This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In this post, we’ll cover the Commission’s recommendations regarding “Default Plan Treatment Provisions” in Section E.1 of the Report.

The Commission addresses 2 common plan provisions: (i) those that provide that the failure of a class to vote on a plan  is a deemed acceptance and (ii) those that provide for the deemed assumption/rejection of executory contracts that are not otherwise expressly assumed/rejected before confirmation.

On the one hand, those provisions provide certainty where there might otherwise be uncertainty. On the other hand, it is not clear whether they’re permissible and/or or might have undesired consequences.

Deemed Plan Acceptance Provisions

Section 1129(a)(8) of the Bankruptcy Code conditions plan confirmation on each class accepting the plan or remaining unimpaired. Section 1129(a)(10) and Section 1129(b) provide for “cramdown” (i.e., confirming a plan over the objection of a class of dissenting creditors) if, among other things, at least one impaired class of claims has accepted the plan. With those voting requirements in mind, it’s not unusual for a plan to include a provision that deems a failure to vote (for whatever reason) as an acceptance.

However, deemed acceptance arguably conflicts with Section 1126(c) and Rule 3018(c), each of which appears to tie “acceptance” to an affirmative act by a creditor. In particular, Rule 3018(c) provides that “acceptance or rejection [of the plan] shall be in writing, identify the plan or plans accepted or rejected, be signed by the creditor or equity security holder or an authorized agent, and conform to the appropriate Official Form.” [We note that the affirmative act requirement is not as clear in Section 1126(c) as it is in Rule 3018(c) and that Rule 3018(c) cannot trump Section 1126(c) to the extent that Congress did not intend such a requirement in Section 1126(c).]

The Commission points out that courts are split on “deemed acceptance” provisions. Apparently, the Second, Third, and Tenth Circuits follow the Tenth Circuit’s decision in In re Ruti-Sweetwater, Inc., 836 F.2d 1263 (10th Cir. 1988). In that case, the Tenth Circuit held that inaction can amount to a deemed acceptance. At least in part, Ruti-Sweetwater was based on the policy argument that the alternative would be to permit creditors to “sit idly by” and then attack a plan later (thus rendering voting and objection deadlines meaningless). However, other courts have rejected Ruti-Sweetwater, including the Fourth Circuit, the Ninth Circuit B.A.P., and various bankruptcy courts. The gist of those cases is that Congress knew how to provide for deemed acceptance when it wanted to, as shown by the Section 1126(e) (which deals with deemed acceptance by unimpaired classes), but did not expressly provide for it for impaired voting classes.

The Commission focused on the various reasons that creditors do not vote and determined that it is inappropriate to have a bright-line rule that deems acceptance in all such circumstances. Additionally, the Commission departed from its usual “case-by-case” approach to Chapter 11 problems, finding that a case-by-case approach to deemed acceptance would be impracticable.

Ultimately, the Commission determined that the better rule is to prohibit “deemed acceptance” if an impaired class fails to vote, particularly in light of the Commission’s recommendation to eliminate cramdown’s “accepting impaired class” requirement and the Commission’s introduction of “redemption option value” in the cramdown analysis.

[We’ll address the former in a later post; we addressed redemption option value in a series of posts which started here.]

The Commission’s recommendation likely gets it right. However, as an aside, it’s useful to consider the purpose of the Code’s voting provisions for Chapter 11 plans–something that the Commission did not consider specifically. Arguably, the purpose of the Chapter 11 voting provisions is to facilitate a binding contract between a debtor and its creditors.

Therefore, if one views the Chapter 11 plan process as a contractual process, and moves past the hyper-technical Code provisions, the notion of “silence as acceptance” arguably takes on a different light. Generally under state law, silence is not presumed to be an acceptance. However, in limited circumstances, silence can amount to an acceptance, particularly when performance is accepted from the offeror. Therefore, at what point, if any, should a creditor’s silence in the confirmation process constitute an acceptance? Upon the expiration of the voting deadline? Upon confirmation? On the plan effective date? Upon substantial consummation of the plan?

Regardless of the answer, one could argue that the import of silence on the question of contract formation under state law should inform the import of silence in the plan confirmation context. To that point, the argument that “Congress knew how to codify deemed acceptance, but didn’t codify so for impaired claims” is in line with the state law starting presumption that silence is generally not deemed an acceptance. The Commission didn’t discuss it that way, but it rejected, as impracticable, a mechanism whereby courts would answer that question of fact on a creditor by creditor basis.

Deemed Acceptance/Rejection of Executory Contracts

The Commission points out that similar concerns apply to executory contracts and unexpired leases that are not expressly assumed, assigned, or rejected before confirmation. Under Section 365(d)(2), the debtor has through and including confirmation to assume, assign, or reject.  However, unlike in Chapter 7, the Code is not clear on what happens to contracts (other than nonresidential leases) that are not assumed, assigned, or rejected by confirmation in a Chapter 11. Therefore, many plans, including our plans, routinely provide for deemed assumption or rejection of executory contracts that are not otherwise expressly addressed. It appears that the Commission has no issues with such provisions, per se.

Rather, the issue for the Commission is the impact of silence–that is to say, what is the impact of a failure to assume, assign, or reject at or before confirmation? The Commission points to 3 “default” rules for addressing that silence: (i) treating the silence as a deemed rejection; (2) treating the silence as a deemed assumption; or (iii) invoking the “ride through” doctrine. The Commission notes that either default rule could “produce significant unintended consequences for the debtor or the counterparty.” For example, a deemed rejection could inadvertently terminate debtor and non-debtor rights, and cause the debtor to lose access to important services, goods, or receivables.

Alternatively, under the “ride-through” doctrine, “executory contracts that are neither affirmatively assumed or rejected by the debtor under § 365, pass through bankruptcy unaffected.” The Commission points out that many courts have endorsed that doctrine on the theory that it’s consistent with (i) Section 365(a) (the debtor “may assume or reject”) and (ii) Section 1141(b) (property re-vests in the debtor upon confirmation).

Although the ride-through doctrine is not expressly authorized by the Code, and although it, too, can create unexpected consequences for debtors and non-debtors alike, the Commission ultimately concluded that the ride-through doctrine is the better default rule for executory contracts, as it best preserves rights, it permits post-confirmation negotiations, and it’s consistent with the Code’s treatment of non-executory contracts.

The Commission also recommends, though, that a plan proponent have the ability to alter that default ride-through rule with an express plan provision.

In our next post, we’ll address Section E.2 regarding the use of exculpatory clauses in Chapter 11 plans.