In In re Tribune, 972 F.3d 228 (3d Cir. 2020), the U.S. Court of Appeals for the Third Circuit affirmed the confirmation of Tribune Co.’s Chapter 11 plan. In so doing, the court identified certain principles to be applied when determining whether a plan unfairly discriminates against a dissenting class of creditors. In particular, the court established a new eight-step analysis to be applied in “cramming down” such a dissenting class pursuant to Section 1129(b)(1) of the Bankruptcy Code.
Tribune, the largest media conglomerate in the country, filed for bankruptcy in 2008 and proposed a Chapter 11 plan that separated its various unsecured creditors into distinct classes. Under the plan, certain senior noteholders (whose unsecured claims totaled over $1 billion) comprised creditor “Class 1E,” and certain other unsecured creditors constituted “Class 1F.” Pursuant to Tribune’s prepetition loan agreements, Tribune and its lenders agreed that certain senior obligations would be satisfied in full before any other unsecured creditor would receive payment on account of its debt. The plan provided that both Class 1E and Class 1F creditors were to receive 33.6 percent of their outstanding claims. The senior noteholders objected, arguing that the allocation of payments to Class 1F under the plan violated Tribune’s subordination agreements and unfairly discriminated against them as Class 1E creditors.
The U.S. Bankruptcy Court for the District of Delaware examined section 1129(b)(1) of the Bankruptcy Code, the “cramdown provision,” to determine whether it could confirm Tribune’s plan over the senior noteholders’ dissent. The bankruptcy court first concluded that the senior noteholders’ claims and a portion of Class 1F’s claims qualified as senior obligations. Accordingly, and pursuant to the parties’ prior stipulations, were the prepetition subordination agreements to be strictly enforced, the senior noteholders’ recovery would have been 34.5%, as compared to the 33.6% recovery they would actually receive under the plan. The court concluded that the difference between Class 1E’s desired and actual recovery—nine-tenths of a percentage point—was immaterial, and confirmed the plan over Class 1E’s objection. The U.S, District Court for the District of Delaware affirmed the decision of the bankruptcy court, and the senior noteholders appealed that decision to the U.S. Court of Appeals for the Third Circuit.
The Cramdown Provision
Section 1129(a) of the Bankruptcy Code sets forth the requirements for confirmation of a Chapter 11 plan. Pursuant to Section 1129(a)(8), one such requirement is that each unimpaired class of claims or interests accept the plan. A class of claims or interests is impaired if, essentially, the plan adversely alters the rights the claimants or interest-holders would otherwise have. Thus, a court cannot generally confirm a plan that modifies a creditor’s rights unless the creditor’s class consents to and accepts the plan.
The cramdown provision sets forth an important exception to this rule. Section 1129(b)(1) of the Bankruptcy Code provides that, notwithstanding Section 510(a) of the Bankruptcy Code, if all of the other applicable requirements for confirmation of a debtor’s Chapter 11 plan are satisfied, a court must confirm the plan over the objection of an impaired class “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.”
Notably, Section 510(a) of the Bankruptcy Code provides that subordination agreements are enforceable in a bankruptcy case. Applied to the Tribune fact scenario, the cramdown provision provides that, notwithstanding the existence of an otherwise enforceable subordination agreement, a debtor’s plan may still impact certain creditors’ rights derived from that subordination agreement: a plan that meets all of the other requirements of Section 1129(a), and that “does not discriminate unfairly, and is fair and equitable, with respect to” the dissenting class can be “crammed down” over that class’s dissent.
The Bankruptcy Code does not define “unfair discrimination.” While various courts, including the Third Circuit, have examined the “fair and equitable” requirement for cramdown, the “unfair discrimination” standard has received significantly less attention.
The Appellate Court’s Analysis
On appeal, the senior noteholders first argued that Tribune’s plan improperly failed to fully enforce the company’s subordination agreements per Section 510(a) of the Bankruptcy Code. The court of appeals rejected this argument. The court analyzed the meaning of the “notwithstanding Section 510(a)” language in Section 1129(b)(1), concluding that Section 1129(b)(1) overrides Section 510(a); as a result, courts need not strictly enforce subordination agreements in cramdown cases in their application of Section 1129.
The senior noteholders also argued that Tribune’s plan unfairly discriminated against Class 1E. According to the senior noteholders, the bankruptcy court should have compared the proposed distributions to Class 1E and Class 1F; it complained that the bankruptcy court had instead improperly compared Class 1E’s proposed plan distribution to the distribution Class 1E would have received had the prepetition subordination agreements been fully enforced.
The appellate court rejected this argument as well. In so doing, it drew from the various tests that other courts have applied to determine whether a plan unfairly discriminates, and it devised eight “principles” that should drive an unfair discrimination analysis, explained as follows.
First, Chapter 11 plans may treat similarly situated creditors differently (i.e., such plans may discriminate), but not to such an extent as to become “unfair.” Second, “unfair discrimination” only applies to dissenting classes of creditors, and not to the individual creditors comprising any given class. Third, unfair discrimination is determined from the perspective of the dissenting class. Fourth, as a prerequisite to any unfair discrimination analysis, a court must first conclude that creditors have been properly classified. Fifth, courts should measure how the plan proposes to pay each creditor’s recovery in terms of either the net present value of all proposed plan payments or the allocation of materially greater risk in connection with the proposed distribution, in each instance allowing the court to determine the present value of any future distributions at the time of plan confirmation by taking into account both the present value of future payments and the risk of non-payment in the future. Sixth, courts must establish a “pro rata baseline” for creditors of equal priority by dividing the sum total of all of the proposed distributions by the number of creditors sharing the same priority and compare this to the plan’s actual proposed distributions; when subordination agreements are involved, bankruptcy courts should also determine what a creditor would be entitled to receive under full enforcement of those subordination provisions but will not receive under the plan. Seventh, unfair discrimination may be presumed if there is either: a materially lower percentage recovery for the dissenting class; or a materially greater risk to the dissenting class. The court noted that it should be left to the bankruptcy courts to determine “materiality.” Finally, any presumption of unfair discrimination is subject to rebuttal by the plan proponent.
Applying these principles to the argument articulated by the senior noteholders, the court of appeals noted that an “unfair discrimination” analysis need not be limited to a class-to-class comparison. That was determined to be especially relevant to cases where, as in Tribune, such a comparison would have proven difficult, because the subordination provisions were applicable to a portion of the Class 1F claims. In such cases, the court encouraged a “pragmatic” approach that would compare the dissenting class’s anticipated and actual recoveries. Although the court acknowledged that the pragmatic approach might not be the preferred way to measure unfair discrimination, such an approach might be appropriate given the factual circumstances of a given case. Consequently, the court of appeals agreed with the bankruptcy court: the difference between the senior noteholders’ anticipated and actual recoveries—0.9 percentage points— was not material. Although the plan did discriminate against the senior noteholders’ class, the discrimination was found not to be “unfair.” As a result, the court affirmed the decision of the district court.
The Third Circuit Court of Appeal’s ruling in Tribune provides important insight into the meaning of unfair discrimination, an issue that has been characterized as “an orphan” in reorganization practice. The court’s eight-step test should provide a benchmark for courts and parties-in-interest in analyzing unfair discrimination in the context of a cramdown plan. Additionally, the Tribune decision should serve as an advisory to senior creditors that otherwise valid subordination agreements may be disregarded in the event a cramdown plan is deemed not to unfairly discriminate.
Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.
Elisa Hyder, an associate with the firm, practices in the area of business reorganization and financial restructuring.
Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.