Denial of Chapter 11 Plan Confirmation Unwarranted Even if Plan Support Agreements Violated Disclosure Requirements
A bedrock principle underlying chapter 11 of the Bankruptcy Code is that creditors, shareholders, and other stakeholders should be provided with adequate information to make an informed decision to either accept or reject a chapter 11 plan. For this reason, the Bankruptcy Code provides that any "solicitation" of votes for or against a plan must be preceded or accompanied by stakeholders' receipt of a "disclosure statement" approved by the bankruptcy court that explains adequately the background of the case as well as the key provisions of the chapter 11 plan. The solicitation of votes of stakeholders outside of this process is deemed improper, and those votes accordingly may be disallowed.
However, to promote communication and negotiation among the debtor and other stakeholders throughout the course of a chapter 11 case, courts generally construe the term "solicitation"—and the remedies for improper solicitation—narrowly. The United States Bankruptcy Court for the Southern District of New York recently addressed this issue in In re LATAM Airlines Grp. S.A., 2022 WL 2206829 (Bankr. S.D.N.Y. June 18, 2022) (unpublished opinion), as amended, 2022 WL 2541298 (Bankr. S.D.N.Y. July 7, 2022), stay pending appeal denied, No. 20-11254 (JLG) (Bankr. S.D.N.Y. July 7, 2022), certification denied, No. 20-11254 (JLG) (Bankr. S.D.N.Y. July 26, 2022), aff'd, 2022 WL 3910718 (S.D.N.Y. Aug. 31, 2022). In an unpublished opinion, the court overruled an objection to confirmation of a chapter 11 plan based on the debtors' alleged violation of the plan solicitation requirements by entering into agreements with certain creditors, prior to the court's approval of a disclosure statement, that obligated those creditors to vote in favor of a plan in exchange for allowance of their claims. According to the court, even if those plan support agreements were improper (and the court did not reach that question), the only remedy for the violation was disallowance of the creditors' votes, which would not change the outcome of the voting process.
Solicitation and Disqualification of Votes on a Chapter 11 Plan
Section 1125(b) of the Bankruptcy Code provides that votes in favor of a chapter 11 plan can be solicited postpetition only after the creditor or shareholder receives a court-approved disclosure document containing "adequate information," a concept defined in section 1125(a). The provision is "designed to 'discourage the undesirable practice of soliciting acceptance or rejection at a time when creditors and stockholders were too ill-informed to act capably in their own interests.'" In re Heritage Org., LLC, 376 B.R. 783, 794 (Bankr. N.D. Tex. 2007) (quoting In re Clamp-All Corp., 233 B.R. 198, 208 (Bankr. D. Mass. 1999)).
In cases where section 1125(b) has been violated, section 1126(e) provides a remedy:
On request of a party in interest, and after notice and a hearing, the court may designate any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.
11 U.S.C. § 1126(e) (emphasis added). "Designation" of an entity under section 1126(e) means that it is disqualified from voting or its vote is disallowed. See Collier on Bankruptcy ¶ 1126.06 (16th ed. 2022). Votes cast by any creditor or interest holder designated under the provision are not counted for the purpose of determining whether the plan has been accepted by a class of creditors or interest holders under sections 1126(c) and 1126(d). See In re DBSD N. Am., Inc., 634 F.3d 79, 106 (2d Cir. 2011).
Designation of a vote under section 1126(e) "is a drastic remedy, and, as a result, designation of votes is the exception, not the rule. The party seeking to have a ballot disallowed has a heavy burden of proof." In re Adelphia Commc'ns Corp., 359 B.R. 54, 61 (Bankr. S.D.N.Y. 2006)).
What constitutes "solicitation" of a vote on a plan is unclear. Most courts agree that the term "must be read narrowly … because [a] broad reading of § 1125 can seriously inhibit free creditor negotiations." Century Glove, Inc. v. First Am. Bank of New York, 860 F.2d 94, 101 (3d Cir. 1988). Relevant case law suggests that the term "should relate to the formal polling process in which the ballot and disclosure statement are actually presented to creditors with respect to a specific plan, and the term should not be read so broadly as to chill the debtor's postpetition negotiations with its creditors." In re Residential Capital, LLC, 2013 WL 3286198, *19 (Bankr. S.D.N.Y. June 27, 2013) (quotations and citations omitted).
