Amicus Curiae Brief — US Bancorp Mortgage Co. v. Bonner Mall Partnership

Supreme Court, U. 8. \

— FILED

2 FEB 24 1994

THE CLERA

No. 93-714

In the Supreme Court of the United States

OcTOBER TERM, 1993

U.S. BANCORP MORTGAGE COMPANY, PETITIONER

v.

BONNER MALL PARTNERSHIP

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING PETITIONER

Drew S. Days, III

Solicitor General

FRANK W. HUNGER

Assistant Attorney General

PAUL BENDER

Deputy Solicitor General

RONALD J. MANN

Assistant to the Solicitor General

Department of Justice

Washington, D.C. 20530

(202) 514-2217

QUESTION PRESENTED

Whether the Bankruptcy Code authorizes a judge to

confirm a plan of reorganization that grants the equity

owners of a failed debtor an exclusive opportunity to

purchase an ownership interest in the reorganized

business, but does not provide for full payment of

objecting classes of unsecured claims.

(I)

2

TABLE OF CONTENTS

e „„

Argument:

The plan proposed by respondent does not satisfy the

requirements of the Bankruptcy Code

Sections 362 and 1129 of the Bankruptcy Code pro-

vide a comprehensive framework for determining

whether a proposed plan of reorganization is suffi-

cent to justify continuation of an automatic stay

preventing a creditor from taking control of its

collateral upon default by a bankrupt debtor .........

The Bankruptcy Code does not authorize a judge

to confirm a plan of reorganization that grants the

equity owners of a failed debtor an exclusive opp-

ortunity to purchase ownership interests in the

reorganized business if the plan does not provide

for full payment of objecting classes of unsecured

claims 113

A. The fair and equitable standard does not per-

mit confirmation of a plan granting - equity

owners an ownership interest in the reorgan-

ized enterprise over the objection of a class of

unpaid unsecured elaims ..

B. At a minimum, the absolute priority rule does

not permit confirmation of a plan that grants

equity owners an exclusive right to acquire an

ownership interest in the reorganized enter-

prise over the objection of a class of unpaid un-

Zn

e ESET

D ESE eT

1

13

15

> N

IV

TABLE OF AUTHORITIES

Cases: Page

Bjolmes Realty Trust, In re, 134 B.R. 1000 (Bankr. D.

K ͤ A . 26

Case v. Los Angeles Lumber Products Co, 308 U.S. 106

3 12, 15-16, 17, 18, 21, 22

Dewsnup v. Timm, 112 8. Ct. 773 (1992) . . 4

Louisville Trust Co. v. Louisville, N.A. & C. K, 174

III . 17

Marine Harbor Properties Inc. v. Manufacturers Trust

Gag SEF Gree Ce ED . 17

Norwest Bank Worthington v. Ahlers, 485 U.S. 197

— . 7 . ß 14

Phoenix Mutual Life Insurance Co. v. Greystone II]

Joint Venture (In re Greystone III Joint Venture), 995

F.2d 1274 (th Cir. 1991), withdrawn on reh’g, 995

F.2d 1284 (1992), cert. denied, 113 8. Ct. 72 (1992) ....... 6

Toibb v. Radloff, 111 S8. Ct. 2197 (1991) . ccccceeeeees 2

United Savings Association v. Timbers of Inwood

Forest Associates, 484 U.S. 365 (1988))))))))) 3. 10

Statutes:

Bankruptcy Act of 1898, ch. 541, 30 Stat. 54ũ4 6, 15

Act of June 7, 1934, ch. 424, 48 Stat. 911 (formerly codi-

fied as Bankruptcy Act § 77B, 11 U.S.C. 207 (1935)) ..... 15

Bo 4 12, 15, 16, 17

r . 16

L. UE venrecenccisesitdactinaniindtteuniniondnidass 15

Act of June 22, 1988 (Chandler Act), ch. 575, 52 Stat.

883 (formerly codified as Bankrupty Act Chapter X, 11

e 15, 16, 17, 18

Len 16

LON. 15

21), 11 U.S.C. 62102) (1976) . . . 15, 16

Bankruptcy Code, 11 U.S.C. 101 et seg:

Ch. 1, 11 U.S.C. 101 et seq:

ü 11

U

Statutes—Continued: Page

Ch. 3, 11 U.S.C, 301 et seq.:

I —, . ——— 23, 9

1. K — 10

. nciicnscstencupuntiiaetennicscenipiiaiamiesieaiios 3

Ch. 5, 11 U.S.C, 501 et seq.:

I. ——,, 4

I 0 4

Ch. 11, 11 U.S.C, 1101 et seq. ....... 2, 7, 8, 9, 10, 19, 20, 23, 24, 25

Ic . 4

By Se IEEE cccsserccesetprccstpiactbncbiestisnsdtbaveenieiccctetl 29

. 10, 14

I cnccscucasenitpccnsscetsensteipetntnenunnninananeienin 11, 16

RFS ³ͤ 2, 7, 10, 15, 19, 28, 29, 30, la

l. . 10, 1a

IL acenssconsrencessitpascniactetingzarvesteqnmesiel 10, 2a

I ..KLͤ˖ö˖1łỹ4j%äĩç 8 22, 3a

SES ͤͤ—4 9, 10, 11, 13, 16, 25, 4a

11 U.S.C. 112 b) 8, 11, 12, 13, 19, 20, 25, 29, 4a

ee ene 11, 25, 4a

L cxnsccnsevcecocessspanqensnsocemginentd 11, 12, 4a

29e — 11, 12, 18, 5a

11 U.S.C. e 12, 14, 22, 5a

11 U.S.C. 1129(b)2)( Bi) ........ 7, 9, 12, 13, 22, 26, 27, 28, 5a

Miscellaneous:

Harry E. Adler, Bankruptcy and Risk Allocation, 77

Gre 23

John D. Ayer, Rethinking Absolute Priority After Ahlers,

ee 17, 19

Douglas G. Baird, The Uneasy Case for Corporate Reor-

ganizations, 15 J. Legal Stud. 127 (1986) 23

Lucian A. Bebchuk, A New Aproach to Corporate Reor-

ganizations, 101 Harv. L. Rev. 775 (1988) .................... 23

Black’s Law Dictionary (Sth ed. 1978) 27

Walter J. Blum and Stanley A. Kaplan, The Absolute

Priority Doctrine in Corporate Reorganizations, 41 U.

ENS . eee 20-21

VI

Miscellaneous—Continued: Page

Michael Bradley and Michael Rosenzweig, The Untenable

Case for Chapter 11, 101 Yale L.J. 1043 (1992) ............. 23, 24

Collier on Bankruptcy (James Wm. Moore 14th ed. 1940,

Ian. . eee 12, 15, 16

124 Cong. Ree. (1978):

— — Ekä—— — 19

ͤ—ẽ———— — 19

Peter F. Coogan, Confirmation of a Plan Under the

Bankruptcy Code, 32 Case W. Res. L. Rev. 301 (1982) .. 15

H.R. Rep. No. 595, 95th Cong., Ist Sess. (1977) ....... 11, 12, 13, 20

Thomas H. Jackson and Robert E. Scott, On the Nature

of Bankruptcy: An Essay on Bankruptcy Sharing and

the Creditor’s Bargain, 75 Va. L. Rev. 155 (1989) ......... 23

Jerome R. Kerkman, The Debtor in Full Control: A Case

for Adoption of the Trustee System, 70 Marq. L. Rev.

2 ———— — 25

Lynn M. LoPucki, Strategies for Creditors in Bank-

rupte Proceedings (2d ed. 1991) .. . . 4. 27

Lynn M. Lo Pucki, The Debtor in Full Control Systems

Failure Under Chapter 11 of the Bankruptcy Code? (Pt.

