Michael Chaisanguanthum, Charter: the Most Important Recent Bankruptcy Decision for Secured Creditors

• Citation: Vol. 27 No. 1
• Publication year: 2011

CHARTER: THE MOST IMPORTANT RECENT BANKRUPTCY DECISION FOR SECURED CREDITORS

Michael Chaisanguanthum^*

INTRODUCTION

On March 27, 2009, Charter Communications, Inc. ("Charter") and numerous subsidiaries filed for chapter 11 bankruptcy protection.¹Charter, the fourth largest cable operator in the United States, could not sustain its debt load of $22 billion, which consisted of various tranches of bank and bond debt.²The bankruptcy was pre-arranged; the company had already negotiated the key terms of a restructuring with certain major constituents.³These terms included canceling and equitizing certain bond debt and raising billions of dollars of new capital.⁴

Among those not invited to negotiate were bank lenders. Their claims would be deemed unimpaired and reinstated, meaning all the terms of their debt would remain unchanged by the bankruptcy plan.⁵The plan could reinstate the company's bank debt so long as it complied with its credit agreements.⁶While the bank lenders were not entitled to vote against the pre- arranged plan, they objected in court that the company did not comply with certain provisions of the credit agreements, including the provision prohibiting changes of control of the company.⁷

After months of litigation, the Charter decision was quietly published on November 17, 2009.⁸While noteworthy given the outcome (the bank lenders lost), the size of Charter's bankruptcy, and the unique legal issue of reinstatement involved, the decision did not generate widespread fear about its impact on secured lending. This is likely because the ruling did not set sweeping precedent on reinstatement, as such disputes revolve around whether a change of control has occurred. Indeed, such a determination is highly subjective and often limited to a situation's specific facts. Moreover, reinstatement is not a terrible outcome for secured lenders. They retain substantially all of their contractual rights, including coupon, maturity, covenants, and collateral.⁹A secured lender's primary loss in reinstatement is a re-pricing opportunity, the chance to obtain a higher interest rate on the loan.¹⁰

This Article will argue that the Charter ruling has enormous potential to disturb settled expectations about bankruptcy practice and to undermine secured creditors' chapter 11 protections by making cram-up significantly easier. It will argue: (1) cram-up is the biggest risk faced by senior secured creditors, (2) 11 U.S.C. Sec. 1129(a)(10)¹¹is the primary cram-up safeguard for senior secured creditors, and (3) the Charter decision undermines

Sec. 1129(a)(10) because it is wrongly decided on the legal issues of (a) whether the impaired accepting class requirement is tested on a per-debtor or per-plan basis, and (b) what constitutes impairment.

A. Why Cram-up Is Important to Senior Secured Creditors

Cram-up is the most significant and probable risk senior secured creditors face in chapter 11. Accordingly, it is the baseline for debtors when negotiating with their senior secured creditors.¹²Cram-up is the ability of the debtor to satisfy senior secured lenders' claims with the new secured debt of the reorganized company over the objection of such senior secured lenders.¹³It is a powerful tool because cram-up provides financing for reorganization and enhances distributable enterprise value for junior stakeholders. Junior creditors can acquire the equity of the reorganized company using cram-up debt to finance such a transaction, thereby handing the senior secured creditors new secured debt in the reorganized company. The further below market the terms of the cram-up debt are, the more reorganization value is being given to junior creditors. In any cram-up, senior secured creditors risk receiving debt-like compensation for taking equity-like risk, since bankruptcy courts might err in determining replacement value, cram-up interest rate, and other terms that are important to lenders.¹⁴Secured creditors have protections, but the statutory guidelines in the Bankruptcy Code are limited; specifically, the deferred cash payments must have a value equal to, "as of the effective date of the plan, . . . at least the value of such holder's interest in the estate's interest in such property . . . ."¹⁵This requirement contains two key issues: value and interest rate.

