Working Group Proposals ##10, 11, & 12: Prepackaged Plans of Reorganization
At its May session, the chapter 11 Working Group devoted a substantial amount of time to discussing prepackaged plans of reorganization. Prepacks constitute a significant percentage of the bankruptcies filed by publicly held corporations. [ FN: According to the 1997 Bankruptcy Yearbook & Almanac, over 20% of bankruptcies of publicly held companies filed in 1993 were filed (and completed) as prepacks.] While they have become more prevalent in the 1990s, the notion of a prepackaged bankruptcy far pre-dates the enactment of the Bankruptcy Code of 1978.
A prepack can have significant advantages over either a traditional chapter 11 case or an out-of-court restructuring, especially for a company that does not need to repair operational problems with the extended use of bankruptcy tools. Unlike a restructuring that takes place fully-out-of-court, a prepack allows a company to minimize the leverage of holdouts and to reach and effectuate an arrangement that satisfies the majority of creditors. Unlike an ordinary chapter 11 case (in which the debtor files, obtains approval of its disclosure statement, solicits votes, and seeks to have the plan confirmed), a company in a prepackaged chapter 11 case does much of the work before entering the bankruptcy system. It negotiates and solicits votes on a plan, then files for bankruptcy with the potentially confirmable plan in hand. This enables the debtor to confirm a plan and emerge from bankruptcy within a few months or less.
The use of prepackaged plans of reorganization is consistent with the goal of encouraging swift and successful reorganizations with lower transaction costs. [ FN: See, e.g., Prof. James J. White, "The Virtue of Speed in Bankruptcy Proceedings, " Testimony before the National Bankruptcy Review Commission, p. 6, May 14, 1997 (concluding that "speed is an antidote to many of the substantive ills in chapter 11. That speed will benefit not only secured creditors, but unsecured creditors as well, "); accord Neal Batson & Matthew W. Levin, "Prepackaged and Pre-Negotiated Plans of Reorganization, " submitted in connection with New York University School of Law 21st Annual Workshop on Bankruptcy and Business Organizations, (1995) ( "[a] prepackaged or pre-negotiated bankruptcy plan may avoid some of the delay and expense inherent in the more typical chapter 11 bankruptcy process ").] These narrowly-tailored proposals are intended to facilitate the prepack process to the benefit of all parties involved.
Working Group Proposal #10: Prepackaged Plans of Reorganization:
Congress has provided disclosure requirements to govern solicitation in connection with a plan of reorganization that preempt otherwise applicable nonbankruptcy standards. [ FN: See 11 U.S.C. §1125(a), (d).] However, prepetition solicitations in connection with a plan of reorganization are subject to these nonbankruptcy requirements. Thus, depending on the timing of the solicitation, the same activity is governed by two different sets of standards and procedural requirements.
The standards and requirements provided in the Bankruptcy Code that currently apply to postpetition solicitation should be applicable to solicitation for a plan of reorganization within 120 days prior to filing a chapter 11 petition by a company that is subject to and in compliance with the public periodic reporting requirements of the Securities Exchange Act of 1934. Notice of such prepetition solicitation should be served on the Securities and Exchange Commission. If a company solicits for a plan of reorganization but does not file for bankruptcy, the bankruptcy requirements and standards should be applicable if the company does not complete an exchange offer or any other transaction on the basis of such solicitation. [ An attached memorandum from Jay M. Goffman provides examples of specific language that could be implemented to effectuate this recommendation. The language in that memorandum is not part of this recommendation.]
