Tribune Cramdown Standard
On August 26, 2020, the U.S. Court of Appeals for the Third Circuit affirmed Delaware Bankruptcy Judge Kevin Carey’s order confirming the Tribune Company’s chapter 11 plan.1 As a matter of first impression, the Court held that the prohibition against “unfair discrimination” in cramdown plans supplants the requirement that subordination agreements be enforced in bankruptcy. The decision comes more than eight years after Judge Carey initially entered the Bankruptcy Court order, and follows years of appeals by the senior noteholders.
In ruling, the Third Circuit held:
- A cramdown plan under section 1129(b)(1) of the Bankruptcy Code that allocates a portion of the amounts otherwise owed to senior unsecured noteholders to contractually subordinated general unsecured creditors may be approved, notwithstanding the fact that subordination agreements are otherwise enforceable in bankruptcy, if there is no “unfair discrimination.”
- Discrimination in this context is not “unfair” where the creditor entitled to senior treatment in a subordination agreement receives treatment that is only minimally different from what it would otherwise receive were the subordination agreement to be strictly enforced, such that the Court finds the difference to be “immaterial.”
The senior noteholders, represented by Delaware Trust and Deutsche Bank, had argued that Tribune Company’s plan was improperly confirmed because it allowed for the distribution of approximately $30 million owed to junior noteholders (to which the senior noteholders were entitled pursuant to a subordination agreement2) – swap claimants, retiree, and trade claims – which violated section 510(a) of the Bankruptcy Code.3 Here, the plan classified the senior noteholders claims in one class (1E) and separately classified the Swap Claim, Tribune Media Retirees’ Claims, and Trade Creditors’ Claims in another class (1F), and payments to the creditors holding claims in class 1F “included monies [otherwise owed to the holders of Senior Obligations] from the subordination of the PHONES Notes and EGI Notes.”4 The senior noteholders objected to the payment of more than $30 million to class 1F from their recovery (allocable to them due to contractual subordination of the PHONES Notes and EGI Notes).5 It was “undisputed that the Class 1E Senior Notes were Senior Obligations and thus entitled to payments from the subordinated creditors,” but “a principal dispute concerned whether other creditors (in class 1F) also qualified” as “Senior Obligations.”6 The senior noteholders alleged that the plan unfairly discriminated against them by providing another class of similarly situated general unsecured creditors with a higher percentage recovery on their claims than they would have received had the subordination agreement been strictly enforced.
The three-judge appellate panel, in an opinion authored by Judge Thomas Ambro, rejected both arguments, holding that a “more flexible unfair discrimination standard” applies when evaluating treatment of similarly situated creditors under a cramdown plan that supplants strict enforcement of a prepetition subordination agreement.7 In so holding, the court analyzed the introductory caveat in section 1129(b)(1), which states “[n]otwithstanding section 510(a) of this title” the court may confirm a plan via cramdown “if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”8 The panel concluded that the phrase “notwithstanding section 510(a)” means that a plan could be confirmed over the rejection by a dissenting class of general unsecured creditors via cramdown “in spite of” a subordination agreement, consistent with the plain meaning of “notwithstanding” and previous definitions of the phrase “notwithstanding” used in the bankruptcy context.9 The Court did explain that courts do not have carte blanche to disregard pre-bankruptcy contractual arrangements; however, cramdown may be utilized to leave “play in the joints” in order to facilitate the necessary flexibility to negotiate a confirmable plan in a complex case.
Therefore, the court determined that allocation of certain amounts to other general unsecured classes that would not be entitled to such recovery outside bankruptcy due to a contractual subordination agreement was permissible so long as that allocation is not “presumptively unfair (and, if so, the presumption is not rebutted).”10 The test for determining whether discrimination rises to the level of “unfair” is whether it materially affects the amounts actually received by the rejecting class.11
Applying this test, the panel determined that the difference in the senior noteholders’ recovery was not material. The panel agreed with Judge Carey’s original decision comparing the senior noteholders’ percentage recovery under the plan (33.6%) to their percentage recovery had the subordination agreements been strictly enforced (such that the senior noteholders and holders of the Swap Claim were entitled to benefit from the subordination of the PHONES Notes and EGI Notes) (34.5%), finding the less than 1% difference was immaterial and did not rise to the level of unfair discrimination.12 Moreover, the panel determined that the increase in the recovery percentage for the Tribune Media Retirees’ Claims and the Trade Creditors’ Claims from the reallocated amounts resulted in only a small reduction of the senior noteholders’ recovery percentage, due in part to the relatively small amounts owed to the retiree and trade claimants as compared to the senior noteholders.13
- Under a cramdown plan, creditors otherwise entitled to be paid ahead of contractually subordinated creditors pursuant to a prepetition subordination agreement should closely scrutinize a debtor’s attempts to distribute those funds to another similarly situated class.
- A court may confirm a cramdown plan where the difference in recovery for a creditor otherwise entitled to the benefits of a prepetition subordination agreement is found by the court to be immaterial, which may be based on a comparison of what such creditor would be entitled to receive with and without strict enforcement of the subordination agreement.
- This opinion is an example of a bankruptcy court achieving “rough justice” in favor of preserving flexibility of the parties to negotiate and confirm a plan at the expense of strict enforcement of prepetition contractual arrangements.
- A creditor not receiving the benefit of strict enforcement of a subordination agreement in bankruptcy should carefully review the terms of that agreement to determine whether any counterparty has breached that agreement such that remedies may be pursued against such counterparty.
- Senior creditors should include a turnover provision in subordination agreements requiring that, notwithstanding any court order to the contrary, the senior creditors must be paid before any junior creditor is paid.
This update presents a high-level summary and several key takeaways from the Third Circuit’s ruling in In re Tribune Co., et al., 2020 WL 5035797 (3d Cir. Aug. 26, 2020).
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1 In re Tribune Co., et al., Case No. 18-2909, 2020 WL 5035797 (3d Cir. Aug. 26, 2020).
2 Under the facts here, the senior notes indentures of the senior noteholders ($1.283B) contained covenants requiring that they be paid before “any other debt incurred by the company.” Id. at *2. Two series of notes were subsequently issued under indentures that subordinated payment thereof “to all ‘Senior Indebtedness’ of Tribune,” and those notes are referred to as the “PHONES Notes” ($1.256B) and the “EGI Notes” ($225M). Id. Additionally, the following other general unsecured claims were owed: (a) the “Swap Claim” ($150.9M); (b) the “Tribune Media Retirees’ Claims” ($105M); and (c) the “Trade Creditors’ Claims” ($8.8M). “[W]hether a creditor should benefit from these subordination provisions depends on its claim qualifying as a Senior Obligation.” Id. at *3.
3 Id. at *3.
6 Id. The Bankruptcy Court below “assumed without deciding that none of the Class 1F creditors are Senior Obligations” but appears to have also determined in a footnote that the Swap Claim was a Senior Obligation that “should benefit from the partial enforcement of the subordination agreements.” Id. at *4. The Third Circuit took into account for purposes of its unfair discrimination analysis the Bankruptcy Court’s determination that the Swap Claim was a Senior Obligation. Id.
7 Id. at *1.
8 11 U.S.C. § 1129(b)(1); Tribune, 2020 WL 5035797, at *1.
9 Id. at *6.
10 Id. at *10.
11 Note, this opinion does not address the “fair and equitable” requirement under cramdown, which is frequently at issue in disputes involving cramdown of a class of secured creditors. See id. at *6.
12 Id. at *11 – *12.
13 Id. at *12.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.