Amicus Curiae Brief — Bank of America Nat. Trust and Sav. Assn. v. 203 North LaSalle Street Partnership

e+)

PR 1 1998 No. 97-1418

IN THE

Supreme Court of the United States

OCTOBER TERM, 1997

BANK OF AMERICA NATIONAL TRUST

AND SAVINGS ASSOCIATION,

. Petitioner,

203 NorTH LASALLE STREET PARTNERSHIP,

Respondent.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Seventh Circuit

MOTION FOR LEAVE TO FILE BRIEF AMICUS CURIAE

AND BRIEF AMICUS CURIAE OF THE

AMERICAN COUNCIL OF LIFE INSURANCE

IN SUPPORT OF PETITIONER

Of Counsel: JAMES A. PARDO, JR.

Purulr E. STANO Counsel of Record

AMERICAN COUNCIL OF DAVID G. EPSTEIN

LIFE INSURANCE SARAH ROBINSON BORDERS

1001 Pennsylvania Ave., N.W. BRIAN C. WALSH

Washington, D.C. 20004-2599 - KING & SPALDING

(202) 624-2183 191 Peachtree Street, N.E.

Atlanta, Georgia 30303-1763

(404) 572-4600

Counsel for Amicus Curiae

WILSON - EPES PRINTING Co.. INC. - 789-0096 - WASHINGTON. D.C. 20001

IN THE

Supreme Court of the United States

OCTOBER TERM, 1997

No. 97-1418

BANK OF AMERICA NATIONAL TRUST

AND SAVINGS ASSOCIATION,

m Petitioner,

203 NorTH LASALLE STREET PARTNERSHIP,

Respondent.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Seventh Circuit

MOTION FOR LEAVE TO FILE BRIEF AMICUS CURIAE

Pursuant to Rule 37.2(b) of this Court, the American

Council of Life Insurance (“ACLI”) respectfully moves

this Court for leave to file the accompanying brief amicus

curiae in support of the Petition for Writ of Certiorari

filed by Bank of America National Trust and Savings

Association. Petitioner has consented to the filing of this

brief, and petitioner’s written consent has been filed with

the Clerk of the Court. Respondent has refused its con-

sent.

ACLI is the principal national trade association of life

insurance compames in the United States. Its members

have a significant s.ake in the resolution of the question

presented in this case. Life insurance companies are a

major source of investment capital, providing more than

ten percent of institutional funds flowing into U.S. finan-

cial markets in 1996 and holding more than $1 trillion in

corporate bonds and mortgages as of year-end 1996,

ACLI participated as amicus curiae when the question

presented in this case was last before the Court four

Terms ago in U.S. Bancorp Mortgage Co. v. Bonner Mall

Partnership, No. 93-714, Although the Court did not

reach the merits in that case, ACLI believes that its briefs

at the petition stage and on the merits provided the Court

with a valuable perspective on the importance of the issue

and the proper resolution of the question on the merits.

ACLI believes that its views in this case will be equally

valuable to the Court.

WHEREFORE, ACLI respectfully requests that the

Court grant it leave to file the accompanying brief amicus

curiae in support of the Petition for Writ of Certiorari.

Respectfully submitted,

Of Counsel:

PHILLIP E. STANO

AMERICAN COUNCIL OF Davip G. EPSTEIN

LIFE INSURANCE SARAH ROBINSON BORDERS

1001 Pennsylvania Ave., N.W. BRIAN C. WALSH

Washington, D.C. 20004-2599 KING & SPALDING

(202) 624-2183 191 Peachtree Street, N.E.

Atlanta, Georgia 30303-1763

(404) 572-4600

Counsel for Amicus Curiae

JAMES A. PARDO, JR.

Counsel of Record

TABLE OF CONTENTS

TABLE OF AUTHORITIES. .............2..2.-.0-cccceccocseeseeeeee .

INTEREST OF AMICUS CURIAB |... 20s

SUMMARY OF REASONS FOR GRANTING THE

WRIT .. Sicaintahinineapieies

REASONS FOR GRANTING THE WRIT ......... anions

I. THE COURTS OF APPEALS, DISTRICT

Ill.

COURTS, AND BANKRUPTCY COURTS ARE

DIVIDED ON WHETHER AN _ EQUITY-

ONLY NEW VALUE RIGHT IS CONSISTENT

WITH ABSOLUTE PRIORITY |...

THE AVAILABILITY OF AN EQUITY-ONLY

NEW VALUE RIGHT IS AN ISSUE OF EX-

CEPTIONAL IMPORTANCE TO LENDERS

AND BUSINESS OWNERS |

THE DECISION OF THE COURT OF AP.-

PEALS IS INCONSISTENT WITH THE

PLAIN MEANING OF SECTION 1129(b) OF

THE BANKRUPTCY CODE, THIS COURT'S

JURISPRUDENCE ON THE INTERPRETA-

TION OF THE BANKRUPTCY CODE, AND

BANKRUPTCY POLICY .