In keeping with a series of court decisions beginning with the bankruptcy court's ruling in Trans World Airlines, Inc. v. Texaco, Inc. (In re Texaco, Inc.), 81 B.R. 813 (Bankr. S.D.N.Y. 1988), restructuring support agreements ("RSAs") or plan support agreements ("PSAs") have generally been deemed not to run afoul of the Bankruptcy Code's solicitation requirements. See, e.g., Heritage Org., 376 B.R. at 792; In re Kellogg Square Partnership, 160 B.R. 336 (Bankr. D. Minn. 1993). Among other reasons, courts have noted that such agreements typically contain provisions allowing signatories to back out of their commitments where: (i) their fiduciary obligations require it; or (ii) the plan actually proposed by the debtor is materially different from what was agreed upon.
However, in a pair of unpublished bench rulings handed down in 2002, Delaware Bankruptcy Judge Mary F. Walrath held that postpetition "lock-up" agreements violate section 1125(b), and she consequently disallowed the votes of the signatories under section 1126(e). See In re Station Holdings Company, Inc., No. 02-10882 (MFW) (Bankr. D. Del. Sept. 30, 2002) [document no. 177]; In re NII Holdings, Inc., No. 02-11505 (MFW) (Bankr. D. Del. Oct. 22, 2002) [document no. 367]. Both cases involved prepackaged chapter 11 plans. However, certain supporting creditors signed lock-up agreements after the petition date but before the court approved a chapter 11 plan disclosure statement. The transcripts of the proceedings indicate that Judge Walrath placed particular emphasis on the absence of any provision in the lock-up agreements permitting the signatories to change their votes if the information contained in the disclosure statement turned out to be different from what they had received previously.
Another Delaware bankruptcy judge, Brendan L. Shannon, revisited this issue in In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013). In that case, the court rejected arguments that a postpetition RSA was impermissible, adopting a narrow interpretation of "solicitation" in section 1125(b) in accordance with the Third Circuit's ruling in Century Glove. Id. at 294. The court rejected the argument that provisions in the RSA requiring the signatories to vote in favor of a conforming plan and providing for the remedy of specific performance amounted to solicitation. According to the court, the specific performance provision in the RSA was appropriate because the parties "were entitled to demand and rely upon assurances that accepting votes would be cast." Id. at 297.
Courts from other jurisdictions have similarly concluded that the negotiation of postpetition PSAs or RSAs prior to approval of a disclosure statement does not amount to improper solicitation under section 1125. See In re Fin. Oversight & Mgmt. Bd. for Puerto Rico, 637 B.R. 223, 284 (D.P.R. 2022) ("The process of negotiation and solicitation of assent to the plan support agreements prior to the approval and distribution of the disclosure statement did not constitute improper solicitation of votes with respect to the Plan."); COMM 2013 CCRE12 Crossings Mall Rd., LLC v. Tara Retail Grp., LLC, 591 B.R. 640, 651 (N.D.W. Va. 2018) (drawing the distinction between plan support agreements that permit a signatory to change its vote under appropriate circumstances and prohibited lock-up agreements that do not and therefore violate section 1125); In re Residential Cap., LLC, 2013 WL 3286198, *20 (Bankr. S.D.N.Y. June 27, 2013) (citing cases).
LATAM
In May 2020, LATAM Airlines Group S.A. and certain affiliates (collectively, "LATAM"), Latin America's leading airline group, filed for chapter 11 protection in the Southern District of New York after losing 95% of its passenger business due to travel restrictions imposed during the COVID-19 pandemic.
After months of negotiations and several rounds of mediation, LATAM and its principal creditor and shareholder constituencies ultimately agreed on an RSA that established the framework of a chapter 11 plan that would permit LATAM to emerge from bankruptcy with an appropriate level of capital and debt, as well as access to substantial liquidity.
