Bank of America (BoA) was the major creditor of LaSalle. It had lent $93mm, which was secured by a non-recourse mortgage on the debtor’s principal assets, which was a building in Chicago. Upon default, BoA started foreclosure which the debtor responded to with a Chapter 11 voluntary petition, trying to ensure that the partners retain title to the property, which would fall due if the bank foreclosed. If BoA foreclosed, the debtor would incur a huge tax liability. Generally, the debtor was driven by tax consequences while forming the plan. The value of the property was less than the amount due (BoA undersecured, resulting in an unsecured deficiency claim under Sec. 506(a) and Sec. 1111(b)). The Bank wanted to quickly foreclose and sell and not to reorganize the debtor.
The plan provided the following structure:
Repayment of 2/3 of the loan
Discharge of the rest
Contribution of $6mm by the old owners in exchange for the entire property of the partnership.
BoA blocked the plan (it could do it because its deficiency claim was impaired), seeking that the absolute priority rule was not recognized in the plan. The other unsecured creditors would not object because they would prefer to get paid without interest, but quickly. They are trade creditors who had long term r-ship and whose payments depend on the debtor (they just want to continue business). The debtor wants to cram down the Bank’s deficiency claim.
Whether and under what circumstances can the old equity be paid over the unsecured creditors? What are the exceptions to absolute priority rule?
The old equity cannot have an exclusive right (in the absence of any competing plan) to obtain property interest in the reorganized debtor over the unsecured creditors, without paying full value for an option to be able to obtain this property.
Instead of giving such exclusive right to the old equity, a market test should be established to assess whether the old equity offers the highest bid for the property in the reorganized debtor, or whether there are higher bids out there.
The court analyzed the three interpretations of the expression “on account of” in sec. 1129(b)(iii)(B)(ii):
If on account of means “in exchange for”, there plan does not violate the absolute priority rule as long as the equity makes a new contribution to the new firm. This is not the case as the language of the code (“or retaining property”) clearly shows.
Instead, the phrase could mean “because of” as it also means in other parts of the code, meaning that the casual relationship between holding of the prior claim and receiving property in the reorganized debtor activates the absolute priority rule. The question here is then, why the phrase was not just omitted if old equity holders should just be excluded from receiving new equity.
The phrase thus has to be understood correctly as a reconciliation of policies preserving going concerns and maximizing property available to satisfy creditors (this is the correct interpretation according to the court).
Under the debtor’s plan, the benefit of equity in the reorganized p-ship can be obtained only by the old equity partners. Upon the court’s approval of the plan, the partners were in the same position that they would have enjoyed have they exercised an exclusive option under the plan to buy the equity in the reorganized entity, or contracted to purchase it from a seller. At the moment of the plan’s approval the debtor’s partners necessarily enjoyed an exclusive opportunity that was in no economic sense distinguishable from the advantage of the exclusively entitled offeror or option holder. While it can be argued that such opportunity has no market value, being significant only to old equity because of their potential tax liability, it is established that any cognizable property interest must be treated as sufficiently valuable to be recognized under the Code.
The opportunity to buy in the reorganized debtor has value (like call option). The opportunity to give value is already an asset and the old equity has not paid for that (option to buy new equity on account on having old equity). This is what the court claims violates the absolute priority rule. The court has doubts why the old equity should have this exclusive opportunity to purchase the new equity. If the price that the new equity offers is the best, they don’t need such protection (we trust the market to do such evaluation). Thus, the court establishes the market test, but does not elaborate on it further.
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