Reasons for the Changes
Currently, corporate debtors in chapter 11 that are properly soliciting votes on a plan of reorganization are not subject to securities laws and regulations governing solicitation of acceptance or rejection of a plan or the offer, issuance, sale, or purchase of securities; they are exempt from the registration and disclosure requirements and protected from strict liability under section 5 of the 1933 Act. [ FN: 11 U.S.C. §1145(a) (establishing that section 5 of the 1933 Act and parallel state laws do not apply to the offer of a security of debtor); Id. §1125(d) (exempting disclosure statements from securities law requirements); Id. §1125(e) (to effectuate subsection (d), precluding liability for anti-fraud provisions relating to disclosure requirements).] Congress specifically created this exemption and safe harbor because the circumstances precipitating a chapter 11 reorganization warrant less cumbersome procedural requirements and a somewhat more flexible standard than otherwise would be imposed. [ FN: S. Rep. 989, 95th Cong. 2d Sess., 120-121 (1978), H.R. Rep. No. 595, 95th Cong., 1st Sess, 408-409 (1977). See generally Stephen H. Case & Mitchell A. Harwood, "Current Issues in Prepackaged chapter 11 Plans of Reorganization and Using the Federal Declaratory Judgment Act for Instant Reorganizations, " 1991 Surv. of Am. Law 75, 105.] The Bankruptcy Code requires a disclosure statement in place of a prospectus and employs an"adequate disclosure" requirement as defined in section 1125(a). [ FN: 11 U.S.C. §1125(a)(1) provides that " ‘adequate information means information of a kind, and in sufficient detail as far as is reasonably practical in light of the nature and history of the debtor and the condition of the debtor s books and records, that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the plan, but adequate information need not include such information about any other possible or proposed plan. "]
Unlike solicitation in the course of a chapter 11 case, prepetition solicitation for a plan does not fit the bankruptcy exemption from the securities law registration and disclosure requirements, [ FN: Section 1145(a) only applies to offer of securities of the debtor , defined in the Code as a party "concerning which a case under this title has been commenced . " 11 U.S.C. §101(13). Section 1125 appears to protect only postpetition disclosure, although some commentators do not agree with this interpretation. See, e.g., Stephen H. Case & Mitchell A. Harwood, "Current Issues in Prepackaged chapter 11 Plans of Reorganization and Using the Federal Declaratory Judgment Act for Instant Reorganizations, " 1991 Surv. of Am. Law 75, 184.] nor does it always fit an exemption under the securities laws themselves. [ FN: See, e.g., Securities Act of 1933, §3(a)(9), 15 U.S.C. §77c(a)(9) (exempting certain exchange offers from Section 5 registration requirements); Id. §4(2), 15 U.S.C. §77d(2) (exempting private exchanges).] Thus, a corporation soliciting votes for a plan prepetition currently must comply with applicable registration and disclosure requirements under the Securities Act of 1933, the Securities Exchange Act of 1934, and state securities and blue sky laws. [ FN: See 11 U.S.C. §1126(b) (prepetition solicitations are valid only if in accordance with applicable nonbankruptcy law, if such law exists). See Neal Batson & Matthew W. Levin, "Prepackaged and Pre-Negotiated Plans of Reorganization, " submitted in connection with New York University School of Law 21st Annual Workshop on Bankruptcy and Business Organizations, 904 (1995) ( "biggest disadvantage of the prepackaged plan process . . . is that the debtor may need to comply with two separate sets of disclosure laws relative to its prepackaged plan: nonbankruptcy law and bankruptcy law. . . nonbankruptcy disclosure requirements oftentimes can be exceedingly arcane and complex. ").] The bankruptcy system imposes additional restraints on prepetition solicitation, which, if not satisfied, can result in invalidation of votes and the need to re-disclose and re-solicit. [ FN: Rule 3018(b) provides that "a holder [of record] of a claim or interest who has accepted or rejected a plan before the commencement of the case under the Code shall not be deemed to have accepted or rejected the plan if the court finds after notice and hearing that the plan was not transmitted to substantially all creditors and equity security holders of the same class, that an unreasonably short time was prescribed for such creditors and equity security holders to accept or reject the plan, or that the solicitation was not in compliance with section 1126(b) of the Code. " ] The lack of exemption for prepetition solicitation can be a significant impediment, which might lead a company to initiate a traditional chapter 11 case instead, or to pursue a "pre-negotiated plan," in which most of the negotiation --but not the solicitation -- takes place prior to filing.
