As discussed in previous posts on this site, back in December the Second Circuit Court of Appeals issued a summary order that reversed the bankruptcy court’s confirmation of the reorganization plan (the “Plan”) of DBSD North America, f/k/a ICO North America (“DBSD”). The Court sustained a challenge to the Plan brought by Sprint-Nextel, an unsecured creditor, against the proposed “gift” of value from second lien secured creditors down to DBSD’s equity holder, by-passing holders of unsecured claims. However, it denied the appeal brought by senior secured creditor DISH Network (“DISH”), the holder of all of DBSD’s first lien debt, against its unfavorable treatment under the Plan. The summary order stated that an opinion would follow “in due course”. (Kelley Drye & Warren LLP represents the agent to the lenders that previously held the first lien debt purchased by DISH, but has taken no part in the litigation over the confirmation of the Plan or the appeals before the Second Circuit).
The opinion has now come out and has appropriately garnered wide attention. The decision to prohibit the long-standing practice of “gifting” value to a junior class of creditors or interests over the objection of a non-consenting intermediate class will certainly shape the contours of plan negotiations in chapter 11 cases going forward. The determination to uphold the “designation” (i.e., disallowance) of DISH’s vote against the Plan, for its alleged “bad faith” in pursuing a “strategic purpose”, will also affect the purchase and sale of claims for purposes of acquiring control of companies as they emerge from bankruptcy (although this ruling was fact specific and narrowly focused).
However, the Second Circuit’s opinion is equally important for what it did not say. The bankruptcy court had ruled that because DISH was the sole member of its Plan class and its vote against the Plan was disallowed, the Plan class should be deemed to have accepted the Plan. The bankruptcy court concluded that the Plan therefore did not have to satisfy the cramdown standards of Section 1129(b)(2)(A) of the Bankruptcy Code with respect to DISH. Nevertheless, the bankruptcy court alternatively ruled that the proposed Plan treatment of DISH’s first lien did in fact meet the cramdown standard of Section 1129(b)(2)(A)(iii), by providing DISH with the “indubitable equivalent” of its claim. The Second Circuit, in upholding the bankruptcy court’s decision ruling regarding vote designation, specifically stated that it would not address the bankruptcy court’s alternate ruling that DISH could be crammed down.
The “indubitable equivalent” standard under Section 1129(b)(2)(A)(iii) allows a debtor to confirm a plan over a secured creditor’s objection so long as it gives the creditor the present value of its secured claim and provides substitute collateral that is of equal value and of no greater risk than its existing collateral. The first lien debt purchased by DISH was a one year note that paid cash interest, and was secured by all of DBSD’s operating assets plus its only liquid assets — a portfolio of auction rate securities (the “Securities”). The Plan proposed to provide a new note with a four year maturity, non-cash (i.e., payment in kind (“PIK”)) interest, and liens on all of reorganized DBSD’s operating assets — but not on the Securities, which are to be used to help fund ongoing operations. In addition to appealing the designation of its Plan vote, DISH argued to the Second Circuit that it could not be forced to accept the heightened risk of a four year note and a diminished collateral package that deprived it of its lien on the Securities with no substitution.
A ruling by the Second Circuit affirming the cramdown judgment by the bankruptcy court — a determination that a one year loan facility secured by liquid assets could be replaced under the “indubitable equivalent” standard by a four year PIK facility with non-liquid collateral — would have had a huge impact in future cases, altering the relative leverage among secured creditors, debtors and junior creditors. The decisions on gifting and designation make DBSD a significant opinion. A ruling on cramdown would have made it a seminal one.