Add the Eight Circuit to a growing list of courts that have found that a plan of reorganization which proposes better treatment for creditors who have agreed to purchase any leftover securities in an offering (a “backstop agreement”) done pursuant to that plan does not violate the requirement that each claim within a class of creditors receive the same treatment under 11 U.S.C. § 1123(a)(4). In re: Peabody Energy Corp., --- F.3d --- (Docket No. 18-1302) (8th Cir. August 9, 2019).
The Peabody Plan
Peabody Energy Corporation filed a voluntary petition under Chapter 11 in April 2016. A victim of decreased demand and falling coal prices, Peabody found its debt obligations unbearable. Immediately after the bankruptcy filing, disputes arose between several of Peabody’s secured and senior-unsecured creditors involving collateralization issues. The parties sought to mediate this dispute which eventually expanded to include plan negotiations. The plan that resulted from these negotiations provided a method for Peabody to raise $1.5 billion in new money to pay for distributions under the plan and fund operations of the reorganized entity. This was to be accomplished by two sales of securities of the reorganized entity.
The first sale was of common stock at a discount to certain classes of creditors. But it was the second sale of preferred stock at a discount to certain qualifying creditors that raised the ire of creditors who were not involved in the mediation (the “Non-Consenting Creditors”). In this second sale, the holders of second-lien and Class-5B claims could qualify to buy the preferred stock by (1) agreeing to buy a specified amount of the preferred stock, (2) agreeing to “backstop” the sale (i.e. purchase shares of the offering that did not sell), and (3) agreeing to support the plan of reorganization. This purchase by the second-lien and Class-5B creditors was at a substantial discount and they would also receive significant premiums as part of the transaction.
Equal Treatment Under § 1123(a)(4)
The Non-Consenting Creditors attacked the plan asserting that those creditors who qualified to participate in the second sale of preferred stock received unequal treatment for their claims in violation of 11 U.S.C. § 1123(a)(4) which states that a plan must “provide the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment of such particular claim or interest.”
The Non-Consenting Creditors cited Bank of America National Trust & Savings Ass’n v. 203 North LaSalle Street Partnership, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999) in support of their position. LaSalle is known for its clarification of the new value exception to the absolute priority rule where it rejected a plan that gave equity holders in a debtor the exclusive right to receive ownership interests in a reorganized entity if the equity holders contributed new money to the reorganized entity. The Non-Consenting Creditors asserted that just like the equity holders in LaSalle, the creditors qualifying to participate in the second sale were given this opportunity because of their prior interest in a debtor (in this case Peabody) which was condemned by the LaSalle Court.
Distinguishing LaSalle, the Eighth Circuit found that unlike the creditors in LaSalle, the Non-Consenting Creditors were not excluded from the opportunity to receive better treatment as they could have participated in the sale had they taken the necessary steps to qualify. Secondly, unlike the equity holders in LaSalle, the creditors qualifying to participate in the second sale gave value for these rights in the form of a promise to support the plan and backstop the entire offering. And finally, unlike LaSalle, Peabody had considered alternative proposals to fund the plan including proposals submitted by the Non-Consenting Creditors.
The Eight Circuit concluded that right to participate in the second sale was not “treatment for” a claim within the meaning of § 1123(a)(4), but instead consideration for valuable new commitments which included the agreement to backstop the sale.
Proposed in Good Faith
The Non-Consenting Creditors alternative attack on the plan asserted that it was not proposed in good faith as required by 11 U.S.C. § 1129(a)(3). The Non-Consenting Creditors asserted that (1) the failure to maximize the value of Peabody’s estate (selling preferred stock at a discount), (2) the preferential treatment given certain class members in being able to buy more preferred stock that other members of their class, and (3) a coercive process that induced creditors to vote to accept the plan constituted a lack of good faith.
Although bothered by the tactics employed by Peabody in requiring commitments to participate in the second sale before approval of the agreements related to it and the disclosure statement, the Eighth Circuit employed a “totality of the circumstances” analysis and found that the plan was proposed in good faith. The court noted that all twenty classes of creditors voted overwhelmingly to approve the plan and 95% of Peabody’s unsecured creditors agreed to participate in the second sale and make backstop commitments.
The Future of Backstop Agreements
The methodology of the Peabody plan proponents appears to have been to recognize the problems identified by LaSalle and carefully avoid them. Disparate treatment of creditors belonging to the same class involves proposing new consideration to be given by the preferred creditor which can include a backstop agreement. The opportunity to provide a backstop agreement in exchange for this preferred treatment would appear to be required to be offered to all members of the class. Also, alternatives to preferring creditors who agree to provide a backstop agreement must be weighed. With the addition of the Eighth Circuit, the usage of backstop agreements in this context would appear to be well on the road to mainstream acceptance.