This proposal recommends that the Bankruptcy Code disclosure requirements, which were designed with a financially-troubled company in mind, should be equally applicable to pre-filing solicitations in lieu of otherwise applicable requirements. In so doing, the proposal would eliminate the dual-track governance of disclosure for prepackaged chapter 11 plans ofreorganization and would provide a clear set of rules and standards for prepacks if the debtor fit the requirements of the exemption. This recommendation seems to comport the view of some commentators who believe that prepetition solicitations already are protected by the section 1125(e) safe harbor for potential violations of the securities laws. [ FN: Stephen H. Case & Mitchell A. Harwood, "Current Issues in Prepackaged chapter 11 Plans of Reorganization and Using the Federal Declaratory Judgment Act for Instant Reorganizations, " 1991 Surv. of Am. Law 75, 184; Richard M. Cieri, David P. Porter, Scott J. Davido & Heather Lennox, "Safe Harbor in Unchartered Waters -- Securities Law Exemptions Under Section 1125(e) of the Bankruptcy Code, " 51 Bus. Law. 379, 409 (1996).]
Prepetition solicitation would not be without significant constraints: prepetition votes would be invalidated if the court ultimately determined that the plan proponent failed to meet the requisite standards. [ FN: See, e.g.,In re Colorado Springs Spring Creek Gen. Imp. Dist., 177 B.R. 684 (Bankr. D. Colo. 1995) (finding securities law deficiencies in prepetition disclosures and denying confirmation);In re Southland Corp., 124 B.R. 211 (Bankr. N.D. Tex. 1991) (finding defects in prepetition solicitation and requiring resolicitation).] The expense and delay that accompany a second disclosure and re-solicitation provide a strong incentive to make ones best efforts to comply with the applicable disclosure standards. [ FN: " The difficulties in the mechanics of the Southland solicitation illustrate that debtor's counsel must utilize extreme care to assure that disclosure is adequate and that the procedure of the solicitation cannot be attacked. " Marc S. Kirschner, Dan A. Kusnetz, Laurence Y. Solarsh, Craig S. Gatarz, "Prepackaged Bankruptcy Plans: The Deleveraging Tool of the ‘90s in the Wake of OID and Tax Concerns, " 21 Seton Hall L. Rev. 643, 674 (1991).] In addition, although the adequacy of disclosure would not be governed by nonbankruptcy law, federal or state agencies regulating securities could be heard on the issue of whether the plan proponent provided adequate information in the context of the situation. [ FN: 11 U.S.C. §1125(d).]
This proposal would have a very limited application overall. If a prepack were being considered as an alternative to an out-of-court workout, a corporation could not rely on the proposed extension of the exemption for its solicitation. Under this proposal, the exemption would be available to those corporations that solicit directly in connection with a future plan of reorganization under Title 11 and file a bankruptcy petition within 120 days after commencing solicitation. The proposed procedure would be available only for those companies that are subject to and in compliance with the periodic reporting requirements of the Securities Exchange Act of 1934. [ FN: 15 U.S.C. §78m. Periodic reporting requirements apply to companies registered on any national securities exchange under section 12(b) of the ‘34 Act and to companies with more than five hundred shareholders of record in any class of securities and with more than $10 million in assets. 15 U.S.C. §78m, 781(b). See also 17 C.F.R. S 240.12g - 1 (1996) (raising asset threshold to $10 million). See generally Stephen J. Choi, "Company Registration: Toward a Status-Based Antifraud Regime, " 64 U. Chicago L. Rev. 567 (1997) (describing current system and presenting arguments for status - based antifraud regime).] This would provide extra assurance that public investors have ample information about a company soliciting prepetition for a prepack in accordance with the bankruptcy lawstandards. [ FN: The types of transactions that may be involved for prepacks of very small companies not subject to the ‘34 Act periodic reporting requirements may be eligible for other registration exemptions under nonbankruptcy law, such as that for private placements. See, e.g., 15 U.S.C. §77d(2); 17 C.F.R. 230.144A.]
A company also would be protected by this exemption if it solicited in good faith but did not file a chapter 11 petition because it failed to get the requisite votes for confirmation. This is consistent with the approach already taken by the Bankruptcy Code rules and standards; if a debtor solicits votes after the court approves its disclosure statement but cannot get a plan confirmed, for example, the debtor is not liable for failing to register with the SEC in connection with the solicitation. The ultimate success or failure of the solicitation should not determine the applicable standards. Otherwise, any corporation seeking to complete a prepack would have to comply with otherwise applicable registration and prospectus requirements just in case it did not obtain the requisite votes to go forward and file a prepackaged plan, which would nullify the proposed prepetition exemption. However, the exemption would not protect a corporation from liability under the securities laws if the corporation used the solicitations for another type of workout, such as an exchange offer.