FF GB FOE fF ee 24, 29

Lynn M. LoPucki, The Trouble with Chapter 11, 1993

eS Oe eC) SLL eee eee 24

Lynn M. LoPucki and William C. Whitford, Bargaining

over Equity Share in the Bankruptcy Reorganization

of Large, Publicly Held Companies, 139 U. Pa. L. Rev.

1...— —. 7 2⁵

Lynn M. LoPucki and William C. Whitford, Venue Choice

and Forum Shopping in the Bankruptcy Reorganiza-

tion of Large, Publicly Held Companies, 1991 Wis. L.

TOD. ED ccnssssensesenrecatneiennitenimensgmusininuanaptbmenniteeaiapnmsageees 29, 30

Robert K. Rasmussen, Debtor’s Choice: A Menu Approach

to Corporate Bankruptcy, 71 Texas L. Rev. 51 (1992) 23

Report of the Commission on the Bankruptcy Laws of the

United States, Pt. 2, H.R. Doc. No. 137, 93d Cong.,

IL... T 18

David A. Skeel, Jr., Markets, Courts and the Brave New

World of Bankruptcy Theory, 1993 Wis. L. Rev. 4665 .... 24

Vil

Miscellaneous—Continued:

Elizabeth Warren, A Theory of Absolute Priority, 1991

Ann. Survey Amer. Law 9

—— ñ œ[u9ſꝛ—2⸗,Rũãõů „„ HEHEHE

Page

—

In the Supreme Court of the United States

OCTOBER TERM, 1993

No. 93-714

U.S. BANCORP MORTGAGE COMPANY, PETITIONER

.

BONNER MALL PARTNERSHIP

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING PETITIONER

INTEREST OF THE UNITED STATES

This case presents the question whether the

Bankruptcy Code authorizes a judge to confirm a plan

of reorganization that grants the equity owners of a

failed debtor an exclusive opportunity to purchase an

ownership interest in the reorganized business, but

does not provide for full payment of objecting classes

of unsecured claims. That question is of great

interest to the United States because various agen-

cies of the federal government—including the Federal

Deposit Insurance Corporation, the Resolution Trust

Corporation, the Small Business Administration, the

Farmers Home Administration, and the Rural Elec-

trification Administration—frequently participate as

creditors in bankruptcy reorganization proceedings,

(1)

2

and because the Court's resolution of that question

significantly will affect the ability of creditors to vain

control of businesses that seek to reorganize under

the Bankruptcy Code without repaying their credi-

tors.

STATUTORY PROVISION INVOLVED

Section 1129 of the Bankruptcy Code, 11 U.S.C.

1129, is set forth in an appendix, infra, la-6a.

STATEMENT

1. In 1984 and 1985, an entity named Northtown

Investments built the Bonner Mall in Bonner County,

Idaho, Northtown financed construction of the mall

with a $6.3 million loan from First National Bank of

North Idaho; petitioner now holds that loan. In

October of 1986, Northtown sold the mall to respon-

dent, subject to the mortgage that secures repayment

of petitioner’s loan. Respondent is an investment

vehicle formed for the purpose of buying the mall; it is

composed of five trusts and an individual investor.

When income from the mall declined, respondent

defaulted in the payment of real property taxes owed

to Bonner County, Idaho. Petitioner then exercised

its right under the loan documents to schedule the

property for a foreclosure sale to be held on March 14,

1991. See Pet. App. A4-A5, A91-A92.

2. On the day before the sale, respondent filed a

petition in the United States Bankruptcy Court for

the District of Idaho, seeking relief under Chapter 11

of the Bankruptcy Code.' Under Section 362(a) of the

Chapter 11 generally provides for the reorganization of

business enterprises. See Toibb v. Radloff, 111 S8. Ct. 2197,

2199-2202 (1991) (discussing the scope of Chapter 11).

Code, 11 U.S.C, 362(a),* the filing of the bankruptcy

petition automatically stayed petitioner’s foreclosure

sale. Petitioner accordingly sought relief from the

stay. Because the amount due to petitioner (about

$6.6 million) exceeded the value of the mall, petitioner

was entitled under the Code to proceed to foreclosure

unless respondent could establish that retention of

the mall was necessary to an effective reorganization

and that there was a reasonable possibility of a

successful reorganization within a reasonable time.

Section 362(d)(2); see United Savings Association v.

Timbers of Inwood Forest Associates, 484 U.S. 365,

374-376 (1988); Pet. App. A5-A7, A19, A92-A93.

a. On August 23, 1991, the bankruptcy court issued

an opinion denying petitioner’s motion for relief from

the stay. Pet. App. Al18-A129. The court accepted

respondent's argument that there was a realistic

prospect for reorganization, based on respondent's

intention to contribute additional capital, in return

for which it was contemplated that respondent would

retain an ownership interest in the reorganized

enterprise. Id. at Al24-Al25. Because the court

concluded that it could not rule out the possibility of

an effective reorganization, the court denied the

motion for relief from the stay. Id. at A127.

b. Respondent filed its First Amended Plan of

Reorganization on October 31, 1991. See Pet. App.

Agg. That plan provides for transfer of respondent's

assets to a new entity, Bonner Mall Properties, Inc.

(BMP). J.A. 6. Three aspects of the plan are impor-

tant for this case. First, BMP would pay petitioner's

* For convenience, we cite the provisions of Title 11 by

Section number only; similarly, we refer to the entire Title as

the Code.

— —

4

secured claim ($3.2 million)“ in a single balloon

payment 32 months after confirmation, with monthly

interest payments to be made during the interim.‘

J. A. 11. Second, the general unsecured claims

(petitioner’s deficiency of about $3.4 million,“ as well

as the claims of other miscellaneous creditors) would

be discharged in exchange for shares of stock in BMP

at a rate of under ten cents on the dollar; all of those

claims would be satisfied by the-issuance of 300,000

shares of preferred stock with a par value of $1 each.

Those preferred shares could be redeemed at any time

by BMP for their par value, but could be converted by

petitioner, if respondent succeeded in repaying

petitioner’s secured claim, to 15% of the then out-

standing common stock of BMP. J.A. 19-20. In return

for a contribution of $200,000, and an obligation to

fund. any shortfall in working capital until the

In its — 1991 epinien, the court concluded that the

mall was worth only $3.2 million, relying on local tax assess-

ment figures. Pet. App. Al25-A126.

* Alternatively, if petitioner elected that its entire claim be

treated as secured under Section 1111(b), petitioner would be

repaid in equal monthly installments over 30 years in an

amount that would have a discounted present value equal to

petitioner's secured claim. J. A. 14. For a general discussion of

the reasons a creditor would make a Section 1111(b) election,

see Lynn M. LoPucki, Strategies for Creditors in Bankruptcy

Proceedings § 12.9.4 (2d ed. 1991) [hereinafter LoPucki, Strat-

egies}.

The holders of the other secured claims also were to be

repaid by various schedules of monthly or annual payments

specified in the plan. J. A. 13-17.

Under Section 506(a), the portion of petitioner’s claim that

exceeds the value of the collateral is treated as an unsecured

claim. See generally Dewsnup v. Timm, 112 S8. Ct. 773 (1992)

(discussing the effect of Section 506 on undersecured

creditors).

5

maturity date of petitioner’s claim, respondent's

owners would receive 2 million shares of common

stock. J. A. 19. See generally Pet. App. Al9-A22, A93-

A95 (summarizing terms of the plan).

To put the matter in practical terms, if BMP did

not succeed in paying off petitioner’s secured claim,

petitioner would be able to take control of the mall at

the end of the 32 months,’ in which event the

ownership interests (including the preferred stock

representing petitioner’s unsecured claim) would

have negligible value. If BMP did succeed, peti-

tioner’s secured claim would be repaid, and the

preferred stock representing petitioner’s $3.4 million

unsecured claim could either (a) be redeemed for

$300,000 (if BMP desired to do so) or (b) be exchanged

for 15% of the ownership in BMP (if BMP did not

redeem the stock before petitioner decided to ex-

change it for common stock).* If petitioner's pre-

ferred stock were converted to common stock, re-

spondent’s owners would hold about 85% of the owner-

ship as compensation for their contribution of

$200,000; if petitioner’s preferred stock were re-

deemed, the contribution of respondent's owners

would bring 100% of the ownership interests.

