1. Class 19 Bankruptcy, Spring, 2009 Absolute Priority Rule Randal C. Picker Leffmann Professor of Commercial Law The Law School The University of Chicago 773.702.0864/r-picker@uchicago.edu Copyright © 2005-09 Randal C. Picker. All Rights Reserved.

2. September 8, 2015Copyright © 2005-09 Randal C. Picker2 Substantive Standards under Sec. 1129(a) n Key Issues u Good faith (a(3)) u Creditor must do better than liquidation (best interest of creditors test); individual right, not a group right (a(7)) u To avoid 1129(b) cramdown issues, each class must approve or be unimpaired (a(8)) u An impaired class must approve the plan, if there are impaired classes (a(10)) u Plan must be feasible (a(11))

3. September 8, 2015Copyright © 2005-09 Randal C. Picker3 Cramdown Under Sec. 1129(b) n As to Impaired Classes that Disapprove u Must not discriminate unfairly u Must be fair and equitable u Fair and equitable includes the requirements of 1129(b)(2), which is absolute priority

4. September 8, 2015Copyright © 2005-09 Randal C. Picker4 1129 n Confirmation of Plan u (a) The court shall confirm a plan only if all of the following requirements are met: w (1) The plan complies with the applicable provisions of this title. w (2) The proponent of the plan complies with the applicable provisions of this title. w (3) The plan has been proposed in good faith and not by any means forbidden by law.

5. September 8, 2015Copyright © 2005-09 Randal C. Picker5 1129 (cont.) n Confirmation of Plan (cont.) u (a) (cont.) w (7) With respect to each impaired class of claims or interests - (A) each holder of a claim or interest of such class - –(i) has accepted the plan; or –(ii) will receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date; or

6. September 8, 2015Copyright © 2005-09 Randal C. Picker6 1129 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (8) With respect to each class of claims or interests - (A) such class has accepted the plan; or (B) such class is not impaired under the plan.

7. September 8, 2015Copyright © 2005-09 Randal C. Picker7 1129 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (9) Except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that - (A) with respect to a claim of a kind specified in section 507(a)(2) or 507(a)(3) of this title, on the effective date of the plan, the holder of such claim will receive on account of such claim cash equal to the allowed amount of such claim;

8. September 8, 2015Copyright © 2005-09 Randal C. Picker8 1129 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (9) (cont.) (B) with respect to a class of claims of a kind specified in section 507(a)(1), 507(a)(4), 507(a)(5), 507(a)(6) or 507(a)(7) of this title, each holder of a claim of such class will receive - –(i) if such class has accepted the plan, deferred cash payments of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or –(ii) if such class has not accepted the plan, cash on the effective date of the plan equal to the allowed amount of such claim; and (C) with respect to a claim of a kind specified in section 507(a)(8) of this title ….

9. September 8, 2015Copyright © 2005-09 Randal C. Picker9 1129 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (10) If a class of claims is impaired under the plan, at least one class of claims that is impaired under the plan has accepted the plan, determined without including any acceptance of the plan by any insider.

10. September 8, 2015Copyright © 2005-09 Randal C. Picker10 1129 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (11) Confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.

11. September 8, 2015Copyright © 2005-09 Randal C. Picker11 1129 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (13) The plan provides for the continuation after its effective date of payment of all retiree benefits, as that term is defined in section 1114 of this title, at the level established pursuant to subsection (e)(1)(B) or (g) of section 1114 of this title, at any time prior to confirmation of the plan, for the duration of the period the debtor has obligated itself to provide such benefits.

12. September 8, 2015Copyright © 2005-09 Randal C. Picker12 1129 (cont.) n Confirmation of plan (cont.) u (b)(1) Notwithstanding section 510(a) of this title, if all of the applicable requirements of subsection (a) of this section other than paragraph (8) are met with respect to a plan, the court, on request of the proponent of the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.

