and clear
of its interest or claim
– The claimed interest is a lien and the price to be obtained
exceeds the aggregate of all liens against the property
– The claimed interest is subject to a bona fide dispute
– Entity claiming an interest can be compelled in a legal or
equitable proceeding to accept money satisfaction of its
interest
18
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• Case law is mixed whether Section 363(f) of the Bankruptcy
Code authorizes bankruptcy court to order that a sale is
free and clear of successor liability
• Better view is that the order cannot provide such
protection, especially when the asserted claim bears no
relationship to the subject assets
• However, where it can be established that the party
asserting successor liability received notice of the sale and
did not timely object or preserve its rights, party may be
barred from seeking to impose successor liability under
principles of res judicata
19
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• One of the benefits of acquiring assets under a 363 sale is
that it eliminates any fraudulent transfer risk since
– Terms of the sale, including purchase price and other
considerations, will be “blessed” by the sale order entered by
the court
– No issue whether value paid is reasonably equivalent since
assets were sold pursuant to court-approved process
20
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• Party objecting to proposed 363 sale must obtain stay
pending an appeal in order to prevent consummation of a
sale to a “good faith” purchaser
– Section 363(m) provides that reversal of sale order on appeal
does not affect transfer of assets to a good faith purchaser;
sale order should contain specific finding that buyer is
entitled to protection of 363(m)
– In such circumstances, objecting party will need to post a
bond, typically an amount equal to purchase price, to
prevent consummation of sale pending its appeal
– Sale agreement should provide buyer with discretion to
decide whether to close in the face of such an appeal
21
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• Summary overview of 363 sale process
– Absent extraordinary circumstances, proposed sale will be
subject to competitive bidding process
• DIP/Trustee must demonstrate proposed sale is result of sound
business judgment and in best interests of estate
• DIP/Trustee must demonstrate assets were effectively marketed and
that the sale process will yield the “highest and best” value
obtainable for the assets under the circumstances
22
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• In connection with a competitive bidding process, there
often is a “stalking horse” bidder
– DIP/Trustee and its professionals typically will seek to
negotiate an initial purchase agreement with a stalking horse
bidder and then seek approval of the sale to that party or to
a higher bidder pursuant to proposed bidding procedures
• Process can take many different forms
• Much of the actual due diligence, marketing and negotiations to
determine the stalking horse may take place before a 363 sale
motion is even filed, particularly in larger cases with sophisticated
debtors
23
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• Advantages to Being a Stalking Horse Bidder:
– Provides timing advantage where extensive due diligence or
regulatory approval is necessary since stalking horse bidder likely
to have advantage over other potential competing bidders; ability
to demonstrate certainty and ability to close provides advantage
over competing bids
– Can shape the sale contract and potentially require other
competing bidders to use its form of agreement
– Ability to negotiate bid protections, including, at least, expense
reimbursement and typically some amount of a break-up fee; bid
protections require bankruptcy court approval
– Influence bidding procedures, including minimum overbids, closing
contingencies, right to credit-bid break-up fee, mechanism for
valuing non-cash consideration, criteria for qualifying competing
bids, and process of identifying higher and better bids at auction
24
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• Potential Disadvantages to Being a Stalking Horse Bidder
– Due diligence/negotiation expenses at risk until bid
procedures, including, inter alia, expense reimbursement,
are approved
– May over-price assets
– Potentially allows other bidders to utilize your due diligence
efforts at less expense
25
Overview of Asset Sales
Under Section 363 of the Bankruptcy Code
• 363 Sales Usually Involve a Two-step Process
– Motion to approve bid procedures, including bid protections,
• Typically, this will be heard on fairly expedited basis, some period of
due diligence may follow and, if qualified bids submitted, a sale
auction will be held to determine highest and best bid
– Motion also will seek to schedule a hearing to approve
the sale
• Includes proposed form of sale order; minimum 20 days’ notice
required before sale hearing, which usually is scheduled as close to
completion of auction as court’s calendar allows
• Also includes process of identifying executory contracts and
unexpired leases to be assumed and assigned to winning bidder,
including notice and cure procedures
26
Changing Nature of Section 363 Asset Sales
• Nature of 363 sales has changed in recent years
– Previously, generally used to sell some assets of the debtor (attempts to
sell all assets disfavored as “sub-rosa” plan).
