Back in April, AOG Entertainment and 40+ of its favorite affiliates (collectively, “Core“) filed Chapter 11 cases in the Southern District of New York. Those cases are best known as encompassing the production companies for the “American Idol” and “So You Think You Can Dance” television shows. Recently, Law360 reported that “American Idol Producer Cleared for Exit From Chapter 11.” We can’t afford Law360 so we dug-up the pleadings. Ultimately, Judge Bernstein confirmed Core’s amend Chapter 11 plan after the parties settled the last objection.
However, the objection raised 2 confirmation issues that are worth highlighting:
(1) To which plan classes does the “absolute priority rule” apply?
(2) Who has standing to make plan objections?
Core was set for a confirmation hearing on its amended plan with all objections resolved but one: Simon Fuller’s objection. Not to be confused with Simon Cowell (also of American Idol fame), Simon Fuller created “American Idol” and “So You Think You Dance.” Over the years, Fuller had served in various high-profile creator, producer, and consulting roles for those shows. In the bankruptcy, Fuller claimed that 19 Entertainment Limited, one of the debtors, owed him at least $10 million under a consulting agreement through which he continued to serve those shows and which provided him lucrative profit-sharing entitlements. Core rejected the consulting agreement under § 365.
Unhappy with the proposed plan, Fuller engaged McDermott Will & Emery to contest confirmation. He sought discovery under Rule 2004, sought to extend certain challenge deadlines in the Debtors’ DIP Financing Order, and objected to the plan on various grounds, including the ground that it violated the absolute priority rule (the “APR“). His theory: Discovery would reveal info that would permit him to challenge certain pre-petition loans t0 19 Entertainment. In turn, a successful challenge of those loans would defeat the plan’s proposal to distribute equity in 19 Entertainment to those pre-petition lenders. Fuller characterized the challenge as an APR challenge. Frankly, the objection is rather convoluted. In plain English, “confirmation would be premature because my investigation might reveal plan defects.”
Judge Bernstein denied Fuller’s 2004 motion and his motion to extend the DIP Financing Order’s challenge deadline, mainly because Fuller had “sat on his hands” in pursuing that relief. Additionally, Judge Bernstein questioned whether Fuller’s investigation would turn-up anything, particularly given that the Unsecured Creditors Committee had passed on those issues after investigating them.
Core filed a 66 page brief in support of confirmation and, in the process, addressed Fuller’s confirmation objection, both as to mootness and the APR. With respect to mootness, Core argued that Judge Bernstein’s denial of the 2004 motion mooted much of Fuller’s objection. Nevertheless, Core still addressed the absolute priority rule issue.
Overview of the Absolute Priority Rule
As we’ve blogged before, the absolute priority rule is relevant in Chapter 11 cases, like the Core cases, when the debtor attempts to “cram down” a Chapter 11 plan over the objection of dissenting unsecured creditors. If the debtor satisfies all of the other confirmation requirements, then a debtor may cram down by satisfying two additional requirements: (1) the plan must not discriminate unfairly against the objecting class of creditors and (2) the plan must be “fair and equitable” under 11 U.S.C. § 1129(b)(1).
To be fair and equitable, a plan must satisfy the APR, as codified in § 1129(b)(2)(B)(ii):
With respect to a class of unsecured claims—the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property…
Dating back to the 19th century, the APR prevents senior creditors and equity holders from imposing unfair terms on unsecured creditors. The case of In re Arnold, 471 B.R. 578 (Bankr. C.D. Cal. 2012) provides a treatise-worthy discussion of the APR’s history in bankruptcy.
Simply put, the APR requires that a dissenting class of unsecured creditors be provided for in full before any junior class can receive or retain any property under a plan.
Absolute Priority Rule Reminders
Again, it appears that the parties settled Fuller’s objection. Therefore, Judge Bernstein’s 58 page confirmation order did not need to address it.
However, Core’s brief raises 2 APR issues that are worth noting.
Issue 1: To which plan classes does the absolute priority rule apply?
Core submitted that it is “well-settled” that the § 1129(b) cramdown provisions “do not apply to impaired classes of claims or interests that have voted to accept a plan.” First, Core cites 11 U.S.C. § 1129(b)(1). That subsection provides that the fair and equitable and unfair discrimination requirements only apply “with respect to each class of claims or interests that is impaired under, and has not accepted, the Plan.” Second, they point to In re Adelphia Commc’ns Corp., 544 F.3d 420, 426 (2d Cir. 2008).
In that case, the Second Circuit held that a “plan need not satisfy the Absolute Priority Rule so long as any class adversely affected by the variation accepts the plan.” Finally, Core relies on Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 207 (1988). In that case, the Supreme Court explained that it’s “up to the creditors . . . to accept or reject a reorganization plan which fails to provide them adequate protection or fails to honor the absolute priority rule, 11 U.S.C. § 1126.”
Because Fuller’s claim was calculated in Class 5 and Class 5, among other classes, voted “overwhelmingly” to accept the plan (97.54% in amount and 98.61% in number), the APR did not apply to Fuller’s Class 5. Therefore, the plan did not violate the APR as to Class 5.
The reminder: The APR is only a valid objection as to an impaired, rejecting class.
Issue 2: Who has standing to make plan objections?
According to Core, the only classes to which cramdown applied were Class 7 (subordinated claims) and Class 8 (equity interests). Cramdown applied to those classes because creditors or interest holders in those classes would receive no distributions under the plan and, thus, were deemed to reject it. However, Core argued that Fuller did not hold a claim in either of those classes and, thus, had “no standing to object to treatment provided to such classes.”
In Quigley, the court held that a party cannot “object to the Plan based on how it affects the rights of third parties” and “[i]ssues relating to classification, treatment, solicitation and voting come immediately to mind” as issues that may be raised only by the affected creditors. More directly, the court held in Manville that “no party may successfully prevent the confirmation of a plan by raising the rights of third parties who do not object to confirmation.”
The reminder: A creditor only has standing to raise confirmation objections that impact its rights.
At first glance, Core’s analysis and citations appear sound:
1. The absolute priority rule does not apply to an impaired class that has voted to accept a plan.
2. A creditor objecting to confirmation is limited to confirmation objections that impact its rights or objections already raised by affected creditors.
Nevertheless, I’ll probably ask my colleague Tom to go behind the debtors and check their work on these 2 issues.
On the one hand, these are debtor-friendly rules. Therefore, as a debtor’s lawyer, I should hope that they’re correct. On the other hand, I’m not so sure about the second rule. If it’s true, then does that mean that the United States Trustee, for example, can’t raise the absolute priority rule on behalf of a class of creditors who rejected, but failed to object? I tend to think that any party-in-interest can raise a valid confirmation objection. Is there a different rule for creditors versus gatekeepers like the UST? We’ll let you know…