* See J. A. 11-12 (discussing petitioner's remedies if respond-

ent fails to comply with the plan).

The actual amounts would be about 93% of the $300,000

and 15% figures stated in the plan, because those entitlements

were to be shared pro rata among all of the general unsecured

claimants (classified under the plan as Class 3a unsecured

claims). J. A. 19-20. Petitioner's $3.4 million claim constitutes

about 93% of the $3.644 million in Class 3a unsecured claims.

See First Amended Disclosure Statement (Oct. 31, 1991),

Record on Appeal item 15, at 18 & n.4 (included in the excerpts

of record filed by petitioner in the court of appeals).

ce. After consideration of the proposed plan, the

bankruptcy judge issued an opinion on December 6,

1991, granting petitioner’s motion for relief from the

stay, based on the court’s conclusion that the

Bankruptcy Code does not permit the owners of a

failed enterprise to retain an ownership share in the

reorganized business over the objection of unpaid

creditors, even if the ownership share rests on “new

value” contributed by the owners. J.A. 29-33. The

court relied on the opinion issued by a panel of the

Fifth Circuit in Phoenix Mutual Life Insurance Co.

v. Greystone III Joint Venture (In re Greystone 111

Joint Venture), 995 F.2d 1274 (1991), which set forth a

similar interpretation of the Code.’ J. A. 31-32.

3. The district court reversed. Pet. App. A90-

A117.“ The court concluded “that the new value

exception to the absolute priority [rule) did survive

the enactment of the 1978 Bankruptcy Code.” Id. at

All6.

4. The court of appeals affirmed. Pet. App. Al-A84.

The court first concluded (id. at A33-A51) that the

precise terms of the Code did not eliminate the rule,

developed in cases under the old Bankruptcy Act, that

permitted owners to participate in reorganizations if

they contributed new value to the reorganized entity

(a rule generally referred to as the “new value

exception”). The court acknowledged that the Code

bars owners from receiving an interest under a plan

of reorganization “on account of” their prior interest

* The Greystone panel's opinion subsequently was with-

drawn on rehearing. 995 F.2d 1284 (per curiam), cert. denied,

113 S. Ct. 72 (1992).

1% A slight correction was made by an opinion reprinted at

Pet. App. A88-A89.

7

in the failed business. The court reasoned, however,

that a plan giving the prior owners an interest is

permissible—even if they have an exclusive right to

acquire that ownership interest—because their par-

ticipation is permitted not “on account of” their prior

interest in the debtor but “because such participation

is necessary for a successful reorganization and in

the best interests of all concerned.” Id. at A50.

The court also rejected (Pet. App. A61-A71) peti-

tioner’s argument that the dramatic changes in reor-

ganization practice introduced by the Code had

abolished the new value exception. The court con-

cluded that “the structural changes to the reorgani-

zation process made by the Code are in harmony with

the pro-confirmation principle underlying the new

value exception.” Id. at A64.

Finally, the court stated (Pet. App. A71-A79) that

the new value exception is consistent with the under-

lying policies of Chapter 11 because it encourages

“successful rehabilitation of debtors,” and “max-

imizels] the value of the estate.” Id. at A71-A72. The

court rejected petitioner’s argument that the new

value exception conflicts with the Chapter 11 policy of

protecting creditor interests because “successful

debtor reorganization and maximization of the value

of the estate are the primary purposes [of Chapter

111“ Id. at A74-A75.

SUMMARY OF ARGUMENT

Section 1129 of the Code bars confirmation of a plan

of reorganization in a Chapter 11 proceeding over the

objection of a class of unpaid unsecured claims if the

plan grants the owners of the failed business “any

property” “on account of” their ownership of the

failed business, Section 1129(b)(2)(B)(ii), and permits

8

confirmation only if the plan is otherwise “fair and

equitable,” Section 1129(b)(1). The plan proposed in

this case fails both of those standards.

1. The statutes that preceded the Code permitted

confirmation of a plan only if it was both fair and

equitable and also approved by the creditors. In cases

interpreting those statutes, this Court suggested

that a plan could be fair and equitable even if the

owners retained an interest in the reorganized

business without repaying all of the creditors, but

only if that interest were given in return for a contri-

bution of new value by the owners. Because those

statutes did not permit confirmation of any plan with-

out creditor consent, the new value rule recognized

by the Court did not permit the owners of the failed

business to retain an interest without consent of the

creditors as a group.

The Code adopts a different framework for approv-

ing reorganizations, under which a plan can be

confirmed if it is either fair and equitable or approved

by the creditors. In our view, that framework is

designed to allow creditors to determine when con-

tinuing participation in ownership by the owners of

the failed business would aid the success of the

reorganized enterprise. Because the creditors are

the parties with money at stake, the Court should be

reluctant to read the Code to permit judges to second-

guess the creditors’ judgment regarding how best to

reorganize the business. Furthermore, offering the

owners an opportunity to insist on a share of the

reorganized business without repaying their credi-

tors would tend to exacerbate the problems that have

made Chapter 11 proceedings both expensive and pro-

tracted. These considerations indicate that a plan

allowing owners to retain an interest over the

9

objection of a class of unpaid unsecured claims is not

“fair and equitable” within the meaning of the Code

and thus cannot be confirmed under Section 1129(b).

2. The Court can decide this case without reaching

the broad question whether the Code permits any plan

providing for continued participation without repay-

ing objecting creditors, because the plan proposed in

this case is objectionable on a narrower ground as

well. The plan would grant respondent’s owners the

exclusive right to purchase a controlling interest in

the reorganized business; that exclusive right

constitutes “property” that would be conferred by the

plan. Because the only plausible basis for granting

that right would be the status of its recipients as

former owners of the business, the grant would be one

made “on account of” the interest those individuals

held in the failed business. Accordingly, it is barred

by the language of Section 1129(b)(2)(B)(ii).

ARGUMENT

THE PLAN PROPOSED BY RESPONDENT DOES

NOT SATISFY THE REQUIREMENTS OF THE

BANKRUPTCY CODE ;

I. Sections 362 And 1129 Of The Bankruptcy

Code Provide A Comprehensive Framework

For Determining Whether A Proposed Plan Of

Reorganization Is Sufficient To Justify Con-

tinuation Of An Automatic Stay Preventing A

Creditor From Taking Control Of Its Collat-

eral Upon Default By A Bankrupt Debtor

This case comes to the Court on appeal from

petitioner’s motion for relief from the automatic stay

imposed by Section 362(a) of the Code. Petitioner

seeks relief from the stay so that it can foreclose the

mortgage it holds on the mall respondent owns.

10

Under Section 362(d), petitioner is entitled to relief

from the stay if respondent “does not have an equity

in [the] property” and if the “property is not neces-

sary to an effective reorganization.” Because it is

clear that respondent does not have an equity in the

property—petitioner’s claim of about $6.6 million far

exceeds the value of $3.2 million determined by the

bankruptcy court—the remaining question is

whether the property is necessary to an effective re-

organization. See generally United Savings Associa-

tion v. Timbers of Inwood Forest Associates, 484 U.S.

365, 374-376 (1988) (discussing Section 362(d)). As the

case now stands, the only possible basis for an

effective reorganization is the plan considered by the

court of appeals. Hence, petitioner is entitled to relief

from the stay if the Code prohibits confirmation of

that plan.