– Now, often used to sell all assets of the debtor
• Has led courts to develop increasingly standardized process for
“all-asset” 363 sales
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Auction process
At least 30 days to bid
“Stalking horse” bid
Qualified bid requirements
• No plan or creditor vote required to Section 363 sale
• Potential for abuse by debtor/purchase (especially when
purchaser is also a creditor)
27
Changing Nature of Section 363 Asset Sales
• Gifting provisions
– Assets sold as part of Section 363 sales are usually fully
encumbered  only secured parties benefit from sales
– To avoid objections, secured creditors often “gift” some
portion of proceeds to unsecured and/or lower-priority
creditors
– Potentially problematic to the extent lower-priority creditors
receive distributions prior to and/or greater than higherpriority creditors
28
Changing Nature of Section 363 Asset Sales –
GM & Chrysler
• Each of GM, Chrysler and Detroit bankruptcy cases
characterized by carefully-structured Section 363 sales
meant to cushion retirees from blow of bankruptcy
• All good assets sold to newly-created entities (“New GM”
and “New Chrysler”) with U.S. government serving as
secured lender during bankruptcy and to new entities
• Primary consideration paid by new entities was assumption
of some, but not all legacy liabilities, in particular those
liabilities relating to retirees (e.g., healthcare benefits).
– New Chrysler paid only $2 billion; New GM paid nothing.
• Protected lower-priority creditors (i.e., retirees) at expense
of higher-priority creditors (e.g., noteholders)
29
DIP Financing / Cash Collateral Financings
Introduction
• “Offensive” DIP Lending
• “Defensive” DIP Lending
– Adequate protection
– “Bootstrapping”
• Cash Collateral Financings
• “Exit” Financing
30
Timeline for DIP Financing
• Short Timeline to Finalize DIP Financing
• Limited Due Diligence
• Expense Agreement
• Documentation: Term Sheet; Credit Agreement and Order
Approving DIP Financing
• Two-Step Court Approval Process
31
Timeline for DIP Financing
• The Interim Hearing and Order
– “First Day” Motion; limited opportunity to object
– Capped Commitment – limit as necessary to prevent
irreparable harm until the final hearing
– Finding of Good Faith: protects lender from reversal on
appeal
• The Final Hearing and Order
– Schedule for the final hearing
– Re-trading the deal with creditor committee, US
trustee/negotiating leverage
– Good faith lender still protected against appeals
32
Reasons to Engage in DIP Financing: Offensive
• Profitable: Interest rates and fees are often higher than
traditional lending
• Business Opportunity: DIP Loans may lead to exit loans and
other post-confirmation business
• Bankruptcy Protections
33
Reasons to Engage in DIP Financing: Offensive
• Court Order Provides
– Lien package
• Lien on free assets / junior lien on liened assets
• Priming lien / if “adequate protection” to existing lienholder
• Automatic perfection of collateral
– Given superpriority claim
– Clearer path to exercise remedies upon default
– Protection from appeals
34
Reasons to Engage in DIP Financing: Defensive
• Leverage to Get “Adequate Protection” for Secured Loans
• Cardinal Rule: Adequate Protection Required for Secureds
– No use of cash collateral permitted without adequate
protection
– Debtor’s use of collateral conditioned upon provision of
adequate protection
– Stay must be lifted if adequate protection is not provided
• What is Required: Protect from Diminution in Collateral
Values
– Numerous considerations taken into account (e.g., valuation;
debtor’s financial performance)
35
Reasons to Engage in DIP Financing: Defensive
• Typical Forms of Adequate Protection
– Periodic cash payments
– Junior replacement lien on DIP lenders’ collateral package
– Junior superpriority claim – to extent protection is
inadequate
• Additional “Defensive” Benefits
– Approval of budget process; financial reporting requirements
– Other performance covenants, e.g., requiring assets sales
– Secure waiver from debtor to challenge liens; limit time for
creditors committee to bring challenges
36
Reasons to Engage in DIP Financing: Defensive
• “Bootstrapping” Strategies
– Bootstrapping – Cross-Collateralization
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Granting liens to “shore-up” existing loans is controversial
Almost never approved if lender is not fully collateralized
Purpose of adequate protection is protecting not improving position
Sometimes approved if lender is fully secured and financing not
otherwise available
– Bootstrapping – “Roll-up”
• Using DIP loan to pay out existing loans
• Also controversial: protects from “cramdown” and restructuring
• Some courts will approve if loans are fully secured and if successful
reorganization is likely
• “Roll-over” – using collections to first pay down existing debt raises
similar issues
37
“Cash Collateral” Financings
• Form of Defensive Financing:
– Similar to DIP lending, except:
• No “new” $$ lending
• Recycles cash and collections