Some might be concerned that businesses could take advantage of the ability to solicit plan votes without complying with the specific requirements of the securities laws. To resolve such concerns, the Working Group sought to keep the exemption narrow in time and scope. For this reason, any company ambivalent about filing for bankruptcy and concerned about adverse publicity is not likely to avail itself of this option. Misuse of the exemption in contravention of the securities laws would be treated like any other violation of the securities laws.
Others recommended a longer prepetition period for solicitation under the bankruptcy standards. After discussing various recommendations, however, the Working Group concluded that 120 days was sufficient.
Working Group Proposal #11: Prepackaged Plans of Reorganization
The Bankruptcy Code expressly contemplates that a company may make disclosures and begin the solicitation process for a plan prior to the filing of a bankruptcy case. Section 1125(b), which governs "Postpetition Solicitation and Disclosure," authorizes solicitation postpetition only after the court has approved a disclosure statement. [ FN: 11 U.S.C. §1125(b) provides that "[a]n acceptance or rejection of a plan may not be solicited after the commencement of the case under this title from a holder of a claim or interest with respect to such claim or interest unless, at the time of or before such solicitation, there is transmitted to such holder the plan or a summary of the plan, and a written disclosure statement approved, after notice and a hearing, by the court as containing adequate information. "] Literally interpreted, this provision precludes the postpetition continuation or completion of the solicitation process in a prepack.
Section 1125(b) should be amended to provide that the acceptance or rejection of a plan may be solicited after the commencement of a case under Title 11 but before the court approves a written disclosure statement from those classes that were solicited for the plan prior to the filing of the bankruptcy petition.
Reasons For the Change
According to the Working Group discussion participants, the inability to solicit postpetition in a prepack enables a few dissenting creditors to exercise undue leverage and derail a prepack by filing an involuntary petition in the venue of their choosing before the solicitation is complete. [ FN: See Nicholas P. Saggese & Alesia Ranney-Marinelli, A Practical Guide to Out-of-Court Restructurings and Prepackaged Plans of Reorganization, §4.04[C], at 4-83 (2d Ed. 1993) (Code offers no clear guidance as to status of plan once petition is filed, which might be precipitated by dissatisfied creditors filing involuntary petition to derail plan).] To promote out-of-court collective negotiation and to reduce the leverage of those who have nothing to lose by causing delay, the proposed amendment would minimize the incentives for dissenting creditors to derail a plan by permitting the plan proponent to continue its solicitation postpetition.
However, although this proposal would permit the solicitation process to continue, it does not speak to the adequacy of the disclosure or the validity of the process of solicitation; like prepetition solicitation under the current rules, votes obtained in this interim postpetition period would be subject to later disqualification if the court ultimately did not approve the debtors disclosures, and therefore the plan proponent would bear the risk of potential retroactive invalidation of these votes. Moreover, this proposal is narrow in scope: the plan proponent couldcontinue to solicit only those classes that were solicited for the plan prepetition. [ FN: Rule 3018 of the Federal Rules of Bankruptcy Procedure already requires that prepetition solicitation be made to substantially all members of the class.] A broader rule would enable the debtor to solicit one class prepetition as a means to avoid the general rule against solicitation prior to court approval of the disclosure statement, which is not the intent of this proposal.
Completely restricting postpetition solicitation in a prepack may not serve any valid function to the extent that the debtor already has made disclosures and solicited votes prepetition. Indeed, some practitioners may perceive this proposed amendment to be merely a clarification of what they already are entitled to do; depending on how one defines a "solicitation" event, some believe that solicitation that is commenced but not completed upon the filing of the petition can be classified as prepetition solicitation and thus does not run afoul of the restriction in section 1125(b). [ FN: See Nicholas P. Saggese & Alesia Ranney-Marinelli, A Practical Guide to Out-of-Court Restructurings and Prepackaged Plans of Reorganization, §4.04[C], at 4-86 (2d Ed. 1993) (explaining alternative views of section 1125(b) restriction as applied to prepacks). Richard M. Cieri, David P. Porter, Scott J. Davido & Heather Lennox, "Safe Harbor in Unchartered Waters -- Securities Law Exemptions Under Section 1125(e) of the Bankruptcy Code, " 51 Bus. Law. 379, n. 50 (1996) (noting impractibility of applying section 1125(b) to prepack solicitations).] The Working Group does not take a position on this interpretation.
