Chapter 11

Working Group Proposals #11: 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 #11: Prepackaged Plans of Reorganization

Postpetition Solicitation

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.

The Recommendation

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 debtor’s 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 could continue 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 rulewould 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).

Competing Considerations

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).]