On May 4, 2016, the Court of Appeals for the Third Circuit held that a bankruptcy settlement in the form of a tender offer did not violate the principles of the bankruptcy process. See opinion here.
In April 2014, Energy Future Holdings Corp. (“EFH”), a major Dallas-based power generator and distributor, filed for bankruptcy under Chapter 11 in the United States Bankruptcy Court for the District of Delaware. Upon filing its bankruptcy petition, EFH initiated a tender offer directed at its secured creditors, in an effort to settle its disputes with the creditors. The proposal offered, subject to bankruptcy court approval, each secured creditor 105% of their notes’ aggregate principal amount and 101% of the accrued interest, in exchange for the release of any potential claim to the make-whole premium (which compensated noteholders for the loss of future interest resulting from an early refinancing). Creditors who declined the offer retained their full claim and the right to litigate seeking to obtain full value for their make-whole premium.
When EFH sought approval of the settlement from the bankruptcy court, Delaware Trust Company, as indenture trustee (the “Trustee”), objected, alleging that settlement in the form of a tender offer constituted a violation of bankruptcy principles, in that it was not “fair and equitable.” The bankruptcy court approved the settlement, noting that the offer would save EFH’s estate over ten million dollars each month in interest payments. The bankruptcy court also found that the settlement was a proper use of estate assets and included no “incidents of discriminatory treatment.” The District Court for the District of Delaware affirmed the bankruptcy court’s decision, and the Trustee appealed to the Court of Appeals for the Third Circuit.
On appeal, the Trustee first alleged that the use of tender offers as a means to settle claims is impermissible under Chapter 11. The Court held that the tender offer “clearly did not violate the Bankruptcy Code” and was equivalent to “a detailed settlement memorandum.” The Court also noted that the Trustee had failed to identify any section of the Bankruptcy Code that forbids settlements through tender offers. Just like the Bankruptcy Court, the appeals court found that the settlement would benefit the estate, as it “immediately saved the estate millions of dollars each month and thus provided more assets to satisfy all creditors.” This view that an outcome can be equitably permitted unless specifically forbidden by the Bankruptcy Code seems to take a broader view of the equitable powers of the bankruptcy court that some other recent decisions. But there is no question that the immediate and substantial benefit to the estate had a material impact on the analysis of each court that considered the issue.
The Court of Appeals also dismissed the Trustee’s argument that the settlement violated the “equal treatment” rule, which requires that all similarly situated creditors in bankruptcy are entitled to equal treatment. The Court first found that the rule applies by its terms only to reorganization plans, and not to settlements. Nevertheless, the Court stated that there was in fact equal treatment because each creditor “was offered the same percentage of both principal and accrued interest,” each was offered the opportunity to retain its rights to seek a ‘make whole remedy,’ and “no group of eligible creditors was deprived of the opportunity to participate.” The proposal in this instance was not materially different from a plan of reorganization where creditors are given the ability to opt-in to cash treatment of their claims at a reduced basis. Such plans have been regularly upheld and are not commonly viewed as involving discriminatory treatment. The existence of an individual choice regarding treatment is the critical element, just as it was here.
While the immediate implications of this decision are unclear, it certainly demonstrates the Court’s flexibility and willingness to approve settlement offers. In affirming the bankruptcy court’s decision to approve the settlement, the Court of Appeals noted that it should adopt a “flexible approach” and “read the Code’s requirements together with the recognition of the importance of compromise in bankruptcy.” The Court’s willingness to approve the settlement in the form of a tender offer was largely due to the financial benefit it would provide to the estate, and thus, the creditors. Therefore, if you are representing a creditor in bankruptcy, you may now encounter more debtors who want to make you a (tender) offer.