Badges of Opportunism: Principles for Policing Restructuring Support Agreements
Business reorganizations are corporate control transactions. When a debtor is insolvent, control is in play along two different axes. The first axis allocates control within the existing capital structure. The filing of bankruptcy effectuates a change of control from equity to debt. Second, the company itself is on the auction block, meaning that its assets, or even the entire firm, may be transferred to a new owner. Outside investors may wish to buy the company, and the choice among offers implicates serious governance concerns. Bankruptcy law provides a preferred procedure for addressing such choices; the Chapter 11 plan confirmation process implements a supervised negotiation with the end-goal of either class acceptance or cramdown. The plan process encourages the flow of information and class voting and the threat of cramdown minimize the power of holdouts. Modern Chapter 11 practice has, however, also embraced a more expeditious process, the ‘all asset sale’ under section 363(b) of the Code that lacks the substantive and procedural protections of a confirmed plan.
Our recent article considers the dynamics of control both prior to the bankruptcy filing and after through the lens of restructuring support agreements (‘RSAs’)—contractual agreements among creditors, and sometimes the debtor, to support restructuring plans that have certain agreed-upon characteristics. We conclude that RSAs offer a salutary bridge between the efficiencies of a quick sale and the procedural protections of a plan of reorganization, but they also pose a potential avenue for opportunistic abuse. We identify these as well.
Opportunistic behavior arises on both sides of negotiation in bankruptcy. It is well understood that insolvency creates a variety of opportunities for creditors (and the debtor) to use situational leverage to influence the allocation of scarce assets: secured creditors may foreclose; depositories may engage in setoff; key suppliers may threaten to stop supplying; landlords can threaten to evict; unsecured creditors may get judgments and start grabbing assets; and purchasers may seek to take advantage of a depressed valuation to purchase the company on the cheap. To the extent that the debtor has value as a going concern, individual creditors may have the power to hold such going concern value hostage by threatening to force liquidation. Alternatively, fully secured creditors may prefer a quick realization on their collateral, because they do not benefit from increasing the value of the firm.
The Bankruptcy Code seeks to limit these uses of situational leverage in a number of ways: (1) it stays unilateral creditor action (the automatic stay); (2) it allows for the unwinding of certain prepetition transfers (avoidance); (3) it sets a baseline distribution if the firm liquidates, but promises more if the firm can restructure (the allowed secured claim); (4) it creates a structured bargaining process that ensures adequate information and reduces the ability of a creditor to holdout in the face of a reorganization plan that is supported by key creditor constituencies (supermajority acceptance); and (5) it sets an entitlement baseline if the firm reorganizes (cramdown). Bargaining in bankruptcy and on its threshold is, of course, informed by these procedural requirements and substantive entitlements, for if a deal is not reached, then liquidation will ensue.
In recent decades, a number of end-runs have been used to frustrate these procedural protections and reinstate situational leverage. On the front-end, sales of substantially all of the debtor’s assets under section 363 can lock in a particular distribution without the protections of the plan process, either by fixing the value of the debtor on sale, or through the selective assumption of liabilities by the purchaser. On the back-end, ‘gift’ plans, rights offerings, and structured dismissals distribute value without complying with the Code’s statutory priorities. RSAs are a useful tool for aiding the plan process, but they too must be scrutinized to ensure that they are not being used to further such behavior. Indeed, the Supreme Court raised concerns about such end-runs in Czyzewski v. Jevic Holding Corp., where it held that structured dismissals could not deviate from the Code’s statutory priorities.
Against this backdrop, RSAs appear harmless. Indeed, they seem a relatively transparent mechanism for bringing order to a complex and difficult situation. RSAs can also, however, be used opportunistically to exploit situational leverage in order to reallocate value and thus favor one investor constituency over others. Indeed, the fact that RSAs are sometimes referred to as ‘lockup’ agreements highlights this concern. Once an RSA is proposed and supported by key constituencies, the costs of opposing the general outlines of the contemplated plan are prohibitive for most creditors. The proposal may operate as a fait accompli for all but the fine details of the plan, committing the debtor to a particular restructuring path. If the RSA freight train is being used to stop creditors from developing information or identifying bases for objection, the device becomes problematic.
The difficulty is in distinguishing beneficial RSAs from harmful ones. In that regard we articulate what we see as a fundamental norm of chapter 11 that guides RSAs, sales, and a range of other transactions: the common interest in value maximization may not be held hostage by a creditor seeking to improve its own priority.
The full article proceeds in five parts. First, we describe the practice surrounding restructuring support agreements and identify some of the anecdotal concerns raised. Second, we catalogue the good and bad in RSAs. Third, we offer some examples that illustrate how to distinguish the good from the bad by focusing on bargaining in the shadow of entitlements. We link RSAs to the lesson of Jevic, which cautions against ‘end-runs’ around the plan process. Fourth, we flesh out the concept of an end-run around the plan process in the context of an RSA and identify certain ‘badges of opportunism’. Specifically, we are concerned with provisions in an RSA that hold value maximization hostage to a reordered priority scheme. Finally, we consider corporate control transactions in bankruptcy in light of this analysis. The guiding principle, we suggest, in evaluating corporate control transactions in bankruptcy should be to prevent a reordering of priorities through the threat of value destruction.
Edward J. Janger is the David M. Barse Professor of Law at Brooklyn Law School. He teaches and writes in the areas of bankruptcy law, commercial law, and consumer credit.
Adam J. Levitin is the Agnes N. Williams Research Professor, and Professor of Law at Georgetown Law. He teaches and writes in the areas of bankruptcy, commercial law, and financial regulation.
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