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

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No. 97-1418

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JUN 26 1998

IN THE

Supreme Court of the Anited States

OCTOBER TERM, 1997

BANK OF AMERICA NATIONAL TRUST AND

SAVINGS ASSOCIATION,

Petitioner,

Vv.

203 NORTH LASALLE STREET PARTNERSHIP,

Respondent.

On Writ of Certiorari to the

United States Court of Appeals for the

Seventh Circuit

BRIEF OF THE AMICI CURIAE

AMERICAN BANKERS ASSOCIATION AND

CALIFORNIA BANKERS ASSOCIATION

IN SUPPORT OF PETITIONER

CHRISTOPHER E. CHENOWETH JOHN J. GILL II

CALIFORNIA BANKERS Counsel of Record

ASSOCIATION MICHAEL F. CROTTY

201 Mission Street AMERICAN BANKERS

Suite 2400 ASSOCIATION

San Francisco, CA 94105 1120 Connecticut Ave., NW

(415) 284-6999 Washington, DC 20036

(202) 663-5026

June 26, 1998 Attorneys for Amici Curiae

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PRESS OF BYRON S. ADAMS @ WASHINGTON, D.C. # 1-800-347-8208

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QUESTION PRESENTED

Whether the Bankruptcy Code authorizes the

confirmation of a Chapter 11 plan of reorganization that

provides that existing equity owners will contribute “new

value” to the reorganization and will own equity in the

reorganized debtor, even though the plan does not provide

for full payment to a senior, objecting class of unsecured

creditors.

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li iii

TABLE OF CONTENTS TABLE OF AUTHORITIES

Page Page

QUESTION PRESENTED ...0.........cccccccccccccomoccesess.... i CASES:

BARES OF AUTIBORITIBS .....cc0cccccccsccccccemoecoesese... iii Case v. Los Angeles Lumber Products Co., 308 U.S.

itt Gd oi bianedaiedicebadembeddndeveiatateiedin 6, 9, 10

INTEREST OF THE AMICUS CURIAE................... 2

Consolidated Rock Products Co. v. DuBois, 312 U.S.

SUMMARY OF THE ARGUMENT............................ 3 TT cthindiathietidiiimrsindiantiesbdbdbenesenbuiscebeceresuesees 8

RANA RE IE pee Bz eae RSS eee 4 Dewsnup v. Timm, 502 U.S. 410 (1992) ...00000000000000000.. 3,9

. I. History of the Absolute Priority Rule | Group of Institutional Investors v. Chicago,

SESE RIE RS 8 ip ee 4 . Milwaukee, St. Paul & Pacific Railroad , 318 U.S.

ta ETc cidnidennbenistndcneannsesdenaatanewensoesnessosesoceseecene: 8

Il. Legislation and the Case Case ....................... 6

/ Mason v. Paradise Irrigation District, 326 U.S. 536

Hil. The 1978 Bankruptcy Code ....0..0......ccccccccceee 9 | 1.) ieestaatodcipntonbsosonecueres 8

NEN cechivksvshisepusdcuiamibinekiscpeicsie oo | 14 Kansas City Terminal R. Co. v. Union Trust Co., 271

at TENE shinsrereensnransnscawensadoncetetetncnesicatontesmnenedauael 7

Marine Harbor Properties, Inc. v. Manufacturers

Trust Co., 317 U.S. 78 (1942) 00.0. oo ooo ccccccccccccece ence eee 8

Matter of 203 N. LaSalle St. Partnership, 126

F.3d 955 (7th Cir. 1997) 00000. senennasoneees 3,9

Louisville Trust Co. v. Louisville N.A. & C. R. Co.,

174 U.S. 674 (1899) ooo ccc ccccccccncceeceweeees 4,6

Northern Pacific Railway v. Boyd, 228 U.S 482 (1913) ... 5-7

iV

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

RITE nensincimacsventenidaanenepencibaieaiiednane ae 14

United Savings Association v. Timbers of Inwood

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

U.S. National Bank of Oregon v. Independent

Insurance Agents of America, 113 S. Ct. 2173 (1993) ....... 8

STATUTES:

So Es Peter a ee 12

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BE DA. FED vvccistninactepiesdadenamettiderdicns 12

RE TA et TER ai 12

RS Dine ip Se askdbstiiscibedieceiiaiecie ae 13

EN LA Pe TON PSEA EE ET Oe gs Coe Ye 6

Act of June 7, 1934, Ch. 424, § 77B, 48 Stat. 911

GRD sencsneanatadebiindinsinideniddini ee as as» 6

LEGISLATIVE MATERIAL:

H.R. Rep. No. 595, 95th Cong., Ist Sess. 224 (1978)....... ll

2 OOS ae ee ae Mw «

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MISCELLANEOUS:

Ayer, Rethinking Absolute Priority After Ahlers, 87

a OE

6A Collier on Bankruptcy, (14th ed. 1978)...................2..

