Court: District Court, D. Delaware; February 18, 2015; Federal District Court
Delaware Trust Company appeals the Bankruptcy Court's Order approving the First Lien Settlement in the chapter 11 bankruptcy case of Energy Future Holding Corporation (EFHC) and its subsidiaries, which filed for bankruptcy on April 29, 2014. EFHC, particularly through its subsidiary Energy Future Intermediate Holdings, LLC (EFIH), has significant assets, including an 80% stake in Oncor, Texas's largest regulated utility. At bankruptcy filing, EFIH's debt included $4 billion in first lien notes, $2.2 billion in second lien notes, and $1.7 billion in unsecured notes, with the first lien notes comprising $3.5 billion of 10% notes due in 2020 and $500 million of 6% notes due in 2017. Both sets of first lien notes feature make-whole provisions, requiring EFIH to pay a premium if redeemed early, with the premium's value based on the remaining time until maturity and the interest rate.
The parties concur on the principal and interest owed but dispute whether the make-whole claims are valid in bankruptcy. Concurrently with the bankruptcy petition, EFHC filed a Global Settlement that included a First Lien Settlement reached with certain first lien noteholders through a tender offer. This offer allowed noteholders to exchange their existing notes for new debt under a $5.4 billion DIP Financing Facility, providing 105% of principal and 101% of accrued interest. The agreement required settling noteholders to release their disputed make-whole claims, while those who did not accept the offer retained the right to litigate those claims.
The Bankruptcy Court approved the First Lien Settlement on June 6, 2014, under Federal Rule of Bankruptcy Procedure 9019. Although the Global Settlement has been withdrawn, the First Lien Settlement remains effective and is now the focus of the appeal.
Appellant sought and failed to obtain a stay pending appeal of the June 6 Settlement Order from both the Bankruptcy Court and this Court, subsequently appealing the order on June 9, 2014. Oral arguments were heard on January 5, 2015. Appellant does not dispute the Bankruptcy Court’s factual findings supporting the approval of the First Lien Settlement under Federal Rule of Bankruptcy Procedure 9019 but contests the Settlement Order due to unequal effective recoveries for the make-whole claims of the 6% and 10% noteholders. Although both classes received a 5% principal premium to encourage settlement, the actual recovery differed significantly due to the varying amounts of outstanding principal. Specifically, for the 6% noteholders, the 5% premium represents 64% of their maximum potential make-whole claim value, while for the 10% noteholders, it only constitutes 27%. Appellant argues that this disparity contravenes the similar contractual language of the make-whole provisions.
Three legal errors are alleged against the Bankruptcy Court: (1) the improper use of a tender offer by the Debtors; (2) the violation of 11 U.S.C. § 1123(a)(4) by approving a settlement with disparate recoveries for similarly situated creditors; and (3) the First Lien Settlement being an improper sub rosa plan. Appellant does not seek to vacate the Settlement Order but requests a remand to require the Debtors to equalize recoveries between the noteholder classes and to impose restrictions on future tender offers.
In response, Appellee claims that Appellant's requests render the appeal prudentially moot and argues that Appellant has not substantiated claims against the use of tender offers in pre-confirmation settlements or their applicability under 11 U.S.C. § 1123(a)(4). Appellee also contends that since other portions of the Global Settlement were withdrawn, the First Lien Settlement cannot be considered a sub rosa plan.
The standard of review for appeals from the Bankruptcy Court to this Court is governed by 28 U.S.C. § 158, where district courts have mandatory jurisdiction over final judgments, and findings of fact are reviewed for clear error while legal questions receive plenary review. Appellant argues against the appropriateness of tender offers in Chapter 11 reorganizations based on the limited role of the SEC in such cases.
Appellant contends that tender offers in chapter 11 cases are infrequent and typically face no significant opposition from interested parties, referencing the case of In re AMR Corp. The Appellant argues it was improper for the Debtors to utilize an SEC-governed procedure instead of obtaining judicial approval for the First Lien Settlement offer. However, the Court finds these arguments unconvincing, noting that pre-confirmation settlements are permissible under 11 U.S.C. § 363(b) and Fed. R. Bankr. P. 9019, which promote the minimization of litigation and efficient bankruptcy estate management. The Bankruptcy Court must evaluate the proposed settlement's fairness and reasonableness against the claim's value being compromised.
