By nearly any measure, the Chapter 11 cases of Hawker Beechcraft and its affiliates (the “Debtors”) stand as a significant success. The cases began as a standalone reorganization predicated upon a restructuring support agreement (the “RSA”) among the Debtors’ senior lenders and noteholders, which soon thereafter gained the support of the creditors’ committee. The cases then switched over to a sale process, and when that bogged down the Debtors seamlessly restarted the standalone reorganization based on the RSA. The Debtors’ plan of reorganization (the “Plan”) provides for the cancellation of all existing equity of the existing corporate parent, Hawker Beechcraft, Inc. (“HBI”) and the issuance of equity in a new holding company to creditors, with 89% going to the Debtors’ senior bank lenders and the remaining 11% going to noteholders and other unsecured creditors. The Plan contemplates that the Hawker Beechcraft corporate structure will otherwise remain the same, with existing intercompany interests being unimpaired. (Kelley Drye & Warren LLP represents a major Hawker Beechcraft creditor.)
The Debtors went into the confirmation hearing for the Plan last week with almost no major objections and without any substantial litigation having taken place along the way, a remarkable achievement for Chapter 11 cases of the Debtors’ size and complexity. It therefore surprised nearly everyone in the courtroom when Judge Stuart Bernstein raised an objection on his own based on the alleged failure of one Debtor to satisfy the cramdown requirements of Section 1129(b) of the Bankruptcy Code.
The Plan required the approval of creditors of each of the separate Debtors. When the votes were tabulated, however, the unsecured creditors of one Debtor, Hawker Beechcraft Corporation (“HBC”), had voted to reject the plan. This in and of itself did not give rise to substantial concern, as the Debtors believed that they would readily be able to confirm the Plan over the HBC creditors’ rejection under the cramdown provisions of Section 1129(b). That section provides that a plan may be confirmed notwithstanding the rejection of one or more classes of creditors (i.e., “crammed down”), so long, among other things, as it is “fair and equitable.” With respect to unsecured creditors who are not paid in full, “fair and equitable” requires adherence to the “absolute priority rule”, which in turn means that
the holder of any claim or interest that is junior to the claims of the [rejecting] class will not receive or retain under the plan on account of such junior claim or interest any property . . .
Since all of the existing equity of HBI is being cancelled and new equity is being issued to creditors, the Debtors believed that they complied fully with Section 1129(b). Judge Bernstein, however, in a very strict reading of the rule, stated that while he would confirm the Plan for all of the other Debtors, he could not do so for HBC because of the provisions that left the Hawker Beechcraft corporate structure intact. In other words, Judge Bernstein saw a violation of the absolute priority rule with respect to HBC’s creditors because the equity of HBC itself was not being cancelled, and viewed that as an impermissible retention of “property” by the direct parent of HBC (itself a subsidiary of HBI) “under the plan on account of [a] junior claim or interest[.]”
An interesting colloquy followed, in which Debtors’ counsel contended that the HBC stock was remaining in place solely to maintain the Hawker Beechcraft corporate structure for the benefit of the new equity holders, and that the cancellation of HBI’s stock satisfied the dictates of the absolute priority rule. Judge Bernstein eventually agreed to allow the Debtors to brief the issue and to make technical changes to the Plan.
Judge Bernstein’s reading of Section 1129(b) can be justified as a “plain language” reading of the statute but, as with other recent instances of “plain language” interpretations of the Bankruptcy Code, it contravenes widely-accepted views regarding the purpose and intent of the absolute priority rule. Other judges who have ruled on cramdown in similar situations, such as Judge James Peck in the Ion Media case, have agreed that preserving intercompany interests in order to maintain an existing corporate structure does not have any economic substance, and that only the treatment of the equity of the ultimate corporate parent should be considered for purposes of determining whether the absolute priority rule has been satisfied.
After reviewing the Debtors’ submission and the proposed changes to the Plan, Judge Bernstein the following day confirmed the Plan for all of the Debtors, including HBC.