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Delaware District Court Agrees That Plans Need Not Reflect Bargained For Priority Provisions in Subordination Agreements
In this Memorandum, the Delaware District Court upheld the decision of the Delaware Bankruptcy Court to confirm the plan of reorganization (the “Plan”) of Tribune Media Company (“Tribune”) and its debtor affiliates (collectively, the “Debtors”), despite the fact that the distributions proposed therein on account of certain claims infringed on prepetition subordination agreements. In rendering the decision, Judge Sleet agreed with Judge Sontchi’s lower court opinion that the strict enforcement of subordination agreements, including provisions therein governing payment priority, is not required under the plain language of section 1129(b)(1) and does not amount to per se unfair discrimination. This case came to the District Court on remand from the Third Circuit for a determination on the merits after appeal by multiple parties, including the Law Debenture Trust Company of New York and Deutsche Bank Trust Company Americas (the “Trustees”), and a finding that the District Court erred in previously concluding that the Trustees’ claims were equitably moot. Our prior discussion of those issues can be found here.
The Debtors commenced their bankruptcy cases approximately one year after they completed a leveraged buyout (“LBO”). Prior to the LBO, Tribune’s debt included $1.2 billion in so-called “Senior Notes” and about $1 billion in subordinated debt, in the form of certain notes referred to as the “PHONES Notes” and the “EGI Notes.” Pursuant to subordination agreements between the holders of the Senior Notes, the PHONE Notes, and the EGI Notes, the PHONES and EGI Notes were contractually subordinate to the Senior Notes and any recovery based on the PHONES and EGI Notes was to be paid to those holding the Senior Notes (the “Class 1E Creditors”). However, when the Debtors proposed their Plan, it provided for the recoveries based on the outstanding PHONES and EGI Notes’ obligations to be divided pro rata among not only the Class 1E Creditors but also about 700 “Class 1F Creditors” comprised of a majority of individuals and small businesses. The Trustees, on behalf of the Class 1E Creditors, objected to this distribution scheme, arguing that they alone were entitled to the recoveries allocable to the subordinated PHONES and EGI Notes under the subordination agreements and that any proposed sharing amounted to unfair discrimination.
In overruling the Trustees’ confirmation objection, the Bankruptcy Court found that, pursuant to section 1129(b)(1) of the Bankruptcy Code, full implementation of subordination agreements within a plan was not required for confirmation and that the discrimination (if any) that the Class 1E Creditors would suffer as a result of the recovery sharing was immaterial and permitted. More specifically, prior to the confirmation trial, the parties stipulated that the Class 1E Creditors would recover only 2.9% more absent the sharing. And following the trial, the Bankruptcy Court made additional findings that lowered such percentage to only 0.9%, making the Plan in its opinion “even less vulnerable to a charge of ‘unfair discrimination.’” Op. at 611. The Trustees appealed these findings, and Judge Sleet for the District Court addressed each issue in turn.
First, His Honor held that the subordination agreements – and the bargained for priority provisions therein – did not need to be enforced and reflected in the Plan pursuant to the plain language of section 1129(b)(1) of the Bankruptcy Code. That section sets forth the cramdown requirements, providing, in pertinent part, that a court “shall confirm” a plan over the objection of an impaired dissenting class “[n]otwithstanding section 501(a)” so long as the plan satisfies sections 1129(a)(1)-(7) and (9)-(16) and does not discriminate unfairly and is fair and equitable with respect to each impaired dissenting class. The referenced section 501(a) provides that a subordination agreement is enforceable to the same extent that the same agreement would be enforceable under nonbankruptcy law. Judge Sleet ruled that the “notwithstanding” provision of section 1129(b)(1) permits the Bankruptcy Court to confirm a plan over objection even if it does not fully enforce a subordination agreement. While the Appellants argued that the legislative intent behind section 1129(b)(1) indicates that subordination agreements should strictly be enforced, Judge Sleet found no need to consider the legislative intent because the statute in question is unambiguous.
Second, Judge Sleet found that the Plan did not unfairly discriminate against the Class 1E Creditors. In reaching this conclusion, Judge Sleet applied the commonly-accepted rebuttable presumption standard, whereby in the presence of an allegation of a materially lower percentage recovery in a plan by a dissenting class as compared to a similarly situated class, a rebuttable presumption of unfair discrimination is found to exist. Under this standard, such a presumption will also exist regardless of percentage recovery if there is an allocation under the plan of materially greater risk to the dissenting class than to a similarly situated class. Judge Sleet agreed with Judge Sontchi’s analysis and found that the Class 1E Creditors received a percentage recovery that was, at most, 2.3 percentage points lower than the recovery to which they claimed they were entitled. While the actual amount of money at issue may have been large, the percentage difference is the relevant focus in an unfair discrimination analysis and here, it was immaterial. As such, no rebuttable presumption of unfair discrimination was found to have arisen, and the Bankruptcy Court’s confirmation order was affirmed.
Importantly, while Judge Sleet applied the rebuttable presumption analysis to resolve the allegations of unfair discrimination in this appeal, His Honor did so because of an agreement by the parties that such a standard was applicable. “Unfair discrimination” is undefined in the Bankruptcy Code and other courts, such as those in In re Ambanc La Mesa Limited Partnership, 115 F.3d 650 (9th Cir. 1997), and In re Dow Corning Corp., 244 B.R. 696 (Bankr. E.D. Mich. 1999), have applied a traditional four factor test that focuses on, among other things, the basis for and necessity of the discrimination. Judge Sleet noted that the Third Circuit has not yet opined as to which standard should apply when assessing unfair discrimination, and His Honor declined to do so in this case.