I ipdeiabtianibesih a ee

(i)

Page

ii

1

17

ii

TABLE OF AUTHORITIES

Cases Page

In re Ahlers, 794 F.2d 388 (8th Cir. 1986), rev'd

on other grounds, 485 U.S. 197 (1988) ............. 5

In re Ambane La Mesa Ltd. Partnership, 115 F.3d

650 (9th Cir. 1997), cert. denied, 118 S. Ct. 1039

', ie ke SS ees 7

In re Bonner Mall Partnership, 2 F.3d 899 (9th

Cir. 1993), motion to vacate denied and case dis-

missed, 613 U.S. 18 (1994) _............-.......cce-eeeeeeeees 5

In re Bryson Properties, XVIII, 961 F.2d 496 (4th

Cir.), cert. denied, 506 U.S. 866 (1992) . 6, 10

Case v. Los Angeles Lumber Products Co., 308 U. s.

|, passim

Coltex Loop Central Three Partners, L.P. v. _ BT/

SAP Pool C Associates, L.P., 1998 WL 90844

(2d Cir. Feb. 19, 1998) .. aes 6

Dewsnup v. Timm, 502 U. s. 410 (1992) .. aA es Al 12, 13

In re Greystone III Joint Venture, 995 F.2d 1274

(5th Cir. 1991), withdrawn in part, 995 F.2d at

1284 (5th Cir.), cert. denied, 506 U.S. 821

|S / See ae 6

In re Homestead Partners, Ltd., 197 B.R. 706

(Bankr. N.D. Ga. 1996) .. 7

Kham & Nate’s Shoes No. 2, ‘Ine. v. | First Bank,

908 F.2d 1351 (7th Cir. 1990) .......................... 4, 16

In re Mallard Associates, 475 F. Supp. 1045

J ls i ee ee ae 15

Marine Harbor Properties, Inc. v. Manufacturer's

a OR BSE) Fee 12

In re Moonraker Associates, Ltd., 200 B.R. 950

I, OE 7

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

ff, x. passim

Pennsylvania Department of Public Welfare v.

Davenport, 496 U.S. 552 (1990) .......................... 13

SEC v. American Trailer Rentals Co., 379 U.S. 594

> _ 15

In re Snyder, 967 F.2d 1126 (7th Cir. 1992) .

In re Tallahassee Associates, L.P., 132 B.R. 712

I OO ————EEEs 7

Statutes

iii

TABLE OF AUTHORITIES—Continued

Page

Toibb v. Radloff, 501 U.S. 157 (1991) - 11

U.S. Bancorp Mortgage Co. v. Bonner Mall Part-

nership, 513 U.S. 18 (1994) .............---------n---n0 3, 4,8

In re U.S. Truck Co., 800 F.2d 581 (6th Cir.

a 6

Union Bank v. Wolas, 502 U.S. 151 (1991) leslie 13

United States v. Ron Pair Enterprises, Inc., 489

yyy EE 11, 13

In re VIP Motor Lodge, Inc., 133 B.R. 41 (Bankr.

A eeey———————————EEEEEEa 7

In re Winters, 99 B.R. 658 (Bankr. W.D. Pa.

I eiinctstereesiscicenecctsnesenentnninclantitinciatnehisintanatomarenanaeet 7

Act of June 7, 1934, ch. 424, sec. 1, § 77B(f), 48

Stat. 911, 919 (superseded 1938) .................. 12

Bankruptcy Act of 1898 (formerly codified at 11

U.S.C. § 1 et seq. (repealed 1979)) —................ passim

Bankruptcy Reform Act of 1978, 11 U.S.C. § 101

CB DEE. cnccracenceseceecsecescareensccnenatecmmeseserensenteccaceancensneerons passim

11 U.S.C. § 556 (repealed 1979) ............ eS ee ee 14

11 U.S.C. § 569 (repealed 1979) ............... to 14

11 U.S.C. § 621(2) (repealed 1979) ......... eat as 12

11 U.S.C. § 706(1) (repealed 1979) ......................... 14

11 U.S.C.4 723 (repealed 1979)... ------eeeeeeee 14

11 U.S.C. § 742 (repealed 1979)... eee 14

11 U.S.C. § 823 (repealed 1979) ...........................--.-... 14

11 U.S.C. § 844 (repealed 1979) ................. oe ay 14

hl) f)) | 14

LR) U6") 14

0 yy 5, 15

11 U.S.C. § 1129(a) ............ ES ee eos See 2 a eee Faia 15

ob fa) es a

I yy ——————————— 9

11 U.S.C. § 1129(b) (2) ~......... LS ed ae HEA passim

Eta h, f. | 10

11 U.S.C. ee (2) (B) (ii) -......... cateiisiihaibaetiealades 9, 10

28 U.S.C. § 1408 .. ecaeiatiniedasndiiadaeaatate 6

iv

TABLE OF AUTHORITIES—Continued

Other Authorities

Administrative Office of the U.S. Courts, Calendar

Year 1997 Shows Bankruptcy Filings Up 19

Percent Over 1996 (press release Feb. 27,

BOT a. .cxssscressinatnatcthesandinencinsenanspiaiiinatincclniitemaienepete

American Council of Life Insurance, Life Insur-

genes Pst Breld (IBGG) ...~-<.cnccccceccsseeceonsctensessrenes

Douglas G. Baird, The Elements of Bankruptcy

| a

7 Collier on Bankruptcy © 1129.04[4][c]) (Law-

rence P. King ed., 15th ed. rev. 1997) .

Julian R. Franks & Walter N. Torous, An Empiri-

cal Investigation of U.S. Firms in Reorganiza-

tion, 44 J. Fin. 747 (1989) .

