Background

Following various disputes as to the scope of the collateral given to secured creditors, the debtors and certain of their noteholders jointly proposed a chapter 11. The plan included a rights offering that the consenting noteholders agreed to backstop. These consenting noteholders were granted the right to purchase significant equity of the reorganized debtors at a discount and receive significant premiums for their agreement to backstop the rights offering and support the plan.

Members of the ad hoc committee of the non-consenting holders elected not to sign the various agreements and thus were not qualified to participate in the rights offering and receive the related premiums. Instead, they proposed various alternative restructuring proposals to the debtors, which the debtors rejected as inferior.

The Bankruptcy Court

The bankruptcy court confirmed the plan rejecting the non-consenting holders’ arguments that the plan violated the equal treatment requirement of section 1123(a)(4) (since they were not given the rights and premiums granted to the consenting holders) and that the plan was proposed in bad faith. The district court affirmed.

The Eighth Circuit

On further appeal, the court of appeals for the eighth circuit affirmed as well.

Equal Treatment Issue

As to the equal treatment argument, the court held that the opportunity to participate in the rights offering was not a treatment of the consenting noteholders’ pre-petition claims; rather it was consideration for “valuable new commitments made by the participating creditors.” Since they agreed to “support the plan, buy preferred stock that did not sell in the Private Placement, and backstop the Rights Offering,” they received in exchange “the opportunity to buy preferred stock at a discount as premiums designed to compensate them for shouldering significant risks.”

Good Faith Issue

On the good faith issue, the non-consenting holders argued, among other things, that the debtors employed a coercive process because the creditors wishing to participate in the private placement had to elect to do so prior to the approval of the various agreements and the disclosure statement. Nevertheless, and although the Court expressed reservations on the issue, the court found credible the debtors’ argument that time was of the essence due to the volatility of the coal market, resulting in a likely cost of $30 million per month of delay in the process.

Implications

There are two important takeaways from the Circuit Court’s holding, at least with the Eighth Circuit. First, backstops are not subject to the section 1123(a)(4) equal treatment requirement. Second, debtors may get away with some procedural violations of due process, provided they convince the court that exigent circumstances justified them.

Read the opinion >>