Debt-for-equity swaps and debt exchanges are common features of out-of-court as well as chapter 11 restructurings. For publicly traded securities, out-of-court restructurings in the form of "exchange offers" or "tender offers" are, absent an exemption, subject to the rules governing an issuance of new securities under the Securities Exchange Act of 1933 (the "SEA") as well as the SEA tender offer rules. By contrast, it is generally understood that the SEA rules do not apply if an exchange or tender offer takes place as part of a restructuring under chapter 11 of the Bankruptcy Code, which provides in section 1145 that certain federal and state securities laws do not apply to the offer or sale of securities under a chapter 11 plan.
In Del. Trust Co. v. Energy Future Intermediate Holdings, LLC (In re Energy Future Holding Corp.), 2015 BL 44121 (D. Del. Feb. 19, 2015), the district court affirmed a bankruptcy court order approving a settlement between the debtors and certain secured noteholders. The vehicle for the settlement was a postpetition tender offer of old notes for new notes to be issued under a debtor-in-possession ("DIP") financing facility. The district court ruled that a tender offer may be used to implement a classwide debt exchange in bankruptcy outside a plan of reorganization. It also held that the Bankruptcy Code's confirmation requirements do not apply to a pre-confirmation settlement and that the settlement at issue did not constitute a sub rosa chapter 11 plan.
Known as TXU Corp. until 2007, when it was acquired in what was then the largest leveraged buyout ever, Texas-based Energy Future Holding Corp. and its subsidiaries (collectively, "Energy Future") filed for chapter 11 protection on April 29, 2014, in the District of Delaware to implement a restructuring that would split the company between groups of creditors and eliminate more than $26 billion in debt. Energy Future is organized into two principal businesses, one of which is Energy Future Intermediate Holdings, LLC ("EFIH"). EFIH owns 80 percent of Oncor Electric Delivery Co. LLC, the largest regulated utility in Texas.
EFIH's capital structure includes $4 billion of first-lien notes, $2.2 billion of second-lien notes, and $1.7 billion of unsecured notes. The first-lien notes consist of two separate tranches: $3.5 billion of 10 percent notes due 2020 (the "10% Notes") and $500 million of 6⅞ percent notes due 2017 (the "6⅞% Notes"). Both issuances of first-lien notes include identical "make-whole" provisions that protect the noteholders from early redemption. However, the amount of the make-whole premiums payable in respect of the 10% Notes and the 6⅞% Notes differs to account for the different interest rates and maturity dates governing the instruments.
On the bankruptcy petition date, Energy Future filed a restructuring support and lockup agreement that documented a broad settlement reached among Energy Future and various creditors. This "global settlement" included a settlement between Energy Future and some of the first-lien noteholders (the "first-lien settlement") that was to be implemented by means of a postpetition "tender offer." The tender offer proposed a "roll-up"—an exchange of existing first-lien notes for new notes bearing a lower interest rate to be issued under a $5.4 billion DIP financing facility.
In exchange for new notes valued at 105 percent of outstanding principal and 101 percent of accrued interest, participating noteholders would agree to release their make-whole premium claims (the allowance of which in bankruptcy was disputed by Energy Future). However, although the settlement offered all first-lien noteholders principal and accrued interest premiums as an inducement to settle their claims for a make-whole premium, the amounts the two classes of noteholders would receive compared to "the maximum potential value" of their make-whole claim ("MPV") were unequal, due to the varying principal amounts and maturities. Specifically, for holders of the 6⅞% Notes (the "6⅞% Noteholders"), 5 percent of their principal represented 64 percent of MPV, whereas for the holders of the 10% Notes (the "10% Noteholders"), 5 percent of principal amounted to only 27 percent of MPV.
Ninety-seven percent of the 6⅞% Noteholders and 34 percent of the 10% Noteholders accepted the tender offer. Nonsettling noteholders retained the right to litigate the validity of their make-whole premium claims.