– Finances operations and preserves going concern values
– Way to obtain adequate protection – similar to DIP lending
• Similar Short Timeline to Negotiate Cash Collateral
Financing
• Similar Two-Step Approval Process
• Avoids Litigation Risks in “Contested” Cash Collateral
Hearing
38
Other DIP Lending / Cash Collateral Issues
• Carve-Out
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Most courts require “carve-out” to pay professional fees
Typical arrangement – “carve out” $$ amount from collateral
Carve-out allows for wind-down
Restrictions on use of carve-out: not to litigate with lenders
• Termination of DIP Loan / Cash Collateral Order
– Relief from stay; notice; bankruptcy court involvement
• Collateral Surcharge
– Recover from collateral cost of its preservation and sale
– Waiver provisions remain controversial
39
Potential Risks Associated with DIP Lending /
Cash Collateral Financing
• Limited Due Diligence
• Potential Creditor Challenges to Prepetition Claims and
Liens
• Second Lien Disputes over Waivers of Adequate Protection
and Related Rights
• Failure to Confirm Plan / Conversion to Chapter 7
40
Exit Financing
• Purpose of Exit Financing: Funds Emergence from
Chapter 11
• Benefits to Lenders
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Debtor has “deleveraged” balance sheet
Defensive: releases and protections for existing lenders
Special findings and decrees
Potentially higher fees and interest rates
41
Recovery of Vendor Claims:
From Reclamation to Critical Vendor Programs
• Bankruptcy Code provides sellers of goods with certain
additional protections that are not afforded to other
creditors
– Whether creditor is a “seller of goods” (e.g., as opposed to,
provider of services) may be subject to dispute
– Courts look to various definitions (e.g., Bankruptcy Code,
Uniform Commercial Code, etc.)
• Seller may “reclaim” goods it has sold to the debtor, if
goods were received by debtor within 45 days of petition
date assuming debtor as already insolvent (subject to any
priority rights of a secured creditor in same goods)
42
Recovery of Vendor Claims:
From Reclamation to Critical Vendor Programs
• Seller may also seek to recover unpaid prepetition amounts
through “critical vendor” payment programs
• Not expressly authorized by statute and may be contrary to
other payment/priority provisions of the Bankruptcy Code
• Debtor’s ability to obtain approval of such program may
therefore depend on particular jurisdiction and particular
judge
43
Avoidance Powers: Preferences
• Elements of Preference, Bankruptcy Code § 547
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Transfer made on account of preexisting debt
Made while debtor is insolvent
Made within 90 days of bankruptcy (1 year if insider)
Allows creditor to recover more than in liquidation
• Limitation period for suit – 2 years
• Typical Examples:
– Grant of collateral to unsecured lenders;
– Payments made to creditors – lenders and suppliers
44
Avoidance Powers: Preferences
• Key Defenses to Preferences
– Payment was made in the ordinary course of business
– New value: value given by creditor to debtor after an
otherwise preferential payment
– Payments to a “fully secured” creditor – so that not receiving
more than in a liquidation
– Contemporaneous exchange for new value – no antecedent
debt
45
Avoidance Powers: Fraudulent Transfer
• Fraudulent Transfers, Bankruptcy Code §§ 544, 548
• DIP/Trustee Can Avoid Transfers and Obligations
incurred within 2 years of filing:
– If (1) debtor didn’t receive “reasonably equivalent” value, (2)
debtor was insolvent or had unreasonably small capital, or
(3) transfer was to an insider under an employment contract,
not in the ordinary course of business
• Certain charitable contributions exempt
– Can also challenge based on debtor having had actual intent
to defraud, delay or hinder creditors (no need to show
insolvency)
46
Avoidance Powers: Fraudulent Transfer
• Highly Fact-Intensive Determinations
– Determinations are made as of the date of the transaction
– Battle of experts
• Limitations period for voiding transfers is 2 years under
bankruptcy law, and extends to 4 to 6 years using state
laws
47
Avoidance Powers: Fraudulent Transfer
• Remedy for Fraudulent Transfer
– Recovery of the property transferred or its value
– Elimination of the obligation incurred
– If party was in “good faith,” then protected from avoidance
to the extent of the value given
• Examples of Fraudulent Transfer Attacks
– Pre-petition sales of assets
– LBO transactions have also been subject to attack
– Dividends
48
Set Offs: An Overview
• Set off is Protected in Bankruptcy, except
– It is subject to the Automatic Stay
– Cannot set off if no “mutuality” (same parties; same
capacity)
– Cannot set off if claim owed to Debtor was incurred or
acquired during the preference period for purpose of
creating a setoff
– The pre-bankruptcy exercise of a setoff can be avoided to the
extent the creditor got an improvement in its position during
the 90-day preference period.
