By Edward J. Janger (Brooklyn Law School) and Adam J. Levitin (Georgetown University Law Center)
Business reorganizations are corporate control transactions. When a debtor is insolvent or nearly so, control is in play along two different axes. The first axis allocates control within the existing capital structure. The filing of bankruptcy effectuates a change of control from equity to debt. On the second axis, the company itself is on the auction block, meaning that its assets, or even the entire firm, may be transferred to a new owner. Outside investors may wish to buy the company, and the choice among offers implicates serious governance concerns. This article considers the dynamics of control through the lens of restructuring support agreements (“RSAs”)—contractual agreements among creditors, and sometimes the debtor, to support restructuring plans that have certain agreed-upon characteristics. We conclude that RSAs offer a salutary bridge between the efficiencies of a quick “all asset” sale and the procedural protections of a plan of reorganization. However, they also pose a potential avenue for opportunistic abuse. Specifically, we are concerned with provisions in an RSA that hold value maximization hostage to a reordered priority scheme. Thus, we argue that courts should scrutinize RSAs carefully, and prohibit those that lock in opportunistic value reallocation.
Opportunistic behavior can arise on all sides of restructuring negotiations. Insolvency creates opportunities for creditors (and the debtor) to use transactional leverage to influence the allocation of scarce assets: secured creditors may foreclose; banks may engage in setoff; key suppliers may threaten to stop supplying; landlords can threaten to evict; unsecured creditors may get judgments and start grabbing assets; and purchasers may seek to take advantage of a depressed valuation to purchase the company on the cheap. To the extent that the debtor has value as a going concern, individual creditors may have the power to extort value by threatening to force liquidation. Alternatively, fully secured creditors may prefer a quick realization on their collateral, because they do not benefit from increasing the value of the firm.
The Bankruptcy Code seeks to limit these uses of situational leverage in a number of ways: (1) it stays unilateral creditor action (the automatic stay); (2) it allows for the unwinding of certain prepetition transfers (avoidance); (3) it sets a baseline distribution if the firm liquidates, but promises more if the firm can restructure (best interests/adequate protection); (4) it creates a structured bargaining process that ensures adequate information and reduces the ability of a creditor to holdout in the face of a reorganization plan that is supported by key creditor constituencies (supermajority acceptance); and (5) it sets an entitlement baseline if the firm reorganizes (cramdown). Bargaining in bankruptcy is informed by these procedural requirements and substantive entitlements. If a deal is not reached, liquidation follows.
Recently, in Czyzewski v. Jevic Holding Corp., the Supreme Court raised concerns about procedural innovations that might be used to create “end-runs” around the plan process and these procedural protections. In this regard, RSAs can be a useful tool for aiding compliance with the plan process. However, they are also sometimes also referred to as “lockup” agreements. Once an RSA is proposed and supported by key constituencies, the costs of opposing the contemplated plan may be prohibitive for most creditors. The proposal may operate as a fait accompli. If the RSA freight train is being used to stop creditors from developing information or identifying bases for objection, the device becomes problematic.
The difficulty is distinguishing beneficial RSAs from harmful ones. In our view, a fundamental norm of chapter 11 should govern RSAs, all-asset sales, and a range of other transactions: the common interest in value maximization may not be held hostage by a creditor seeking to improve its own priority. The essay begins by describing the practice surrounding restructuring support agreements and identifies some of the anecdotal concerns raised. We then catalogue the good and bad in RSAs. Next, we illustrate how to distinguish the good from the bad by focusing on bargaining in the shadow of entitlements. Finally, we flesh out the concept of an end-run around the plan process in the context of an RSA and identify “badges of opportunism” that should raise an inference that the practice is being abused.
The full article can be found here.