Chapter 11
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:
Prepetition Solicitation
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 Recommendation
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 one’s
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.
Competing Considerations
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.
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