49
Protected Contracts: Safe Harbor Provisions
• Swaps; Repos; Securities Contracts; and Forward and
Commodity Contracts are Given Special Protections:
– They are exempt from the automatic stay and can be freely
closed out based on the debtor’s bankruptcy
– Protections include the right to net out and set off collateral
proceeds
– Pre-bankruptcy transfers made in connection with protected
contracts are protected from avoidance – except when made
with intent to defraud
50
Subordination
• Types of Subordination and Treatment in Bankruptcy
– Contractual Subordination
• Where the subordinated creditors contractually agree to payment
after the seniors
• Contractual subordination agreements are enforceable according to
their terms in bankruptcy under section 510(a) of the Bankruptcy
Code
– Structural Subordination
• Where the holding company creditor’s claim comes out behind
claims based on debt extended to the operating company, to the
extent the operating company has assets
• Generally, corporate formalities recognized in bankruptcy; however,
risk of substantive consolidation (Owens Corning)
51
Plan of Reorganization: Some Rules of the Road
• Ultimate Objective of a Chapter 11 Case is the Confirmation
of a Plan of Reorganization
– Plan is, in essence, a new contract that reshapes and governs
the prepetition debtor/creditor relationships and obligations
– Bankruptcy Code imposes strict requirements that must be
met in order for the court to confirm a plan
– The requirements attempt to balance the sometimes
competing goals of promoting successful reorganizations,
assuring equality of treatment of similar claims, and
protecting fundamental notions of due process
– Chapter 11 plan process does not always result in
reorganization; case may also result in confirmation of a plan
of liquidation
52
Plan of Reorganization: Some Rules of the Road
• Only the debtor may file a plan within an exclusive period
of time
– In small business cases (i.e., undisputed debts of less than
$2 million), debtor has exclusive period to file that is 180
days from filing date; unless extended or decreased for
cause, up to maximum extension of 20 months
– In any other business cases, period is 120 days from filing
date, unless increased or decreased for cause, up to
maximum exclusive period of 18 months
– Appointment of Chapter 11 trustee terminates exclusivity
period
– At end of exclusivity period, any party in interest (e.g., banks,
creditors’ committee, etc.) may file plan
53
Plan of Reorganization: Some Rules of the Road
• A plan of reorganization must:
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classify all claims and interests
specify any class that is not impaired
describe the treatment to be accorded any impaired class;
treat every claim or interest within a particular class
identically
– establish adequate ways to implement the plan (e.g., raise
new capital, sell assets, exit financing, selection of
management)
54
Plan of Reorganization: Some Rules of the Road
• A plan of reorganization may provide for:
– any class of claims or interests to be impaired or unimpaired
– the assumption, rejection, or assignment of executory
contracts or unexpired leases
– the settlement of any claim or interest
– the liquidation of all or substantially all of the estate’s
property
– the modification of the rights of secured and unsecured
creditors
– any other appropriate measure
55
Plan of Reorganization: Some Rules of the Road
• Plan Typically Contains
– Placement of creditors into various classes
• Administrative (e.g., expenses of the bankruptcy – post-petition trade
credit, professional fees)
• Secured (debt secured by a perfected lien on assets)
• Priority unsecured (e.g., taxes, employee claims – up to $ 12,475)
• General unsecured claims (e.g., trade debt)
• Equity (e.g., common stock)
56
Plan of Reorganization: Some Rules of the Road
• Treatment of Creditors (typically)
– Bankruptcy Code requires plan to provide for payment in full
of administrative and non-tax priority claims
– Certain unsecured tax claims paid out in installments up
to 5 years (with enough interest so deferred payments
equals present value of tax claim)
– New note to secured lenders, secured by lien on same
collateral
– Negotiate pro-rata distribution of cash and/or stock in
reorganized entity to unsecured creditors
– No recovery for equity, existing shares cancelled
57
Plan of Reorganization: Some Rules of the Road
• Implementation of Plan (typically)
