On January 31, 2013, the United States Bankruptcy Court for the District of Delaware (the court) upheld a post-petition “lock-up” agreement in approving confirmation of the proposed plan in In re Indianapolis Downs, LLC, 2013 Bankr. LEXIS 384 (Bankr. D. Del. Jan. 31, 2013) (Indy Downs). In issuing its ruling, the court provided significant new guidance on how the court will scrutinize the propriety of these increasingly common agreements.
A lock-up agreement, which is also commonly known as a plan support agreement, is an agreement between a creditor and debtor, pursuant to which the creditor becomes bound to vote for a plan as long as certain key plan provisions are included in the proposed plan. Through the plan support agreement, the parties bind one another to a deal, even though the underlying plan and disclosure statement remain to be drafted and executed.
In Indy Downs, the debtors and certain key creditors engaged in extensive negotiations and achieved agreement on an approach to the debtors’ reorganization. The terms of that agreement were memorialized in a plan support agreement, which provided for: (i) specific terms of the plan of reorganization to be proposed; (ii) the requisite timeframe for the debtors to propose the plan; (iii) a prohibition against any party to the agreement proposing, supporting, or voting for a competing plan of reorganization; and (iv) the requirement, enforceable by an order of specific performance, that the signatories to the plan support agreement vote for the plan. Under its terms, the plan support agreement was binding upon its non-debtor signatories upon execution and binding upon the debtors only upon approval of a disclosure statement.
A conforming plan of reorganization was filed and thereafter approved by the majority of the creditors and stakeholders of the debtors’ estates. However, certain parties objected to plan confirmation and filed a motion to designate the claims of the parties to the plan support agreement pursuant to Section 1126 of the Bankruptcy Code, which allows the court to designate the votes of any entity whose acceptance or rejection of a plan was not solicited in accordance with the provisions of the Bankruptcy Code. In so moving, the objecting parties argued that the plan support agreement constituted an impermissible post-petition solicitation of votes prior to court approval of a disclosure statement, in violation of Section 1125 of the Bankruptcy Code. The significance of the designation of a vote under Section 1126 is that the designated vote is not counted in determining whether a class of claims has accepted a Chapter 11 plan. In Indy Downs, the debtors would have had insufficient votes to confirm their Chapter 11 plan if the court had granted the motion to designate the votes of the parties to the plan support agreement.
In appraising the merits of the motion to designate, the court found guidance from the Third Circuit’s opinion in In re Century Glove, 860 F.2d 94 (3d Cir. 1988). In Century, one of the debtor’s major creditors contacted several other substantial creditors and provided them with a proposed plan of reorganization outside of the plan process. In upholding the district court’s ruling that such actions were appropriately characterized as “negotiations,” the Third Circuit held that, in accordance with congressional intent, “solicitation” under Section 1125 must be read narrowly so as not to constrain creditor negotiations.
In reaching its decision in Indy Downs, the court similarly relied on the legislative intent that creditors, stakeholders, and Chapter 11 debtors be provided full opportunity for negotiation. The court reiterated that a narrow interpretation of “solicitation” under Section 1125 fulfills the legislative intent of allowing parties to freely negotiate and to capture any agreements thereby reached in a way that advances the Chapter 11 case.
The court found it antithetical to the goals of the Bankruptcy Code to deny creditors the right to vote, absent a showing of bad faith or wrongful conduct. This was especially true because the primary purpose of Section 1125 and the disclosure statement requirements, namely the goal of prohibiting the solicitation of votes on a plan when creditors and stockholders are not well enough informed to act in their own self-interest, was not at risk on the facts before the court. The parties to the plan support agreement were sophisticated financial entities that had been represented capably throughout the Chapter 11 case. The court held that it would “grossly elevate form over substance” to rule that Section 1125 required designation of the votes of these sophisticated, well-represented entities, who had negotiated at length with the debtors to advance their own economic interests, simply because they executed the plan support agreement prior to being afforded the occasion to review a court-approved disclosure statement.
The court found that the non-debtor parties to the plan support agreement were acting in their own self-interest to maximize their own recoveries and to advance the Chapter 11 process in a manner that facilitated a prompt and significant return on their claims. After extensive negotiations, it was not surprising, and indeed appropriate, that the plan support agreement contained a commitment to vote to approve a plan that adhered to the requirements set forth in the agreement.
The court categorized the filing of a Chapter 11 petition as “an invitation to negotiate.” The court continued by stating that Congress has carefully balanced the Chapter 11 process to provide creditors and other stakeholders with the ability to bargain to advance their respective economic positions. The court noted that each case requires a fact-driven analysis to determine whether there is a material risk to the important policies sought to be advanced by the disclosure requirements contained in the Bankruptcy Code. Mindful of the fact that “courts must be chary of construing those disclosure and solicitation provisions in a way that chills or hamstrings the negotiation process that is at the heart of Chapter 11[,]” the court held that when a deal is negotiated in good faith between a debtor and sophisticated parties, and the arrangement is memorialized in a written commitment and promptly disclosed, the Bankruptcy Code does not automatically require designation of the votes of the participants. Accordingly, the court denied the motion to designate in confirming the debtors’ Chapter 11 plan.
The practice of involving major creditors in the Chapter 11 plan negotiation process and memorializing agreements thereby reached has become an increasingly common technique in reaching a pragmatic and efficient resolution of a Chapter 11 case. Although the court took care to note that the analysis is fact-specific, the decision in Indy Downs provides comfort that plan support agreements, when negotiated at arms’-length and in good faith between sophisticated parties, should survive court scrutiny.