H.R. Rep. No. 95-595 (1977), reprinted ¢ in 1978

ot Ts dS Fe eR ee

Kenneth N. Klee, Vaiuation and Cram Down, SB

OE, yy

David R. Kuney & Timothy R. Epp, Aftermath of

Bonner Mall: Evolution or Regression in the

Notion of “New Value”?, 5 J. Bankr. L. & Prac.

211 (1996) ...... PR OT ig i eee ALE I

Lynn M. LoPucki & William C. Whitford, Bargein-

ing over Equity’s Share in the Bankruptcy Re-

organization of Large, Publicly Held Companies,

139 U. Pa. L. Rev. 125 (1990) .................-.--...-.--.

Pruce A. Markell, Owners, Auctions, and Absolute

Priority in Bankruptcy Reorganizations, 44

Stan. L. Rev. 69 (1997) ............

Supreme Court Rule 10(a) .....

Page

14

12

IN THE

Supreme Court of the United States

OcTOBER TERM, 1997

No. 97-1418

BANK OF AMERICA NATIONAL TRUST

AND SAVINGS ASSOCIATION,

. Petitioner,

203 NortH LASALLE STREET PARTNERSHIP,

Respondent.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Seventh Circuit

BRIEF AMICUS CURIAE OF THE

AMERICAN COUNCIL OF LIFE INSURANCE

IN SUPPORT OF PETITIONER

INTEREST OF AMICUS CURIAE '

ACLI is the principal national trade association of life

insurance companies. The 532 member companies of

ACLI account for eighty-nine percent of the legal reserve

life insurance in this country and are among the nation’s

largest and most significant commercial lenders. In 1996,

life insurance companies’ net investment in U.S. money

and capital markets totaled $107 billion, more than ten

In accordance with Supreme Court Rule 37.6, ACLI represents

that no party other than counsel for ACLI authored this brief in

whole or in part, and no person or entity, other than ACLI, ha:

made a monetary contribution to the preparation of submission of

this brief.

2

percent of total institutional funds flowing into the finan-

cial markets. American Council of Life Insurance, Life

Insurance Fact Book 50 (1997). At year-end 1996, life

insurers held $951.7 billion in corporate bonds and

$207.8 billion in mortgages. /d. at 53, 102.

The interest of ACLI as amicus arises out of the im-

portance of this case to the commercial lending com-

munity. As a principal source of investment capital for

both real estate developments and operating businesses,

life insurance companies have a broad and important per-

spective on the need for this Court’s review of this case.

Life insurance companies, like all lenders, presently

are faced with conflicting rules as to the propriety of a

bankruptcy reorganization plan that grants the debtor's

owners (“old equity”), and only old equity, the right to

purchase ownership of the reorganized debtor by con-

tributing additional capital to the debtor’s bankruptcy

estate (an “equity-only new value right”). The courts of

appeals, district courts, and bankruptcy courts are divided

on whether the Bankruptcy Reform Act of 1978, 11

U.S.C. $101 et seq. (as amended, the “Bankruptcy

Code”) permits an equity-only new value right, as are the

law review and treatise writers.

Lenders make credit decisions, price loans, and bargain

for security and other terms based in part on the risks of

nonpayment and the potential for recovery in the event

of default. Lenders (and borrowers) need a uniform na-

tional rule of bankruptcy rights and priorities. Uncertainty

as to the rights and priorities of debt holders and equity

holders adversely affects credit decisions, the cost of

credit, and the consensual resolution of troubled loans.

Review of the decision of the Court of Appeals is thus

vitally important to ACLI and its members.

SUMMARY OF REASONS FOR GRANTING THE WRIT

The five courts of appeals that have considered the

issue presented in this case—-whether an equity-only new

value right meets the requirements of the Bankruptcy

—

3

Code’s absolute priority rule—are divided. This division

at the appellate level reflects a split in the bankruptcy

courts, sometimes among judges in the same judicial dis-

trict. A decision from this Court on the merits is neces-

sary to establish a uniform nationwide rule of decision.

The equity-only new value question is an issue of great

importance to both creditors and debtors. Clarification of

this area of the law will remove significant uncertainties

from the processes of negotiating and litigating bank-

ruptcy reorganization plans and will enable the credit

markets to allocate bankruptcy-related risks appropriately.

This Court recognized the importance of this issue by

granting certiorari in Bonner Mall four Terms ago.

The Court of Appeals in this case disregarded the

significance of Congress’ deliberate statutory choices in

enacting the Bankruptcy Code in 1978 and misread the

plain language of the statute that resulted from those

choices. At the same time, the Court of Appeals mis-

understood pre-Bankruptcy Code law and ignored crucial

differences between that law and present law. The result-

ing decision of the Court of Appeals is inconsistent with

the language of the Bankruptcy Code, with congressional

intent, and with several decisions of this Court. =

REASONS FOR GRANTING THE WRIT

I. THE COURTS OF APPEALS, DISTRICT COURTS,

AND BANKRUPTCY COURTS ARE DIVIDED

ON WHETHER AN EQUITY-ONLY NEW VALUE

RIGHT IS CONSISTENT WITH ABSOLUTE

PRIORITY.

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

(1988), this Court expressly declined to address the

United States’ argument as amicus curiae that Congress’

“codification of the absolute priority rule eliminated any

‘exception’ to that rule suggested by [Case v.] Los Angeles

Lumber |Products Co., 308 U.S. 106 (1939)].” Id. at

203 n.3. The Court recognized, however, that the vitality

4

of the new value doctrine® is “a question which has di-

vided the lower courts since passage of the Code in 1978.”

