Article courtesy of Margaret G. Parker-Yavuz (Akin Gump)
In re Tribune Co., 972 F.3d 228 (3d Cir. 2020)
Holders of senior notes issued by the Tribune Company argued that the company’s plan of reorganization should not have been confirmed because it did not fully enforce subordination provisions in the indentures, and that the plan unfairly discriminated against them. The Third Circuit upheld rulings of the bankruptcy court and district court that the cramdown provisions of section 1129(b)(1) do not require subordination agreements to be strictly enforced in order for a plan to be confirmed, and that although the plan discriminated against the senior noteholders, the discrimination was not unfair.
The Tribune Company (“Tribune”) filed for bankruptcy under Chapter 11 in 2008 following a failed leveraged buyout. Prior to its bankruptcy, Tribune was the largest media conglomerate in the U.S. At the time of its filing, its debt included $1.283 billion in unsecured senior notes issued between 1992 and 2005 (the “Senior Notes”), $759 million in unsecured exchangeable subordinated debentures issued in 1999 (the “PHONES Notes”), $225 million in subordinated unsecured notes issued as part of the LBO (the “EGI Notes”), an unsecured $150.9 million “Swap Claim” also relating to the LBO, and other unsecured claims owing to retired employees and trade and other creditors. The indentures for the Senior Notes required that they be paid prior to any other debt incurred by Tribune; the indentures for the PHONES Notes and the EGI Notes provided that their payment is subordinate to all “Senior Indebtedness” or “Senior Obligations” of Tribune.
In 2012, the bankruptcy court approved a plan of reorganization over the dissenting votes of the holders of the Senior Notes (the “Senior Noteholders”) – i.e., cramming down the Senior Noteholders under section 1129(b)(1) of the Bankruptcy Code. The plan classified the Senior Noteholders as “Class 1E”, and the holders of the Swap Claim, the retiree claims and the trade creditor claims as “Class 1F”. The Senior Noteholders objected to the plan on the grounds that (1) the plan allocated a portion of their Class 1E recovery from the subordinated PHONES Notes and EGI Notes to Class 1F, and therefore violated the Code’s standards for confirmation by not fully enforcing the subordination provisions in the indentures in accordance with section 510(a) of the Code (which provides that subordination agreements are enforceable in bankruptcy to the same extent as they are enforceable under non-bankruptcy law), and (2) the allocation of subordination payments to Class 1F unfairly discriminated against Class 1E because, in its unfair-discrimination analysis, the bankruptcy court incorrectly included recoveries due Class 1E from the subordination agreements in their plan distributions and failed to compare their recovery under the plan to that of Class 1F. The bankruptcy court found that section 1129(b)(1) does not require subordination agreements to be strictly enforced in order for a plan to be confirmed, and that the plan did not unfairly discriminate against Class 1E. The Senior Noteholders appealed, and the district court affirmed.
On appeal, the Third Circuit affirmed the holdings of the bankruptcy court and district court. With respect to the Senior Noteholders’ first argument – that the plan should not have been confirmed because it did not strictly enforce the subordination agreements – the Third Circuit found that both the plain meaning and the purpose of section 1129(b)(1) support the lower courts’ approach. Section 1129(b)(1) states that a nonconsensual plan may be confirmed “[n]otwithstanding section 510(a)”. The court found that the purpose of section 1129(b)(1) – which is to provide flexibility to negotiate a confirmable plan even in the face of complex debt structures and intercreditor arrangements, while still protecting the interests of a dissenting class by requiring plans to be fair and equitable and not discriminate unfairly – supports this analysis.
With respect to the Senior Noteholders’ second argument – that the plan unfairly discriminates against them – the Third Circuit found that the bankruptcy court appropriately applied the “rebuttable presumption” test to find that there was no unfair discrimination. The Third Circuit noted that the Bankruptcy Code does not define unfair discrimination and that courts have relied primarily on one of four tests to determine what unfairness means and, in certain cases, whether it can be rebutted: (1) the “mechanical” test, which requires similarly situated creditors’ recoveries to be 100% pro rata and is not widely adopted, (2) the “restrictive” approach, which defines unfair discrimination narrowly such that, absent subordination, there is no unfair discrimination, and is also not widely adopted, (3) the “broad” approach, which is a more widely used test that considers whether (a) a reasonable basis for discrimination exists, (b) the debtor cannot consummate its plan without discrimination, (c) the discrimination is imposed in good faith and (d) the degree of discrimination is directly proportional to its rationale, and (4) the “rebuttable presumption” test, which was applied by the bankruptcy court in this case.
Under the “rebuttable presumption” test, there is a rebuttable presumption of unfair discrimination when there is (a) a dissenting class, (b) another class of the same priority, and (c) a difference in the plan’s treatment of the two classes that results in either (i) a materially lower percentage recovery for the dissenting class (measured in terms of the net present value of all payments), or (ii) regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution. A presumption of unfair discrimination may be overcome if the court finds that a lower recovery for the dissenting class is consistent with the results that would obtain outside of bankruptcy, or that a greater recovery for the other class is offset by contributions from that class to the reorganization. The presumption of unfairness based on differing risks may be overcome by a showing that the risks are allocated in a manner consistent with the prebankruptcy expectations of the parties.
The court set out eight principles with respect to the unfair discrimination standard: (1) discrimination against a class of creditors is permitted, but the discrimination may not be unfair; (2) unfair discrimination apples only to classes of creditors (not to individual creditors), and only to classes that dissent, (3) unfair discrimination is determined from the perspective of the dissenting class; this principle is subject to interpretation and, although the preferred approach is to compare the recovery of the preferred class and the dissenting class, as was done in this case, a court may in certain circumstances consider the difference between what the dissenting class argues it is entitled to recover and what it actually received under the plan or use other measures to assess the harm to the dissenting class; (4) creditors must be classified correctly in order to effectively assess unfair discrimination; (5) courts should determine how a plan proposes to pay each creditor’s recovery in terms of the net present value of payments, or the allocation of materially greater risk with respect to distribution; (6) proposed distributions under a plan should be compared to what each creditor would receive under a pro rata calculation; (7) in order for there to be a presumption of unfair discrimination, there must be a “materially lower” percentage recovery for the dissenting class or a “materially greater risk to the dissenting class in connection with its proposed distribution”; and (8) if a court finds that a plan materially discriminates against a dissenting class and follows this test or a variation of it, the finding is presumptive and can be rebutted (for example, it could be rebutted if the preferred class made contributions to the reorganization).
In this case, the bankruptcy court compared Class 1E’s recovery under the plan (which was 33.6%) to what its recovery would have been had Class 1E and the holder of the Swap Claim (which the bankruptcy court found to be a senior obligation) been the only creditors to benefit from the subordination provisions (which was 34.5%). Although the bankruptcy court did not compare Class 1E’s recovery to that of Class 1F, section 1129(b)(1) and the rebuttable presumption test do not require a class-to-class comparison. It would have been difficult for the bankruptcy court to compare on a class-to-class basis in this case, and it was entitled to use the more pragmatic approach that is used. The Circuit Court also agreed with the bankruptcy court and the district court that the difference in the Senior Noteholders’ recovery was not material. As a result, although the plan discriminated against the Senior Noteholders, it was not presumptively unfair.