October 29, 2015
Small business debtors are faced with a challenge when attempting to confirm a business bankruptcy plan under Chapter 11 of the Bankruptcy Code. Satisfying the “new value” exception to the “absolute priority rule” by providing value money or money’s worth to the Debtor can be a difficult test. 11 USC 1129 addresses confirmation of a chapter 11 plan. 11 USC 1129(a) states, in relevant part:
(a) The court shall confirm a plan only if all of the following requirements are met:
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(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.
11 USC 1129(b) allows for nonconsensual confirmation, or "cramdown," if at least one impaired class votes in favor of the plan. 11 USC 1129(b) states:
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.
Thus, assuming Debtor has met all its burdens under 11 USC 1129(a), 11 USC 1129(b) excuses the subsection (a)(8) requirement of all impaired classes voting in favor of the plan, instead requiring acceptance by at least one impaired class if: (1) the plan “does not discriminate unfairly”; and (2) the plan is “fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted the plan.” In re G & D Inv. Props., LLC, 2014 Bankr. LEXIS 4946, *7 (Bankr. E.D. Mich. June 5, 2014).
11 USC 1129(b)(2) addresses the “fair and equitable” requirement, and it states, in relevant part:
(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:
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(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, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section. [emphasis added.]
The language highlighted above states what is commonly known as the “absolute priority rule.” In re G & D Inv. Props., LLC, 2014 Bankr. LEXIS 4946, *7 (Bankr. E.D. Mich. June 5, 2014). The “absolute priority rule” is a limitation created due to “the danger inherent in any reorganization plan proposed by a debtor, then and now, that the plan will simply turn out to be too good a deal for the debtor’s owners.” Bank of Am Nat'l Trust & Sav Ass'n v 203 N Lasalle St P'ship, 526 US 434, 444; 119 S Ct 1411; 143 L Ed 2d 607, 617 (1999).In its simplest form, “the ‘absolute priority rule’ requires that dissenting unsecured creditors must be paid in full if a junior claim holder is to retain its ownership interest under the reorganization plan. In re Target Graphics, Inc., 372 B.R. 866, 871 (E.D. Tenn. 2007), citing 11 U.S.C. § 1129(b)(2)(B)(ii).
There is a well recognized exception to the “absolute priority rule.” The “new value” exception “provides the absolute priority rule is not a bar to confirmation if the shareholders contribute new capital in money or money’s worth, reasonably equivalent to the property’s value, and necessary for successful reorganization of the restructured enterprise.” In re Target Graphics, Inc., 372 B.R. 866, 872 (E.D. Tenn. 2007) (citation and quotation omitted). There are five requirements for the new value exception to apply: “1) new, 2) substantial, 3) money or money's worth, 4) necessary for a successful reorganization and 5) reasonably equivalent to the value or interest received.” In re RTJJ, Inc., 2013 Bankr. LEXIS 481, *31 (Bankr. W.D.N.C. Feb. 6, 2013)
In some cases the debtor may urge the Court to apply the “new value” exception and confirm the Plan despite the Plan not satisfying the “absolute priority rule.” Often the controlling shareholder or member is attempting to retain the reorganized business debtor. A shareholder may agree to make a small payment (depending on the value of the reorganized Debtor). The small contribution may be $25,000.00 in cash. Thus, the first and third requirements of the “new value” exception are satisfied. The value of the $25,000.00 contribution is new money.
The contribution also serves a necessary function. This contribution is the additional funding to pay, at least part, of the administrative expenses. The payment of administrative expenses is required under 11 USC 1129(a)(9) as a condition of confirmation, although administrative claimants may have agreed to be paid over time. The contribution is certainly necessary to confirmation of the plan. See In re RTJJ, Inc., 2013 Bankr. LEXIS 481, *31 (Bankr. W.D.N.C. Feb. 6, 2013) (finding a contribution of $20,000 to be necessary when it serves the important function of paying administrative expenses).