Following the expiration of the claims bar date, LATAM and its advisors initiated a process to review and reconcile the many thousands of filed and scheduled claims. Part of this process involved contacting creditors to exchange supporting materials and address questions or seek resolutions regarding claims. In several dozen instances, LATAM and creditors reached agreement on the allowed claim amounts, and the parties entered into claim allowance agreements ("CAAs").
LATAM filed a proposed chapter 11 plan and disclosure statement on November 26, 2021.
Beginning in late December 2021—and prior to the court's March 2022 approval of the disclosure statement for LATAM's chapter 11 plan—LATAM began to insert the following "plan support provision" ("PSP") in CAAs with general unsecured creditors of the LATAM parent company (later designated as class 5 in LATAM's chapter 11 plan):
Support of the Plan. Counterparty shall timely cast any and all votes in respect of the Claim to vote in favor of acceptance of the Plan. Counterparty shall not oppose or object to approval of the Disclosure Statement and confirmation of the Plan. To the extent the Counterparty sells or otherwise transfers any portion of its interest in the Claim, including the right to vote on the Plan, such sale or transfer agreement (or any similar agreement) shall include a provision binding the purchaser or transferee, and any subsequent purchasers or transferees, to this Agreement.
LATAM obtained at least 41 CAAs with the PSP from class 5 creditors covering 95 separate claims. LATAM did not seek court authorization to enter into the CAAs but filed separately executed claim allowance stipulations, which did not include or mention the PSPs, and then sought court approval of the stipulations.
Because the CAAs did not contain confidentiality provisions, LATAM's unsecured creditors' committee obtained a copy of one in January 2022. After learning of this disclosure, LATAM, without conceding any impropriety, took steps to disclaim any attempt to rely on or enforce the PSP, including: (i) adding language to its proposed disclosure statement committing not to enforce compliance with any provisions in the CAAs; (ii) notifying all counterparties to CAAs containing a PSP that LATAM expressly disclaimed the provisions; and (iii) submitting or resubmitting for court approval all claim allowance stipulations with language stating that the counterparties were not bound by a PSP.
The bankruptcy court approved LATAM's disclosure statement on March 21, 2022. It later approved procedures for the solicitation of votes on the plan.
The plan classified holders of claims and interests into 11 classes, of which class 1 (claims under a prepetition revolving credit facility), class 5 (general unsecured claims against the LATAM parent company), and class 7 (general unsecured claims against a single LATAM debtor affiliate) were classified as impaired and therefore entitled to vote.
The plan was overwhelmingly accepted by classes 1, 5, and 7. Fewer than half of the 95 class 5 claims originally subject to the PSPs were voted to accept the plan.
Several parties objected to confirmation of the plan. Among them, the U.S. Trustee argued that LATAM's negotiation of the CAAs constituted improper solicitation in violation of section 1125(b), and consequently, the plan was not confirmable because LATAM could not demonstrate that its actions comported with section 1129(a)(2) of the Bankruptcy Code, which provides that a plan must "compl[y] with the applicable provisions of this title." The U.S. Trustee acknowledged that LATAM's negotiations with the class 5 creditors leading up to the execution of the CAAs did not touch upon matters relating to the development of a confirmable chapter 11 plan or the adequacy of the disclosure statement. Even so, it argued, LATAM "aggressively sought out" CAAs from the class 5 creditors "in an effort to ensure that they could satisfy the numerosity requirement under section 1126(c) of the Bankruptcy Code for Class 5's acceptance of the Plan."
According to the U.S. Trustee, the CAAs "were pre-drafted, with no room for negotiation with the creditors; all the creditors were required to sign it," and LATAM's actions qualified as "solicitation in substance," because "[i]f the creditor sign[ed] the agreement, it [was] legally bound to vote for the plan, as opposed to a tentative agreement or informal promise to vote for the plan."
LATAM countered that negotiating the CAAs did not amount to solicitation of votes and that the U.S. Trustee failed to demonstrate grounds for designating the votes of the class 5 creditors. LATAM likened the CAAs to postpetition PSAs that were "negotiated in good faith and at arm's length, between sophisticated commercial parties, and only after the Disclosure Statement and Plan had been filed." In addition, LATAM argued, even assuming it did violate section 1125(b), the remedy for such a violation is vote designation under section 1126(e), not denial of confirmation under section 1129(a)(2).
