A bankruptcy court in the Southern District of New York has recently designated the plan vote of a secured creditor because it acquired its secured claims with the motivation of taking over the debtor. Designation normally permits the court to ignore votes on a bankruptcy plan cast in bad faith; in this case, however, the court ordered that votes cast against the plan be counted as votes cast in favor of the plan. The decision in In re DBSD North America, Inc., 2009 WL 5088734 (Bankr. S.D.N.Y. Dec. 21, 2009), raises important issues to be considered by investors purchasing distressed debt with any intent to acquire a strategic asset or even trade creditors with an outlook to preserve future business rather than maximize recovery on a single claim
Background
DBSD North America, Inc. and its subsidiaries (the "Debtors") are a development stage enterprise formed to develop an integrated mobile satellite and terrestrial services network. DISH Network Corporation ("DISH") has made significant investments in TerreStar Corporation, a direct competitor of the Debtors. Under their plan of reorganization, the Debtors proposed to satisfy their first lien secured prepetition debt through issuance of a modified promissory note under an amended first lien facility. About two weeks after the Debtors filed their plan, DISH purchased all of the Debtors' outstanding first lien debt at par. Additionally, DISH, through an affiliate, purchased a majority of the Debtors' second lien debt that the plan proposed to convert to equity; significantly, DISH purchased second lien notes only from holders who were not bound by an agreement to vote in favor of the plan. DISH's own internal documents revealed that it was at least in part motivated by the possibility of consummating a strategic acquisition of the Debtors' assets that are useful in DISH's business. DISH voted all of its claims against the plan. All other classes with only one exception voted to accept the plan. The day before the plan confirmation hearing DISH filed a motion seeking to terminate the Debtors' exclusive period for obtaining approval of a plan and for authority to propose a competing plan centered upon a strategic transaction with the Debtors.
Bad Faith
The Debtors moved to designate DISH's vote rejecting the Debtors' plan of reorganization, pursuant to section 1126(e) of the United States Bankruptcy Code, which provides that a court may designate any entity whose acceptance or rejection of a plan was not in good faith. "Good faith" is not defined in the Bankruptcy Code. The case law provides that bad faith (i.e., an absence of good faith) may be found where a claim holder attempts to extract or extort a personal advantage not available to other creditors in the class or where a creditor acts in furtherance of an ulterior motive, unrelated to its claim or its interests as a creditor. See In re Dune Deck Owners Corp., 175 B.R. 839, 844 (Bankr. S.D.N.Y. 1995).
Certain "badges of bad faith" have developed over the years to include efforts to: (1) assume control of the debtor; (2) put the debtor out of business or otherwise gain a competitive advantage; (3) destroy the debtor out of pure malice; or (4) obtain benefits available under a private agreement with a third party which depends on the debtor's failure to reorganize.
Traditionally, courts have held that "the ability to vote on a reorganization plan is one of the most sacred entitlements that a creditor has in a chapter 11 case," and "should not be denied except for highly egregious conduct-principally, seeking to... extract plan treatment that is not available for others in the same class." In re Adelphia Communications Corp., 359 B.R. 54, 56-57 (Bankr. S.D.N.Y. 2006). Some courts have thus required a showing of wrongdoing beyond desire to acquire the debtor to designate a vote. See In re Allegheny Int'l, Inc., 118 B.R. 282, 293 (Bankr. W.D. Pa. 1990). In short, courts adopting such an approach reserve the application of § 1126(e) for circumstances in which the creditor has attempted to effectively extort the debtors. See In re Marin Town Center, 142 B.R. 374, 379 (N.D. Cal. 1992).
Facts similar to those presented in DBSD have been held insufficient to warrant designation where the court has required evidence of wrongdoing. In In re Marin Town Center, for example, a real estate investment firm learned of a secured creditor's right, pursuant to a court-approved stipulation, to foreclose on a shopping center owned by the debtor if the debtor failed to refinance under its plan of reorganization. The investor purchased the secured creditor's claim and the claims of several unsecured creditors and voted those claims against the plan. The bankruptcy court disregarded the investor's votes because its interest was that of a potential purchaser rather than a true creditor. On appeal, however, the district court reversed, holding that a "vote cannot be said to have been cast in bad faith simply because it was voted for the purpose of blocking confirmation of a reorganization plan. In fact, rejection of a plan by 'a party, largely interested in the Debtor before his acquisition of controlling rights, who withholds consent to a plan primarily because he believes its consummation will be more injurious to his investment in the Debtor than liquidation, meets the standard of good faith.'" Id. See also Kremer v. Clark (In re Frank Fehr Brewing Co.), 268 F.2d 170, 180 (6th Cir. 1959) ("Self interest is not the same as ulterior motive or bad faith.").
In DBSD, however, the bankruptcy court designated DISH's vote on the basis of DISH's motivation to engage in a strategic transaction with the Debtors and seemingly without additional evidence of wrongdoing. In the event that DBSD represents a departure from the wrongdoing requirement, the decision may have implications for the plan votes of creditors beyond simply those looking to acquire a debtor. Trade creditors may have an interest in preserving a long-term business relationship with a debtor. Holders of claims in multiple classes may be driven by maximizing overall recovery rather than maximizing recovery under a particular class. DBSD may open the door wider for the votes of such creditors to be designated as a result of ulterior motivation. Further development, either on appeal or in other cases, will guide investors using claims to acquire a debtor.
O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