Klee, Cram Down II, 64 Am Bankr. L. J. 229 (1990)........

Markell, Owners, Auctions and Absolute Priority in

Bankruptcy Reorganizations , 44 Stanford L. Rev. 69 .......

Report of the Commission of the Bankruptcy Laws

of the United States, H.R. Doc. No. 137, 93d Cong.

SE cdncdtisininciiinkdendttintieddsienmmmnctnddidaadaimibdiniedie

ee

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1997

No. 97-1418

BANK OF AMERICA NATIONAL TRUST

AND SAVINGS ASSOCIATION,

Petitioner,

Vv.

203 NORTH LASALLE STREET PARTNERSHIP,

Respondent.

On Writ of Certiorari

to the United States Court of Appeals

for the Seventh Circuit

BRIEF OF THE AMICI CURIAE'

AMERICAN BANKERS ASSOCIATION and

CALIFORNIA BANKERS ASSOCIATION

IN SUPPORT OF PETITIONER

' No counsel for any party had any role in authoring this

brief and no person other than amici curiae made any

monetary contribution to its preparation or submission.

2

In accordance with the provisions of Rule 37.3(a) of

the Supreme Court Rules, the American Bankers

Association and California Bankers Association hereby

respectfully submit this brief as amici curiae in support of

the Petitioner. Both parties have consented to this filing

and their written consents are filed together with this brief.

INTEREST OF THE AMICI CURIAE

The American Bankers Association is the principal

national trade association of the banking industry in the

United States. Its membership includes both commercial

banks and thrift institutions located in each of the fifty

states and the District of Columbia, and those institutions

hold approximately ninety percent of the domestic assets of

the industry.

The California Bankers Association is the principal

state-based trade association for the lending industry in

California, representing virtually all of the commercial

banks and trust companies in that state.

Both associations frequently appear in litigation

either as a party or as amicus curiae in cases raising issues

of widespread importance to their members.

Litigation over the existence or nonexistence of a

“new value exception” to the absolute priority rule in

bankruptcy is of considerable concern to the Associations’

members. Since virtually all debtors are insolvent, the costs

of bankruptcy fall almost exclusively upon creditors, many

of whom are represented by your amici. The “exception,”

if it is found to exist, (despite the fact that it can be found

nowhere in the statutory language), will prove costly and

disruptive, irreconcilable with the priorities Congress set

down in the statute in favor of a vague standard that cannot

3

be administered in a fair and equitable manner, and

ultimately transfers reorganization value from creditors

(where Congress said it belongs) to existing owners.

SUMMARY OF THE ARGUMENT

The dispute among ihe lower courts and the

commemtators over the existence of a "new value

exception" to the absolute priority rule in bankruptcy is

often phrased in the form of a question whether the "new

value exception survived passage of the Bankruptcy Code."

Matter of 203 N. LaSalle St. Partnership, 126 F.3d 955,

963 (7th Cir. 1997)(emphasis added). To phrase the issue

that way, however, is to overstate the alleged “exception's"

pedigree, and thus to lead into errors in logical analysis and

in application of this Court's precedents.

It is acknowledged that this Court is, and has been,

"reluctant to accept arguments that would interpret the

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

not the subject of at least some discussion in the legislative

history." Dewsnup v. Timm, 502 U.S. 410, 419 (1992).

See also United Savings Association v. Timbers of Inwood

Forest Associates, 484 U.S. 365, (1988). We ask the

Court to do no such thing here. Prior to the enactment of

the Bankruptcy Code in 1978, there never really was any

fixed, definable or coherent "new value exception" to the

absolute priority rule that could be or was applied in

bankruptcy proceedings. The 1978 Code changed the

nature of reorganizations so extensively that it is fair and

accurate to say that prior to 1978, no "new value

exception” had ever been or could have ever been applied

to the kind of reorganization at issue in the present

proceeding. Moreover, the legislative history of the 1978

Code is not devoid of any mention of a "new value

4

exception" to the absolute priority rule. Quite the contrary,

there was a highly prestigious recommendation that

Congress adopt am exception--a recommendation that

Congress did not follow. Finally, Congress has carved out

exceptions to the absolute priority rule in certain

bankruptcy matters, thereby clearly showing that it knows

how to do so when that is its intention. Those exceptions

do not apply to the case at hand, and it must therefore be

concluded that Congress did not intend for them to apply

here.

