Holdout Panic

Reorganization law inherently glides toward majority rule, because majority rule favors successful reorganization by overcoming the normal holdup powers of individual creditors. Thus, it requires determination to keep the system balanced and retain the basic individual creditor rights that are required for equity to prevail.

As I argue in my forthcoming paper, modern Chapter 11 of the US Bankruptcy Code, motivated by what I term an unbridled fear of holdouts, and US restructuring law generally, has drifted toward a system where the majority always wins. In short, it is out of balance.

Examples of this loss of balance can be seen in a variety of new practices. For instance, some institutional lenders have begun to upgrade their priority at the expense of their fellow institutional lenders. In 2020 a simple majority of syndicated lenders under the Serta, Boardriders and TriMark loans approved amendments allowing for ‘super priority’ debt under each of these agreements. In connection with their agreement to provide new debt, the lenders exchanged their existing term loan for new ‘super priority’ term loans. Lenders that did not participate were left with effectively subordinated debt, and in the case of Boardriders and TriMark, they lost most of their covenants – as the participating lenders voted to remove those as well.

These ‘uptier’ or priming transactions benefit both the debtor-issuer and the new capital providers (a subset of the old lenders). The company receives much needed liquidity and the new money lenders get favorable terms, such as priority liens or claims and enhanced treatment for their existing debt. But it is rather clear that much of the benefit comes at the expense of non-participating lenders.

Another point of concern begins with the observation that many modern restructurings feature a restructuring support agreement (‘RSA’). The RSA binds signing creditors to support a plan, but most modern RSAs also:

• set deadlines for important bankruptcy events, like approval of post-petition financing, filing of a disclosure statement, rejection of key contracts, and plan confirmation;
• set forth specific terms for securities to be issued under the proposed plan and releases of liability for certain claims;
• provide for payment of the negotiating creditors’ legal and financial advisor fees.

Hidden in all the nooks and crannies of the RSA is a generalized assault on section 1123(a)(4) of the US Bankruptcy Code, which provides that a reorganization plan must ‘provide the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment of such particular claim or interest’. A confusing payout scheme, broken into several pieces within the RSA, can be just the solution to the problem of how to pay one group of bondholders more than others holding the same instruments.RSAs can also confer control rights upon creditors with valuable consent rights. For example, by providing a debtor in possession (‘DIP’) loan, creditors (as lenders) get strong powers to enforce the RSA and protection against a hostile cramdown plan. Moreover, in the recent US financial environment, with lots of money chasing after distressed deals, by becoming a DIP lender, such 65% creditors guard against the appearance of an outside bidder. And once an RSA is proposed and supported by key constituencies, the costs of opposing the contemplated plan may be prohibitive for most other creditors. 

The change in restructuring law to favor the majority ­– and punish the dissenting minority – was not part of some grand plan, but rather the result of a series of incremental decisions, each reacting to perceived abuses by those holding out. But the end result has been to move the US restructuring system to the point where a debtor and a majority of its lenders can inflict serious harm on minority creditors. At some point, this reality is bound to have consequences.

Stephen J. Lubben is the Harvey Washington Wiley Chair in Corporate Governance & Business Ethics at Seton Hall Law School