Id. The division over new value and absolute priority has

intensified since Ahlers, the only consensus is the need

for Supreme Court review.

A divided Seventh Circuit panel held in this case that

a plan of reorganization may grant old equity, and only

old equity, the right to purchase the ownership of the

reorganized debtor without competitive bid or counter-

proposal by creditors or others.* That holding sanctioned

the conferral on old equity of what is in essence an

“equity-only new value right.” *

* Like most other courts, this Court has referred to the new value

doctrine as an “exception” to the absolute priority rule. U.S.

Bancorp Mortgage Co. v. Bonner Mall Partnership, 513 U.S. 18,

20 & n.1 (1994) ; Ahlers, 485 U.S. at 203 n.8. The majority opinion

of the Court of Appeals panel in this case, for the most part, pre-

ferred the phrase “new value corollary.” App. to Pet. for Cert. at

l4a. We refer to the issue generally as the “new value doctrine”

and to the new value issue involved in this case as an “equity-only

new value right.”

* It is not surprising that the Seventh Circuit panel was divided

in this case. In Kham & Nate’s Shoes No. 2, Inc. v. First Bank, 908

F.2d 1351, 1361-62 (7th Cir. 1990), Judge Easterbrook strongly sug-

gested that the new value doctrine did not survive the enactment of

the Bankruptcy Code. Later, in /n re Snyder, 967 F.2d 1126, 1129-30

(7th Cir. 1992), Judge Cudahy strongly suggested just the opposite.

In both cases, the panels held that even if the new value doctrine

were viable, the debtor’s proposed new value contribution did not

satisfy the requirements of the doctrine. See Kham & Nate’s Shoes

No. 2, 908 F.2d at 1362; Snyder, 967 F.2d at 1131. The Seventh

Circuit denied rehearing en banc in the case at bar by an evenly

divided vote. See App. to Pet. for Cert. at 49a.

*A red herring frequently colors the arguments of debtors and

courts in favor of an equity-only new value right. It is the errone-

ous conclusion that without an equity-only new value right, old

equity would be barred f:om owning an interest in the reorganized

debtor unless either (1) all classes of creditors accepted the plan

or (2) all creditors were to be paid in full. The Ninth Circuit, for

example, reasoned that if an equity-only new value right were

5

In five circuts, courts of appeals have taken positions

on whether an equity-only new value right is inconsistent

with the absolute priority rule of Section 1129(b). In

addition to the Seventh Circuit’s decision in this case, the

Eighth and Ninth Circuits have authorized equity-only

new value rights. In re Ahlers, 794 F.2d 388, 401-42

(8th Cir. 1986), rev’d on other grour.ds, 485 U.S. 197

(1988);° In re Bonner Mall Partnership, 2 F.3d at 907.°

The Sixth Circuit has approved the confirmation of a plan

containing an equity-only new value right without directly

impermissible, “{w]e would then be left with an absolute prohibition

against former equity owners’ receiving or retaining property in

the reorganized debtor [where senior classes are not paid in full].”

In re Bonner Mall Partnership, 2 F.3d 899, 909 (9th Cir. 1993),

motion to vacate denied and case dismissed, 513 U.S. 18 (1994).

The law does not require, and ACLI does not suggest, that old

equity may never own or control the reorganized debtor unless all

classes of creditors either consent to the plan or are paid in full.

The absolute priority rule does prohibit a plan that gives old equity

greater rights to buy assets of or interests in the debtor than other

parties in interest receive. For example, a new value right that is

limited to old equity only is a grant of property to old equity on

account of old equity’s ownership of the debtor and triggers the

prohibition of 11 U.S.C. § 1129(b)(2), as explained infra at 10-11.

* The Eighth Circuit decided Ahlers in a procedural posture in

which no reorganization plan had been filed, and the court’s opinion

does not address specifically whether the debtors’ right to purchase

the equity in their farm would be exclusive. Instead, the contem-

plated new value considered by the Eighth Circuit was the debtors’

“farm operation and management skills,” which presumably could

be provided only by the debtors. Ahlers, 794 F.2d at 402.

*In Bonner Mall, the Ninth Circuit held squarely that a plan

may grant exclusively to old equity the right to purchase ownership

for new value. 2 F.3d at 910-11. The Ninth Circuit’s conclusion

apparently was bolstered by its belief that the expiration of the

debtor’s exclusive period to file a plan under 11 U.S.C. § 1121

affected the propriety of the equity-only plan. See id. at 910 n.26.

The issue in the instant case is the exclusivity of the right granted

to old equity to purchase ownership of the debtor, not the exclusivity

of the debtor’s right to file a plan.

6

addressing the issue. In re U.S. Truck Co., 800 F.2d 581,

588 (6th Cir. 1986).

