The Bottom Line
The Delaware Bankruptcy Court, in In re Nuverra Environmental Solutions, Case No. 17-10949 (Bankr. Del. July 24, 2017), confirmed a chapter 11 plan of reorganization despite separate classification and disparate gifted consideration between classes of general unsecured creditors. The Court determined the gift from secured creditors to certain classes of general unsecured creditors, but not the class of unsecured bondholders, created a rebuttable presumption of unfair discrimination and did not violate the absolute priority rule. Because the proposed classification scheme was necessary to foster reorganization and maintain ongoing business relationships, the plan was confirmable.
In In re Nuverra Environmental Solutions, Case No. 17-10949 (Bankr. Del. July 24, 2017), the Court confirmed the Debtors’ prepackaged plan of reorganization (the “Plan”) and overruled the sole unresolved objection by David Hargraves (“Hargraves”), an unsecured bondholder. The Plan separately classified (i) unsecured bondholder claims, (ii) general unsecured claims and (iii) rejection damage claims. The Plan provided that unsecured bondholders would receive common stock, warrants and equity equating to a 6% recovery, while certain other general unsecured creditors were left unimpaired. The unimpaired general unsecured creditors were to receive distributions as a “gift” from secured creditors, who received equity in the reorganized company under the Plan.
Hargraves asserted the Plan was not confirmable because the classification of unsecured claims in more than one class was improper, provided for disparate treatment and violated the absolute priority rule.
The Court first examined its ruling in In re Tribune Co., 472 B.R. 223 (Bankr. D. Del. 2012), and noted that section 1122(a) does not require all similar claims to be placed in the same class. Debtors have flexibility to classify claims into different classes as long as the classification scheme is reasonable and a rational, legal or factual basis for separate classification exists. The Debtors explained the separate treatment of claims of general unsecured creditors was necessary to maintain ongoing business relationships that the Debtors needed to continue operations.
The Court also applied the Markell test from Tribune to determine whether unfair discrimination existed under section 1129(b) the Plan. The Markell Test provides a rebuttable presumption of unfair discrimination arises when there is:
(1) a dissenting class;
(2) another class of the same priority; and
(3) a difference in the plan’s treatment of the two classes that results in either:
(a) a material lower percentage of recovery for the dissenting class measured in terms of the net present value of all payments; or
(b) regardless of a lower percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution.
The Court determined there was a rebuttable presumption of unfair discrimination but that despite the disparate treatment, there was no unfair discrimination because the unsecured bondholders were “indisputably out of the money and, not otherwise, entitled to any distribution under the Bankruptcy Code’s priority scheme.” Further, the Debtors’ proposed classification and treatment of other general unsecured creditors fostered the Debtors’ reorganization.
The Court also dismissed Hargraves argument that the gifts to general unsecured creditors conflicted with the Third Circuit’s decision in In re Armstrong World Indus., Inc., 432 F.3d 507 (3d Cir. 2005). The Court found that confirmation of the Plan was consistent with Armstrong because the gift provided here was a similar gifting scenario to the one provided in In re Genesis Health Ventures, Inc., 266 B.R. 591 (Bankr. D. Del. 2001), which the court in Armstrong viewed favorably. In Genesis, the plan allowed a secured creditor to give up a portion of its distribution under the plan to holders of unsecured and subordinated claims but not holders of rejection damage claims. The Court found both gifting scenarios were similar because they each involved a secured creditor giving up a portion of value in favor of unsecured creditors that the secured creditors would have otherwise been entitled to receive under the plan.
Lastly, the Court determined that the classification scheme did not implicate Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017) because the Plan received overwhelming creditor support and allowed the reorganization of an ongoing business.
Why the Case is Interesting
This case confirms (no pun) the Debtors’ flexibility to separately classify unsecured claims as part of a global restructuring that involves a secured creditor gifting a portion of its recovery in favor of certain, but not all, unsecured creditors. The court did not derail an otherwise consensual restructuring that involved different treatment of otherwise similarly situated unsecured creditors where the objecting creditor belongs to a class that is indisputably out of the money and not otherwise entitled to distribution under the priority scheme under the Bankruptcy Code. The decision is being appealed, so stay tuned.