Third Circuit Court of Appeals Adopts New Cramdown Test

By Sarah E. Wenrich
Bernstein-Burkley, P.C.

In the precedential Third Circuit decision In re Tribune Co., No. 18-2909, 2020 U.S. App. LEXIS 27158 (3d Cir. Aug. 26, 2020), the Third Circuit Court of Appeals adopted a new “cramdown” test to be applied in analyses involving 11 U.S.C. § 1129(b) of the Bankruptcy Code.

The case involved senior noteholders who had pre-bankruptcy subordination agreements which provided that payment to certain other subordinated creditors would be limited until the senior noteholders were paid in full. The senior noteholders argued that § 510(a) of the Bankruptcy Code pertaining to and allowing subordination agreements required that the agreements in question be strictly complied with. The Debtor’s plan of reorganization did not fully enforce the subordination provisions per § 510(a) and determined that the claims of the senior noteholders and those of the “subordinated creditors” were of equal priority. The Bankruptcy Court for the District of Delaware confirmed the plan over the objection of the senior noteholders.

In affirming the decision of the Bankruptcy Court, the Third Circuit Court of Appeals first explained that the plain language of the § 1129(b) and § 510(a) and use of the term “notwithstanding” in § 1129(b) gives courts flexibility to confirm a plan that does not strictly enforce subordination agreements. However, the refusal to strictly enforce subordination agreements must be fair and equitable and must not unfairly discriminate against the dissenting creditor.

In order to determine whether a plan unfairly discriminates against certain creditors, the Third Circuit Court of Appeals adopted what is known as the “rebuttable presumption” test. The court explained that the presumption of unfair discrimination exists where there is:

(1) a dissenting class; (2) another class of the same priority; and (3) a difference in the plan’s treatment of the two classes that results in either (a) a materially lower percentage recovery for the dissenting class (measured in terms of the net present value of all payments), or (b) regardless of percentage recovery, and allocation under the plan of materially greater risk to the dissenting in connection with its proposed distribution. [1]

In re Tribune Co., 2020 U.S. App. LEXIS 27158 at *23 (quoting Bruce A. Markell, A New Perspective on Unfair Discrimination in Chapter 11, 72 Am. Bankr. L.J. 227, 244 (1998)). The Court further explained that this presumption can be overcome where a court finds that

a lower recovery for the dissenting class is consistent with the results that would obtain outside of bankruptcy, or that a greater recovery for the other class is offset by contributions from that class to the reorganization. The presumption of unfairness based on differing risks may be overcome by a showing that the risks are allocated in a manner consistent with the prebankruptcy expectations of the parties.

Id. The relevant perspective to be considered is that of the dissenting class of creditors and not the other classes of creditors that have voted to accept the plan. Id. at *29. In In re Tribune, the pool of senior lenders’ claims was much larger than that of creditors with similar priority ($1.283B as opposed to $105 and $8.8M). By limiting the enforcement of the subordination provisions, the senior lenders received a 33.6% recovery under the plan as opposed to a 34.5% recovery that they would have received had the provisions been strictly enforced. In comparison, the other classes of creditors that had voted to accept the plan were to also receive a 33.6% recovery under the plan as opposed to a 21.9% recovery that would occur had the subordination provision been strictly enforced. The court explained that, for the dissenting class, the 0.9% difference in recovery was only a minimal reduction and was not material such that the plan did not discriminate unfairly. However, it also warned that what constitutes a material difference in recovery “is a distinct and context specific inquiry.” Id. at 30*.

The end goal of a Chapter 11 bankruptcy case is the confirmation of a Chapter 11 plan, and the flexibility provided by § 1129(b) and the “rebuttable presumption” test adopted by the Third Circuit support this goal. 

[1] The Third Circuit Court of Appeals also set forth a more detailed, step-by-step analysis of what a court should look for in determining whether the rebuttable presumption exists. See 2020 U.S. App. LEXIS 27158 at *24-28.

Written by Bernstein- Burkley, P.C. on September 1, 2020

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