On August 26, 2020, the United States Court of Appeals for the Third Circuit issued its ruling in In re: Tribune Company, et al., a Chapter 11 bankruptcy case involving the operator of well-known newspapers such as the Chicago Tribune and the Los Angeles Times.
The issue before the Court was whether a Chapter 11 plan that violated various subordination agreements involving different groups of unsecured debt could be confirmed over the objection of the adversely impacted creditors. Generally, a subordination agreement is a contractual mechanism used to dictate the order of priority of debts of otherwise equal rank. The creditors who benefited from the subordination agreements argued that the agreements should be enforced as written, arguing that § 510(a) of the Bankruptcy Code generally requires the enforcement of security agreements in bankruptcy. The debtor, on the other hand, argued that the Bankruptcy Code’s “cramdown” provision (11 U.S.C. § 1129(b)(1)) allowed it to disregard the subordination agreements and obtain confirmation, so long as the proposed treatment of the negatively impacted creditors did not result in “unfair discrimination.”
For those who may be unfamiliar, the “cramdown” provision of the Bankruptcy Code is aptly named and brings to mind the experience of many a parent of small children at dinnertime: one child likes the dinner; the other child hates the dinner. Over the objecting child’s objection, the parent forces the child to eat it. To analogize to Chapter 11 cases, the plan proponent is the parent, the child who likes the dinner is a creditor class who votes in favor of the plan, and the child who hates the dinner is a creditor class who votes against the plan. “Cramdown” is the process of forcing the plan on a creditor class over its vote against it.
In the Tribune case, the Court ruled that § 1129(b)(1) trumps § 510(a), meaning that a plan can be confirmed over a creditor’s objection that the plan violates subordination agreements. However, the analysis does not end there. To obtain “cramdown” confirmation, the plan proponent must still convince the Court that the plan does not “unfairly discriminate” between similarly situated creditors. The Third Circuit found that the difference between what the objecting creditors would receive under the plan and what they would have received had the subordination agreements been enforced was less than 1% (33.6% vs. 34.5%). The Court ruled that this difference was not material, and as such, there was no “unfair discrimination.”
“Unfair discrimination” is not defined in the Bankruptcy Code, and as such, courts have struggled with the concept. The Third Circuit characterized the “unfair discrimination” standard as “rough justice” that “attempts to ensure that debtors and courts do not have carte blanche to disregard pre-bankruptcy contractual arrangements, while leaving play in the joints.” Perhaps not surprisingly, at least four (4) different tests for “unfair discrimination” have been developed by various courts, each of which focuses on different factors.
In the end, the Third Circuit set forth eight (8) considerations for evaluating whether a plan “unfairly discriminates” which will likely govern the matter going forward, at least in the Third Circuit. Among the most significant takeaways are as follows:
- Different treatment is permitted, so long as the difference is not “unfair”;
- In evaluating what is “unfair,” courts should compare the objecting class’s recovery under the plan with what the class would receive if distributions were strictly pro rata and, if subordination agreements are involved, what the creditor would receive if those agreements are enforced;
- If the objecting class’s recovery under the plan is “materially different” under the plan than it would be if distributions were pro rata and/or if subordination agreements were enforced, there is a “presumption” of unfair discrimination, but that presumption can be rebutted.
Please contact John O’Keefe, Roger Poorman, Justin Tuskan, or your primary Metz Lewis contact for more information.