Bankruptcy and Restructuring Litigation Update

Court Refuses to Approve Debtors’ Decision to Assume Plan Support Agreement: On December 20, 2010, the Bankruptcy Court for the Southern District of New York refused to approve a debtors’ request to assume a prepetition plan support agreement (“PSA”) that provided for the issuance of 100 percent of the reorganized debtors’ equity to one of the debtors’ prepetition secured lenders. Notably, the lender had cut a side deal with the debtors’ prepetition equity holder to sell half the equity received under the PSA. Although the court noted that the entire fairness standard was likely applicable, it applied the less stringent business judgment standard in refusing to approve the PSA. It also refused to find that the debtors’ decision was disinterested. The debtors had always intended to transfer equity to its former owner whether directly, as a back-stop party, or through the side deal with a secured creditor. Similarly, the court found that the PSA was not entered into with due care because the debtors did not “shop” the deal to potential alternative counterparties. Finally, the court refused to find the debtors had acted in good faith. It noted that “virtually all of the other parties in interest in the debtors’ capital structure” complained they had been shut out of the process. It additionally ruled that the fact that the debtors’ equity holder would retain 50 percent of the reorganized equity was “at best, downplayed and, at worst, obfuscated” from such parties. Finally, the court viewed as excessive the control over cash collateral afforded to the secured creditor under the PSA, including a prohibition imposed on the debtors precluding them from seeking competitive proposals, reimbursement of the secured lender’s costs, and, in certain instances, a requirement that the debtors consent to lifting the stay. The case is In re Innkeepers USA Trust, et al., No. 10-13800 (SCC) (Bankr. S.D.N.Y. Jul. 19, 2010), and is important precedent examining the limitations of prepetition plan arrangements among debtors and stakeholders.

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Published In: Bankruptcy Updates, General Business Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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