13. September 8, 2015Copyright © 2005-09 Randal C. Picker13 1129 (cont.) n Confirmation of plan (cont.) u (b)(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements: w (A) With respect to a class of secured claims, the plan provides - (i) –(I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and –(II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property;

14. September 8, 2015Copyright © 2005-09 Randal C. Picker14 1129 (cont.) n Confirmation of plan (cont.) u (b)(2) (cont.) w (A) (cont.) (ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or (iii) for the realization by such holders of the indubitable equivalent of such claims.

15. September 8, 2015Copyright © 2005-09 Randal C. Picker15 1129 (cont.) n Confirmation of plan (cont.) u (b)(2) (cont.) w (B) With respect to a class of unsecured claims - (i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property.

16. September 8, 2015Copyright © 2005-09 Randal C. Picker16 1129 (cont.) n Confirmation of plan (cont.) u (b)(2) (cont.) w (C) With respect to a class of interests - (i) the plan provides that each holder of an interest of such class receive or retain on account of such interest property of a value, as of the effective date of the plan, equal to the greatest of the allowed amount of any fixed liquidation preference to which such holder is entitled, any fixed redemption price to which such holder is entitled, or the value of such interest; or (ii) the holder of any interest that is junior to the interests of such class will not receive or retain under the plan on account of such junior interest any property.

17. September 8, 2015Copyright © 2005-09 Randal C. Picker17 Role of Valuation n None u absent objection n Only chapter 7 valuation u if objection by individual but not by class n Class disapproval u puts us to 1129(b) n Meaning? u Individual can require comparison of treatment and chapter 7 outcome u Class can force 1129(b) valuations

18. September 8, 2015Copyright © 2005-09 Randal C. Picker18 Unfair Discrimination n Hypo u Three classes of unsecured creditors w Trade: $100 w Senior Unsecured: $100 w Junior Unsecured: $100 u Plan w $40 in assets: $15 to trade; $25 to senior; $0 to junior

19. September 8, 2015Copyright © 2005-09 Randal C. Picker19 Unfair Discrimination n Does this plan discriminate unfairly?

20. September 8, 2015Copyright © 2005-09 Randal C. Picker20 Plan Hypo I n Hypo u Secured creditor owed $200, unsecured creditors owed $100 and an entrepreneur E who owns the stock u Business is worth $100 without E’s human capital and $150 with it u Plan to give $125 to S, $0 to U and $25 to E u What happens?

21. September 8, 2015Copyright © 2005-09 Randal C. Picker21 Plan Hypo II n Hypo u Secured creditor owed $100, unsecured creditors owed $100 and an entrepreneur E who owns the stock u Business is worth $100 without E’s human capital and $150 with it u Plan to give $100 to S, $0 to U and $50 to E u What happens?

22. September 8, 2015Copyright © 2005-09 Randal C. Picker22 203 N. LaSalle n Organizing Our Thinking u How should the assets of the firm be used? u What does the pre-petition capital structure look like? u What capital structure going forward will the debtor’s business support?

23. September 8, 2015Copyright © 2005-09 Randal C. Picker23 Use of the Firm’s Assets n Key Asset u 15 floors in downtown Chicago office building u This is a single-asset real estate case (SARE) n Likely Use Going Forward u 15 floors in downtown Chicago office building u Fight about tenants etc. but small stuff

24. September 8, 2015Copyright © 2005-09 Randal C. Picker24 The Pre-Petition Capital Structure n Bank of America u $93 million nonrecourse loan u Space is worth $54.5 million u Treat BoA as having secured loan for $54.5 million and unsecured loan for $38.5 million n Trade Creditors u Originally: $160K u After purchases: $90K outsiders, $70K insiders n Equity: Limited Partnership

25. September 8, 2015Copyright © 2005-09 Randal C. Picker25 The Proposed Plan n Class 1: BoA Secured Claim u Pay $1,149,500 in cash now, pay balance in 7 to 10 years under secured note n Class 2A: BoA Unsecured Claim u Based on sale or refinancing in 10 years, pay $19 million, or 15% of PV n Class 2B: General Unsecured Creditors u Pay principal but not interest in full

26. September 8, 2015Copyright © 2005-09 Randal C. Picker26 The Proposed Plan n Class 3: Equity u ??? u Some of the partnership interests would contribute $6.125 million over 5 years in exchange for partnership interests u Tax consequence: preserves tax shelter

27. September 8, 2015Copyright © 2005-09 Randal C. Picker27 Approval of the Plan n Votes u BoA opposes u General Unsecureds favor u Equity favors n Is this plan confirmable under 1129(a)?