ARGUMENT

I. History of the Absolute Priority Rule in the

Courts

The "rule" that a debtor's creditors must be paid in

full before the debtor's owners can retain any value has its

genesis in railroad reorganizations of a century ago. In the

absence of a federal bankruptcy statute at the time, such

reorganizations took place in the form of equitable

receiverships. In Louisville Trust Co. v. Louisville N.A. &

C. R. Co., 174 U.S. 674 (1899), a secured lender

foreclosed on a railroad's property, thereby wiping out the

interests of junior unsecured creditors, and yet apparently

(and mysteriously), at least some equity ownership interest

in the railroad was maintained by at least some

stockholders. The unsecured creditors suspected collusion

and attempted to challenge that outcome. The lower courts

disallowed the challenge, but this is Court reversed,

holding that "the stockholder's interest in the property is

subordinate to the rights of creditors; first, of secured, and

then of unsecured, creditors. And any arrangement of the

parties by which the subordinate rights and interests of the

stockholders are attempted to be secured at the expense of

ee ed

5

prior rights of either class of creditors comes within

judicial denunciation." /d at 684. "It is one thing for a

bondholder who has acquired absolute title by foreclosure

to mortgaged property to thereafter give of his interest to

others, and an entirely different thing whether such

bondholder, to destroy the interest of all unsecured

creditors, to secure a waiver of all objections on the part of

the stockholder and consummate speedily the foreclosure,

may proffer to him an interest in the property after the

foreclosure. The former may be beyond the power of the

courts to inquire into or condemn. The latter is something

which on the face of it deserves the condemnation of every

court." /d. at 688.

The unsecured creditors having thus acquired rights

that they could protect, it became necessary to determine

the scope of those rights, still without benefit of applicable

federal bankruptcy law. This Court began to do so in

Northern Pacific Railway v. Boyd, 228 U.S. 482 (1913), ia

which a balance was struck among the desirability of

continuing to operate a railroad (instead of dismantling it),

the need for funds to do so (recognizing stockholders as the

most likely source of those funds) and the unsecured

creditors’ rights. The Court said that it was not "necessary

to pay an unsecured creditor in cash as a condition of

stockholders retaining an interest in the reorganized

company. His interest can be preserved by the issuance, on

equitable terms, of income bonds or preferred stock. If he

declines a fair offer, he is left to protect himself as any

other creditor of a judgment debtor; and having refused to

come into a just reorganization, could not thereafter be

heard in a court of equity to attack it." /d. at 508.

But that, of course, left open the question of what

constitutes a “fair offer." Two definitions were suggested

6

and debated: a rule of “absolute priority which recognized

state law claims and did not permit owners to participate in

the reorganized debtor unless those claims were satisfied in

full, and a rule of "relative priority" which permitted

owners to participate if earnings met certain levels and

relative priorities among classes were observed.’

II. Legislation and the Case Case

Finally, Congress entered the picture. In 1933, it

added Section 77 to the Bankruptcy Act of 1898, pertaining

to railroad reorganizations (Act of March 3, 1933, Ch.

204, § 77, 47 Stat. 1467, 1474 (1933)). A year later, it

added Section 77B to the Act, pertaining to other kinds of

corporations (Act of June 7, 1934, Ch. 424, § 77B, 48

Stat. 911, 912 (1934)). While the two new sections of the

law differed in some respects, both required that plans be

"fair and equitable" as to each creditor and that all classes

of affected creditors accept the plan by the required class

vote. In Case v. Los Angeles Lumber Products Co., 308

U.S. 106 (1939) this Court held that those words, “fair and

equitable," were "words of art which...had acquired a fixed

meaning through judicial interpretations in the field of

equity receivership reorganizations." /d. at 115. Those

"judicial interpretations" included, according to the Court,

Louisville Trust and the "fixed principle" of Northern

Pacific Railway (id. at 115-116) which the Court further

described as "this rule of full or absolute priority." (id. at

117).

> Markell, Owners, Auctions and Absolute Priority in

Bankruptcy Reorganizations, 44 Stanford L. Rev. 69, 82; 6A

Collier on Bankruptcy, 9 11.06 (14th ed. 1978)

oe ee a oe

7

In Case, the lower courts had approved a

reorganization plan in which old stockholders were entitled

to some 23% of the reorganized company in return for the

intangible value they would contribute to _ the

reorganization: familiarity with the operation of the

business, financial standing and influence in_ the

community, and continuity of management. The Supreme

Court agreed that the plan would have maintained the

“relative priorities of the bondholders and stockholders."

