(Indian guest workers protesting alleged human trafficking by Signal International)
Last week, Judge Walrath, a Delaware bankruptcy judge, entered her order confirming the Plan of Liquidation in the Signal International, Inc. Chapter 11. For the backstory on Signal’s July 12, 2015 filing, the Morris James Delaware Business Bankruptcy Report has you covered. The confirmation is newsworthy and the order is significant in its own right, but I went straight to the “good stuff”: Signal’s imposing 73 page memorandum (i.e., “Section 1129 Manifesto”) in support of plan confirmation. I must admit that it took a couple of tries to finish it all. However, near the end of the brief, the following quote jumped out:
“As section 1129(a)(7) makes clear, the liquidation analysis applies only to individual holders of impaired claims or interests that do not accept the plan.”
That might be a subtle or forgotten point for some. It certainly got us thinking about the effect of § 1129(a)(7) on the formulation of the liquidation analysis. But let’s back-up.
Overview of the “Best Interests of Creditors Test”
Section § 1129(a)(7) is commonly referred to as the “best interests of creditors test.” It requires that, for a given class of claims, each holder of a claim or interest in such class must either (i) accept the plan or (ii) “receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain” in a hypothetical Chapter 7 liquidation (i.e., get at least what it’d get in a Chapter 7 liquidation, with interest on any payment stream).
As Collier describes it, § 1129(a)(7) provides “an individual guaranty to each creditor or interest holder that it will receive at least as much in reorganization as it would in liquidation.”
Three Potentially Subtle Points About the “Best Interests” Test
With the concept in mind, we can then get particular about the application of the “best interests” test. In short, it applies to individuals holding impaired claims who do not accept the plan. Taking those requirements in reverse order, the test is satisfied as to an individual creditor if that creditor votes in favor of the plan, regardless of the amount of that creditor’s projected Chapter 7 distribution. Therefore, the test focuses on creditors who don’t consent.
Similarly, the test is not applicable to unimpaired claimants. Therefore, the test doesn’t protect those who are unimpaired under § 1124. Rather, they (who are deemed to accept the plan) are protected by having their rights unaltered by the plan. Finally, the test is applied at the individual claimant level, not the class level. Therefore, overall acceptance of a plan by a particular class will not relieve the plan proponent of satisfying the test as to an individual, hold-out creditor in that accepting class.
These points are particularly important when preparing the liquidation analysis. The liquidation analysis, which sets out the “best interests” test’s projections, is usually included as a part of the disclosure statement. The form of the liquidation analysis might be important in the situation where multiple creditors have a competing security interest in a single asset and where the liquidation analysis projects a payout from that asset to more than one of those creditors. While it’s easy to lump all payments to secured creditors into a single category, a lumped presentation or classification could be subject to a valid objection to the liquidation analysis if the individual creditors with an interest in the collateral cannot determine what they would receive in the hypothetical Chapter 7 liquidation. [Of course, a classification objection under § 1122 might join that § 1129(a)(7) objection.]
Measuring Date for the “Best Interests” Test
We can’t revisit § 1129(a)(7) without also discussing the measuring date for the “best interests” test. As Signal’s counsel reminds us:
“The measuring date for such a comparative recovery is the effective date of the proposed bankruptcy plan.”
Again, we look to § 1129(a)(7): each holder of a claim or interest must “receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date.” (emphasis added).
The term “effective date” is not defined by the Code; rather, the plan proponent defines it in the plan. Usually, the effective date is keyed to to the confirmation date, subject to the occurrence of certain conditions and often with an appeal period built-in, but not always. Therefore, the requirement that the liquidation analysis be prepared as of the “effective date” of the plan is important for 2 reasons. First, it means that the liquidation analysis is not projected as of the petition date, regardless of the amount of time that passes between the petition date and the effective date. As Collier instructs, “if an estate declines in value during the period after filing but before confirmation, creditors generally will bear that loss.” 7 Collier ¶ 1129.02[b][iv].
Second, the choice of the effective date can make a difference, especially when:
• The subject assets tend to fluctuate in value (think commodities and the like);
•The asset is likely to perish or must be sold prior to the effective date (agriculture products come to mind);
• Contractual rights are set to expire prior to the effective date.
Additionally, if there is a significant gap between the appraisal date for your key asset and the effective date, then proceed at your own risk.
See, e.g., Southern Pac. Transp. Co. v. Voluntary Purchasing Groups, 252 B.R. 373 (E.D. Tex. 2000) (cited by Collier) (“Because such matters as asset valuation and the estimation of liquidation recoveries can be drastically affected by the timing of one’s calculations, a court must ensure that all financial projections incorporated into its analysis reflect the resources that are likely to be available to a debtor on a plan’s effective date.”)
Finally, it’s helpful to see these concepts in practice. For example, click here for Signal’s Liquidation Analysis. If you’re like us, then the liquidation analysis tends to end-up being the last thing that we prepare (sometimes minutes) before filing a plan and disclosure statement. Although putting it last might be appropriate when it’s a virtual given that the plan proposal is better than the liquidation alternative, the better practice is to prepare it on the front-end and leave plenty of time to vet it. You could be stuck dragging that liquidation analysis from one critical evidentiary hearing to the next.
At a minimum, a hasty, perfunctory liquidation analysis can wreck a plan proponent’s credibility with the court, particularly when objecting parties start fly-specking it against other statements (pre- and post-petition) that the debtor has made about its assets. It can also bear on plan feasibility and Till rate determinations. Finally, a liquidation analysis and, for that matter, a plan budget are only as good as their underlying assumptions (which should be stated!).
It’s easy, especially as one becomes more experienced in Chapter 11 work or dependent on go-to plan forms, to become untethered from the Bankruptcy Code or, at least, paint in broad brush strokes in drafting plan-related documents such as the liquidation analysis. But as Signal reminds us, the liquidation analysis is designed to provide a projection of liquidation at the individual creditor level (rather than the class level) as of the effective date (rather than the petition date) for the benefit of impaired, non-consenting creditors (rather than unimpaired, consenting creditors).
And here’s an “inside tip” for the creditor lawyers out there: Nail down your understanding of a plan’s proposed effective date before confirmation. You can’t just assume that it’s tied to the confirmation date. Additionally, identify any conditions for the occurrence of the effective date. A misunderstood effective date definition can, in a cascading fashion, impede a creditor’s ability to make an informed vote for or objection to a plan.
With those takeaways, thanks to Young Conaway and Hogan Lovells for an excellent close reading of § 1129(a)(7). We can’t promise that we’re done with the Signal case. There might just be too much going on in its plan for one blog post.