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).]
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