28. September 8, 2015Copyright © 2005-09 Randal C. Picker28 Answer n Class Approval Under 1129(a)(8) u Classes 1 and 2A oppose u Class 2B approves u Class 3, according to proponent view, would be deemed to oppose u 1129(a)(8) not satisfied u Mean cannot confirm under 1129(a)

29. September 8, 2015Copyright © 2005-09 Randal C. Picker29 Confirmable Under 1129(b)? n Need Impaired Class to Say Yes (1129(a)(10)) u General unsecured impaired as not getting interest payments u Said yes, so plan can move on to 1129(b) cramdown u How should we assess this?

30. September 8, 2015Copyright © 2005-09 Randal C. Picker30 Answer n Key Question u What role does creditor consent play in this process? u Can unsecured consents for BoA? n Classification Issue u Had unsecured claims of BoA and generals been put together, class would vote against u Could not satisfy 1129(a)(10), so no cramdown possible

31. September 8, 2015Copyright © 2005-09 Randal C. Picker31 Cramdown Under 1129(b) n The Absolute Priority Rule u General idea that higher levels in capital structure are entitled to full payment before junior levels n New Value “Exception” u Cases seem to support some sort of idea that juniors can make new investments to get/retain equity even if seniors not paid in full

32. September 8, 2015Copyright © 2005-09 Randal C. Picker32 Case v. Los Angeles Lumber n 308 U.S. 106 (1939) u It is, of course, clear that there are circumstances under which stockholders may participate in a plan of reorganization of an insolvent debtor.... Where th[e] necessity [for new capital] exists and the old stockholders make a fresh contribution and receive in return a participation reasonably equivalent to their contribution, no objection can be made....

33. September 8, 2015Copyright © 2005-09 Randal C. Picker33 Case v. Los Angeles Lumber u [W]e believe that to accord ‘the creditor his full right of priority against the corporate assets’ where the debtor is insolvent, the stockholder’s participation must be based on a contribution in money or in money’s worth, reasonably equivalent in view of all the circumstances to the participation of the stockholder.

34. September 8, 2015Copyright © 2005-09 Randal C. Picker34 Reading 1129(b) n Secured Claims u Present value of payments promised must be in amount of secured claim (here $54.5 million) n Unsecured Claims u Pay in full, or u Juniors must “not receive or retain under the plan on account of such junior claim or interest any property”

35. September 8, 2015Copyright © 2005-09 Randal C. Picker35 How Should We Evaluate the Investment Here?

36. September 8, 2015Copyright © 2005-09 Randal C. Picker36 Test and Rule n Holding u “Whether a market test would require an opportunity to offer competing plans or would be satisfied by a right to bid for the same interest sought by old equity is a question we do not decide here. It is enough to say, assuming a new value corollary, that plans providing junior interest holders with exclusive opportunities free from competition and without benefit of market valuation fall within the prohibition of § 1129(b)(2)(B)(ii).”

37. September 8, 2015Copyright © 2005-09 Randal C. Picker37 Evaluating Feasibility under 1129(a)(11) n Plan Must Be Feasible u No likelihood of liquidation or further need for reorg n How does that apply here?

38. Armstrong World Industries n Try Two Plans n Plan 1 u General USC: Owed $1.65 billion; get 59.5% of that u Asbestos USC: Owed $3.146 billion; get 20% of that plus warrants worth $35-40 million u Equity: Gets nothing n Confirmable? September 8, 2015Copyright © 2005-09 Randal C. Picker38

39. Armstrong World Industries n Plan 2 u General USC: Owed $1.65 billion; get 59.5% of that u Asbestos USC: Owed $3.146 billion; get 20% of that plus warrants u Equity: Gets warrants worth $35-40 million; given to equity by Asbestos USC n Confirmable? September 8, 2015Copyright © 2005-09 Randal C. Picker39