The Second Circuit recently addressed this issue at

length and held that the absolute priority rule does not

permit equity-only new value rights. Coltex Loop Central

Three Partners, L.P. v. BT/SAP Pool C Assocs., L.P.,

1998 WL 90844, at *3 (2d Cir. Feb. 19, 1998). Earlier,

the Fourth Circuit reached the same conclusion. /n re

Bryson Properties, XVIII, 961 F.2d 496, 504 (4th Cir.),

cert. denied, 506 U.S. 866 (1992). And a panel of the

Fifth Circuit initially so held, but the panel withdrew the

relevant portion of its opinion after concluding that it did

not need to reach the issue. In re Greystone Ill Joint

Venture, 995 F.2d 1274, 1284 (Sth Cir. 1991), with-

drawn in part, 995 F.2d at 1284 (Sth Cir.), cert. denied,

506 U.S. 821, 822 (1992).

This sharp division among the courts of appeals is

alone sufficient to justify this Court’s exercise of its cer-

tiorari jurisdiction. See Sup. Ct. R. 10(a). For a lender,

however, the division among the bankruptcy courts has

an even greater impact than the circuit split. Bankruptcy

courts are responsible for applying the absolute priority

rule in the first instance. The economics of many Chapter

11 cases limit lenders to proceedings in the bankruptcy

court; costs and delay deter the first appeal to the district

court or bankruptcy appellate panel, much less the second

appeal to the court of appeals.

Because of the bankruptcy venue rules, sharp divisions

among the courts on new value issues make it nearly im-

possible to evaluate the bankruptcy-related risk of a par-

ticular borrower. See 28 U.S.C. § 1408. For example, the

principals of the debtor in Coltex surely regret filing for

bankruptcy protection in New York, where their equity-

only new value plan caused the Second Circuit to con-

clude that an equity-only new value right is impermissible.

Had they filed in Delaware, where the debtor was or-

ganized, they might have found support for their position

~

7

in In re VIP Motor Lodge, Inc., 133 B.R. 41 (Bankr.

D. Del. 1991); had they filed in the Southern District of

Texas, where the debtor’s principal assets were located,

they could have argued about new value on a clean slate.

And even if a creditor could somehow divine at the

time of the transaction where the debtor might file for

bankruptcy protection, it still might not know whether the

debtor would receive the benefit of an equity-only new

value right. In certain districts, the permissibility of an

equity-only new value right may depend on the turn of the

wheel that decides which judge is assigned the case. For

example, in the Northern District of Georgia* and the

Western District of Pennsylvania," bankruptcy judges have

published equity-only new value decisions in direct con-

tradiction of their colleagues. In light of the split among

the courts of appeals, there is little likelihood that these

inter-district and intra-district divisions will be resolved

consistently.”

7 Compare In re Moonraker Assocs., Ltd., 200 B.R. 950, 954-56

(Bankr. N.D. Ga. 1996) (equity-only new value right is permissible)

with In re Homstead Partners, Ltd., 197 B.R. 706, 716 (Bankr. N.D.

Ga. 1996) (equity-only new value right is not permissible).

S Compare In re Tallahassee Assocs., L.P., 182 B.R. 712, 717

(Bankr. W.D. Pa. 1991) (equity-only new value right is permissible)

with In re Winters, 99 B.R. 658, 663 (Bankr. W.D. Pa. 1989)

(equity-only new value right is not permissible) .

® Further confusion results from the inablity of courts that allow

equity-only new value rights to agree about what old equity must

offer to qualify. One common formulation of the requirements

draws from Los Angeles Lumber the proposition that old equity

must “offer value under the Plan that is (1) new, (2) substantial,

(3) in money or money’s worth, (4) necessary for successful re-

organization, and (5) reasonably equivalent to the value or interest

received.” In re Ambanc La Mesa Ltd. Partnership, 115 F.3d 650,

654 (9th Cir. 1997), cert. denied, 118 S. Ct. 1089 (1998). (The

debtor in Ambane petitioned for certiorari, but its petition raised

questions only as to the elements of the new value doctrine.) The

courts’ efforts to apply this test have led to numerous inconsistent

results. See David R. Kuney & Timothy R. Epp, Aftermath of

Il. THE AVAILABILITY OF AN EQUITY-ONLY NEW

VALUE RIGHT IS AN ISSUE OF EXCEPTIONAL

IMPORTANCE TO LENDERS AND BUSINESS

OWNERS.

The reported cases discussed above reflect only a small

portion of the impact of uncertainty about the new value

doctrine upon creditors and debtors. In 1997, 9694 busi-

nesses filed for Chapter 11 protection, at least one in

every judicial district in the United States. See Adminis-

trative Office of the U.S. Courts, Calendar Year 1997

Shows Bankruptcy Filings Up 19 Percent Over 1996, at

tbl. F-2 (press release Feb. 27, 1998). Most decisions of

bankruptcy courts in these Chapter 11 cases remain un-

reported. In many of these cases, creditors and debtors

reach consensual solutions to disputed issues, after nego-

tiations that are complicated by the uncertainty in this

area of bankruptcy law. .

The question of the existence and content of the new

value doctrine is one of the most important issues of bank-

ruptcy law today. The absolute priority rule lies at the

heart of bankruptcy reorganization. It reflects the non-

bankruptcy ordering of rights and priorities between hold-

ers of debt and equity and “sets the ground rules of Chap-

ter 11.” Douglas G. Baird, The Elements of Bankruptcy

73 (1992). If old equity is permitted an exclusive oppor-

tunity to capture the value of the reorganized debtor by

contributing new capital to the debtor’s estate at a price

set by the bankruptcy judge, lenders will adjust their

credit decisions to account for this upsetting of nonbank-

ruptcy priorities.

