Alert: Eighth Circuit Allows Chapter 11 Debtors to Sell Securities to Creditors at Steep Discounts in Exchange for New Commitments and Plan Support

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August 15, 2019

After a recent decision by the Eighth Circuit Court of Appeals, large chapter 11 debtors have a powerful option to resolve disputes, raise new capital, and offer creditors an incentive to support a plan of reorganization.

In Ad Hoc Comm. of Non-Consenting Creditors v. Peabody Energy Corp., et al. (In re Peabody Energy Corp.), No. 18-1302 (8th Cir. Aug. 9, 2019), the Eighth Circuit, addressing an issue of first impression in this circuit, held that a chapter 11 plan may provide creditors with an opportunity to participate in offerings of the Debtors’ securities at significant discounts without violating the statutory requirement that similarly situated creditors receive equal treatment when, among other things:

  1. All creditors have an opportunity to participate in the securities offering
  2. the participating creditors provide new commitments in exchange for the opportunity to participate in the securities offering; and
  3. the debtor(s) consider several alternatives before determining that the securities offering is the best option to raise capital and provide a recovery to creditors.

The Eighth Circuit also rejected an argument that the Debtors proposed the plan in bad faith. Under the totality of the circumstances, the Eighth Circuit held that the proposed plan resolved various disputes with secured and senior unsecured creditors that otherwise may have prevented the Debtors from reorganizing at all and avoided the substantial costs of delay.

The Debtors, a coal company and its subsidiaries, filed voluntary petitions under chapter 11 and then commenced an adversary proceeding seeking a declaratory judgment to resolve a dispute among seven junior-secured and senior-unsecured creditors (the “Noteholder Co-Proponents” of the plan) about the scope of security interests in coal mines. During non-binding mediation, the parties went beyond the security-interest dispute and negotiated a plan of reorganization.

The plan involved raising $1.5 billion of new money through discounted sales of common and preferred stock to certain qualified creditors. All creditors had an opportunity to participate in a “Rights Offering” that allowed them to purchase common stock at a 45 percent discount to the value that the parties believed the stock to have. In addition, creditors had an opportunity to purchase preferred stock at a 35 percent discount if they became “qualified” by agreeing to:

  1. Buy a certain amount of preferred stock,
  2. backstop both sales by committing to buy any unsubscribed shares; and
  3. support the plan in the confirmation process.

The Rights Offering took place in three stages. In stage one, the Noteholder Co-Proponents had the exclusive right to purchase the first 22.5 percent of preferred stock if they agreed to the three conditions and committed to buy whatever remained unsold after the next two stages. In stage two, the Noteholder Co-Proponents and any creditor who became qualified during a three-day window had the exclusive right to purchase the next 5 percent of preferred stock if they agreed to the three conditions. In stage three, the Noteholder Co-Proponents and any creditor who became qualified during a thirty-three-day window could purchase the remaining preferred stock. In addition to the discounts, the qualified creditors received an aggregate $60 million premium for agreeing to backstop the sales and an additional $18,750,000 premium for committing to purchase set amounts of the stock. Finally, the plan provided that the junior-secured creditors would receive an estimated 52.4 percent distribution and the senior unsecured creditors would receive an estimated 22.1 percent distribution on their claims.

A small Ad Hoc Committee of Nonconsenting Creditors chose not to participate in the securities offerings. Instead, they submitted alternative plan proposals, including one by which they offered to backstop a $1.77 billion rights offering that would replace the Debtors’ proposal. The Debtors’ CFO testified that the Debtors reviewed each proposal and determined that the proposals would either not achieve the Debtors’ reorganization goals or would add significant expense and delay to the process, estimating the cost at $30 million per month of delay. The Official Committee of Unsecured Creditors independently reviewed the Ad Hoc Committee’s proposals and found them to be inferior to the Debtors’ proposed plan.

By the time of the confirmation hearing, all twenty classes of creditors voted to approve the plan and approximately 95 percent of unsecured creditors committed to participate in the securities offerings. The bankruptcy court confirmed the plan, holding that the opportunity to participate in the Rights Offering was not treatment for a claim but rather consideration for valuable new commitments. The Ad Hoc Committee promptly appealed to the District court. Following confirmation, the reorganized Debtors began consummating the plan by, among other things, completing the securities offerings, receiving exit financing, and distributing more than $3.5 billion to holders of claims under the plan. The District court held that the appeal was “equitably moot” because the plan had been substantially consummated and, in the alternative, found that the equal-treatment requirement of § 1123(a)(4) had been satisfied and that the plan had been proposed in good faith. The Ad Hoc Committee again promptly appealed.

After noting that other circuits have allowed more favorable treatment to certain claim holders so long as the more favorable treatment is for a new contribution unrelated to the claim, the Eighth Circuit rejected the Ad Hoc Committee’s argument that the plan was contrary to Bank of America Nat’l Trust & Savings Ass’n v. 203 North LaSalle Street P’ship, 526 U.S. 434 (1999). In that case, the Supreme Court held that an exclusive right for old equity to purchase shares in the reorganized debtor violated the absolute priority rule. The Eighth Circuit held that this plan was different because: (1) all creditors, including the members of the Ad Hoc Committee, could participate in the securities offerings; (2) in exchange for the right to purchase the securities, creditors gave something of value by committing to support the plan and backstop the sales; and (3) several alternative proposals were considered. Because the right to participate in the securities offerings was consideration for valuable new commitments, it was not “treatment for” a claim and did not violate the equal-treatment rule of § 1123(a)(4).

The Eighth Circuit also rejected the Ad Hoc Committee’s arguments that the plan was not proposed in good faith because:

  1. The stock was sold at a discount;
  2. the Noteholder Co-Proponents had a disproportionate opportunity to purchase stock; and
  3. the plan employed a coercive process to induce support.

The Eighth Circuit found that the plan was proposed in good faith under the totality of the circumstances because all creditors had notice of and an opportunity to join the negotiations that led to the Debtors’ plan and, even though the stock was sold at a discount, the plan allowed the debtors to avoid the substantial cost of an extended stay in bankruptcy and resolve a dispute that could have cost significant time and legal fees, provided for significant distributions to creditors, and was supported by approximately 95 percent of creditors. Although the Noteholder Co-Proponents had a disproportionate opportunity to participate in the Rights Offering, they also took on more obligations and risk by committing to backstop the sales. While the Eighth Circuit expressed concern about the coercive nature of the plan support agreements, it found no clear error in the bankruptcy court’s finding of good faith, especially given the need to resolve the case quickly due to the volatile nature of the coal market and the significant costs of a protracted bankruptcy case.

Peabody Energy may have little impact on cases that involve a § 363 sale of assets and a liquidating trust, which admittedly is the majority of large chapter 11 cases.  For large chapter 11 debtors that wish to reorganize, however, Peabody Energy lays out a framework for a way to resolve disputes and provide creditors with substantial financial incentives to both support a plan of reorganization and inject new capital into the debtor.