CHAPTER 7 Formulating and Implementing a Plan of Reorganization

• Jurisdiction: United States

CHAPTER 7: Formulating and Implementing a Plan of Reorganization

CONTRIBUTING AUTHORS:

Melissa A. Hager (Morrison & Foerster LLP)

William M. Hildbold (Morrison & Foerster LLP)

Brett H. Miller (Morrison & Foerster LLP)

Jordan A. Wishnew (Morrison & Foerster LLP)

Edward T. Gavin (Gavin/Solmonese LLC)

Until recently, the plan of reorganization was the hallmark of large corporate bankruptcies. Debtors sought to reorganize their debts and emerge with a consensual plan agreed-upon by their creditors. Now, with the prevalence of § 363 sales, plans are less frequently used as a means of reorganization. In those cases where plans are still the preferred method of reorganizing, the plan must classify all claims against the debtor and set forth, by class, the treatment of their claims. Much like a U.S. Securities and Exchange Commission (SEC) registration statement,²⁸⁶ the debtor submits a disclosure statement to the court and its creditors in conjunction with the solicitation of votes for the plan so that creditors can make an informed decision when voting either in favor of or against the plan.²⁸⁷ Holders of interests and claims—both secured and unsecured—vote by class either to accept or reject the plan.

As described below, there are many nuances for the CRO engaged in the creation, solicitation and approval processes of a plan. This section provides an overview of some of the more important topics and pitfalls encountered in the plan process. Included in those topics are the debtor's rights to exclusively file and solicit a plan for a certain period after the commencement of the case; the Bankruptcy Code's required plan components and provisions that may be included in a plan; and what the Bankruptcy Code requires a court to consider when approving a plan.

A. EXCLUSIVITY

Section 1121 of the Bankruptcy Code provides a debtor with a window of time within which, absent a court order, the debtor is the only party in interest that may file a plan. This "exclusivity" period is meant "to provide a debtor, at the outset of a Chapter 11 case, with the unqualified opportunity to negotiate a settlement and propose a plan of reorganization without interference from creditors and other interests."²⁸⁸ The period commences when the debtor files its petition for relief and the court enters the order for relief in the bankruptcy case and extends it for 120 days. If the debtor files a plan within the 120-day period, the exclusivity period is automatically extended for 60 days for the debtor to solicit acceptance of the plan and for the court and creditors to approve of and accept the plan. This gives the debtor a total of 180 days from the commencement of the bankruptcy case to confirm its plan.

The debtor may seek an extension of the exclusivity period by filing a motion with the court during the initial exclusivity period that establishes "cause" to increase the exclusivity period.²⁸⁹ Courts normally consider nine factors in determining whether "cause" exists to grant an extension of the exclusivity period. Those nine factors are:

1. the size and complexity of the case;
2. the necessity for sufficient time to permit the debtor to negotiate a plan and prepare adequate information for its disclosure statement;
3. the existence of good-faith progress toward reorganization;
4. whether the debtor is paying its bills as they become due;
5. whether the debtor has demonstrated reasonable prospects for filing a viable plan;
6. whether the debtor has made progress in negotiations with its creditors;
7. the amount of time that has elapsed in the case;
8. whether the debtor is seeking an extension of exclusivity in order to pressure creditors to submit to the debtor's reorganization demands; and
9. whether an unresolved contingency exists.²⁹⁰

Although six months may seem like a sufficient time for a debtor to file a plan, many significant and potentially time-consuming events occur within that period that may impede a debtor from filing its plan. Often, the debtor is preparing its statements of financial affairs and schedules of assets and liabilities; establishing procedures for the filing of claims against the debtor and a date beyond which a creditor can no longer file claims against the debtor; negotiating with secured creditors and establishing procedures for the use of cash collateral; creating procedures for the continued use of the debtors' bank accounts; and addressing the contested motions and applications filed by creditors seeking an expedited return of their capital or the continuation of the debtor's business. Consequently, motions to extend exclusivity have become common in many large chapter 11 cases.