The Court recognized the importance of the issue pre-

sented in this case by granting certiorari in Bonner Mall,

but the parties’ settlement prevented the Court from reach-

ing the merits. Bonner Mall, 513 U.S. at 20 n.1. The

Bonner Mall: Evolution or Regression in the Notion of “New

Value”?, 5 J. Bankr. L. & Prac. 211, 234-46 (1996) (collecting

cases).

9

issue is no less important today, as debtors and creditors

continue to struggle with inconsistent interpretations of

the absolute priority rule.

The importance of the proper application of the abso-

lute priority rule also has a temporal teach far beyond

bankruptcy proceedings. A lender making a determina-

tion whether to extend credit in the first instance must

consider the worst possible outcome. For a lender, the

worst possible outcome is (1) failure of the debtor to

repay its obligations, followed by (2) a bankruptcy filing,

followed by (3) failure of the debtor to propose a plan

of reorganization that meets with the approval of the

majority of a class of unsecured creditors, followed by

(4) a cramdown that gives old equity, and only old equity,

the opportunity to retain ownership of the debtor for “new

value” at a price fixed by old equity and the bankruptcy

judge rather than the market. In an environment in which

lenders cannot predict whether a particular court will con-

firm a plan containing an equity-only new value right, a

prudent lender will adjust its credit standards accordingly.

The impact of such credit decisions on the canital markets

nationwide argues strongly in favor of this Court’s exercise

of its jurisdiction to review the decision of the Court of

Appeals.

Ill. THE DECISION OF THE COURT OF APPEALS IS

INCONSISTENT WITH THE PLAIN MEANING

OF SECTION 1129(b) OF THE BANKRUPTCY

CODE, THIS COURT’S JURISPRUDENCE ON THE

INTERPRETATION OF THE BANKRUPTCY CODE,

AND BANKRUPTCY POLICY.

This case involves the text of a single subsection of the

Bankruptcy Code, Section 1129(b)(2)(B) (ii). Twenty

years ago. Congress codified the absolute priority rule,

which previously was a matter of federal common law, as

part of the Bankruptcy Code’s requirement that a reor-

ganization plan be “fair and equitable” to be confirmed

over the objection of a class of creditors. 11 U.S.C.

10

§ 1129(b)(1). Section 1129(b)(2) provides that when

a Chapter 11 plan is crammed down on a dissenting class

of creditors, it is not fair and equitable unless:

(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 account of such

claim property of a value, as of the effective date of

the plan, equal to the allowed 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 account of such junior

claim or interest any property.

11 U.S.C. § 1129(b)(2)(B). This is a clear congressional

statement that if a class of unsecured creditors objects to

a plan that does not propose full repayment of those un-

secured creditors, a junior class cannot receive or retain

any property under the plan because of its claim against

or interest in the debtor. There is no dispute in the courts

that an equity interest in the reorganized debtor, what-

ever its value, constitutes “property” for purposes of the

absolute priority rule. Ahlers, 485 U.S. at 207-08. Sim-

ilarly. old equity’s exclusive opportunity to purchase this

property is itself “property.” Bryson, 961 F.2d at 504.

Section 1129(b)(2) does not prohibit old equity from

becoming the owner of the reorganized debtor. Old equity

has the same opportunity to purchase assets or ownership

of the bankruptcy estate as any other interested investor.

Section 1129(b) (2), however, does prohibit a Chapter 11

plan that confers an old equity greater rights to buy assets

or ownership of the estate than other possible buyers have.

A plan that provides for an equity-only new value right

enables old equity to receive or retain property “on ac-

count of such junior . . . interest.” 11 U.S.C; § 1129

(b)(2)(B) (ii); see also App. to Pet. for Cert. at 34a-35a

(Kanne, J., dissenting). The property received in viola-

a ,

a er

1]

tion of Section 1129(b)(2) is the exclusive opportunity

to purchase ownership.

This Court's decisions on the interpretation of the Bank-

ruptcy Code demonstrate that the Court of Appeals erred

in affirming confirmation of respondent's plan. In United

States v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989),

this Court stated:

The task of resolving the meaning of [a section of the

Bankruptcy Code] begins where all such inquiries

must begin: with the language of the statute itself.

In this case, it is also where the inquiry should end,

for where, as here, the statute’s language is plain,

“the sole function of the courts is to enforce it accord-

ing to its terms.”

Id. at 241 (citations omitted). The Court of Appeals

erroneously concluded that the language of the absolute

priority rule was ambiguous because courts and com-

mentators have reached different conclusions about its

proper interpretation. See App. to Pet. for Cert. at 18a-

19a. If disagreements among judges and scholars were

sufficient to make a statute ambiguous, this Court would

not have relied on the plain language of the Bankruptcy

Code in Ron Pair. See Ron Pair, 489 U.S. at 238 & n.!

(collecting decisions and commentary reaching conflicting

conclusions about interpretation of 11 U.S.C. § 506(b));

see also Toibb v. Radloff, 501 U.S. 157, 160-61 (1991)

(following plain language of Bankruptcy Code despite

disagreement among courts).

