In the bankruptcy case of In Re: Tribune Company, et al., 2020 WL 5035797, the Third Circuit recently issued a decision determining that a Chapter 11 plan could be crammed down and confirmed over the objection of dissenting unsecured creditors who sought to fully enforce the terms of prepetition subordination agreements in their favor. In doing so, the Court was required to analyze cramdown confirmation in the face of 11 U.S.C. §510(a) (pertaining to subordination agreements), along with the meaning of unfair discrimination in 11 U.S.C. §1129(b)(1).
Under 11 U.S.C. §1129(b)(1), if a debtor is unable to obtain consensual confirmation of a Chapter 11 plan, a debtor may still confirm that plan over the objection of impaired creditors if at least one (1) impaired class of creditors accepts the plan, the plan is fair and equitable, and does not “discriminate unfairly.” The Bankruptcy Code set forth requirements for what is “fair and equitable” under 11 U.S.C. §1129(b)(2), but it does not provide the same guidance as to when a Chapter 11 plan discriminates unfairly. A Chapter 11 plan may treat similarly situated creditors differently for various reasons and still be confirmable, as long as the treatment does not arise to the level of “unfair” discrimination.
In Tribune, a class comprised of unsecured senior noteholders holding nearly 1.3 billion in debt objected to debtor’s plan based on perceived unfair discrimination. The senior noteholders were the beneficiaries of prepetition subordination agreements and believed that certain proposed plan disbursements, which would otherwise be payable to them pursuant to the priority conferred by prepetition subordination agreements, were being allocated by the plan to another class of unsecured creditors. It was argued that this other “preferred” class was benefitting by receipt of a portion of the subordinated sums to the senior noteholders’ detriment.
The Court was first tasked with determining whether §510(a) of the Bankruptcy Code prohibited the modification of a creditor’s subordination rights in the face of a cramdown. Section 510(a) of the Code provides that “[a] subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law.” Meanwhile, §1129(b)(1) (pertaining to cramdown) begins by stating “Notwithstanding section 510(a) of this title….” The Court determined that the use of the term “[n]otwithstanding” in §1129(b)(1) meant that a debtor could seek a cramdown confirmation of a Chapter 11 plan without giving full force and effect to existing subordination rights, so as long as all other requirements for cramdown confirmation were met.
Having decided that subordination agreements need not be strictly enforced for a plan to be confirmed by cramdown, the Court next turned to whether the plan unfairly discriminated against the senior noteholders. The senior noteholders argued that the Plan allocated over $30 million dollars to a smaller and separate class of unsecured creditors in violation of their subordination rights.
The Court took the time to examine four separate tests which had developed in various jurisdictions for unfair discrimination. The “mechanical” test prohibited all discrimination and required that similarly situated creditors receive an equal pro rata distribution from a plan. The “restrictive” test provided that in the absence of subordination, there could be no disparate treatment between similarly situated creditors. The “broad’ approach was a factor test requiring analysis as to whether there was a reasonable, good faith basis for discrimination, whether the plan could be confirmed without discrimination and the degree of discrimination in proportion to the rationale for the discrimination. Finally, the Court looked at the “rebuttable presumption” test, where a rebuttable presumption of unfair discrimination exists if a dissenting class, when compared to another class of the same priority, have materially lower percentage recovery for the dissenting class, or, regardless of recovery, an allocation of materially greater risk to the dissenting class.
The Court distilled these four (4) tests into eight (8) principles of unfair discrimination:
1. A debtor may discriminate against creditors in a chapter 11 plan, just not unfairly.
2. Unfair discrimination only applies to classes of dissenting creditors.
3. Unfair discrimination is determined from the perspective of the dissenting class.
4. Before an unfair discrimination assessment can be made, it should be determined that the creditors have been classified appropriately in the plan.
5. In analyzing unfairness, recovery of the dissenting class should be measured in terms of the net present value of all payments, or the allocation of materially greater risk in connection with its proposed distribution.
6. In analyzing unfairness, one should create a pro rata baseline for the priority level of the creditors from which the dissenting class arises, and then compare the preferred and dissenting class distributions and risk, should the plan become effective. When subordination agreements are involved, a determination should be made as to which claims the subordination applies, and then compare the preferred and dissenting class recoveries and risk, inclusive of subordinated sums, should the plan become effective.
7. To presume unfair discrimination, there must be a materially lower percentage recovery for the dissenting class or a materially greater risk to the dissenting class in connection with its proposed distribution.
8. If it is found that a plan materially discriminates against a dissenting class, and the Court is in a jurisdiction following the rebuttable presumption test or some variation, the unfair discrimination finding is by definition presumptive and can be rebutted.
Applying these principles, the Third Circuit noted that the senior noteholders recovery under the plan was projected at 33.6%, whereas the senior noteholders would receive only a .9% increase in recovery to 34.5% with all subordinated payments, since a percentage of the alleged preferred class was also seemingly entitled to the benefit of the subordination. The Court noted that it did not find a materially lower percentage of recovery for the senior noteholders and that “[a]lthough the plan discriminates, it is not presumptively unfair when understood, as ruled above, that a cramdown plan may reallocate some of the subordinated sums.”
The Court concluded noting that it had looked to maintain equality, pragmatism and the flexibility of Section 1129(b). Moving forward, whether a Chapter 11 Plan unfairly discriminates will be determined on a case by case basis, with the Tribune case providing guidance as to those factors which may establish unfair discrimination.