Section 1129 of the Code sets forth the exclusive

circumstances under which a judge can confirm a plan

of reorganization in a Chapter 11 proceeding." The

thirteen paragraphs of Section 1129(a) impose specific

requirements for confirmation, including, of particu-

lar relevance here, the requirement in paragraph (8)

that each impaired class of claims must accept the

plan. Section 1129%(b), however, allows a judge in

The first clause of Section 1129(a) states that It he court

shall confirm a plan only if all of the following requirements

are met” (emphasis added).

1 Section 1124 of the Code defines impairment. It is

undisputed that the proposed plan would impair the classes of

claims that include petitioner's secured and unsecured claims.

See J.A. 11, 17. It also is undisputed that petitioner would

oppose the plan. See Pet. App. A23 (“It is a foregone conclusion

that * * * the unsecured class of which [petitioner] is the

principal member will vote not to confirm the plan.”). Because

11

certain circumstances to confirm a plan even if an

impaired class of claims does not consent, but only 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,” Section 1129(b)(1). The common references

to “cramdowns” in reorganization proceedings refer

to a judge’s approval of a plan under Section 1129(b)

without the consent of all of the impaired classes of

claims."

Paragraph (2) of 1129(b) sets forth the minimum

content for the meaning of the “fair and equitable”

requirement, by stating that “the condition that a

plan be fair and equitable with respect to a class in-

cludes the following requirements.” Those re-

quirements are grouped into three subparagraphs:,

subparagraph (A) dealing with secured claims,

subparagraph (B) dealing with unsecured claims, and

subparagraph (C) dealing with interests. Subpara-

graph (B) is the provision relevant to this case, which

involves the fairness of the plan’s treatment of

petitioner holds about 93% of the clairns in that class, see note

8, supra, its vote would be sufficient to prevent acceptance of

the plan by that class under Section 1126(c); that Section

requires an affirmative vote of “at least two-thirds in amount

and more than one-half in number of the allowed claims of [the]

class.”

See, e.g., H.R. Rep. No. 595, 95th Cong., Ist Sess. 413

(1977) (hereinafter House Report] (noting that Section 1129(b)

“contains the so-called cramdown”).

4 The provisions of the Code establishing rules of con-

struction make it clear that the specific references in Section

1129(b)(2) to what the “fair and equitable” standard “includes”

are not exclusive. See Section 102(3) (“‘{I}ncludes’ and

‘including’ are not limiting.”).

12

petitioner’s unsecured elaim.“ Subparagraph (B)

requires a plan, at a minimum, to meet one of two

options in order to satisfy the “fair and equitable”

standard of Section 1129(b)(1). First, the plan can pay

the claim in full as of the date of the plan. Section

1129(b)(2)(B)(i). If the plan does not pay the claim in

full, however, it must comply with the so-called

“absolute priority” rule,“ which states: IThhe 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.“ “ Section 1129(b)(2)(B)(ii). In addition, as

1 The proposed plan would satisfy the requirements of

Section 1129 6b ANA) with respect to petitioner’s secured claim

by providing for payments with a present value as of the date

of the plan equal to the entire value of petitioner's secured

claim. See J.A. 11-12.

1s The term “absolute priority” apparently was adopted to

distinguish the rule from a system of “relative priority,” which

would allow interests with claims of lower priority to share in

the estate, provided they received less than claims of higher

priority. See Collier on Bankruptcy J 11.06, at 221 (James Wm.

Moore 14th ed. 1940, Lawrence P. King rev. 1977) [hereinafter

Colliers 14th ed. see also Case v. Los Angeles Lumber

Products Co., 308 U.S. 106, 119 (1939) (holding that a plan

violated the absolute priority rule of Section 77B of the

Bankruptcy Act even though “the relative priorities of the

bondholders and the old * * * stockholders are maintained”).

7 The House Report explained the purpose of the provision

as follows:

It requires simply that the plan meet certain standards of

fairness to dissenting creditors or equity security holders.

The general principle of the subsection permits confirma-

tion notwithstanding nonacceptance by an impaired class if

that class and all below it in priority are treated according

to the absolute priority rule. The dissenting class must be

13

noted above, even if a plan meets one of subparagraph

(B)’s two options, it also must satisfy the general

“fair and equitable” standard of Section 1129(b)(1).

Respondent’s plan proposes that its owners, whose

interests are junior to petitioner’s, receive an owner-

ship interest in the reorganized debtor in return for a

capital contribution of $200,000 and an obligation to

fund working capital shortfalls during the first 32

months of the plan. J.A. 19. That plan violates

Section 1129(b) if it fails the general “fair and

equitable” standard established by Section 1129(b)(1),

or if it gives those junior claimants any “property”

“on account of” their prior ownership interest,

Section 1129(b)(2)(B)(ii). For the reasons set forth

below, we submit that the proposal does not comport

with either of those standards.

Il. The Bankruptcy Code Does Not Authorize A

Judge To Confirm A Plan Of Reorganization

That Grants The Equity Owners Of A Failed

Debtor An Exclusive Opportunity To Purchase

Ownership Interests In The Reorganized

Business If The Plan Does Not Provide For

Full Payment Of Objecting Classes Of Unse-

cured Claims

This is not the first time that the Court has

considered the permissibility under the Code of a plan

of reorganization that would force creditors to accept

a plan under which the equity owners of a failed

paid in full before any junior class may share under the

plan. If it is paid in full, then junior classes may share.

House Report, supra note 13, at 413; see ibid. (II the class is

impaired, then they must be paid in full or, if paid less than in

full, then no class junior may receive anything under the

plan.”).

14

debtor would retain an ownership interest in a

reorganized debtor. The Court previously considered

that question in Norwest Bank Worthington v.

Ahlers, 485 U.S. 197 (1988), where the Court deter-

mined that the plan proposed in that case violated the

Code because the consideration offered by the owners

for the interest in the reorganized debtor was not

sufficiently concrete. Id. at 202-209. We argued in

that case that the language and structure of the Code

prohibit in all circumstances confirmation of a plan

that grants the prior owners an equity interest in the

reorganized debtor over the objection of a class of

unpaid unsecured claims.“ See Brief for the United

States as Amicus Curiae at 11-23, Ahlers (No. 86-958,

O. T. 1987) [Ahlers Brief }'*; Ahlers, 485 U.S. at 203-

204 n.4 (noting the government’s argument). As

explained below, we continue to hold the views we

expressed in Ahlers. See Point II. A, infra. But even

if there are some circumstances in which the Code

would permit confirmation of such a plan, this case

does not present them, because the plan proposed in

this case would grant the prior owners an exclusive

opportunity to acquire an ownership interest in the

reorganized debtor. See Point II. B, infra.

' We refer to a class of unpaid unsecured claims as a

convenient term to describe a class of claims that is both

impaired (under Section 1124), and not paid in full (under

Section 1129(b)\(2)(B)i)).

1% We have provided copies of the Ahlers Brief to all counsel

who participated in this case at the petition stage.

15

A. The fair and equitable standard does not

permit confirmation of a plan granting

equity owners an ownership interest in the

reorganized enterprise over the objection

of a class of unpaid unsecured claims

1. The Congress that enacted the Code in 1978 did

not write on a clean slate in drafting the framework

for approving plans of reorganization that appears in

Section 1129. Both the Chandler Act of 1938 (codified

as Chapter X of the old Bankruptcy Act of 1898) and

Section 77B (its 1934 precursor)" included procedures

for adopting plans for the reorganization of failing

businesses. Three features of those predecessor

statutes are important for understanding the legal

landscape that confronted the drafters of the Code.

First, the prior statutes authorized a court to

approve a plan only if it was “fair and equitable”; thus,

those statutes did not permit adoption of a plan that

did not meet the “fair and equitable” standard, even if

the creditors voted to approve the plan.” Second,

The Chandler Act of 1938, ch. 575, 52 Stat. 883, added a

new Chapter X to the Bankruptcy Act. Under Section 221 of

that Chapter, a court could confirm a plan only if it found,

among other things, that “the plan is fair and equitable.” 11

U.S.C. 621(2) (1976). See generally Collier’s 14th ed., supra

note 16, 1 11.06 (discussing “fair and equitable” requirement of

Chapter X of the Bankruptcy Act).