After concluding that the statute was ambiguous, the

Court of Appeals turned for guidance to the law and

practice under the Bankruptcy Act of 1898 (formerly

codified at 11 U.S.C. $1 et seq. (repealed 1979)) (the

“Bankruptcy Act”). The Court of Appeals relied on this

Court’s decision in Dewsnup v. Timm, 502 U.S. 410

(1992), in which the Court expressed its reluctance “to

accept arguments that would interpret the Code, however

vague the particular language under consideration might

12

be, to effect a major change in pre-Code practice that is

not the subject of at least some discussion in the legisla-

tive history.” Jd. at 419." The Court of Appeals con-

cluded that the new value doctrine had a longstanding

heritage under the Bankruptcy Act and that Congress

evidenced no intent to eliminate the doctrine when it

enacted the Bankruptcy Code. See App. to Pet. for Cert.

at 20a-23a. Both conclusions are incorrect.

The Bankruptcy Act heritage of the new value doctrine

is limited at best. In Los Angeles Lumber, the Court

considered whether the requirement in Section 77B of the

Bankruptcy Act that a plan be “fair and equitable” re-

quired creditors to be accorded absolute priority or merely

relative priority. Both Section 77B and Chapter X of the

Bankruptcy Act, which had already superseded Section

77B by the time Los Angeles Lumber was decided, con-

tained the phrase “fair and equitable” without further

elaboration on the relative priority of creditors and old

equity. See Act of June 7, 1934, ch. 424, sec. 1, § 77B(f),

48 Stat. 911, 919 (superseded 1938); 11 U.S.C. § 621(2)

(repealed 1979). The Court held that absolute priority

was required and then continued, in dicta, to describe a

possible situation in which old equity could participate in

a reorganization. Los Angeles Lumber, 308 U.S. at 115-

16, 121-22."

Neither in Los Angeles Lumber nor in any other pub-

lished decision under the Bankruptcy Act from 1939 to

1978 did any court conclude that a new value exception

to the absolute priority rule applied to the facts of a case.

See Kenneth N. Klee, Valuation and Cram Down, SB37

In Dewsnup, the Court also recognized that “where the lan-

guage is unambiguous, silence in the legislative history cannot be

controling.” Jd. at 419-20. That principle should control this case.

11 This Court stated shortly thereafter that the rule of absolute

priority applied in Chapter X as well as under Section 77B. Marine

Harbor Properties, Inc. v. Manufacturer's Trust Co., 317 U.S. 78,

85 (1942).

13

ALI-ABA 455, 469 (1997); 7 Collier on Bankruptcy

€ 1129.04[4)}[c], at 1129-107 (Lawrence P. King ed., 15th

ed. rev. 1997); Bruce A. Markell, Owners, Auctions, and

Absolute Priority in Bankruptcy Reorganizations, 44 Stan.

L. Rev. 69, 92 (1991). Accordingly, the pre-Bankruptcy

Code new value doctrine existed only in dicta, in stark

contrast to the line of Bankruptcy Act cases on the sur-

vival of liens that this Court found persuasive in Dews-

nup. See Dewsnup, 502 U.S. at 418-19. More importantly,

whatever new value exception existed under the Bank-

ruptcy Act was available only where it had the approval

of all classes of creditors. See Los Angeles Lumber, 308

U.S. at 114. It would not have applied to a case like the

instant case, where the affected class has rejected the plan.

In 1978, Congress completely rewrote business bank-

ruptcy reorganization law. See Ron Pair, 489 U.S. at 240

(recognizing that Congress “made significant changes in

both the substantive and procedural laws of bankruptcy”

and conducted “a substantial overhaul of the system”). In

the Bankruptcy Code, Congress for the first time enun-

ciated what makes a plan of reorganization “fair and

equitable.” 11 U.S.C. § 1129(b)(2). Congress codified

the absolute priority rule, which was a solidly established

rule under Chapter X of the Bankruptcy Act, but made

no mention of the new value doctrine, which was a part of

Bankruptcy Act practice only in theory. To the extent

that the new value doctrine was a part of past practice at

all, this congressional decision alone is “a clear indica-

tion that Congress intended . . . a departure” from past

practice. See Pennsylvania Dept. of Public Welfare v.

Davenport, 495 U.S. 552, 563 (1990); Union Bank vy.

Wolas, 502 U.S. 151, 160 (1991) (“[T]he fact that Con-

gress carefully reexamined and entirely rewrote the pref-

erence provision in 1978 supports the conclusion that the

text of $547(c)(2) as enacted reflects the deliberate

choice of Congress.”).

The House Report accompanying the bill that enacted

the Bankruptcy Code stated that the bill contained “a

14

partial application of the absolute priority rule now ap-

plied under Chapter X” and a “partial codification of the

absolute priority rule.” H.R. Rep. No. 95-595, at 224,

414 (1977) (emphasis added), reprinted in 1978

U.S.C.C.A.N. 5963, 6184, 6370. This legislative history

reflects Congress’ intent to rework the law of business

reorganization significantly, adopting the absolute priority

rule from one chapter of the Bankruptcy Act and applying

it in modified form. Whatever role the new value doctrine

may have played in Bankruptcy Act practice, Congress

did not intend to import it into the Bankruptcy Code.

Other actions further demonstrate Congress’ intent to

rework the law of business reorganization. Among the

significant changes wrought by Congress was the replace-

ment of three business reorganization chapters of the Bank-

ruptcy Act (Chapters X, XI, and XII) with a single chap-

ter in the Bankruptcy Code (Chapter 11). Chapter 11 of

the Bankruptcy Code incorporated certain features of the

Bankruptcy Act’s reorganization chapters and included

several important new provisions:

* Chapter X of the Bankruptcy Act required the

appointment of a disinterested trustee to manage

any debtor with liabilities of $250,000 or more.

