Outnumbered, Not Outplayed: Minority Lenders Successfully Challenge Exclusive Backstop Agreement On Equal Treatment Grounds In ConvergeOne

The District Court for the Southern District of Texas (the "District Court") recently issued a ruling¹ in the chapter 11 cases of ConvergeOne Holdings, Inc. and its affiliated debtors (together, the "Debtors") prohibiting the offer of the exclusive opportunity to backstop a plan's equity rights offering to select creditors while excluding creditors in the same plan class.

This is the first published decision addressing this issue since the Fifth Circuit's Serta² decision, which held that chapter 11 plans must provide equal opportunities and results for creditors in the same class. The ConvergeOne decision departs from other courts' decisions allowing chapter 11 plans to distribute additional value to certain creditors in a class on account of their agreement to backstop a chapter 11 plan's rights offering. Given the frequency of backstopped equity rights offerings in chapter 11 cases, ConvergeOne and its application of Serta may significantly impact debtors' strategies for raising capital and marshaling creditor support for plan confirmation.³ It also remains to be seen whether courts will extend the prohibition on exclusive backstop opportunities to other contexts, such as debtor-in-possession financing ("DIP financing").

In ConvergeOne, the District Court reversed and remanded an order of the Bankruptcy Court for the Southern District of Texas (the "Bankruptcy Court") confirming the Debtors' plan of reorganization (the "Plan"). Relying on the Fifth Circuit's Serta decision and the U.S. Supreme Court's LaSalle⁴ decision, the District Court held:

• The Plan violated the equal treatment requirement of Bankruptcy Code section 1123(a)(4) in two ways: (i) it provided certain creditors within a particular class with an exclusive investment opportunity that resulted in higher recoveries than for other creditors in that class; and (ii) the Debtors failed to market the backstop opportunity to prove that the backstopping lenders paid adequate consideration for the backstop opportunity instead of receiving the opportunity on account of their claims.⁵
• More generally, a backstop opportunity in a plan must either be offered to all members of a plan class or subjected to market testing; merely considering alternative plan proposals from disaffected class members is insufficient to meet the market test requirement.

Like Serta before it, ConvergeOne demonstrates a court's willingness to closely scrutinize majority lender transactions that exclude minority lenders.

Background

Prior to the Debtors' prepackaged chapter 11 filing in April 2024, they negotiated a restructuring support agreement (the "RSA") with approximately 81% of the first and second lien holders of the Debtors' $1.6 billion funded debt obligations.

Pursuant to the RSA, the parties agreed that the Plan would be funded by a $245 million equity rights offering backstopped by certain of the first lien holders (the "Majority Lenders"). The Majority Lenders committed to purchase 35% of the available new equity interests offered to holders of first lien claims under the Plan. In exchange for the backstop commitment, the Debtors agreed to provide the Majority Lenders with a 10% put option premium.

Certain holders of first lien claims (the "Minority Lenders"), collectively holding approximately $164 million (11%) of first lien claims, were intentionally excluded from RSA negotiations and the backstop opportunity despite seeking to participate on the same terms as the Majority Lenders.

A day after the RSA was finalized, the Debtors filed their chapter 11 cases and immediately sought approval of the Plan. The Minority Lenders opposed the Plan and proposed two alternative restructuring plans, both of which the Debtors rejected, as they believed the Minority Lenders' proposals either would not have replaced the Debtors' DIP financing or would not have garnered sufficient support from the other holders of the funded debt.

The Minority Lenders objected to the Plan on the basis that their exclusion from participation in the backstop and the attendant right to additional recoveries violated the equal treatment requirement of Bankruptcy Code section 1123(a)(4) because the backstop opportunity: (i) was exclusive to certain stakeholders on account of their claims while excluding the Minority Lenders holding claims in the same class; and (ii) was not market tested to establish that the opportunity had the best possible terms for the Debtors.⁶

The Debtors did not claim that they openly marketed the backstop opportunity and instead relied on their investment banker's analysis of 25 similar transactions to conclude that the backstop was reasonable. They argued there was no unequal treatment because the extra value provided to the Majority Lenders was consideration for their backstop commitment, which was separate from their treatment as holders of first lien claims under the Plan.

The Bankruptcy Court overruled the Minority Lenders' objection and confirmed the Plan only 49 days after the chapter 11 petition date, finding the Plan was overwhelmingly supported by creditors, the backstop agreement was reasonable and necessary, and a market test was not required. The Minority Lenders appealed.