Id. at 112 and 119. But that was not the test, for even "the

payment of cash by the stockholders for new stock did not

[in Kansas City Terminal R. Co. v. Union Trust Co., 271

U.S. 455] itself save the plan from the rigors of the ‘fixed

principle of the [Northern Pacific v. | Boyd Case, for in

that case the decree was struck down where provision was

not made for the unsecured creditor and even though the

stockholders paid cash for their new stock. Case, supra, at

117.

Having rejected the "relative priorities" approach to

adjusting the interests of owners, secured creditors and

unsecured creditors in favor of a "full or absolute priority"

rule, having accurately discussed the Court's own

precedents holding that even cash contributions to a plan by

old stockholders could not place their interests ahead of

unsecured creditors, and having then rejected the plan of

reorganization actually at issue in Case, the opinion of the

Court then goes on to express a belief that a creditor is

afforded “his full right of priority against the corporate

assets " if the stockholder's participation is "based on a

contribution in money or in money's worth, reasonably

equivalent in view of all the circumstances to the

participation of the stockholder." /d. at 122.

Self-evidently, this brief discussion in the Court's

opinion of the need for there to be a contribution in money

or in money's worth in order for stockholders to participate

in a reorganization plan is mere dicta.’ The Court had no

occasion to examine, in Case or thereafter, a plan in which

such a "contribution" was made, and what might be the

"circumstances" under which such a contribution might

justify a re-ordering of priorities to the detriment of

unsecured creditors senior to the interests of the

stockholders, nor did it discuss how a "new Value" rule

could co-exist with an absolute priority rule. And yet, this

dicta is the entire source of the alleged "new value"

exception to the absolute priority rule. No subsequent

decision of this Court has upheld, as "fair and equitable," a

plan providing for owner participation where senior claims

were not satisfied in full.‘ Indeed, there do not appear to

be any pre-Code published opinions at all in which the dicta

was adopted so as to confirm a "new value" plan over the

* This Court has cautioned that there is a "need to distinguish

an opinion's holding from its dicta.” U.S. National Bank of

Oregon v. Independent Insurance Agents of America, 113 S.

Ct. 2173, 2186 n. 11 (1993).

* See Consolidated Rock Products Co. v. DuBois, 312 U.S.

510 (1941); Marine Harbor Properties, Inc. v.

Manufacturer's Trust Co,, 317 U.S. 78 (1942); Group of

Institutional Investors v. Chicago, Milwaukee, St. Paul &

Pacific Railroad, 318 U.S. 523 (1943). See also Mason v.

Paradise Irrigation District, 326 U.S. 536 (1946) in which -

the courts did confirm a "new value" plan, but it was one in

which the "new value” was contributed not by equity

owners, but rather by a creditor.

9

objection of a dissenting creditor.’ That being so, it was

error for the Seventh Circuit to conclude that Case "for

more than fifty years, the new value precept has been

recognized as an important corollary or exception to the

absolute priority rule," LaSalle, 126 F.3d at 965, so as to

invoke the Dewsnup "rule" against implied major changes

in pre-Code practice.

The absolute priority rule was not without its

problems. Sections 77 and 77B of the Bankruptcy Act

provided creditors with the right to vote by class on

reorganization plans and required that a reorganization plan

be fair and equitable as to each creditor. This effectively

allowed tiny minority class members to block confirmation

of plans by convincing the court that the plan was unfair or

inequitable as to them.®° The absolute priority rule thus

lacked the flexibility that had been present in equity

receiverships. That was a problem which Congress

recognized and upon which it sought advice.

III. The 1978 Bankruptcy Code

In 1970, Congress created the Commission on

Bankruptcy Laws of the United States, Pub. L. No. 91-

354, charged it with studying the existing system and

proposing amy necessary changes to it. Among other

* Ayer, Rethinking Absolute Priority After Ahlers, 87 Mich.

L. Rev. 963, 1016 (1989); Klee, Cram Down II, 64 Am

Bankr. L. J. 229, 241 (1990).

® This is precisely what happened in Case, in which the

Supreme Court disallowed a plan of reorganization though it

had been approved by majorities of 90% or more of the vote

of various classes. Case, 308 U.S. at 111

10

things, the Commission specifically evaluated the judicially

created absolute priority rule. When it made its report to

Congress in 1973, it recommended that the rule be

modified "by allowing stockholders to participate (in a

reorganization plan) if their future contribution, i.e.,

continued management, is essential to the business." Report

of the Commission of the Bankruptcy Laws of the United

States, H.R. Doc. No. 137, 93d Cong. at 254-259 (1973).

