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The Delaware Bankruptcy Insider is a premier blog designed to bring its readers a comprehensive analysis of the latest Delaware corporate bankruptcy news and rulings. Brought to you by Ashby & Geddes, P.A.
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- Post-Confirmation Purchasers of Shares Be Aware: Third Circuit Holds Shares are Subject to the Plan, Including Its Releases
- Delaware District Court Agrees That Plans Need Not Reflect Bargained For Priority Provisions in Subordination Agreements
- Liquidation Consultants Are Not “Professionals” Requiring Retention Under § 327(a) of the Bankruptcy Code
Delaware District Court Affirms Confirmation Order Approving Horizontal Gift Providing Disparate Treatment to Separate Classes of General Unsecured Claims
In this Opinion, the Delaware District Court (the “District Court”) dismissed an appeal of the Delaware Bankruptcy Court’s order confirming the plan of reorganization (the “Plan”) of Nuverra Environmental Solutions, Inc. and its affiliated debtors (the “Debtors”). While the appeal was dismissed on the basis of equitable mootness, the District Court took an extra step and affirmed the entry of the confirmation order. In doing so, the District Court addressed the propriety of “horizontal gifts” in the plan context. More specifically, the Debtors’ Plan proposed to fund distributions to its two classes of general unsecured claims from a voluntary carve-out of the secured creditors’ collateral. While no junior creditors were preferred over senior creditors, one gift resulted in the full payment to an unsecured class comprised of trade and other business-related claims (“Class 7”) while the other gift resulted in only a 4-6% payment to an unsecured class comprised of noteholder claims (“Class A6”). Class A6 rejected the Plan, and a class member (the “Appellant”) objected, arguing that the Plan was unfairly discriminatory and not fair and equitable as required in the cram-down scenario presented to the Bankruptcy Court at confirmation.
In overruling the Appellant’s objection and confirming the Plan, the lower court made two key findings. First, the Debtors’ general unsecured creditors were out of the money by at least $200 million. Second, Class 7 was comprised of trade and other business-related creditors critical to the success of the Debtors’ reorganization. The first finding supported the Bankruptcy Court’s conclusion that the disparate treatment between the two classes of general unsecured claims was not unfair discrimination. The second finding supported its conclusion that the Plan’s dual classification of general unsecured claims was reasonable and based on a justifiable rationale. On appeal, the District Court agreed with both of these determinations.
With respect to the issue of unfair discrimination, the District Court noted that, as a general matter, the different recoveries between Classes A6 and 7 gave rise to a presumption of unfair discrimination. However, such presumption, according to the District Court, was correctly held by the Bankruptcy Court to be rebutted by the fact that the recoveries were funded by the secured lenders’ gifts. See also In re Genesis Health Ventures, Inc., 266 B.R. 591 (Bankr. D. Del. 2001) (finding presumption of unfair discrimination rebutted in the horizontal gifting context). The District Court emphasized that neither Class A6 nor Class 7 were entitled to their distributions under the Plan. Rather, the distributions arose from the senior creditors’ agreement to convert their claims to equity in the reorganized Debtors at a discount and divert such discount to Classes A6 and 7. As a result, if, for instance, Class 7’s 100% recovery was reduced, the reduction would not flow to Class A6. It would flow back from where it came – the senior creditors. Accordingly, Class A6 was not harmed by the disparate recovery provided to Class 7. While the Appellant attempted to muddy the water by citing in support of its argument for reversal case law involving “vertical gifting” (i.e. distributions that skip senior creditors in favor of junior ones), the District Court made clear that those cases – implicating the absolute priority rule of section 1129 – were inapplicable to the case at hand because no class skipping was present.
Finally, in finding no error in the lower court’s ruling regarding the separate classification of Classes A6 and 7, the District Court reiterated the applicable legal framework of section 1122 – i.e. that substantially similar claims may be placed in separate classes so long as a rational legal or factual basis exists for the separation and the classification is reasonable as opposed to arbitrary or fraudulent. The record before the Bankruptcy Court included testimony that the classification and distribution scheme benefiting the trade and other business-related claims would preserve trade credit and help the Debtors’ reputation and vendor relationships. The District Court found this record supportive of the conclusion that the separate classification fostered the Debtors’ reorganization and thus, was rationale and reasonable.