1. BENEFITS OF EXCLUSIVITY

There are many benefits to the debtor of maintaining the exclusivity period, which center around two concepts. First, the filing of a bankruptcy case gives the debtor "breathing room" from its pre-petition debts and creditors. Exclusivity removes the fear that parties in interest—who may be competitors or potential purchasers—will file a plan immediately upon the debtor's entry into bankruptcy in an attempt to take back its collateral, shut down the debtor's business, or worse, take over the debtor's business. Instead of worrying about these competing interests fighting against the debtor, the exclusivity period gives the debtor time to focus on its restructuring and manage its balance sheet and case strategy.

Second, during the exclusivity period, the debtor is the only party with whom parties in interest can expect to bargain in a meaningful way because only the debtor can file and solicit acceptances for its plan. As a result, the debtor controls its future and determines how various claims will be settled or compromised. Although the official unsecured creditor's committee is likely to have input on the content of the plan, ultimately the manner in which the debtor will emerge from chapter 11 will be dictated by the debtor so long as it can file a plan within the exclusivity period.

2. BURDENS OF EXCLUSIVITY

For a large corporate debtor with complex financial systems and multinational affiliates, exclusivity is certainly desired; however, the limited statutory exclusivity period can be a burden, as the debtor must continue to manage its business as well as its transition into bankruptcy—including prosecuting necessary substantive and procedural motions and applications, continuing the operation of its business or the wind-down of its business and addressing challenges from various creditor constituencies—while developing its plan and disclosure statement. With only six months, the Bankruptcy Code's time limit can prevent the debtor from realizing the optimal resolution of its bankruptcy case and maintaining control of the course of its case. As stated above, the Bankruptcy Code requires the debtor to prepare a disclosure statement that is similar to a registration statement with the SEC. The level of detail necessary to provide adequate information for an informed creditor to make a business decision can be time-consuming and difficult as creditor constituencies seek to weigh in on its contents. Preparing the disclosure statement alone requires a team of people to work diligently for an extended period of time to gather the necessary information, draft the document, solicit comments from creditors, make further revisions, obtain the court's approval, and finally solicit the creditor body as a whole.

As the deadline nears for a debtor, and the loss of exclusivity becomes a possibility, the potential for incomplete or imperfect plans that have not been fully vetted with the committee or other important constituencies in the case could lead to a hotly contested confirmation hearing. Alternatively, if the debtor is given additional time to negotiate a consensual plan with its creditors, it may ultimately provide for a quicker resolution. Moreover, if a debtor loses exclusivity and competing plans are filed, the resulting litigation will likely result in a longer and more expensive chapter 11 case.

In addition, nothing prevents a creditor from petitioning the court to end or shorten the exclusivity period and allow the creditor to file its own plan. Although it is a difficult standard to meet for the creditor,²⁹¹ the debtor will be forced to defend against the motion, which detracts from the time the debtor needs to formulate its own plan. The debtor must be careful, though, as it has a fiduciary duty to consider any competing plan and determine whether such a plan maximizes the value of the estate and the return to creditors. The failure to consider a competing plan that gives a higher recovery to creditors may indicate that the debtor is not acting in good faith or in the best interests of creditors.

B. CONTENTS OF A PLAN

Section 1123 of the Bankruptcy Code governs the contents of a plan and designates, in subsection (a), items that must be in the plan and, in subsection (b), items that may be included in a plan.

1. REQUIREMENTS OF A PLAN

The following outlines the items that a plan must include.

Designation of Classes. Every plan must group similar claims or interests into classes and specify whether the claims or interests are impaired under the plan.²⁹² Each claim or interest in a class must receive equal treatment. Individual claim or interest-holders may agree to different treatment as long as that treatment does not put them in a better position than the other members of the class. This differing-treatment scenario typically arises when a secured creditor is undersecured on its collateral. Pursuant to § 506(a) of the Bankruptcy Code, the secured creditor's claim is bifurcated into a secured portion and unsecured portion. The unsecured portion of the claim would then be classified in a different class, which would include other unsecured claims. Here is an example of how a bifurcation of a claim may arise: A creditor holds a $500,000 claim that is secured only by a lien on the debtor's inventory...