By Debora Hoehne, Robert J. Lemons, Artem Skorostensky, and Katherine Lynn (Goodwin Procter)
The District Court for the Southern District of Texas recently issued a ruling in the chapter 11 cases of ConvergeOne Holdings, Inc. and its affiliated debtors (together, the “Debtors”) prohibiting the offer of the exclusive opportunity to backstop a chapter 11 plan’s (the “Plan”) equity rights offering to select creditors while excluding creditors in the same plan class. This is the first published decision addressing this issue since the Fifth Circuit’s Serta decision, which held that chapter 11 plans must provide equal opportunities and results for creditors in the same class. The ConvergeOne decision departs from other courts’ decisions allowing chapter 11 plans to distribute additional value to certain creditors in a class on account of their agreement to backstop a chapter 11 plan’s rights offering.
Prior to the Debtors’ pre-packaged chapter 11 filing, the Debtors negotiated a restructuring support agreement (“RSA”) with approximately 81% of the first and second lien holders, pursuant to which the Plan would be funded by a $245 million equity rights offering backstopped by certain first lien holders (the “Majority Lenders”). Certain holders of first lien claims (the “Minority Lenders”), collectively holding approximately 11% of first lien claims, were intentionally excluded from RSA negotiations and the backstop opportunity despite seeking to participate on the same terms. Despite objection from the Minority Lenders, the Bankruptcy Court approved the Debtors’ plan
On appeal from the Bankruptcy Court, the District Court held that the Plan violated section 1123(a)(4) by providing certain creditors—but not others in the same class—an opportunity to receive additional value, resulting in disparate treatment. The District Court analogized to the Supreme Court’s LaSalle decision and ruled that section 1123(a)(4) prohibits plans from granting only certain members of a class an investment opportunity that would enhance their recoveries without paying fair consideration as determined by an open marketing process. Applying Serta, the District Court found that the Majority Lenders’ backstop rights provided them with increased distributions under the Plan.
Backstopped equity rights offerings are a common mechanism for companies to incentivize creditors to sponsor successful exits from bankruptcy, however ConvergeOne and its application of Serta may significantly impact debtors’ strategies for raising capital and marshaling creditor support for plan confirmation. The ConvergeOne decision poses a choice for companies pursuing a restructuring: either include all similarly situated creditors in restructuring negotiations and/or permit such creditors to join in the negotiated opportunities, or conduct an adequate marketing process prior to granting an exclusive opportunity to certain creditors. The District Court’s decision offers minimal guidance on what constitutes an “adequate marketing process,” creating ambiguity that threatens to complicate restructuring negotiations and provides excluded creditors with potential litigation leverage.
The District Court’s decision has been appealed, and the Fifth Circuit will now have the opportunity to weigh in on this issue and potentially provide clarity regarding the scope and applicability of its Serta decision.
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