Last month, Judge Laura Grandy, a bankruptcy judge in the Southern District of Illinois, entered confirmation opinion in STC, Inc.’s Chapter 11 case. The opinion is noteworthy for 2 reasons. First, it amounts to an excellent treatise on the Section 1129 confirmation requirements. Second, I’m honored that Judge Grandy cited in her opinion the American Bankruptcy Institute Journal article that I co-wrote with Richard Gaudet of HDH Advisors: “Zero Times Something is Still Zero: Adapting Till to Unsecured Creditors.” We’ll hit the high points, but we recommend that you read the opinion for yourself.
STC, Inc. is a business in McLeansboro, Illinois that designs, manufactures, and tests custom transformers, specialty electronics, and magnetic components used in various industries, including the aerospace, military, and marine industries. In particular, STC designs and manufactures components for the “EMTRAC System,” a public safety system that improves response times and reduces traffic accidents for first responders. In 2010, GTT, a long-time competitor of STC, sued STC and other defendants in a patent infringement suit in Minnesota on account of STC’s production of the EMTRAC System.
(this EMTRAC video is for geeks only)
Ultimately, the jury sided with GTT. The total award against STC, inclusive of damages for willful infringement and pre-judgment interest, was a little over $8.9 million. Unable to stay enforcement of the judgment on appeal in the Federal Circuit, STC filed its Chapter 11 bankruptcy case. Following the resolution of all issues on appeal, an unsuccessful petition for certiorari by STC, and direction from the Court of Appeals, the District Court reduced the judgment against STC to around $6.4 million. With those issues resolved, confirmation of STC’s Chapter 11 plan could proceed.
STC’s “Creditor Trust” plan structure is rather interesting. The Trustee for the Creditor Trust was to receive 99% of STC’s equity. STC’s sole-shareholder, Mr. Cross, was to receive the remaining 1% in exchange for a $58,815 payment. With that structure in place, STC was to make an initial $800,00 payment to the Creditor Trust. The Trustee would then allocate that payment over the various classes, including GTT’s class. Going forward, GTT would receive 9 annual payments out of the STC-funded Creditor Trust of $752,172 each (consisting of principal and interest at 3%). With each timely payment, Mr. Cross would receive 11% of the equity in STC from the Trust (i.e., 9 times 11% = 99%). If STC missed a payment, then the 11% would go to GTT, instead.
Not surprisingly, GTT was the lone hold-out and objected on a host of grounds, including on Till v. SCS Credit Corp, 541 U.S. 465 (2004) grounds.
Various Non-Till Confirmation Issues
GTT objected on non-Till grounds: (i) class gerrymandering; (ii) artificial impairment and lack of of good faith; and (iii) feasibility.
With respect to gerrymandering, Judge Grandy evaluated whether STC had separated Class 3 (general unsecured claims) and Class 4 (GTT’s unsecured claim) to engineer an accepting impaired class in violation of § 1122. As a reminder, § 1122 doesn’t prohibit separate classification, per se. Rather, it merely requires that claims or interests in a particular class be “substantially similar” to each other. Ultimately, Judge Grandy respected STC’s classification according to the Seventh Circuit’s 3-part test which emphasizes whether (i) the claimants have “significantly different legal rights”; (ii) the debtor has a “legitimate business reason” for the separate classification; and (iii) the claimants have “sufficiently different interests” in the plan. STC passed the test.
With respect to artificial impairment, Judge Grandy evaluated whether STC (who had adequate funds on hand to pay Class 3 unsecured claims in full) had “artificially impaired” Class 3 by only proposing to pay Class 3 claimants 75% of their claims. Judge Grandy held that there was no artificial impairment. Her analysis focused on “good faith” under § 1129(a)(3). That is, she found that there was a reasonable likelihood that STC’s proposed treatment would “achieve a result consistent with the objectives and purposes of the Bankruptcy Code.”