District Court Appeal and Decision

On appeal, the District Court held that the Plan violated section 1123(a)(4) by providing certain creditors — but not others in the same class — an opportunity to receive additional value, resulting in disparate treatment among creditors within the class. The District Court held that both the Supreme Court's decision in LaSalle and the Fifth Circuit's recent decision in Serta mandated this outcome.

The Supreme Court's analysis in LaSalle of the "new value" exception to the absolute priority rule⁷ under Bankruptcy Code section 1129(b) guided the District Court's analysis under section 1123(a)(4), even though section 1129(b) was inapplicable in this case because the lenders' class voted in favor of the Plan. In LaSalle, the plan did not pay all creditors in full but nonetheless provided the debtor's prepetition equity holders with an exclusive opportunity to participate in an equity rights offering by the reorganized debtor. The equity holders did not pay for the opportunity to invest new money for new equity; the opportunity was provided solely on account of their prepetition equity interests. A class of claims rejected the plan and objected, arguing that the plan violated the absolute priority rule by offering an investment opportunity to holders of prepetition equity solely on account of their equity, before creditor claims were paid in full. The Supreme Court held that section 1129(b) prohibits awarding exclusive rights to an equity offering to a prepetition equity holder solely on account of their prepetition equity interest, and subjecting the opportunity to market scrutiny—potentially by means of competing bids or competing plan proposals—would be required to show that the investment opportunity was not provided on account of the prepetition equity.⁸

The District Court analogized to LaSalle's holding and ruled that section 1123(a)(4) prohibits plans from granting only certain members of a class an investment opportunity that would enhance their recoveries without paying fair consideration for the opportunity, as determined by an open marketing process. The District Court rejected the Majority Lenders' argument that the ability of the Minority Lenders to make plan proposals between the petition date and the Plan's confirmation date was a market test. The District Court found such an opportunity illusory due to, among other things, the speed of the prepackaged chapter 11 case, and further suggested that even a meaningful opportunity for a minority lender to propose alternative plans would not be a market test. As a result, the District Court found that the Debtors and Majority Lenders failed to conduct a market test to determine an accurate valuation of the backstop opportunity and, therefore, could not demonstrate either that it was the best deal for the Debtors and their estate or that the Majority Lenders did not receive the opportunity on account of their claims.

The District Court then applied Serta. Noting that Serta requires a court to "look 'below the surface to determine whether distributions were in fact equal in value,'"⁹ the District Court found that there was no "approximate equality"¹⁰ in value in this case because the Majority Lenders' backstop rights provided them with substantially more valuable plan distributions than were provided to the Minority Lenders. Specifically, the Plan (with the backstopping opportunity) resulted in a 31% higher recovery for the Majority Lenders.

Following Serta, the District Court also considered whether there was inequality in both the opportunity and result. The District Court held there was inequality in both instances because the Plan only offered the backstopping opportunity to select lenders for no consideration without "even any pretense of equal participation."¹¹ In its opinion, the District Court did not address decisions from other jurisdictions in which those courts approved backstop agreements that provided unequal compensation to similarly situated creditors.¹²

Following these analyses, the District Court held that the exclusive opportunity provided to the Majority Lenders ran afoul of section 1123(a)(4), and, therefore, the Plan was unconfirmable. The District Court reversed the Bankruptcy Court's order confirming the Plan and remanded the case to the Bankruptcy Court for further proceedings.

Takeaways

Analogizing to LaSalle

Although the "new value" exception may have analytical appeal in the equal treatment context, it is unclear whether courts not bound by this opinion will find the analogy to LaSalle's holding as persuasive with respect to interpreting section 1123(a)(4). The District Court treats the application of LaSalle in this context as a foregone conclusion, but other courts have not explicitly applied the legal standard established in LaSalle to find that a plan violates section 1123(a)(4).¹³

Furthermore, the District Court's holding that the market test from LaSalle applies to backstop rights may be challenging to apply because the District Court does not provide guidance as to what would be a proper market test in this context, only noting that neither the Debtors' actions in negotiating the backstop agreement nor the Minority Lenders' submission of competing plan proposals postpetition were sufficient to constitute a valid market test.