The Commission's draft of legislation designed to relax the

absolute priority rule contained a Section 7-303 which,

according to the explanatory notes, "allows the court to

confirm, where the plan allows participation by ownership

not permissible under the absolute priority test, if the

participation is supported by, e.g., continued management;

this adopts the District Court's opinion which was reversed

in Case v. Los Angeles Lumber Products Co." Id. at 254.

While it is clear that the Commission recommended

an exception to the absolute priority rule that is broader

than the one at issue in this case, the fact of the matter is

that Congress elected to codify the absolute priority rule

when it enacted the Bankruptcy Code in 1978, and did so

without making any exceptions to it, though it obviously

knew there was a respectable constituency for exceptions.

In its Report on the Bankruptcy Code, the House of

Representatives Committee clearly expressed its intent that

the bill would closely adhere to the existing absolute

priority rule:

[T]he bill requires that the plan pay any dissenting

class in full before any class junior to the dissenter

may be paid at all. The rule is a partial

application of the absolute priority rule now

applied under Chapter X and requires a full

11

valuation of the debtor as the absolute priority rule

does under current law. The important difference

is that the bill permits senior classes to take less

than full payment in order to expedite or insure the

success of reorganization.

H.R. Rep. No. 595, 95th Cong., Ist Sess. at 224 (1978)

(emphasis added).

The general principle of the subsecticn permits

confirmation notwithstanding nonacceptance by an

impaired class if that class and all below it in

priority are treated according to the absolute

priority rule. A dissenting class must be paid in

full before any junior class may share under the

plan.

Id. at 413 (emphasis added).

The Code's provisions for class voting and

application of the “fair and equitable" standard literally

reversed the statutory scheme of the superseded Bankruptcy

Act. Previously, any class vote rejecting a proposed plan

resulted in the rejection of the plan. But a class vote in

favor of a plan triggered application of the fair and

equitable standard with respect to each creditor. Now, to

the contrary, a class vote in favor of the proposed plan of

reorganization results in its approval, whereas a class vote

against a plan triggers application of the fair and equitable

requirement as to the class as a whole.

A "new value" exception under the old law would

have provided some modicum of protection of creditors

against holdouts, but under the new law, that is no longer

necessary. Under the Code, unlike under the Act,

12

majority creditors no longer have need of such protection,

since minority votes can, by statute, be overridden, without

the need for some sort of imaginary "new value” exception

to the absolute priority rule.

The current law's codification of the absolute

priority rule for Chapter 11 cases such as this one clearly

does not contain any exception to the rule. It provides that

a plan can be accepted by each impaired class of claims or

interests. 11 U.S.C. § 1129(a)(7). If the plan is not

accepted within the meaning of the statute it may,

nonetheless, be confirmed if it “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.” 11 U.S.C. § 1129(b)(1). "Fair and

equitable," means, however, that "the holder of any claim

or interest that is junior to the claims of such class will nor

receive or retain under the plan on account of such junior

claim or interest any property. 11 U.S.C. § 1129(b)(2)

(B)(ii) (emphasis added).

By contrast, bankruptcy proceedings under Chapter

13 or under Chapter 12 do permit the retention of property

by the debtor in retern for monetary contributions of a

sort. A Chapter 13 plan (concerning the adjustment of

debts of an individual with regular income) can be

confirmed over the objection of the holder of an allowed

unsecured claim, even if the holder will not receive the full

value of his or her claim, if "the plan provides that all of

the debtor's projected disposable income to be received in

the three-year period beginning on the date that the first

payment is due under the plan will be applied to make

payments under the plan." 11 U.S.C. § 1325(b)(1)(3).

Chapter 12 proceedings, pertaining to family farm

bankruptcies, are governed by statutory language almost

13

identical to Section 1325. See 11 U.S.C. § 1225(b)(1)(B).

Self-evidently, Congress knows how to preserve some of

the junior interests of debtors, in derogation of the interests

of senior unsecured creditors, when that is its intention.

Yet it is equally self-evident that Congress chose not to do

so with respect to Chapter 11 proceedings. It would have

been a simple enough matter for Chapter 11 to have

provided for confirmation of a plan over the objection of

one or more classes of unsecured creditors if the equity

owners were to make the type of monetary contribution that

is expected of farmers and individuals in their respective

proceedings. But Congress did no such thing. Instead, it

required, in plain language, that objecting classes of senior

creditors must be paid in full before junior classes

(including equity owners) receive or retain any property.