– Raise new capital (issue new stock; exempt from registration
under securities laws)
– Sell certain assets to raise funds to pay creditors
– Replace DIP financing with exit financing to provide
additional liquidity upon emergence from Chapter 11
– Change management
• Select new board of directors
• If plan provides for liquidation, appoint a plan administrator or
liquidating trustee of trust
58
Plan of Reorganization: Some Rules of the Road
• Plan Approval Process
– Typically a two step process in which plan proponents first
obtain approval by the bankruptcy court of a “disclosure
statement”
– Following approval of disclosure statement, proponents can
proceed with solicitation of votes to accept plan, and if
enough votes are received, can then proceed with hearing to
seek confirmation of plan by the bankruptcy court
– In rare circumstances, generally involving single asset real
estate or simple capital structure, court may combine
disclosure statement and plan confirmation hearings
59
Plan of Reorganization: Some Rules of the Road
• Acceptance of a plan is determined through votes cast for
or against confirmation of the plan
– Some classes will be deemed to reject and, therefore, not be
entitled to vote, if plan provides for no recovery (e.g. equity)
– Other classes will be deemed to accept and, therefore, not
solicited if plan provides for full recovery (e.g. administrative
claimants)
– Holders of impaired claims are entitled to vote and will be
solicited (creditor may hold claims in more than one class
and have more than one ballot to submit)
• Confirmation requires acceptance by at least one non-insider
impaired class of creditors based on holders representing at least 2/3
in amount and more than 50% in number of all claims in class voting
in favor of confirmation
• Claims may be estimated for voting purposes
60
Plan of Reorganization: Some Rules of the Road
• Even if approved by creditors, plan still must be confirmed
by the bankruptcy court, which will consider 16 factors,
including:
– Feasibility; confirmation of plan will not be followed by
liquidation of company; standard does not require guaranty
of success but cannot impose too much risk of failure
– Best interests test; does plan provide each creditor with at
least as much recovery as it would on account of its claim as
it would receive in a straight liquidation
– Has at least one impaired, non-insider class voted in favor of
confirmation
61
Plan of Reorganization: Some Rules of the Road
• Through “cram down,” bankruptcy court may confirm plan
over the objection of one or more classes as long as:
– All other confirmation requirements are satisfied AND
– Plan does not “discriminate unfairly” and is “fair and
equitable” as to each such dissenting class of creditors
• Satisfaction of these cram down requirements differ depending on
whether the dissenting class is comprised of secured, unsecured or
equity interest holders
• “Unfair discrimination” means that similarly situated creditors must
not receive substantially different treatment under the plan (e.g.,
court may find plan to be unfair if it provides payment in full of trade
debt but no distribution to another class comprised of the Bank’s
unsecured deficiency claim)
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Plan of Reorganization: Some Rules of the Road
• “Fair and equitable” treatment means different things for
different classes of creditors
– Secured creditors are entitled to receive the “indubitable
equivalent” value of their claim;
– With respect to the so-called “absolute priority rule,”
unsecured creditors are entitled to be paid in full before
equity receives any distributions on account of their
prepetition equity interests, unless equity can successfully
apply the “new value” exception to the absolute priority rule
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Plan of Reorganization: Some Rules of the Road
• Confirmation of Plan is Not the End of the Chapter 11 Case
– Plan must still become “effective” and be substantially
consummated in order for debtor to emerge from
Chapter 11 as a reorganized company
– Final determination of allowance of unsecured claims may
not occur until long after plan has been confirmed; no
statute of limitations for objecting to allowance of a claim
• May be many years before all distributions contemplated by a plan
are finally made
– Effect of discharge, injunction and release under confirmed
plan
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