Section 77B was added to the 1898 Act by the Act of June

7, 1934, ch. 424, 48 Stat. 911. Under Section 77B(f)(1), a judge

could confirm a plan only if it found that the plan was “fair and

equitable and d{id) not discriminate unfairly in favor of any

class of creditors or stockholders.” 48 Stat. 919.

2 See Peter F. Coogan, Confirmation of a Plan Under the

Bankruptcy Code, 32 Case W. Res. L. Rev. 301, 325-326 (1982)

(discussing pre-Code law requiring both approval by creditors

and a finding that plan was fair and equitable); see also Case v.

16

neither of those statutes offered any definition of the

“fair and equitable” standard.” Third, each of those

statutes required creditor consent for adoption of a

plan in all cases.“

In the absence of a statutory definition, this Court

concluded that “(t]he words ‘fair and equitable’ as

used in § 77B(f) are words of art which prior to the

advent of § 77B had acquired a fixed meaning through

judicial interpretations in the field of equity

receivership reorganizations.” Case v. Los Angeles

Lumber Products Co., 308 U.S. 106, 115 (1939). In

Justice Douglas’s words, that phrase was intended to

codify “the ‘familiar rule’ * * * that ‘any arrangement

of the parties by which the subordinate rights and

interests of stockholders are attempted to be secured

at the expense of the prior rights of either class of

Los Angeles Lumber Products Co., 308 U.S. 106, 115 (1939)

(denying confirmation of a Section 77B plan as not fair and

equitable even though creditors had approved the plan;

explaining that “the fact that [an overwhelming majority of the

creditors] have approved the plan is * * * immaterial on the

basic issue of its fairness”).

2 11 U.S.C. 621(2) (1976); 48 Stat. 919 (Bankruptcy Act

§ 77B(f)(1)). See generally Collier’s 14th ed., supra note 16,

411.06 (discussing “fair and equitable” requirement of Chapter

X of the Bankruptcy Act); id. 1 11.04, at 181 & n.1 (noting that

the relevant provision of Chapter X was “derived from former

§77B(f)(1)” and that “(tJhere has been no change in sub-

stance”).

*4 Section 77B(e)(1), 48 Stat. 918 (requiring acceptance of

plan by two-thirds in amount of the claims of each class);

Chapter X § 179, 11 U.S.C. 579 (1976) (requiring acceptance by

two-thirds in amount of the claims of each class); cf. Section

1126(c) (current provision, which requires acceptance by at

least two-thirds in amount and more than one-half in number of

the claims of each class, but which need not be satisfied if plan

is crammed down under Section 1129(b)).

17

creditors comes within judicial denunciation.” Id. at

116 (quoting Louisville Trust Co. v. Louisville, N.A.

& C. Ry., 174 U.S. 674, 684 (1899)). Because the plan

before the Court did not satisfy that standard—old

equity owners received property under the plan, even

though creditors were not repaid in full—the Court

rejected the plan. 308 U.S. at 122-132 (analyzing

plan).

In the course of elueidating the meaning of the

“familiar rule” that the Case Court discerned in the

“fair and equitable” requirement of Section 77B,

Justice Douglas stated in dictum that “there are

circumstances under which stockholders may par-

ticipate in a plan of reorganization of an insolvent

debtor,” which he described as arising out of “the

necessity, at times, of seeking new money essential to

the success of the undertaking from the old stock-

holders.” 308 U.S. at 121. Even in those circum-

stances (which would have included, under the

applicable statutory scheme, onsent by a requisite

majority of the affected classes of claims), the Court

explained that the opportunity for participation by the

old stockholders should be strictly limited. The

Court explained:

[W]e believe that to accord the creditor his full

right of priority against the corporate assets

As at least one commentator has noted, the accuracy of

Justice Douglas’s analysis of the prior cases is questionable. See

John D. Ayer, Rethinking Absolute Priority After Ahlers, 87

Mich. L. Rev. 963, 974-975 (1989).

26 Three years later, in Marine Harbor Properties, Inc. v.

Manufacturers Trust Co., 317 U.S. 78, 85 (1942), the Court

applied its analysis of the “fair and equitable” standard in

Section 77B to cases arising under Chapter X of the Bank-

ruptey Act.

18

where the debtor is insolvent, the stockholder’s

participation must be based on a contribution in

money or in money’s worth, reasonably equivalent

in view of all the circumstances to the participa-

tion of the stockholder.

Id. at 122 (internal quotation marks omitted).

2. When Congress enacted the Bankruptcy Code in

1978, it dramatically restructured the framework for

business reorganizations, in a way that removes any

need or basis for the new value rule articulated by

Justice Douglas in Case. Most importantly, the

Code—unlike Chapter X of the Act—includes a

detailed definition of the “fair and equitable” stan-

dard, which for the most part codifies the absolute

priority rule that was the basis for the holding in

Case. As described above, Section 1129(b)(2)(B)

proscribes plans that allow the old equity owners to

receive “any property” under the plan “on account of”

their ownership interest in the debtor. Nothing in

that definition mirrors the new value rule articulated

in dictum in Case, and thus nothing in the statute

specifically authorizes a judge to confirm a plan

permitting old equity owners to participate over the

objection of a class of unpaid unsecured claims. 25

*7 Congress’s treatment of the subject was not inadvertent.

The 1973 Report of the Bankruptcy Commission, on which the

Code was based, recommended that Congress include a

provision that would have authorized the judge to allow old

equity owners to retain an interest under a plan whenever the

judge determined that the owners would “make a contribution

which is important to the operation of the reorganized debtor.”

Report of the Commission on the Bankruptcy Laws of the

United States, Pt. 2, H.R. Doc. No. 137, 93d Cong., Ist Sess. 242

(1973) (proposed Section 7-303(4)). As the Commission

explained in the accompanying note, its intent was that “the

19

Furthermore, in a significant departure from the

Code’s predecessors, the Code allows a plan to be

confirmed even if it does not meet the fair and

equitable standard, if the creditors consent. The

Code’s reliance on creditor consent limits the scope of

concerns courts need to address under the malleable

“fair and equitable” requirement. Under Chapter 11

of the Code, creditors are permitted to determine if

their best interests will be served by a plan that

permits participation by the old equity holders even if

the creditors’ claims are not repaid in full, and if the

creditors—voting in classes—agree to the plan, the

bankruptcy judge can confirm it, even if it does not

satisfy the “fair and equitable” standard of Section

1129( b)(1).

Creditors might agree to such a plan for any

number of reasons. Most obviously, one or more of

the old equity owners might have a special expertise

absolute priority rule * * * [be] made more flexible.” Id. at 254.

After the Commission’s proposal on that point was criticized

heavily, Congress abandoned it in favor of the scheme that’

appears in Section 1129. See Ayer, supra note 25, at 978-979.

Congress recognized the importance of that change. As

Senator DeConcini and Representative Edwards explained in

their detailed comments to their respective Chambers regard-

ing the final version of the bill that became the Code:

It must be emphasized that the fair and equitable require-

ment applies only with respect to dissenting classes.

Therefore, unlike the fair and equitable rule contained in

chapter X and section 77 of the Bankruptcy Act under

section 1129(b)(2), senior accepting classes are permitted to

give up value to junior classes as long as no dissenting

intervening class receives less than the amount of its claims

in full.

124 Cong. Rec. 32,407 (comments of Representative Edwards),

34,006 (remarks of Senator DeConcini) (1978).

20

or interest in the business that could not securely be

brought to the aid of the continuing business without

according an ownership interest to the old equity

owner. In cases where the creditors believe that

participation in ownership of the reorganized busi-

ness by the old equity owners would increase the

value of the business, they should be able to negotiate

an agreement under which a portion of that increase

would inure to the benefit of the creditors, and thus

increase the amounts they recover on their claims.

