The Bottom Line

After the Third Circuit found that the appeal of confirmation of the Tribune Plan by two senior notes trustees was not equitably moot, Judge Sleet of the Delaware District Court held that the Tribune Plan’s failure to strictly enforce a subordination agreement did not amount to unfair discrimination against the senior noteholders. As a result of the cramdown plan’s partial enforcement of the subordination agreement, the Senior Noteholders’ recovery was reduced from 35.9 percent to 33.6 percent, which amounted to a reduction of approximately $30 million. The District Court also affirmed the lower court’s ruling that swap claims associated with Tribune’s leveraged buyout (LBO) were entitled to share in the partial benefits of the subordination agreement with the Senior Noteholders.

What Happened?

In Law Debenture Trust Company of New York & Deutsche Bank Trust Company Americas v. Tribune Media Company, et al., No. 12-cv-128 (appeals consolidated), 2018 WL 3617936 (D. Del. July 30, 2018), Judge Sleet of the Delaware District Court addressed whether the Chapter 11 Plan of Reorganization (the Tribune Plan) of Tribune Media Company and its affiliated debtors (Tribune), confirmed in 2012, unfairly discriminated against certain classes of senior bondholders. The Third Circuit had previously ruled, in 2015, that Law Debenture Trust Company of New York’s and Deutsche Bank Trust Company Americas’ (the Trustees’) appeals of the Bankruptcy Court’s order confirming the Tribune Plan were not equitably moot, and remanded the Trustees’ appeal to the District Court. 2018 WL 3617936, at *1.

The senior notes were party to a subordination agreement with two issuances of subordinated notes —the PHONES Notes and the EGI Notes. The subordination agreement stated that the Subordinated Noteholders would turn over any recovery received in a Chapter 11 proceeding to the Senior Noteholders. 2018 WL 3617936, at *2. The Tribune Plan, however, distributed the recovery otherwise due to the subordinated notes between the Senior Noteholders (Class 1E) and Class 1F, another class of general unsecured creditors with claims at Tribune’s parent company (the largest creditor in Class 1F being an LBO swap claim). 2018 WL 3617936, at * 2. The Senior Noteholders’ recovery, as a result of being forced to share the recovery due to the Subordinated Noteholders with Class 1F, was reduced from 35.9 percent to 33.6 percent. 2018 WL 3617936, at *2. The Bankruptcy Court had further noted that, as the swap claim — which constituted senior indebtedness under the subordination agreement and was thus due to share in the recovery on the subordinated notes — made up 57 percent of Class 1F, “this reduced the alleged discrimination against the Trustees to [only] 0.9% of their initial recovery percentage.” 2018 WL 3617936, at *2.

The senior notes Trustees objected to confirmation of the Tribune Plan, arguing that failure to strictly enforce the subordination agreement constituted unfair discrimination. The Bankruptcy Court overruled their objections, finding that discrimination resulting from sharing the subordination recoveries “was immaterial and permitted by § 1129(b)(1).” 2018 WL 3617936, at *2. The Tribune Plan was then consummated, and a number of parties appealed. The Third Circuit found that the senior notes Trustees’ appeal was not equitably moot, and remanded the appeal for the Delaware District Court to determine (i) whether the Bankruptcy Court had erred in refusing to enforce the subordination agreements; (ii) whether the Bankruptcy Court had erred in finding that the Tribune Plan did not discriminate unfairly against the senior noteholders; and (iii) the validity of the Bankruptcy Court’s finding that certain swap claims were also senior debt under the subordination agreements. 2018 WL 3617936, at *3.

The District Court, applying clear error and de novo review, found that the Bankruptcy Court had not erred in its interpretation of section 1129(b)(1). The senior notes Trustees asserted that section 510(a) required strict enforcement of subordination agreements. Looking to the plain meaning of § 1129(b)(1), which states that “a court shall confirm a plan over the objection of an impaired dissenting class not withstanding section 510(a),” the District Court disagreed. 2018 WL 3617936, at * 4 (internal citations omitted). The District Court’s decision relied, in part, on use of the word ‘notwithstanding’ to mean “in spite of” or “without prevention or obstruction from or by” in other sections of the Bankruptcy Code, and found that legislative history supported the same outcome. Id. As noted by the Appellees, “beneficiaries of a subordination agreement are entitled to the same protections under § 1129(b)(1) as all other creditors, but they are not entitled to enhanced protections by virtue of inter-creditor negotiations prior to the bankruptcy case.” 2018 WL 3617936, at *5.

The District Court then turned to the senior notes Trustees’ argument that the Tribune Plan unfairly discriminated against the Senior Noteholders by allowing other creditors to receive a share of the recovery from the subordinated notes. Judge Sleet approved the Bankruptcy Court’s use of the Markell rebuttable presumption test for measuring unfair discrimination, where if “there is an allegation of a materially lower recovery” due to unequal treatment, the presumption of discrimination can be rebutted by showing that the dissenting class, outside of bankruptcy, would receive less than the class receiving a better recovery, or that the alleged preferred class infused new value into the reorganization to offset its gain. 2018 WL 3617936, at *6 (citing Dow Corning Corp., 244 B.R. 696, 702 (Bankr. E.D. Mich. 1999). The claim the senior notes Trustees argued the Senior Noteholders were entitled to was only approximately two percentage points higher than the claim they received. The District Court agreed with the Bankruptcy Court’s ruling that this difference was not material.

Finally, the District Court affirmed the lower court’s ruling that the LBO swap claims were senior indebtedness entitled to share in recoveries from the subordinated notes. The subordination agreement and subordinated notes indenture defined senior indebtedness as obligations due in connection with Tribune’s indebtedness and not incurred in the ordinary course of business. The swap claims were debt incurred in relation to the LBO, and were reflected on Tribune’s financial statements as short-term or long-term expenses, not accrued expenses incurred in the ordinary course. 2018 WL 3617936, at *9.

Why This Case Is Interesting

The Third Circuit has not defined what constitutes “unfair discrimination” for the purposes of section 1129(b)(1). Judge Sleet followed the Dow Corning court and applied the Markell test to find that the recovery to the Senior Noteholders was not materially lower than either the claim the Senior Noteholders argued they were entitled to or the recovery of similarly situated classes. In particular, the court focused on the difference in percentage recoveries, noting that “[w]hile the actual amount of money at issue is large, the percentage difference is not significant or material.” 2018 WL 3617936, at *7. The decision underscores that subordination agreements will not be strictly enforced in cramdown plans, particularly in circumstances where failing to strictly apply the subordination agreement does not materially reduce the dissenting class’s recoveries in terms of percentage points, even if the dollar amount is substantial.