11 U.S.C. § 556 (repealed 1979). In contrast,

the debtor normally remained in possession of its

assets under Chapters XI and XII. 11 U.S.C.

$$ 742, 844 (repealed 1979). In the Bankruptcy

Code, Congress drew on Chapters XI and XII and

created a preference for debtor control except in

extraordinary situations. See 11 U.S.C. §§ 1104(a),

1107(a).

* Any party in interest could propose a reorganiza-

tion plan in Chapter X of the Bankruptcy Act.

11 U.S.C. § 569 (repealed 1979). Only the debtor

could propose an arrangement in Chapters XI and

XI. 11 U.S.C. $$ 706(1), 723, 823 (repealed

1979). Congress created a hybrid rule in Bank-

ruptcy Code, giving the debtor-in-possession the

—— oo --

ee

oo ew ee ae — ©

15

exclusive right to propose a plan for the first 120

days after the entry of an order for relief and allow-

ing the court to extead that exclusive period. 11

U.S.C. § 1121.

The absolute priority rule applied rigorously in

cases under Chapter X of the Bankruptcy Act; the

affected creditors were not permitted to consent to

non-priority treatment in a reorganization plan.

Los Angeles Lumber, 308 U.S. at 114. The “fair

and equitable” standard, including the absolute pri-

ority rule, did not apply at all in Chapters XI and

XII after Congress amended the Bankruptcy Act

in 1952. SEC v. American Trailer Rentals Co.,

379 U.S. 594, 606 n.8 (1965); In re Mallard

Assocs., 475 F. Supp. 1045, 1053 (S.D.N.Y. 1979).

In the Bankruptcy Code, Congress imported the

absolute priority rule from Chapter X of the Bank-

ruptcy Act, codified it for the first time, and made

it applicable only when a class of creditors dissents

(and then only as to the dissenting class). See 11

U.S.C. § 1129(a)-(b).

In sum, Congress created a new law of business re-

organization in 1978, adopting elements of the reorgani-

zation chapters of the Bankruptcy Act that it found worth-

while. The decision of the Court of Appeals ignores the

plain language of the Bankruptcy Code and reads into the

Bankruptcy Code an unwarranted intent to continue pre-

Bankruptcy Code practices.

Congress’ rewriting of bankruptcy law in 1978 aleo

reflected a shift in policy. Especially in the area of plan

confirmation, Congress gave responsibility to parties in

interest, rather than judges, to determine what is in the

parties’ best interests. In some cases, creditors may con-

clude that they will benefit if old equity retains ownership

and, in appropriate cases, management control of the re-

organized debtor. Empirical evidence suggests that cred-

itors frequently accept plans that would not satisfy the

absolute priority rule. See Lynn M. LoPucki & William

16

C. Whitford, Bargaining over Equity's Share in the Bank-

ruptcy Reorganization of Large, Publicly Held Companies,

139 U. Pa. L. Rev. 125 (1990); Julian R. Franks &

Walter N. Torous, An Empirical Investigation of U.S.

Firms in Reorganization, 44 J. Fin. 747 (1989).

The equity-only new value right approved in the instant

case operates differently, however, as the Seventh Circuit

explained in another case:

Creditors effectively own bankrupt firms. They may

find it worthwhile, as owners, to sell equity claims

to the managers; they may even find it worthwhile

to give the equity away in order to induce managers

to stay on and work hard. . . . When there is value

to be gained by allowing a lower class to kick in

new value and keep its interest, the creditors should

be willing to go along. A “new value exception”

means a power in the judge to “sell” stock to the

managers even when the creditors believe that this

transaction will not augment the value of the firm.

Kham & Nate’s Shoes No. 2, 908 F.2d at 1360 (citation

omitted). This Court recognized as much in Ahlers:

[T]he Code provides that it is up to the creditors—

and not the courts—to accept or reject a reorganiza-

tion plan which . . . fails to honor the absolute pri-

ority rule.

The Court of Appeals may well have believed that

petitioners or other unsecured creditors would be

better off if respondents’ reorganization plan was con-

firmed. But that determination is for the creditors to

make in the manner specified by the Code.

Ahlers, 485 U.S. at 207 (citation omitted).

The decision of the Court of Appeals places the bank-

ruptcy judge in the position of first determining that old

equity’s proposed payment is “necessary” and “substantial”

(without determining whether creditors or others would

be willing to pay the bankruptcy estate the same amount

17

or more) and then deciding that it is in the creditors’ best

interests that old equity receive ownership of the reorgan-

ized debtor in exchange for this payment. As Congress

directed in the Bankruptcy Code and this Court recog-

nized in Ahlers, that decision is for the creditors to make.

CONCLUSION

For the reasons stated herein and in the Petition for

Writ of Certiorari, the Petition should be granted.

Respectfully submitted,

Of Counsel: JAMES A. PARDO, JR.

PHILLIP E. STANO Counsel of Record

AMERICAN COUNCIL OF DAvip G. EPSTEIN

LIFE INSURANCE SARAH ROBINSON BORDERS

1001 Pennsylvania Ave., N.W. BRIAN C. WALSH

Washington, D.C. 20004-2599 KING & SPALDING

(202) 624-2183 191 Peachtree Street, N.E.

Atlanta, Georgia 30303-1763

(404) 572-4600

April 1, 1998 Counsel for Amicus Curiae