With respect to feasibility, Judge Grandy evaluated whether the plan was feasible under § 1129(a)(11) such that confirmation would “not likely be followed by liquidation, or the need for further financial reorganization”? In pertinent part, she reminds us that the debtor only has the burden of establishing a “reasonable assurance of commercial viability” (as opposed to showing that the plan is “guaranteed to succeed”). The feasibility question in STC came down to a “battle of experts.” STC’s expert came out on top, with Judge Grandy viewing very favorably the plan’s likelihood of success. Although the feasibility analysis is very fact-intensive, we encourage you to read it as a reminder of the plan proponent’s feasibility burden and the importance of evidence.
Till-Related Confirmation Issues
We’ve blogged about Till a number of times before and, thus, will not bear down too hard in this post. Instead, we’ll focus on the most interesting part of STC as it relates to Till. That is, STC is interesting because it has Judge Grandy applying Till‘s formula approach to an unsecured claim rather than to a secured claim. What is the appropriate rate of interest on an unsecured claim? Judge Grandy explains that, in “determining the risk on an unsecured claim, the Court believes that it is necessary to consider what GTT would recover in a chapter 7 liquidation proceeding.”
In a nutshell, that was the gist of Richard’s and my January 2016 Till article. And Judge Grandy was nice enough to cite our article. Specifically, we concluded in our article that the “best interests of creditors” test (i.e., the liquidation analysis) is the “starting point for determining whether an unsecured creditor is entitled to risk-based compensation under Till.” We then concluded that, “if the “liquidation analysis projects a dividend for an unsecured creditor, then the Till rate should compensate the creditor for the time value of money and the risk of default.” However, “if the liquidation analysis does not project a dividend for an unsecured creditor, then the Till rate should compensate the creditor for the time value of money, only, without compensation for the risk of default.”
Humbly, I submit that Judge Grandy’s analysis illustrates our suggested approach. First, she points out that STC’s “undisputed liquidation value” is around $1.7 million. In other words, under the “best interests of creditors test,” GTT would, if STC were liquidated, receive $1.7 million (26% of its claim). Therefore, (i) the liquidation analysis in STC projected a dividend for GTT and, thus, (ii) GTT was entitled, under Till, to be compensated for the time value of money and the risk of default on that dividend. Indeed, Judge Grandy concludes that “the only risk that GTT has is the liquidation value of $1.7 million.”
Concluding that GTT was entitled to risk compensation, too, Judge Grandy then considers the Till risk-adjustment factors. Those factors include the circumstances of the estate, nature of the security, duration and feasibility of the plan, etc. In particular, Judge Grandy emphasizes that GTT was projected to receive, in the first plan year alone, “almost the entire liquidation value.” She also emphasizes that GTT was to receive 3% interest on its entire $9 million claim, not just the $1.7 million liquidation value that was at risk. She also concluded that GTT’s claim was, “effectively,” secured by 99% of STC’s equity via the Creditor Trust. Finally, she incorporated her favorable findings on feasibility and the like. In other words, the plan more than compensated GTT.
With those considerations in mind, Judge Grandy concluded that (i) the risk of nonpayment was “minimal”; (ii) the rate “was beyond any efficient market rate or prime rate”; (iii) GTT was to receive interest on the portion of its claim that was at risk (i.e., the $1.7 million) and the “portion of its claim that is not at risk”; and (iv) GTT would even receive “interest on interest” (i.e., 3% interest on its over $1.3 million in pre-petition judgment interest). Thus, Judge Grandy concluded that the “interest rate of 3% adequately compensates GTT for the ‘time value of money’ component, as well as the risk component.”
When we submitted our ABI article, there was a only small handful of cases, at most, wherein bankruptcy courts had applied Till to unsecured claims. Not only does Judge Grandy’s STC opinion provide an excellent Section 1129 treatise on the most common confirmation objections, but it also provides additional precedent for the application of Till to unsecured claims. And, if we do so say ourselves, Judge Grandy’s emphasis on the liquidation analysis is dead-on. Finally, it’s also nice to see Richard’s (and other experts’) language to describe the elements of an interest rate gain make it into a legal opinion.