On the other hand, creditors in many cases might

oppose continued participation by the old owners,

either because they do not believe that continued

management by the old owners would be helpful

(perhaps because mismanagement by the old owners

was the cause of the business’s failure), or because

they believe that continued assistance in management

by the old owners can be ensured adequately by

employment agreements, without also conferring an

ownership interest in the reorganized enterprise. As

a result, the provisions of Chapter 11 create a

mechanism that allows the parties with an economic

interest in maximizing the value of the business—the

unpaid creditors—the ability to negotiate an agree-

ment with the equity owners allowing continuing

ownership participation in those cases where it is in

the best interests of the creditors.”

See House Report, supra note 13, at 224 (“{NJegotiation

among the parties after full disclosure will govern how the

value of the reorganizing company will be distributed among

creditors and stockholders. * * * Only when the parties are

unable to agree on a proper distribution of the value of the

company does the [Bankruptcy Code] establish a financial

standard.”); Walter J. Blum and Stanley A. Kaplan, The

Absolute Priority Doctrine in Corporate Reovganizations, 41 U.

21

3. The provisions of the Code permitting a court to

confirm a plan that does not meet the “fair and

equitable” standard if the plan secures the requisite

votes of the creditors remove any need for a court to

recognize a rule that would permit prior equity

owners to participate in a reorganization upon the

contribution of new value. The Case Court discerned

such an exception in the general language of the Act

to deal with cases where “the necessity * * * of

seeking new money [was] essential to the success of

the undertaking,” 308 U.S. at 121. As the Case

opinion makes clear, that exception was designed to

increase the economic prosperity of the reorganized

business—and thus the recovery of the unsecured

creditors—not to further some more generalized

policy favoring continued participation by the old

owners for its own sake.“

Because the new Code includes a separate mecha-

nism that allows creditors to decide for themselves

when continued participation will increase their

recovery, there is no need for courts to interpret the

Chi. L. Rev. 651, 653 (1974) (“The absolute priority doctrine

can be characterized as a way of structuring negotiations so

that they are sufficiently disciplined to be held within permis-

sible areas and to permit judicial review.“).

% The “necessity” to which the Court refers in Case is for

money “essential to the success of the undertaking.” Given the

Case Court’s clear premise that “creditors are entitled to

priority over stockholders against all the property of an

insolvent corporation,” 308 U.S. at 120, and its admonition that

the interest given old owners for any contributions of new

value must be “reasonably equivalent to their contribution,” id.

at 121—lest “the creditor’s rights * * * be easily diluted by

inadequate contributions by stockholders,” id. at 122—the Case

Court plainly understood that any net increase in value would

be applied to defray the claims of the creditors.

22

“fair and equitable” standard to permit participation

in other circumstances. When the creditors have not

consented, the parties with money at stake“ have

expressed their view that continued participation by

old equity owners on the terms proposed by the debtor

would not be in the best interests of the enterprise as

a whole. If the purpose of allowing the old owners to

participate is to increase the recovery of the

creditors—and we do not discern any other basis in

the Court’s opinion in Case or the language of the

Code—courts should not second-guess the view of the

creditors themselves that continued participation

would not be beneficial.

The old owners would be entitled to a recovery from the

business (and thus would have money at stake) only if their

participation would be so productive that the business (under

their direction) would produce sufficient funds not only to pay

off the unsecured creditors, but also to produce a return for

their residual interests. If the old owners believed that to be

the case, they could protect their interest by causing the debtor

to propose a plan that would pay off the unsecured creditors

entirely, thus satisfying Section 1129(b)(2)(B)(i), and obviating

the need for application of the absolute priority rule set forth

in Section 1129(b)(2)(B)(ii). Of course, the judge could confirm

such a plan only if it found that the plan was “not likely to be

followed by the liquidation, or the need for further financial

reorganization, of the debtor.” Section 1129(a)(11).

The court of appeals in this case did not suggest that the

new value rule should be used to further some general interest

in continued ownership of the business by the prior owners.

Rather, the court concluded (Pet. App. A50) that the absolute

priority rule does not bar a plan that allows the owners of a

debtor to participate in ownership of the reorganized business

upon the contribution of new value because that “participation

is necessary for a successful reorganization and in the best

interests of all concerned.” In our view, the best yardstick for

measuring a “successful” reorganization under the Code is

A rule permitting judges to force creditors to

accept plans that allow continuing ownership on

terms that the creditors believe would not further the

profitability of the business also would tend to have

adverse consequences for the reorganization process

as a whole. As numerous commentators have recog-

nized, the delay and expense involved in Chapter 11

proceedings has undermined the effectiveness of that

Statute considerably.“ Many commentators believe

that the problems with Chapter 11 are closely related

to a debtor’s incentive and ability to delay those

proceedings and bargain for results to which it is not

entitled under the Code.“ The rule adopted by the

whether it increases the value of the estate over the other

available alternatives. To put it another way, a reorganization

is not “successful” solely because it allows the owners of the

failed business to remain in control if it at the same time

decreases the recovery of the parties who have money at stake

creditors.

= See, é.g., Barry E. Adler, Bankruptcy and Risk

Allocation, 77 Cornell L. Rev. 439, 489 (1992): Douglas G.

Baird, The Uneasy Case for Corporate Reorganizations, 15 J.

Legal Stud. 127 (1986); Lucian A. Bebchuk, A New Approach

to Corporate Reorganizations, 101 Harv. L. Rev. 775, 777-781

(1988); Michael Bradley and Michael Rosenzweig, The Unten-

able Case for Chapter 11, 101 Yale L.J. 1043 (1992); Thomas H.

Jackson and Robert E. Scott, On the Nature of Bankruptcy:

An Essay on Bankruptcy Sharing and the Creditors’ Bargain,

—.— L. Rev. 155, 190 (1989); Robert K. Rasmussen, Debtor's

ice: A Menu Approach to Corporate Bankru „7117

L. Rev. 51, 78-84 (1992). Pein vm

See, e. g., Bebchuk, supra note 33, at 780 & n.19 (“When

the value of the reorganized company is lower than the total

2

24

court of appeals in this case would give debtors an

additional incentive to delay and oppose prompt

resolution of the proceedings, in the hope that they

might be able to convince a judge to confirm a plan

that would allow their owners to retain an interest in

the business even if the owners are not able to repay

all of the unsecured creditors or convince them that

continued ownership would further the creditors’

interests. In light of the problems arising under the

current process, the Court should not adopt a rule

that increases the bargaining power of a debtor

beyond what it currently has.“

value of creditors’ claims, the equityholders might have noth-

ing to lose and something to gain from a delay.”); Bradley &

Rosenzweig, supra note 33, at 1076-1077 (“Filing a Chapter 11

petition, in effect, is a way to keep control of the firm free

from the intrusive monitoring of creditors, thereby permitting

management to extract wealth from the firm’s various security

holders.”); Lynn M. LoPucki, The Trouble with Chapter 11,

1993 Wis. L. Rev. 729, 731-737; Robert K. Rasmussen, supra

note 33, at 76 (“It is clear * * * that equity holders often par-

ticipate in a reorganization even where there is little

probability that they are contributing firm-specific skills to the

reorganized enterprise.”); David A. Skeel, Jr., Markets,

Courts, and the Brave New World of Bankruptcy Theory, 1993

Wis. L. Rev. 465, 515 (referring to “the hold up power cur-

rently wielded * * * by the shareholders of a Chapter 11 debtor

[in a nonclosely held corporation case]”).

Empirical studies suggest that debtors under the current

process generally receive significantly more in Chapter 11

plans than the absolute priority rule would permit. Lynn M.

LoPucki, The Debtor in Full Control—Systems Failure Under

Chapter 11 of the Bankruptcy Code? (Pt. 2), 57 Am. Bankr.