The Bankruptcy Code does not restrict a debtor’s ability to propose pre-confirmation settlements, and there is no requirement for these offers to resemble structures from other cases or non-bankruptcy contexts. The responsibility lies with the Bankruptcy Court to approve settlements once parties have reached an agreement. A tender offer serves as a means to comply with disclosure regulations for public securities offerings. The limited SEC oversight in chapter 11 does not invalidate a debtor's adherence to securities laws, as the Bankruptcy Code provides clear guidelines on their applicability, particularly under 11 U.S.C. § 1145, which outlines specific exemptions from securities law compliance. A reasonable interpretation of these exemptions indicates that some securities laws remain applicable in chapter 11 cases beyond the enumerated scenarios, suggesting the Debtors’ compliance with relevant securities laws for pre-confirmation settlement offers is warranted.
The Court rejects the argument that the SEC's limited role in Chapter 11 litigation prohibits debtors from complying with securities laws, noting that Section 1145(a) does not exempt debtors from such laws in all circumstances. The Appellant contends that a tender offer is inappropriate as it allows for unequal treatment among similarly situated creditors in a debt-exchange settlement, claiming that pre-confirmation settlements could reintroduce problematic practices from historical equity receiverships. The Appellant references the case SEC v. Am. Trailer Rentals Co. to assert that a class-wide debt exchange is only permissible through a confirmed Chapter 11 plan. Concerns are raised about potential coercive behavior in pre-confirmation settlements.
Historical context is provided, explaining that equity receiverships, used in the late 19th century for railroad debt restructuring, often led to unequal treatment of creditors and were dominated by insiders, prompting Congress to enact the 1938 Chandler Act and establish Chapter X of the Bankruptcy Act, which mandated the appointment of a trustee to formulate reorganization plans. The current case differs as there is no evidence of insider dealings or creditor control; the debtors have maintained control over the reorganization, and the First Lien Settlement guarantees all first lien noteholders at least 100% of their undisputed principal and interest. Non-accepting noteholders retain the right to litigate disputed claims, potentially recovering their full value.
The Bankruptcy Code mandates judicial review of settlements, as outlined in Fed. R. Bankr. P. 9019. The Bankruptcy Court found the settlement reasonable, a finding that the Appellant does not dispute on appeal. The protections under the Bankruptcy Code and the terms of the settlement create a negotiating environment distinct from the insider dealings typical of an equity receivership. The Appellant presents a hypothetical scenario involving a chapter 11 debtor with $1 billion in first lien secured bonds, seeking $800 million in DIP financing, offering to pay off only the first 80% of bondholders who accept the deal, thereby creating a second priority for the remaining 20%. While these non-accepting bondholders retain their lien, they face the risk of collateral depreciation, which the Appellant argues creates an economically inferior class of bondholders.
However, this hypothetical is flawed as it overlooks the requirement for Bankruptcy Court approval of settlements, which would scrutinize fairness and reasonableness. Additionally, the Bankruptcy Code protects secured creditors against depreciating collateral by allowing them to seek cash payments or other protections. Therefore, it is unlikely that fully secured lenders would accept less than full payment, nor would the non-accepting bondholders be materially disadvantaged. The Appellant's claim that class-wide tender offers may lead to coercion lacks support and is speculative. The Appellant also incorrectly analogizes the case to Sec. Exch. Comm’n v. Am. Trailer Rentals Co., where the Supreme Court addressed eligibility differences between bankruptcy proceedings rather than judicial approval for pre-confirmation solicitations. The Court distinguished between Chapter X, which allowed for greater judicial oversight and control, and Chapter XI, which provided a more streamlined process with minimal supervision.