Implications of Serta & Impact on Future Chapter 11 Cases

The District Court's reliance on Serta also raises questions as to whether the Fifth Circuit intended its holding to apply to a situation such as this. In Serta, all prepetition lending parties were offered the indemnity that was at issue in that case, but the value of the indemnity only benefited those who had participated in the uptier transaction. Although the District Court followed Serta to conclude there was no equal opportunity for recovery given the Minority Lenders' exclusion from the opportunity itself, the ConvergeOne fact pattern has key differences from Serta, including that the additional consideration was provided as part of the terms of new capital to fund the Debtors' exit from chapter 11, not as a plan distribution. By applying Serta in this context, the District Court has signaled there may be greater scrutiny of transactions — even those under contracts executed prepetition — that result in an exclusive deal for select creditors while excluding others and even where the differing treatment can be characterized as the result of a separate right or contribution (i.e., additional risk associated with backstopping the new money investment and committing capital for such purpose), rather than an additional distribution on account of the claim.

It remains to be seen whether courts widely follow the ConvergeOne decision.¹⁴ Backstopped equity rights offerings, even absent a competitive market test, are a common mechanism for companies to incentivize creditors to sponsor successful exits from bankruptcy, and they are often negotiated as part of an RSA with creditors whose participation can effectively control a voting class under a plan. Courts commonly approve increased recoveries to investors in exchange for such investors ensuring the equity rights offering is fully funded (and, consequently, that there is enough cash to fund plan recoveries and ongoing operations), holding that the increased recoveries do not violate the equal treatment requirement of section 1123(a)(4).¹⁵ As an illustration of the prevalence of backstopped rights offerings in chapter 11 plans, a recent study observed that 49 chapter 11 plans confirmed between January 2016 and June 2024 featured a backstopped rights offering of the debtor's post-bankruptcy common equity^.16

Inherently, the ability to invest in a reorganized company at a discount to plan value benefits parties offered the investment opportunity who have the legal and financial ability to make the investment, sometimes at the expense of investors who do not have that ability (e.g., because they are not "accredited investors"). In this respect, the ConvergeOne decision may implicate related issues, such as whether a debtor could offer the right to purchase discounted equity to some class members but not others based on legitimate legal limitations, without violating section 1123(a)(4). For example, courts have approved chapter 11 plans providing non-accredited investors who cannot participate in a rights offering that is open only to accredited investors with separate cash consideration to ensure there is no disproportionate treatment within the same class.¹⁷ The reasoning in ConvergeOne may lead to more disputes as to whether such procedural differences in the opportunity itself truly provide equal opportunity for recovery and equivalent value.

In addition, ConvergeOne may extend outside of chapter 11 plan treatment to DIP financing terms. An increasing number of DIP financings have included backstops and equity-linked features for participating lenders. For example, the DIP financing in the recently filed First Brands case features a non–pro rata backstop. Although credit documents may provide excluded lenders with additional grounds for objection — a topic beyond this article's scope — ConvergeOne potentially expands the avenues available to excluded lenders seeking to challenge DIP financing packages.

Ultimately, the ConvergeOne decision poses a choice for companies pursuing a restructuring: either include all similarly situated creditors in restructuring negotiations and/or permit such creditors to join in the negotiated opportunities, or conduct an adequate marketing process prior to granting an exclusive opportunity to certain creditors. The District Court's decision compounds this challenge by offering minimal guidance on what constitutes an "adequate marketing process." This ambiguity threatens to complicate restructuring negotiations and provides excluded creditors with potential litigation leverage.

The Debtors and Majority Lenders have appealed the District Court's ruling in ConvergeOne. The Fifth Circuit will now have the opportunity to weigh in on this issue and, among other things, potentially provide clarity regarding the scope and applicability of its Serta decision in the context of non–pro rata backstop transactions.

Footnotes

1. In re ConvergeOne Holdings, Inc., Case No. 24-02001 (S.D. Tex. Sept. 25, 2025) ("ConvergeOne").

2. In re Serta Simmons Bedding, L.L.C., 125 F.4th 555 (5th Cir. 2024), as revised (Jan. 21, 2025), as revised (Feb. 14, 2025) ("Serta").

3. 11 U.S.C. § 1126(c) (providing that an impaired class of claims accepts a plan if two-thirds of the claims by value and half by amount accept it).

4. Bank of Am. Nat. Tr. & Sav. Ass'n v. 203 N. LaSalle St. P'ship, 526 U.S. 434, 442 (1999) ("LaSalle").

5. Section 1123(a)(4) requires all creditors in the same plan class to receive equal treatment under the debtor's plan, unless the creditor agrees otherwise. Bankruptcy Code section 1122(a) permits a plan to place creditors or equity holders in the same plan class if their claims or equity interests are substantially similar to those of other class members.