The Bankruptcy Court's Ruling
In an unpublished (nonprecedential) opinion, the bankruptcy court overruled the U.S. Trustee's objection (as well as all other objections) and confirmed LATAM's chapter 11 plan.
Judge James L. Garrity, Jr. rejected LATAM's contention that the CAAs were no different from postpetition PSAs, which, in other cases, have been deemed not to violate section 1125(b). He explained that the only "plan support" provision in the CAAs was the class 5 creditors' unconditional commitment to vote to accept the Plan. Moreover, Judge Garrity noted, whereas the PSAs cited by LATAM "were executed prior to approval of the disclosure statement and were executed in furtherance of a debtor formulating its plan—i.e., before the plan was filed in court—here that is clearly not the case." LATAM, 2022 WL 2206829, at *54.
Judge Garrity also explained that, although the CAAs did not include specific performance as a remedy for breach—an element that was deemed objectionable by Judge Walrath in NII Holdings and Station Holdings—each CAA was "an enforceable agreement obligating the counterparty Class 5 Claim Allowance Creditor to vote in favor of the Debtors' Plan, that was executed prior to the Court's approval of the Disclosure Statement." However, he noted, LATAM later disclaimed any right to enforce the plan support provisions and entered into new CAAs with the class 5 creditors without them. In addition, only 45 of the 95 claims involved were later voted to accept the plan.
According to Judge Garrity, even if LATAM violated section 1125(b) by entering into the CAAs, denying confirmation of the chapter 11 plan was "neither an equitable nor appropriate resolution" because "[b]y its terms, section 1126(e) provides the exclusive remedy for violations of section 1125(b)." Id. at *55 (citing Texaco, 81 B.R. at 816; In re WorldCom, Inc., 2003 Bankr. LEXIS 2192, *35-36 (Bankr. S.D.N.Y. May 16, 2003)).
On the facts of this case, Judge Garrity explained, if the U.S. Trustee sought relief under section 1126(e) (which it did not), only the votes of the affected class 5 creditors who voted to accept the plan could be designated under section 1126(e), which would not alter the vote tabulation sufficiently to result in the rejection of the plan by that class of creditors.
Judge Garrity rejected the U.S. Trustee's argument that confirmation should be denied under section 1129(a)(2) because LATAM did not comply with section 1125(b)—an "applicable provision" of the Bankruptcy Code. Not only is section 1126(e) the exclusive remedy for a breach of section 1125(b), he wrote, but "section 1129(a)(2) does not provide for an affirmative grant of authority. It cannot provide any relief to remedy the Debtors' alleged breach of section 1125(b), let alone relief that is greater than the relief available under section 1126(e)." LATAM, 2022 WL 2206829, at *56.
On July 7, 2022, the bankruptcy court denied a motion filed by certain LATAM creditors for a stay of the plan confirmation order pending an appeal to the district court. On July 26, 2022, the court denied the creditors' request that it certify a direct appeal of the confirmation order to the U.S. Court of Appeals for the Second Circuit.
The U.S. District Court for the Southern District of New York affirmed the bankruptcy court's confirmation order on August 31, 2022. The district court's affirmance does not address the solicitation issue.
Outlook
LATAM reinforces the principle that "solicitation" of votes on a chapter 11 plan should be narrowly construed to promote communication and negotiation among the debtor and other stakeholders in a chapter 11 case. Even so, the court did not conclusively weigh in on the propriety of the debtors' actions under section 1125(b). It was careful to note that the debtors failed to seek pre-approval of the claim allowance agreements, did not disclose the plan support provisions in the stipulations that the debtors did submit for court approval, and once the information came to light, disclaimed any intention of enforcing the plan support provisions.
Under different circumstances—i.e., where there were enough votes subject to designation to affect the outcome of the vote—the court may well have ruled to the contrary. Finally, LATAM reaffirms the notion that vote designation under section 1126(e) is the sole remedy for violating section 1125(b).
