Ice Cube Bonds: Allocating the Price of Process in Chapter 11 Bankruptcy

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2. Distributional Consequences

The cases that raise the most explicit distributional issues involve sale orders that contain explicit instructions about how to allocate value. These sales are often attacked as "sub rosa" plans--plans of reorganization disguised as sales in order to evade the requirements of plan confirmation. (163) The procedures that govern the Chapter 11 plan process do not apply to the debtor-in-possession's powers to administer the estate, such as the power to sell and use property of the estate under [section] 363, or the power to incur debt under [section] 364. But when the power to sell includes selling everything, and the power to borrow includes terms that predetermine the distribution of proceeds, the plan process can be rendered irrelevant. Thus, early sales, coupled with restrictive financing, facilitate the use of transactional leverage for individualized benefit, particularly by creditors holding prepetition undersecured claims. But even sales that lack obvious sub rosa features can have significant distributional consequences and are procedurally noncompliant, in that they short-circuit the safeguards of Chapter 11.

As we describe below, the Code contains well-developed procedures, with a long historical provenance, that allows parties to negotiate an allocation of enterprise value in the shadow of an established disclosure regime (applicable to Chapter 11 plans), a mandatory set of legal findings, and a distributional scheme established by state law and the priority rules for Chapter 7 liquidations. The Chapter 11 plan confirmation process imposes important limits on the use of transactional leverage to divert value.

Section 1125 of the Code requires a disclosure statement that provides claimants with "adequate information" to make an informed decision whether to support or oppose a plan of reorganization. (164) Section 1129(a)(7) requires a finding that each claimant will receive at least as much under the plan as they would if the debtor were liquidated under Chapter 7. (165) This means that the distributions under the proposed plan must respect the distributional priorities contained in Chapter 7.

Code-authorized priorities among unsecured claims are rooted both in the exigencies of bankruptcy, and in other public policy considerations. For example, unpaid employee wage claims get special priority, (166) and Chapter 11 entitles such claimants to payment in full in cash on the effective date of a confirmed plan. (167) The Code also requires the debtor-in-possession to cure defaults in executory contracts that will be assumed and performed. The estate's counterparty goes from being entitled to only a pro rata share of the debtor's unencumbered assets, to being entitled to one hundred percent payment of its prepetition claim. (168) Debtors-in-possession can seek court permission to give super-priority or secured status to lenders offering to extend credit to the bankruptcy estate. (169) These Code-authorized liens and priorities subordinate prepetition creditors in the interest of a successful reorganization.

Yet, a common theme of these Code-authorized priorities is that they do not exacerbate, and are often designed specifically to limit, the leverage of prepetition creditors on the eve of, and early in, a bankruptcy case. The employee wage priority protects people who often have little leverage. (170) The executory contract provisions allow the debtor to hold a non-debtor to its contract notwithstanding bankruptcy, and sometimes require the non-debtor to accept a contractual assignment, even if the non-debtor would prefer to do business with someone else. The financing provisions are meant to prevent prepetition creditors from placing a credit stranglehold on the debtor.

Other mechanisms for redistributing value have developed (sometimes on shaky statutory grounds) through bankruptcy practice or been placed into the statute as a result of interest group lobbying. …