6. The Plan classified all holders of first lien claims against the Debtors, including the Majority Lenders and the Minority Lenders, together for both voting and distribution purposes.

7. The absolute priority rule mandates that if a class of claims rejects a plan, that class must be paid in full before any junior class of claims or equity interests can receive or retain any property under a plan on account of such junior claims or equity. LaSalle, 526 U.S. at 442.

8. Id. at 456-58.

9. ConvergeOne at 19. (quoting Serta, 125 F.4th at 579).

10. Id. (quoting Serta, 125 F.4th at 579).

11. Id. at 20.

12. See, e.g., In re LATAM Airlines Grp. S.A., No. 20-11254 (JLG), 2022 WL 2206829, at *35 (Bankr. S.D.N.Y. June 18, 2022) (subsequent history omitted) (confirming plan where "the Backstop Fees and Direct Allocation are distributed to the Backstop Parties in consideration for their willingness to backstop the Class C Notes and the ERO Rights Offering, not on account of their General Unsecured Class 5 Claims."); Ad Hoc Comm. of Non-Consenting Creditors v. Peabody Energy Corp. (In re Peabody Energy Corp.), 933 F.3d 918, 927 (8th Cir. 2019) ("The right to participate in the Private Placement was consideration for valuable new commitments. Consequently, the plan did not violate the equal-treatment rule of §1123(a)(4)."); see also In re Joint E. & S. Dist. Asbestos Litig., 982 F.2d 721, 749 (2d Cir. 1992) ("[T]he 'same treatment' standard of section 1123(a)(4) does not require that all claimants within a class receive the same amount of money.").

13. See, e.g., Peabody Energy Corp, 933 F.3d 918. The court in Peabody considered LaSalle's holdingin the context of an argument that a private placement transaction violated section 1123(a)(4). However, the Peabody court held that LaSalle was inapplicablein that particular instance because (1) the ad hoc committee in that case was not excluded from an opportunity, (2) the parties who participated in the private placement gave up value to participate, and (3) the debtors considered a number of alternative ways to raise capital, so there was a market test.

14. After Serta, at least one court in another jurisdiction has rejected equal treatment objections under section 1123(a)(4) with respect to backstop consideration not offered to all creditors in the same class. See, e.g., In re WOM S.A., et al , Case No. 24-10628 (KBO) (Bankr. D. Del. March 11, 2025) [Docket. No. 1255, 81:11-82:20] (overruling plan objection from certain noteholders to greater recovery of backstopping noteholders within same class, finding the additional consideration was on account of the backstop and not related to plan distributions). In WOM, the court had approved the propriety of the backstop consideration earlier in the case, although the objecting noteholders had reserved the right to raise the section 1123(a)(4) objection at confirmation. Nonetheless, the court indicated that if a backstop fee exceeds the benefit provided to the estate, it could be characterized as an additional plan distribution and implicate section 1123(a)(4). See also In re Pacific Drilling S.A., Case No. 17-13193 (MEW), 2018 WL 11435661 *5 (Oct. 1, 2018) (approving backstop proposal and related fees but noting excessive backstop fees could implicate the principle of equality among similarly situated creditors underlying section 1123(a)(4)).

15. See, e.g., In re LATAM., 2022 WL 2206829, at *35; Peabody Energy Corp., 933 F.3d at 927; see also Joint E., 982 at 749.

16. See Vincent S.J. Buccola, Adi Marcovich Gross & Matthew R. McBrady, The Backstop Party (Univ. of Chi. L. Sch., Coase-Sandor Inst. for L. & Econ. Rsch. Paper No. 25-13; Darden Bus. Sch. Working Paper No. 5188727, 2025), https://ssrn.com/abstract=5188727; see also Shelby V. Saxon, Chapter 11 Rights Offerings and Private Placements: How Creditors Can Strike a Windfall, 94 AM. BANKR. L.J. 357 (2020) (documenting increase in rights offerings in second half of 2010s); Marti P. Murray, Assessing the Reasonableness of Rights Offerings: Raising Exit Financing in a Chapter 11 Proceeding, 32 AIRA J. 35 (2020).

17. The rationale for this is that courts have interpreted the equal opportunity requirement of section 1123(a)(4) to mean "approximate equality" and allow for deviations in procedural recovery for holders of claims in the same class, where such deviations are based on legitimate reasoning. See In re W.R. Grace & Co., 729 F.3d 332, 327-328 (3d Cir. 2013).