Chapter X is suitable for adjusting publicly held debt and can be applied when specific case facts necessitate its protections. The Court identified a need for an independent trustee under Chapter X, noting the Respondent's persistent unprofitability, precarious financial state, and hopeless insolvency at the time the arrangement was proposed. The Court dismissed the Appellant's argument based on Am. Trailer Rentals Co., clarifying that it does not imply prior court approval is needed for settlements with unequal treatment among creditors. The Appellant acknowledged that the current Chapter 11 incorporates elements of both Chapter X and Chapter XI, rendering the distinctions discussed in Am. Trailer outdated. Furthermore, the debtor in Am. Trailer proposed a full restructuring plan rather than a pre-confirmation settlement. The Court emphasized that plans of reorganization are not the only means to settle debts in Chapter 11, and there is no absolute prohibition against paying pre-petition secured claims outside of such plans. Payments can be made through mechanisms like "roll-ups," where pre-petition debt is paid using post-petition loan proceeds, often provided by the same secured creditor. The Court confirmed that the First Lien Settlement constituted a roll-up of first lien noteholders with new DIP financing, thus validating the Debtors' use of the tender offer for this exchange under bankruptcy law. Regarding Appellant's claim that differing recoveries for the 10% and 6% noteholders violated 11 U.S.C. 1123(a)(4) concerning equal treatment of creditors within the same class, the Court noted that this statute applies only to plan confirmations. The Appellant's reliance on In re AWECO, Inc. to challenge the Bankruptcy Court's approval of a pre-confirmation settlement was deemed insufficient.
The absolute priority rule, codified as 11 U.S.C. § 1129(b)(2)(B), traditionally applies only to plan confirmations; however, AWECO contended that any settlement must adhere to the priority of creditors to be considered fair and equitable. The Appellant argues that § 1123(a)(4), which mandates equal treatment of creditors in a Chapter 11 plan confirmation, should also apply to pre-confirmation settlements, asserting that this principle is as critical as the absolute priority rule. The Court notes that AWECO is not binding precedent in this circuit, and it has not adopted the extension of the absolute priority rule to settlements prior to plan confirmation. The bankruptcy court indicated that the settlement did not comply with the absolute priority rule, yet this does not preclude its approval since it is not part of a reorganization plan.
Moreover, arguments that other confirmation standards apply to pre-confirmation settlements have been consistently rejected in this district. Even if § 1123(a)(4) were applicable, the First Lien Settlement does not violate it, as creditors can agree to less favorable treatment. The differing treatments of claims by the 10% noteholders and the 6% noteholders were accepted voluntarily by those parties. 'Equal treatment' has been interpreted to mean that claimants within a class must have the same opportunity for recovery, not necessarily identical recoveries. Courts have recognized that varying settlements among similar claimants, based on decisions to avoid litigation risks, do not indicate unequal treatment.
The Appellant also contends that the First Lien Settlement constitutes an improper sub rosa plan, which is a settlement acting as a de facto reorganization plan that circumvents key creditor protections. A settlement may be seen as a sub rosa plan if it dictates the terms of a future Chapter 11 plan by either disposing of all claims against the estate or restricting creditors’ voting rights. The Appellant's argument connects the First Lien Settlement to the larger Global Settlement, suggesting it influences the overall restructuring process.
The Global Settlement and RSA, which were intended to justify the First Lien Settlement, eliminated all claims against the estate and limited creditors' voting rights. However, since the Global Settlement has been withdrawn, only the First Lien Settlement is in effect. The Appellant acknowledges this issue and requests the court to assess the sub rosa claim based on the Bankruptcy Court's approval of the First Lien Settlement during the period when the Global Settlement was still pending, but fails to provide legal support for this request. The Court will not assume facts that contradict the existing record. The Appellant has not shown that the First Lien Settlement alone resolves all estate claims or restricts voting rights, and there is no evidence to substantiate such outcomes from this Settlement. Consequently, the Court finds no error by the Bankruptcy Court in determining that the First Lien Settlement did not constitute a sub rosa plan. The Bankruptcy Court's approval of the First Lien Settlement is upheld, with the Court rejecting claims of impropriety in the Debtors' tender offer. Disparate treatment of the 6% and 10% noteholders' make-whole claims does not violate 11 U.S.C. § 1123(a)(4). The Court also decides not to address the prudential mootness argument, leading to the affirmation of the Bankruptcy Court’s June 6, 2014 Order and dismissal of PIMCO’s Motion to Dismiss. The Court recognizes PIMCO as an interested party and notes ongoing litigation, confirming that the June 6 Settlement Order is a final order without making findings on the applicability of 11 U.S.C. § 1145(a). Any potential full value subject to cram-down does not affect the analysis.