What does "value of such holder's interest . . . in such property" mean? By statute, if a company's senior secured creditors are owed $500 million, they do not necessarily have to receive $500 million worth of debt to be crammed up. In the seminal decision of Associates Commercial Corp. v. Rash,¹⁶the

Supreme Court held that the relevant amount is the replacement value, which is

"the cost the debtor would incur to obtain a like asset for the same

'proposed . . . use.'"¹⁷If the company is using secured creditors' collateral to reorganize, one must look at how much it would cost to purchase such collateral, not what the collateral would fetch if foreclosed and liquidated.¹⁸If similar replacement collateral can be purchased for $300 million, the senior secured lenders can be crammed up with new secured debt worth $300 million.¹⁹

With respect to the question of the appropriate interest rate, the authoritative decision is the Supreme Court's holding in Till v. SCS Credit Corp.²⁰In that decision, the majority held that secured lenders must be compensated for the enhanced risk of default and that the correct methodology for determining the cram-up interest rate is the "formula approach."²¹The "formula approach" looks to the national prime rate (the rate typically charged for highly creditworthy parties) and makes additive adjustments to compensate for greater risk of non-repayment.²²In dissent, Justice Scalia argued that the starting point should be the contract rate (the rate the borrower was previously paying) with adjustments made from there.²³In the real world, default choices and presumptions are powerful, and there is a real risk that courts will err and not make enough additive adjustments.²⁴As Justice Scalia noted, "this approach will systematically undercompensate secured creditors for the true risks of default."²⁵

B. The Biggest Hurdle to Cram-Up: Sec. 1129(a)(10)

Congress acted not once, but twice to insert the cram-up requirement that there be at least one impaired accepting class.²⁶First, Congress specifically added the requirement of an impaired accepting class in Sec. 1129(a)(10) in the

1978 overhaul of the Bankruptcy Code to address the inequities of cram-up in single-asset real estate cases and to foster consensus in reorganization.²⁷

Secured lenders' collateral could be used for reorganization, with secured lenders receiving discounted values for their claims because of a depressed market or undervaluation by the bankruptcy court.²⁸For example, a secured lender may lend $2.5 million against an asset initially valued at $3 million. If the borrower files for bankruptcy and the property is deemed to be worth only

$1.5 million at that time, the debtor can propose a reorganization that uses the property but only compensates the secured lender with $1.5 million in cash or cram-up debt. All of the benefits of future appreciation or value recovery accrues to the reorganized debtor instead of the original secured lender.

Congress's insertion of Sec. 1129(a)(10) addresses this potential inequity to secured lenders by making it harder to confirm a plan only supported by the debtor.²⁹As stated by Judge Crabb in In re Polytherm Industries, Inc.:

Ideally, a reorganization plan will be the product of debtor-creditor cooperation and will serve both sides' interests. However, if the debtor and creditors fail to agree on the reorganization plan as signified by dissension of creditor classes, the cramdown device may permit confirmation of the plan if the plan adequately protects the dissenting classes according to 11 U.S.C. Sec. 1129(b). Section

1129(a)(10) creates an impediment to resort to the cramdown authority and, as such, it can frustrate a debtor's interest in adopting a given plan. However, if no class of creditors agrees to the plan, it would not be equitable to impose acceptance of the plan upon the creditors by enforcing the debtor's interest in confirmation of the plan through the cramdown authority. The point is, if no impaired class accepts the plan, the debtor has failed to negotiate effectively with its creditors in devising a reorganization plan. I find nothing in the Bankruptcy Reform Act to indicate that Congress intended that the bankruptcy courts could saddle creditors with a stake in a reorganized corporation under a plan that had received no acceptances from impaired classes of creditors.³⁰

Essentially, the accepting class requirement is a protective measure for creditors designed to require some measure of support from creditors for a debtor's plan.³¹However, following the 1978 changes, courts were in disagreement about whether the accepting class must be impaired or whether a deemed accepting class (an unimpaired class) sufficed.³²Accordingly, Congress acted a second time. In 1984, Congress made explicit the requirement that the accepting class be impaired.³³The intention of Congress was to reverse cases before the 1978 Bankruptcy Code, where cramdown³⁴was permitted without any consent of creditors.³⁵This safeguard is important given that the debtor has tremendous advantages of exclusivity and control in pushing forward its plan of reorganization.³⁶

C. How Cram-Up is Typically Achieved in Single Asset Cases

To cram-up a secured lender in a single asset bankruptcy case, a debtor must obtain the acceptance of one impaired class.³⁷In the previous example, the secured lender is owed $2.5 million, has a lien on collateral worth $1.5 million, and objects to the debtor's plan. By operation of the Bankruptcy Code, the secured lender has a $1.5 million secured claim as well as a $1 million unsecured deficiency claim that is voted separately as an unsecured claim.³⁸

Typically...