Second Circuit Prohibits Chapter 11 Gifts to Junior Creditor Classes

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In re DBSD N. Am., Inc.,--- F.3d ----, 2011 WL 350480 (2nd Cir. Feb. 7, 2011)

In a recent decision, the Second Circuit Court of Appeals has cast doubt on the continued viability of the gifting doctrine in the context of a contested Chapter 11 plan—marking yet another carve-out from the doctrine, which gained credence in the SPM decision from the First Circuit Court of Appeals. Gifting is a strategy sometimes used in Chapter 11 cases where a senior creditor diverts some of the consideration it would otherwise receive under a plan to a junior class of creditors or equity while bypassing an intervening class of creditors.

Background

In DBSD, the court considered an objection to the debtor’s proposed plan (the Plan) by Sprint Nextel Corporation (Sprint), which held an unliquidated, unsecured litigation claim. Under the Plan, a relatively significant distribution would be made to existing equity, despite the fact that unsecured creditors, which have a higher payout priority than existing equity, were to receive only a minimal distribution and not their full claim amount.

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