If you are considering acquiring claims in a bankruptcy case with the intent of voting against a reorganization plan, you should be familiar with the implications of a recent New York bankruptcy court's ruling. In this case1, Judge Robert E. Gerber disqualified the creditor's votes, ruling that the creditor had bought its claims not to maximize recovery on its debt position but for an ulterior motive—to gain control over the debtor's primary asset. Notably, a few years ago, this judge declined to disqualify votes on a reorganization plan cast by certain distressed debt investors in the Adelphia case2 even though he believed that the conduct of those creditors was more egregious.
A creditor invested over $250 million in a satellite communications company that was a direct competitor of the debtors. After the debtors filed their proposed reorganization plan, the creditor purchased all of the debtors' first lien debt ($40 million) at par and $111 million in second lien debt—only from sellers who did not support the plan—which the debtors' plan proposed to convert to equity. The creditor also sought to terminate exclusivity and file its own reorganization plan. The creditor's internal documents showed that it intended to control the bankruptcy process, convert the debt to equity, and assume control over the debtors' strategic asset: the right to use certain frequency bands. The debtors moved to designate (i.e. disqualify) the creditor's votes on the grounds that they had not been cast in good faith.
Judge Gerber granted the motion, invoking a 20 year old case3 in which a western Pennsylvania judge designated the votes of an investor who was not a pre-petition creditor of the debtors, yet bought claims and voted them against the debtors' plan, while proposing its own plan under which it would gain control over the debtor. In the current case, the judge also ruled that, since the creditor whose votes were designated was the only creditor in its class, the debtors would be deemed to have procured the accepting vote of that class. The creditor has appealed, arguing that: (i) it adopted the position of the prior holders of the first lien debt, who unanimously opposed the plan, (ii) its investment at par was sensible because its expertise in satellite communication systems puts it in a position to realize value if the debtors' plan becomes impractical, and (iii) the bankruptcy court erred by inferring the creditor's intent from internal drafts of documents prepared by junior level personnel who never presented them to senior members of the company.
What This Means For You
1. Creditors may vote "selfishly" to maximize recoveries on their claims and act in their economic interest, as long as the interest being served is that of a creditor as creditor, and not in another capacity, such as the acquirer of the debtor company. Several courts have allowed creditors to buy additional claims to prevent a cramdown of their existing claim and to maximize recovery on their previously held claim. But a court has the discretion to designate votes when it believes the voting creditor is trying to:
In all of these instances, the court—believing that the creditor has an ulterior motive unrelated to its claim or interests as a creditor—may decide that the creditor is acting in bad faith and order designation. Judge Gerber wrote in the Adelphia case that: "The ability to vote on a reorganization plan is one of the most sacred entitlements that a creditor has in a chapter 11 case." Nevertheless, creditors who want to buy claims so as to vote them against a plan must be careful not to take actions that can expose them to designation of those votes.
2. Ensure that you and all of your employees—regardless of seniority—are careful with what is put in internal communications. Do not write anything in an email that you wouldn't want to be published in a court decision.
Copyright © 2010 Herrick, Feinstein LLP. Lending and Restructuring Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
1In re DBSD North America, Inc., Chapter 11 Case No. 09-13061 (REG) (Bankr. S.D.N.Y. Dec. 21, 2009)
2In re Adelphia Communications Corp., 359 B.R. 54 (Bankr. S.D.N.Y. 2006). There, a group of distressed debt investors moved for appointment of a trustee knowing that defaults under the debtors' DIP financing facility and on the sale of the debtors could result. The mitigating factor was that their conduct was designed to increase their recoveries as creditors.
3In re Allegheny International, Inc., 118 B.R. 282 (Bankr. W.D. Pa. 1990)