Due to the substantial time and effort involved in negotiating and confirming a Chapter 11 reorganization plan, and the potential for improperly solicited votes to be disqualified, plan proponents generally are well advised to adhere strictly to the plan voting and disclosure requirements of the Bankruptcy Code. A recent Delaware bankruptcy court decision, In re Indianapolis Downs, LLC,1 indicates that creditors who actively negotiate the terms of a debtor's reorganization can, under certain circumstances, enter into a formal plan support agreement with the debtor without risking that the plan will violate the Code's solicitation and disclosure requirements.
In this case, Bankruptcy Judge Shannon was asked to "designate" (i.e., disqualify) the votes of certain creditors who had executed a post-petition "restructuring support agreement" with the Debtors, before the Debtors' had filed a disclosure statement describing their proposed plan of reorganization. Other creditors had objected to this process, arguing that it constituted an improper "solicitation" of votes in violation of the Bankruptcy Code, such that the supporting creditors' votes should not be counted. Adopting a pragmatic view of what constitutes "solicitation," the bankruptcy court allowed the votes of the Plan Supporters to be counted, overruled remaining objections and confirmed the Plan.
The Debtors operated a racino in Indiana that employed more than 1,000 people. As of April 7, 2011 ("Petition Date"), the Debtors had incurred more than $98 million of first priority secured debt, $375 million of second lien secured debt, and $78 million of third lien secured debt (plus accrued interest and other charges).
A substantial financial institution ("Investor") allegedly held a substantial portion of the second and third lien indebtedness. Investor and certain other second lien debt holders ("Ad Hoc Second Lien Committee") had been unsuccessful in reaching agreement with the Debtors on the terms of an out-of-court restructuring. This impasse led to the Debtors' chapter 11 filing.
Approximately one year later, following additional negotiations and litigation, the Debtors, Investor and the Ad Hoc Second Lien Committee (collectively, "Plan Supporters") agreed to pursue a two-pronged approach to the Debtors' restructuring. The Debtors would test the market to determine whether their assets could be sold at a price high enough to garner the support of their major creditor constituents, while simultaneously proceeding with their recapitalization. The parties executed a Restructuring Support Agreement dated April 25, 2012 ("RSA") that evidenced their agreement to this proposal, with the understanding that the RSA would become binding on the non-debtor parties upon execution and on the Debtors following bankruptcy court approval of a disclosure statement. In addition to including specifics and timing of this parallel approach, the RSA prohibited any party to the RSA from proposing, supporting or voting for a competing plan of reorganization, and required each party to vote in favor of a plan that complied with the RSA (which requirement was enforceable by specific performance). On the same day that the RSA was signed, the Debtors filed their proposed plan of reorganization and disclosure statement.
Following a hearing in June 2012, the bankruptcy court approved the Debtors' disclosure statement. The Debtors' subsequently procured a bid for substantially all of their assets for the purchase price of $500,000,001 from Centaur LLC ("Purchaser"). They did not receive any superior competing bids. After taking into evidence numerous documents and hearing live testimony, the bankruptcy court approved the sale to the Purchaser by order dated October 31, 2012. The court then addressed the Objecting Parties' challenge to the plan voting process.
The Bankruptcy Code prohibits votes on a proposed plan from being solicited post-petition from a claim or interest holder unless the plan (or a summary of it) is transmitted to the holder, either before or at the time of such solicitation, together with "a written disclosure statement approved, after notice and a hearing, by the court as containing adequate information." To provide teeth to these requirements, the Bankruptcy Code authorizes the bankruptcy court to disallow the votes of any entity who accepted or rejected a plan other than "in good faith" or "in accordance with the provisions of this title."
The objecting parties did not allege that the Debtors or Restructuring Support Parties acted in bad faith in entering into the RSA. Instead, they argued solely that the plan voting process failed to comply with the technical requirements of the Bankruptcy Code.
The court declined to grant the "drastic" remedy of designation, primarily because the underlying policy of the Code -- to protect creditors from making an uninformed decision on the plan -- had been served.
The bankruptcy court found dispositive the court's reasoning in In re Heritage Organization, L.L.C., a Texas bankruptcy case.2 In Heritage, the bankruptcy court had declined to designate the votes of creditors who had signed a term sheet embodying the provisions of a plan of which they were co-proponents. In the Texas court's view, it would have been "absurd" to discount the votes of such creditors as having been improperly solicited when they clearly had enough information about the case and available alternatives to enable them to support the term sheet. The Indy Downs court stated "… given their significant respective stakes in the Debtors and the Court's own observation of these parties' involvement in these proceedings, precisely the same considerations pertain here as those found persuasive by the court in Heritage ... Congress intended that creditors have the opportunity to negotiate with debtors and amongst each other; to the extent that those negotiations bear fruit, a narrow construction of 'solicitation' affords these parties the opportunity to memorialize their agreements in a way that allows a Chapter 11 case to move forward."
The court also found that because Indy Downs did not involve the premature solicitation of votes from uninformed constituents, the safeguards sought to be protected by the Bankruptcy Code were not at "material risk." Instead, the parties to the RSA were "sophisticated financial players" that were represented throughout the case by seasoned professionals. In the court's view, under such circumstances, "It would grossly elevate form over substance to contend that § 1125(b) requires designation of their votes because they should have been afforded the chance to review a court-approved disclosure statement prior to making or supporting a deal with the Debtors."
The Indy Downs court reached this conclusion despite court orders entered in two earlier cases decided in Delaware by different bankruptcy judges that designated creditors' votes (without any analysis).3 Judge Shannon noted: "At a minimum, there was no question in those cases that the act in question was a 'solicitation' of a specific ballot relating to a filed plan."
Moreover, the bankruptcy court determined that the Restructuring Support Parties acted to facilitate the reorganization process in order to maximize their recoveries, and that under such circumstances, courts are "extremely reluctant" to penalize such parties through designating their votes.
Indy Downs demonstrates that, in contrast to earlier decisions from the same jurisdiction, the Delaware bankruptcy court is willing, under appropriate circumstances, to permit creditors to support a debtor's proposed plan prior to the filing of a formal disclosure statement. In Indy Downs the Plan was negotiated and supported by the majority of constituents in the proceedings, each of whom was sophisticated and represented by competent counsel, and there was no official committee of unsecured creditors to appease. Therefore, under circumstances where the underlying purposes of the Bankruptcy Code's solicitation rules have been served, the courts need not risk the debtor's rehabilitation by becoming mired in unduly strict application of the formalities of plan solicitation and confirmation.