Working Group Proposals #10: 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 that is commenced within 120 days prior to filing a chapter 11 petition. 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. [ Specific recommended draft language that would effectuate these suggested changes is forthcoming and will be disseminated when available.]
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 of reorganization and would provide a clear set of rules and standards for prepacks if the debtor fitthe 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. 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. Several participants in the Working Group discussion suggested that the prepetition exemption should apply to only to solicitations bearing a statement referring to the intended chapter 11 plan.
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 notobtain 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.