(Kate B.’s “Turkey Art”) (2015)
On Thanksgiving no less (one of my favorite days to post), we continue our series about Georgia’s Ret. Judge W. Homer Drake, Jr. I’m running out of neat Judge Drake pictures so we’ll reuse Kate’s (abstract) Thanksgiving art instead.
You can find the introductory post here. After that, we covered the first half of Judge Drake’s Top 10 Chapter 11 confirmation opinions (#10 through #6) here. And then we covered #5 here. Today we’ll just cover #4 because it’s so extensive and I need to pick up our Fincher’s turkey by 11. We’ll wrap it up with the Top 3 by month-end.
With that, here is Judge Drake’s fourth most cited and perhaps his most scholarly and extensive confirmation opinion.
I tend to confuse Homestead Partners and IPC Atlanta (#9), likely because they’re mid-90s Northern District multi-opinion cases that I consider part of Georgia’s “confirmation canon”—you can’t research plan issues in Georgia without both of them popping-up. To start, Homestead is, above all else, an absolute priority rule (“APR”) case, the rule that kicked-off this blog in 2015 and one that we’ve covered rather extensively over the years, especially on the individual debtor side.
Overview and Facts
You had a 40 year old John Christy representing the debtor and Sarah Borders and Darryl Laddin (barely in their early 30s back then) representing a creditor. The debtor owned a 300-unit apartment complex in Clarkston, Georgia (now known, I believe, as Avalon on Montreal). The 90s saw its share of apartment cases.
Homestead filed its Chapter 11 case after Condor One, its first lien creditor, had a receiver appointed. Four months in, the debtor filed a “new value” plan wherein it (i) classified Condor’s secured and deficiency claims separately and (ii) despite offering to pay the deficiency claim just pennies on the dollar, proposed that former shareholders obtain new equity for a $500,000 equity contribution. Confident that it could confirm the plan, the debtor moved to extend the exclusivity period.
While an exclusivity motion is the focus, Judge Drake’s opinion, with the heft of a mini law review article (15 dense footnotes and all), previews the Supreme Court’s LaSalle new value opinion that came down barely three years later. We briefly covered LaSalle here. While it’s easy to introduce Homestead, providing a faithful summary is a tad daunting. Thus, I’ll break it down into its parts and provide a roadmap of sorts. And then you can decide if you’d like to dive into the opinion itself.
First, Judge Drake provides an “introduction to absolute priority.” If we’re honest, we all need that each time we grapple with the APR, an intricately-worded rule that is embodied in the Code’s “fair and equitable” requirement for cramdown in § 1129(b)(2)(B)(ii). As Judge Drake explains it, the APR is a holdover pre-Code remedy designed to “prevent collusion between senior creditors and the holders of pre-bankruptcy equity interests.” The rule: Pay unsecureds in full or make sure junior claims or interests don’t receive “any property” under the plan “on account of” their junior claims or interests.
Second, Judge Drake confirms that “any property” includes stock, stock options, and the like. It wasn’t controversial, then, for him to conclude that the option offered to the former Homestead shareholders was “property” received under the plan.
Third, he skips right to the APR’s second prong: Were the Homestead stock options being offered “on account of” (read: because of) the shareholders’ former equity interests in the debtor? If so, then the plan would violate the APR. In turn, whether they were being offered because of the former interests came down to whether the stock options were “necessary” and for a “reasonable value.” In other words, what is the “true impetus” for the proposal? If it’s simply to “benefit old equity,” then there is likely no “business necessity,” the existence of which is the plan proponent’s burden to prove.
In short, “new value” will survive scrutiny under the absolute priority rule if there is a necessity for capital; the “new value” mechanism is the “most feasible” means of satisfying that necessity; and old equity is willing to pay “full value for the rights to be acquired.”
Fourth, Judge Drake turns to the exclusivity objection. Can the debtor satisfy its APR burdens (especially the “full value” burden) with exclusivity still in place? Ultimately, Judge Drake extended exclusivity but not without considering the necessity for “competitive bidding” on the new value and whether continued exclusivity is mutually exclusive with competitive bidding. To be sure, he, in foreshadowing what the Supreme Court would resolve in LaSalle, agreed that some form of competitive bidding is essential in new value plans, lest there be doubt about the market value of the new equity .
Thus, permitting existing equity to purchase new equity without “competition in the marketplace” (i.e., through an exclusive option) most likely subjects the plan proponent “to an insurmountable burden of evidentiary proof” under the APR.
But does continued exclusivity undermine or eliminate the required competition? Sarah and Darryl thought so and Judge Drake found their argument “to be well seated in reason.” “Competing plans certainly would foster alternate bids for control” of the debtor and, thus, “dispel any concerns” about the necessity and value requirements. However, after an earnest and extensive consideration, Judge Drake overruled the objection and extended exclusivity. In pertinent part, the court framed the issue in terms of whether terminating exclusivity was the sole means of guaranteeing competition.
For example, the Bjolmes auction approach is one way, among others, to inject competition into the process. Under that approach, named after Judge Queenan’s Bjolmes opinion, the court conditionally confirms a plan subject to conducting an auction of the new equity interest. While you might find impressive Judge Drake’s detailed consideration of how that approach squares with potential securities law issues, the ’33 Act, etc., the takeaway is that while that approach might have some practical hurdles, it’s still a valid alternative that doesn’t depend on terminating exclusivity.
Thus, Judge Drake determined that there wasn’t sufficient cause for terminating exclusivity. Instead, he extended exclusivity for a limited period to permit plan negotiation. Fast forwarding a year, though, it appears that Condor One foreclosed on the apartment complex, taking the complex with a $9.5 million credit bid. I’m not sure what led to that.
I reached out to Sarah Borders about the Homestead case. Given this Series’ theme and respect for Judge Drake, I don’t think she’d mind me sharing her feedback, which I’ll use as the best way to sum up one of her early cases:
Judge Drake had a reputation for allowing debtors every opportunity to confirm a viable plan. The motion to terminate exclusivity was intended to allow an “easy” way to avoid what were at the time very complex and difficult “new value” issues upon which many courts and commentators disagreed. Never one to avoid a challenge, Judge Drake tossed aside the “easy” way out and tackled the more difficult statutory issues. Other than the refusal to allow credit bidding, he arrived early to the position that the U.S. Supreme Court would later adopt on the issues at hand.
Happy Thanksgiving everyone! We’ll be back with the Top 3 soon enough. In the meantime, enjoy this Thanksgiving-themed bankruptcy post from 2015, Plan Proponent’s first year in business. Click here.
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