On the basis of these results, the bankruptcy court approved the first-lien settlement under Fed. R. Bankr. Proc. 9019 ("Rule 9019"). However, Energy Future subsequently abandoned the other elements of the global settlement.
The indenture trustee for the 10% Notes appealed the order approving the first-lien settlement, contending that: (i) Energy Future's use of a tender offer as the vehicle for the settlement was improper; (ii) approval of a settlement that offered disparate make-whole claim recoveries to similarly situated creditors violated section 1123(a)(4) of the Bankruptcy Code; and (iii) the first-lien settlement constitutes an improper sub rosa chapter 11 plan.
The District Court's Ruling
Tender Offer May Be Used to Implement Classwide Debt Exchange in Bankruptcy
On appeal, the indenture trustee argued, among other things, that a tender offer is improper in a chapter 11 case because the Securities and Exchange Commission (the "SEC") plays only a limited role in chapter 11 bankruptcies, and it was improper for Energy Future "to invoke an SEC-governed procedure in lieu of seeking judicial approval to initiate the [first-lien settlement] offer." The district court rejected this argument. According to the court, pre-confirmation settlements are allowed under section 363(b) of the Bankruptcy Code and Rule 9019 as a way "to minimize litigation and expedite the administration of the bankruptcy estate." Moreover, it wrote, the Bankruptcy Code "does not impose any restrictions on a debtor's ability to propose pre-confirmation settlements."
A tender offer, the district court explained, is nothing more than "a vessel to comply with certain disclosure rules when offering securities publicly for sale or exchange," and the SEC's limited role in chapter 11 cases does not suggest that it is improper for a debtor to comply with securities laws. Section 1145 of the Bankruptcy Code, the court noted, delineates specific situations where certain federal and state securities laws do not apply to, among other things, the offer or sale of securities under a chapter 11 plan. Because the provision does not include pre-confirmation settlement offers, the court wrote, Energy Future may have "deemed it necessary to comply with the appropriate securities laws." According to the court, regardless of whether this assessment was correct, "the Court cannot accept the argument that the SEC's limited role in chapter 11 litigation somehow categorically forbids a debtor from complying with securities laws."
The district court also rejected the indenture trustee's argument that allowing a chapter 11 debtor to implement a classwide debt exchange with unequal treatment of creditors other than through a confirmed chapter 11 plan would invite the inequities characterizing "equity receiverships," a form of debt restructuring that was used prior to the Bankruptcy Act of 1898 for failing railroads controlled by insiders for the benefit of large institutional creditors. Equity receiverships were supplanted in the Chandler Act of 1938 by chapter X of the Bankruptcy Act, which eliminated the domination of management and "self-serving inner groups" of creditors by giving a trustee the power to propose a plan of reorganization in cases where the debtors' liabilities exceeded $250,000.
According to the district court, "[t]he problems inherent with equity receiverships are neither present in this case nor implicated by a class-wide settlement offer" because: (i) there was no evidence of insider dealing, coercion of noteholders, or control by outside creditor groups; (ii) nonaccepting noteholders could potentially recover the full value of their claims; and (iii) the bankruptcy court concluded that the settlement was reasonable after subjecting the entire settlement to judicial review.
"Plans of reorganization," the district court concluded, "are not the exclusive mechanism to exchange debt or pay off existing creditors in chapter 11." Noting that the first-lien settlement was simply a roll-up of the first-lien notes with new DIP financing, the court ruled that the use of a tender offer to accomplish this exchange was not improper under bankruptcy law.
Plan Confirmation Requirements Do Not Apply to Pre-Confirmation Settlements
The district court also rejected the indenture trustee's contention that the first-lien settlement should not have been approved because it violated section 1123(a)(4) of the Bankruptcy Code. Section 1123(a)(4) provides that a plan must "provide the same treatment for each claim . . . of a particular class, unless the holder of a particular claim . . . agrees to a less favorable treatment." By its express terms, the district court reasoned, section 1123(a)(4) applies only to plan confirmations. Although other courts have applied certain chapter 11 plan confirmation requirements—such as the absolute priority rule (see, e.g., Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007); United States v. AWECO, Inc. (In re AWECO, Inc.), 725 F.2d 293 (5th Cir. 1984))—to pre-confirmation settlements, the district court in Energy Future noted that courts in the Third Circuit (which includes the District of Delaware) have not adopted, and in some cases have expressly rejected, this approach.