LJ. 247, 263-266 (1983) [hereinafter Lopucki, Full Control?)

(empirical study of one year’s cases from the Western District

of Missouri suggests that small debtors almost uniformly retain

ownership of the company if it successfully reorganizes,

In sum, the differences between the confirmation

provisions of the Code and those of the Act undercut

the concerns that led the Court to suggest in Case

that a contribution of new value by old equity owners

might suffice to permit continued participation under

a plan of reorganization. Under the framework

established by the Code, any plan that permits such

participation over the objection of a class of unpaid

unsecured claims is—even aside from the specific

requirements of Section 1129(b)(2)—not “fair and

equitable” within the meaning of Section 1129(b)(1 ).

Accordingly, Section 1129(b) does not authorize

confirmation of such a plan.

B. At a minimum, the absolute priority rule

does not permit confirmation of a plan

that grants equity owners an exclusive

As in Ahlers, the Court could dispose of this case

without reaching the broad question discussed in

without regard to whether creditors are fully paid); Jerome R.

Kerkman, The Debtor in Full Control: A Case for Adoption of

the Trustee System, 70 Marq. L. Rev. 159, 165-183 (1987)

pirical study of the bankruptcy reorganizations of large,

publicly held companies shows that equity received distrib-

utions in 70% (21 out of 30) of the cases in which the creditors

were not fully repaid).

Point II. A above, because the plan proposed by the

debtor in this case cannot be reconciled with the

language of the absolute priority rule set forth in

Section 1129(b)(2)(B)(ii).

The plan in this case grants the equity owners of

the debtor the right to purchase a substantial (indeed,

controlling) ownership interest in the reorganized

business in return for a contribution of $200,000 and

the obligation to fund any working capital shortfalls

that the enterprise experiences during the first few

years of operations.“ The plan does not allow any

other person—whether a creditor or an independent

financier—an opportunity to bid for that ownership

interest or to purchase a portion of it together with

respondent’s owners. To put it another way, the right

of respondent’s owners to acquire that ownership

interest—which includes the entirety of the common

stock to be issued at the inception of the plan—is

exclusive of the rights of all third parties to bid on or

otherwise acquire that interest.”

% We mention the obligation to fund working-capital

shortfalls for completeness, although the plan does not specify

that compliance with that obligation is a condition of respon-

dent’s owners continuing to control the reorganized business.

See J.A. 19 (describing obligation to fund future shortfalls but

not describing any remedy for a default). Compare J.A. 20

(collateral trust mortgage to be contributed by H.F. Magnuson

would be collateral only for “indebtedness assumed by the

Reorganized Debtor in conjunction with this Plan”).

„* For an example of a court that allowed prior owners to

purchase ownership interests in a reorganized business only if

they were willing to pay more than other parties in a competi-

tive auction, see Jn re Bjolmes Realty Trust, 134 B.R. 1000,

1008-1011 (Bankr. D. Mass. 1991) (Queenan, J.). For a dis-

cussion of the practical advantages a debtor would retain even

if other parties have an opportunity to compete with the

27

We submit that the exclusive right granted respon-

dent’s owners is a species of “property”; it closely

resembles a stock warrant.** The most plausible

justification for the grant is the status of those

individuals and entities as owners of the debtor. That

justification, however, violates the absolute priority

rule set forth in Section 1129(b)(2)(B)(ii), because it

results in a grant of “property” “on account of” the

“junior claim or interest” held by respondent’s

owners.

Nor can the interest granted to the old owners be

justified by stating that it is granted “on account of”

their contribution of new value. To be sure, it has

been argued that an ownership interest in a

reorganized business that is granted to old equity

owners who contribute new value is not barred

directly by Section 1129(b)(2)(B)(ii), because the

interest in the business is granted “on account of”

the contribution of new value, rather than the status

of the purchasers as prior owners.*® But that

argument can justify permitting prior owners to

participate in ownership of a reorganized debtor only

debtor’s owners for the purchase, see Lopucki, Strategies,

supra note 4, § 11.11.2.

See Black's Law Dictionary 1422 (5th ed. 1979) (defining

stock warrant as la] certificate entitling the owner to buy a

specified amount of stock at a specified time(s) for a specified

price”). When a warrant is issued by a company whose articles

of incorporation authorize the issuance of only a limited

number ——_ (as is customary, and as is the case here), the

warrant effective) ts an exclusive ri i

: — — gran right to acquire the

A lucid explication of that view appears in Elizabeth

Warren, A Theory of Absolute Priority, 1991 A

Amer. Law 9, 39. N *

28

if they participate on the same terms as other parties.

When a plan allows the old owners to participate on

terms not available to others, it has given the old

owners something“ property“ for purposes of Sect-

ion 1129(b)(2)(B)(ii)—that cannot be justified solely by

reference to the contribution of value.” If the rights

were granted solely “on account of” the value con-

tributed, then they would be accorded to any party

that is willing to make a similar contribution.“

As Professor Warren explains:

The Code leaves old equity in the position of any other

potential investor: it may offer to buy any of the assets of

the estate on the same terms as any other buyer.

Some commentators argue that the estate is not buying

on the same terms as any other buyer because it enjoys a

better position than all other buyers in chapter 11.

Nothing in the Code gives equity such a beneficial position.

If courts are in fact giving them enhanced status, they

should not do so.

Warren, supra note 39, at 39.

Nor is there merit in the suggestion of the court of

appeals (Pet. App. A50) that the interest is permitted because

it is granted in furtherance of “a successful reorganization and

in the best interests of all concerned.” The fundamental flaw

in that suggestion is that it authorizes confirmation of a plan

that grants an interest to a party with no claim against the

debtor. Section 1129 provides that a plan of reorganization will

distribute the assets and income of the estate of an insolvent

business to repay the claims against the estate. Except where

parties consent to different treatment, the distribution must be

made in accordance with the priority of the claims (except

where parties purchase assets of the estate, or an interest in the

estate, a justification abjured by the court of appeals). The

reasoning of the court of appeals is inconsistent with that

framework, because it authorizes judges to give an interest in

the reorganized business to a party on a basis other than the

party’s holding a claim against the debtor. Just as the Code

Finally, the fact that the plan (typically proposed by

the debtor, as in this case“) makes the right to

acquire the ownership interests exclusive strongly

suggests that—at least in the debtor’s view—the

right has value, in the sense that the debtor believes

that the ownership interests are worth more than the

price set by the plan. If the debtor did not believe that

the ownership interests were worth more than the

price set by the plan, it presumably would be willing

to compete for the purchase with other parties. When

the parties with money at stake object to that plan,

the ground for that inference is particularly strong.

Hence, cramdowns in exclusive-purchase cases pre-

sent especially strong concerns that the debtor’s

owners are securing value under the plan that

expressly provides that it is not fair and quiléble to grant an

interest to a junior claimant while an objecting class of senior

claimants is unpaid, courts should apply the general “fair and

equitable” language in Section 1129(b)(1) to bar plans that vest

in an interest in a party based on a claim junior to the claim

held by the most junior claimant—i.e., a party that has no claim

whatsoever.

Section 1121(b) generally grants the debtor the exclusive

right to file a plan for the first 120 days of the proceeding. As a

practical matter, it appears that it is quite unusual for a judge

to reject a debtor’s request to extend that period. As a result,

it is unusual for a party other than the debtor to propose a plar

of reorganization. See Lynn M. LoPucki & William

Whitford, Venue Choice and Forum Shopping in the Bank-

ruptcy Reorganization of Large, Publicly Held Companies, 1991

Wis. L. Rev. 11, 31 n.67 (empirical study of large bankruptcies

indicating that debtor retained the right of exclusivity

throughout the entire proceeding in 79% (34 of 43] of the

cases); LoPucki, Full Control?, supra note 35, at 253-257 (rarity

of creditor-proposed plans in smal! cases).