This proposed change would be applicable in only a narrow set of circumstances and would not authorize a plan proponent to solicit the votes of creditors or equity holders in the absence of prepetition solicitation under section 1126(b).
Some people advocate a much broader change: they recommend that the Code enable all plan proponents to solicit prior to disclosure statement approval, or alternatively that the Code be amended to abolish the disclosure statement requirement. This proposal only addresses the narrow issue of postpetition solicitation in prepacks to promote the efficient use of pre-bankruptcy negotiations and solicitation.
Conversely, some might argue that this amendment would undermine the disclosure requirements because courts may be less inclined to invalidate votes after the fact on the basis of minor errors in the disclosure statement. Permitting the conditional approval of disclosure statements might be one way to ameliorate this concern. [ FN: Since 1994, the Bankruptcy Code has authorized the solicitation of votes following conditional approval of the disclosure statement in when the debtor has elected to be treated as a small business . See 11 U.S.C. §1125(f).]
Working Group Proposal #12: Prepackaged Plans of Reorganization
Section 341 Meeting of Creditors
In a prepackaged bankruptcy case, a business comes into the bankruptcy system ready to confirm a plan. Rather than negotiating under the protection of chapter 11, the debtor files a petition with most of the difficult negotiation already completed. Conceivably, the majority of the creditors have accepted the proposed plan, and the debtor merely needs one or more of the legal mechanisms that Title 11 provides to effectuate the agreement, perhaps to bind minority dissenters or to wipe out old equity. In such a case, the section 341 meeting of creditors, which currently is mandatory, can delay confirmation significantly without fulfilling its intended function.
Section 341 should provide that upon the motion of any party in interest in a chapter 11 case that entails a prepackaged plan of reorganization, the court may waive the requirement that the U.S. trustee convene a meeting of creditors.
Reasons for the Change
Section 341 of the Bankruptcy Code requires the U.S. trustee to convene a meeting of creditors in every bankruptcy case. [ FN: 11 U.S.C. §341(a) provides that "[w]ithin a reasonable time after the order for relief in a case under this title, the United States Trustee shall convene and preside at a meeting of creditors. "] The Federal Rules of Bankruptcy Procedure establish that the meeting must be held within twenty to forty days after the court enters an order for relief. [ FN: Federal Rule of Bankruptcy Procedure 2003 requires twenty days notice for section 341 meetings and Federal Rule of Bankruptcy Procedure 2004 provides that the meeting shall be called no less than 20 days and no more than 40 days after the order for relief.] In theory, this meeting provides creditors with a meaningful opportunity to examine the debtor and obtain important information. However, when parties have negotiated and voted on the plan before the debtor even filed a bankruptcy petition, creditors are not likely to receive any significant benefit from the section 341 meeting. In some prepacks, the U.S. trustee convenes section 341 meetings only to comply with section 341. In other prepacks, the U.S. trustee does not hold section 341 meetings, which technically violates section 341.
Holding the section 341 meeting in this context entails an unnecessary and costly time delay. In a case that otherwise could be confirmed in a day or two, the notice and scheduling requirements for a section 341 meeting can forestall confirmation for at least twenty days. One participant at the Working Group session explained that the time delay is particularly crucial in a case with transnational implications because of the risk that local authorities in other countries will seize assets of the estate if the case is not resolved on an expedited basis.
Although the efficacy of the section 341 meeting has been questioned in many contexts, this proposal addresses only the narrow situation of a prepack. This proposal would preserve the courts discretion to deny a request for a waiver of the meeting.
Some might argue that the section 341 meeting serves a structural function and thus should
not be subject to waiver, even with court approval.