Furthermore, the court explained, even if section 1123(a)(4) did apply in this context, the first-lien settlement did not violate the provision. As noted, section 1123(a)(4) permits creditors to agree to less favorable treatment of their claims. To the extent that the first-lien settlement treated the make-whole claims of the 10% Noteholders and the 6⅞% Noteholders differently, the district court wrote, "those parties voluntarily accepted that treatment."
In addition, the district court concluded that the indenture trustee's interpretation of the phrase "equal treatment" was flawed. According to the district court, although the phrase is not "precisely" defined in the Bankruptcy Code or its legislative history, courts have interpreted "equal treatment" to mean that "all claimants in a class must have the same opportunity for recovery" (citation omitted and emphasis added). Here, the court wrote, although the first-lien settlement treated the make-whole claims of the 10% Noteholders and the 6⅞% Noteholders differently, "each noteholder had the opportunity to decline the settlement offer and litigate the full value of the claim."
First-Lien Settlement Not a Sub Rosa Plan
Finally, the district court ruled that the first-lien settlement did not constitute an improper sub rosa chapter 11 plan. A sub rosa plan, the court explained, is a broad settlement that amounts to a de facto plan of reorganization but is not subject to the plan confirmation requirements and other creditor protections set forth in the Bankruptcy Code. Energy Future, however, withdrew its request for approval of the global settlement. Thus, the district court found that the indenture trustee failed to demonstrate how the first-lien settlement by itself "disposes of all claims against the estate or restricts creditors' rights to vote."
The district court accordingly affirmed the bankruptcy court's order approving the first-lien settlement.
Energy Future is a highly unusual case, and the ruling is by no means an endorsement of the tender offer as a preferred vehicle for effectuating a debt restructuring in chapter 11. In fact, one of the principal advantages of chapter 11 over out-of-court restructurings for public companies is not having to comply with the registration requirements of laws that govern the offer or sale of securities outside bankruptcy. Compliance with such nonbankruptcy laws is deemed unnecessary in chapter 11 in light of the Bankruptcy Code's disclosure requirements in connection with the solicitation of votes on a plan and the chapter 11 plan confirmation standards. Energy Future filed for chapter 11 protection to implement a prenegotiated restructuring that contemplated a series of exchange offers, cash tender offers, and related transactions. Instead of attempting to implement the exchanges as part of a chapter 11 plan, Energy Future elected to seek court approval of the restructuring under Rule 9019 as part of a global settlement. Because the offers would not be subject to chapter 11's disclosure and plan confirmation requirements, Energy Future decided to comply with securities laws in making the offers, presumably to ward off objections directed toward the propriety of the process.
Why Energy Future chose this strategy is unclear. Perhaps it calculated that the transactions comprising the global settlement were more likely to be approved under the standards governing a Rule 9019 motion—in the Third Circuit, a settlement must be "fair and equitable" and "above the lowest point in the range of reasonableness" (see In re Capmark Financial Group, Inc., 438 B.R. 471, 475 (Bankr. D. Del. 2010))—than under the much more exacting chapter 11 plan confirmation requirements.
The Energy Future court's rejection of the approach employed by the Fifth Circuit (and, to a lesser extent, the Second Circuit) in applying plan confirmation requirements to pre-confirmation settlements is notable. To the extent that a proposed settlement does not comply with such requirements, it puts the burden squarely on objecting parties to demonstrate that the settlement is not fair and equitable.
Finally, it would have been interesting to see how the district court would have ruled on the issue of a sub rosa plan had Energy Future not abandoned its request for approval of the global settlement.