30

properly should belong to the unpaid unsecured

creditors.

SS. &.&: va

The plan proposed by respondent grants respon-

dent’s owners a right—not available to any other

party—to acquire an overwhelming share of the

ownership interests in the reorganized debtor.

Petitioner, however—who controls an impaired class

of unsecured claims—would not consent, and the plan

does not provide for payment in full of the claims of

that class. As a result, Section 1129 bars confirm-

ation of the plan.

CONCLUSION

The judgment of the court of appeals should be

reversed.

Respectfully submitted.

Drew S. Days, III

Solicitor General

FRANK W. HUNGER

Assistant Attorney General

PAUL BENDER

Deputy Solicitor General

RONALD J. MANN

Assistant to the Solicitor General

FEBRUARY 1994

APPENDIX

§ 1129. Confirmation of plan

(a) The court shall confirm a plan only if all of the

following requirements are met:

(1) The plan complies with the applicable pro-

visions of this title.

(2) The proponent of the plan complies with the

applicable provisions of this title.

(3) The plan has been proposed in good faith and

not by any means forbidden by law.

(4) Any payment made or to be made by the pro-

ponent, by the debtor, or by a person issuing securi-

ties or acquiring property under the plan, for ser-

vices or for costs and expenses in or in connection

with the case, or in connection with the plan and

incident to the case, has been approved by, or is

subject to the approval of, the court as reasonable;'

(5)(A)(i) The proponent of the plan has dis-

closed the identity and affiliations of any individual

proposed to serve, after confirmation of the plan, as

a director, officer, or voting trustee of the debtor, an

affiliate of the debtor participating in a joint plan

with the debtor, or a successor to the debtor under

the plan; and

(ii) the appointment to, or continuance in, such

office of such individual, is consistent with the in-

terests of creditors and equity security holders and

with public policy; and

So in original. The semicolon probably should be a period.

(la)

2a

(B) the proponent of the plan has disclosed the

identity of any insider that will be employed or re-

tained by the reorganized debtor, and the nature of

any compensation for such insider.

(6) Any governmental regulatory commission

with jurisdiction, after confirmation of the plan,

over the rates of the debtor has approved any rate

change provided for in the plan, or such rate change

is expressly conditioned on such approval.

(7) With respect to each impaired class of

claims or interests—

(A) each holder of a claim or interest of such

class—

(i) has accepted the plan; or

(ii) will receive or retain under the plan on

account of such claim or interest property of

a value, as of the effective date of the plan,

that is not less than the amount that such

holder would so receive or retain if the debtor

were liquidated under chapter 7 of this title

on such date; or

(B) if section 1111(b)(2) of this title applies to

the claims of such class, each holder of a claim

of such class will receive or retain under the

plan on account of such claim property of a

value, as of the effective date of the plan, that is

not less than the value of such holder’s interest

in the estate’s interest in the property that

secures such claims.

(8) With respect to each class of claims or

interests—

(A) such class has accepted the plan; or

(B) such class is not impaired under the plan.

3a

(9) Except to the extent that the holder of a

particular claim has agreed to a different treatment

of such claim, the plan provides that—

(A) with respect to a claim of a kind specified

in section 507(a)(1) or 507(a)(2) of this title, on the

effective date of the plan, the holder of such claim

will receive on account of such claim cash equal to

the allowed amount of such claim;

(B) with respect to a class of claims of a kind

specified in section 507(a)(3), 507(a)(4), 507(a)(5) or

507(a)(6) of this title, each holder of a claim of such

class will receive—

(i) if such class has accepted the plan,

deferred cash payments of a value, as of the

effective date of the plan, equal to the allowed

amount of such claim; or

(ii) if such class has not accepted the plan,

cash on the effective date of the plan equal to

the allowed amount of such claim; and

(C) with respect to a claim of a kind specified

in section 507(a)(7) of this title, the holder of such

claim will receive on account of such claim deferred

cash payments, over a period not exceeding six

years after the date of assessment of such claim, of

a value, as of the effective date of the plan, equal to

the allowed amount of such claim.

(10) If a class of claims is impaired under the

plan, at least one class of claims that is impaired un-

der the plan has accepted the plan, determined with-

= including any acceptance of the plan by any in-

sider.

(11) Confirmation of the plan is not likely to be

followed by the liquidation, or the need for further fi-

nancial reorganization, of the debtor or any successor

4a

to the debtor under the plan, unless such liquidation

or reorganization is proposed in the plan.

(12) All fees payable under section 1930, as de-

termined by the court at the hearing on confirmation

of the plan, have been paid or the plan provides for the

payment of all such fees on the effective date of the

lan.

a (13) The plan provides for the continuation after

its effective date of payment of all retiree benefits, as

that term is defined in section 1114 of this title, at the

level established pursuant to subsection (e)(1)(B) or

(g) of section 1114 of this title, at any time prior to

confirmation of the plan, for the duration of the period

the debtor has obligated itself to provide such bene-

fits.

(b)(1) Notwithstanding section 510(a) of this ti-

tle, if all of the applicable requirements of subsection

(a) of this section other than paragraph (8) are met

with respect to a plan, the court, on request of the

proponent of the plan, shall confirm the plan notwith-

standing the requirements of such paragraph if the

plan does not discriminate unfairly, and is fair and

equitable, with respect to each class of claims or in-

terests that is impaired under, and has not accepted,

the plan.

(2) For the purpose of this subsection, the condi-

tion that a plan be fair and equitable with respect to a

class includes the following requirements:

(A) With respect to a class of secured claims,

the plan provides—

(i)(1) that the holders of such claims re-

tain the liens securing such claims, whether

the property subject to such liens is retained

by the debtor or transferred to another en-

2 So in original. Probably should be section 1930 of title 28.

5a

tity, to the extent of the allowed amount of

such claims; and

(II) that each holder of a claim of such

class receive on account of such claim de-

ferred cash payments totaling at least the al-

lowed amount of such claim, of a value, as of

the effective date of the plan, of at least the

value of such holder’s interest in the estate’s

interest in such property;

(ii) for the sale, subject to section 363(k)

of this title, of any property that is subject to

the liens securing such claims, free and clear

of such liens, with such liens to attach to the

proceeds of such sale, and the treatment of

such liens on proceeds under clause (i) or (iii)

of this subparagraph; or

(iii) for the realization by such holders

of the indubitable equivalent of such claims.

(B) With respect to a class of unsecured

claims—

(i) the plan provides that each holder of a

claim of such class receive or retain on ac-

count of such claim property of a value, as of

the effective date of the plan, equal to the al-

lowed amount of such claim; or

(ii) 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 ac-

count of such junior claim or interest any

property.

(C) With respect to a class of interests—

(i) the plan provides that each holder of

an interest of such class receive or retain on

account of such interest property of a value,

as of the effective date of the plan, equal to

6a

the greatest of the allowed amount of any

fixed liquidation preference to which such

holder is entitled, any fixed redemption price

to which such holder is entitled, or the value

of such interest; or

(ii) the holder of any interest that is

junior to the interests of such class will not

receive or retain under the plan on account of

such junior interest any property.

(c) Notwithstanding subsections (a) and (b) of

this section and except as provided in section 1127(b)

of this title, the court may confirm only one plan, un-

less the order of confirmation in the case has been re-

voked under section 1144 of this title. If the require-

ments of subsections (a) and (b) of this section are

met with respect to more than one plan, the court

shall consider the preferences of creditors and equity

security holders in determining which plan to con-

firm.

(d) Notwithstanding any other provision of this

section, on request of a party in interest that is a

governmental unit, the court may not confirm a plan

if the principal purpose of the plan is the avoidance of

taxes or the avoidance of the application of section 5

of the Securities Act of 1933 (15 U.S.C. 77e). In any

hearing under this subsection, the governmental unit

has the burden of proof on the issue of avoidance.

*