Similarly, any contribution may be substantial, depending on the case. The value of the $25,000.00 cash contribution is small as compared to the outstanding secured debt. However, the infusion of a cash contribution is significant to the Debtor, especially because it is limited in its cash resources. As compared to net available cash, the contribution is significant in value. In re RTJJ, Inc., 2013 Bankr. LEXIS 481, *31 (Bankr. W.D.N.C. Feb. 6, 2013) (finding a $20,000 contribution to be substantial because the debtor had limited cash resources).
Finally, the fifth requirement, “reasonably equivalent to the value or interest received” is also satisfied. The shares in the reorganized debtor may have no value. The shares may be burdened with significant priority debt. In other words, there is no market for the shares because no one would be willing to purchase the encumbered shares. Thus, what is being purchased from the contribution may be nothing more than the right to control a small family business, which has no net asset value. Thus, the “new value” is substantial.
The Supreme Court has found that the “absolute priority rule” is violated when a plan “provision [vests] equity in the reorganized business[,] in the Debtor's partners[,] without extending an opportunity to anyone else either to compete for that equity or to propose a competing reorganization plan.” Bank of Am Nat'l Trust & Sav Ass'n v 203 N Lasalle St P'ship, 526 US 434, 437; 119 S Ct 1411; 143 L Ed 2d 607, 612 (1999) (emphasis added). In LaSalle, “no one else could propose an alternative” plan, “the Debtor's partners necessarily enjoyed an exclusive opportunity that was in no economic sense distinguishable from the advantage of the exclusively entitled offeror or option holder.” Bank of Am Nat'l Trust & Sav Ass'n v 203 N Lasalle St P'ship, 526 US 434, 455; 119 S Ct 1411; 143 L Ed 2d 607, 623 (1999).
If the exclusivity period has expired, see 11 USC 1121(c), and no one has proposed a competing reorganization plan, should the case be confirmed. After the exclusivity period has expired, any party could have filed a competing plan that proposed a different ownership of the Debtor. Moreover, no one has suggested that there is retained value in the Debtor’s stock in excess of the $25,000.00 contribution. Because there is no value in the Debtor’s stock, any “market testing” would be futile and phony. For these reasons, the shareholder has satisfied the “new value” exception to the “absolute priority rule.”
Valuation is central to bankruptcy. Valuation is more art than science and is determined in Chapter 11 in many different manners, using a variety of different methodologies, depending on the time and circumstances involved. See e.g., Group of Institutional Investors v. Chicago, Milwaukee, (1943) (“’value is a word of many meanings’…..It gathers its meaning in a particular situation from the purpose for which a valuation is being made.”)
In December 2014, the American Bankruptcy Institute Commission to study the Reform of Chapter 11 (the “Commission”) released its Final Report and Recommendations. The Commission explored the new value corollary which is an exception to the Absolute Priority Rule.
The Commission determined that Chapter 11 Reorganizations would benefit from further clarity on the new value corollaries an expressed exception to the absolute priority rule and indentifying the key elements of the exception would enhance the confirmation process in many cases. Accordingly, the Commission recommended a statutory new value corollary that required (i) new money or money’s worth; (ii) in an amount proportionate to the equity received or retained by pre-petition, equity security holders; and (iii) that would be subject to a “reasonable” market test. However, the Commission declined to define an appropriate market test. Rather, it believed that Courts should make this determination based on the facts, the evidence presented and what would be reasonable in the particular case before the Court.
In Sum, commentators and the Commission have recognized the importance of the new value exception. Because of its importance, the Commission recommended that the new value exception be codified, and the "market test", described in LaSalle, be left to the courts to determine. Further, the new value exception serves an important function at the heart of Chapter 11 Reorganization - retention of jobs and restoration of the entity in bankruptcy, and the continuation of businesses to keep our economy moving.
Keller & Almassian, PLC