In re Indianapolis Downs: Court Declines to Designate Votes of Parties to Restructuring Support Agreement

Practical Law Legal Update 7-524-0826 (Approx. 6 pages)

In re Indianapolis Downs: Court Declines to Designate Votes of Parties to Restructuring Support Agreement

by PLC Finance

Background

Indianapolis Downs, LLC and Indiana Capital Corp. (collectively, the Debtors) operate a combined horse racing track and casino in Shelbyville, Indiana. They had outstanding secured debt in the amounts of:

$98 million in first lien debt.
$375 million plus accrued interest and fees in second lien debt, held primarily by Fortress Investment Group, LLC (Fortress).
$78 million in third lien debt, also held primarily by Fortress.

The Debtors struggled to service their debt obligations and filed for bankruptcy on April 7, 2011 in the US Bankruptcy Court for the District of Delaware. Following extensive negotiations, the Debtors, Fortress and a group of holders of the second lien debt (Ad Hoc Second Lien Committee) agreed on a "parallel path" approach that would:

Test the market to determine whether potential asset bids would satisfy the Debtors' major creditor constituents.
Permit the Debtors to proceed with a recapitalization if the asset bids were inadequate.

This parallel path approach was incorporated into a Restructuring Support Agreement (RSA), which was filed with the Court on April 25, 2011 and accompanied by a proposed disclosure statement. The RSA was binding on the non-debtor parties on execution and included:

The specific terms of the parallel path, including the treatment of creditors under a potential sale or recapitalization.
A required time frame within which the Debtors were required to propose a plan of reorganization.
A prohibition on proposing, supporting or voting for a competing plan of reorganization.
A requirement that parties to the RSA vote for a plan that complies with the RSA.

On the same day, the Debtors filed a proposed plan and disclosure statement, which extensively described the RSA. On June 21, 2012, the Court approved the disclosure statement over the objections of certain members of the Debtors' senior management and other debt and equity holders (collectively, the Oliver Parties). Ultimately, the Debtors received a bid of $500,000,000 for substantially all of their assets from Centaur LLC (Centaur). On October 31, 2012, the Court approved the sale and overruled the Oliver Parties' objections.

Key Litigated Issues

The key litigated issues before the Court were whether:

The RSA constituted a wrongful postpetition solicitation of votes on a plan before Court approval of the disclosure statement and therefore whether the votes of the parties to the RSA should be designated under sections 1125(g) and 1126(e) of the Bankruptcy Code.
The Plan was unconfirmable, because, among other things:
- it was not feasible, due to the asset sale being contingent on regulatory approval;
- it imposed an impermissible cap on administrative claims and priority tax claims, which must be paid in full in cash on the effective date of the plan (§ 1129(a)(9)(A) & (C)(i)-(ii));
- it provided for payment of the fees and expenses of the professionals hired by the parties to the RSA, who were holders of undersecured second and third lien debt, in violation of section 506(b) of the Bankruptcy Code. Also at issue was whether these fees qualified as administrative expenses under section 503(b) and whether payment of these fees to Fortress violated the requirement under section 1123(a)(4) that each claim within the same class receive the same treatment under the plan;
- the Debtors lacked the corporate authority to propose the plan because certain members of the Oliver Parties, who opposed the RSA, hold substantial equity interests in the Debtors and perform management functions; and
- it contained non-consensual third-party releases.

Decision

Designation Motion

The Bankruptcy Code requires that votes on a plan may not be solicited from creditors until they receive a court-approved disclosure statement containing adequate information permitting them to make an informed decision about the plan (§ 1125(b), Bankruptcy Code). Failure to comply may result in designation of creditors' votes because courts may designate votes that were not solicited in accordance with the provision of the Bankruptcy Code (§ 1126(e), Bankruptcy Code).

Even though creditors had not yet received a disclosure statement, the Court held that the RSA was not a wrongful postpetition solicitation because Congress intended that creditors have the opportunity to negotiate with the debtor and among each other to advance a bankruptcy case forward. The Court adopted a narrow construction of the term "solicitation" to allow creditors to memorialize these negotiations without forfeiting their bankruptcy voting rights.

Also, the Court noted that the Bankruptcy Code's disclosure requirements are intended to prevent solicitation when creditors are not adequately informed of the restructuring plan. In this case, the creditors were intimately aware of the facts and helped propose a plan that addressed their concerns as creditors, indicating that designation of their votes was neither required nor warranted. Further, the creditors were not obliged to vote for a plan that materially differed from what the parties contemplated in the RSA. Finally, the Court noted that designation is a remedy that is within a court's discretion and that when creditors act to further their self-interest and maximize their recoveries, courts have been reluctant to punish them by designating their votes.

Ultimately, the Court denied the motion to designate and noted that the filing of a Chapter 11 petition is an invitation to negotiate. When a deal is made in good faith between a debtor and sophisticated creditors before distribution of a court-approved disclosure statement, and that deal is memorialized in writing and promptly disclosed, designation of votes on a plan consistent with that deal is not automatically required.

Confirmation Objections

The Court overruled the substantive confirmation objections to the plan that were based on:

Feasibility, because many Chapter 11 plan confirmations are contingent on regulatory approval and the Bankruptcy Code only requires that the plan proponent demonstrate that regulatory approval is not subject to material hurdles or significant obstacles. Here, no such obstacles existed.
The plan's treatment of administrative expenses and priority tax claims, because the record indicated that the plan's caps on these amounts would not limit priority claimants' rights to payment. Instead, the Court held that the plan only provided that the RSA parties would not be required to support the plan if the caps were exceeded.
The payment of the legal and professional fees of the RSA parties, because these payments were previously authorized under the Court's final DIP financing order. Also, these payments qualify as administrative expenses because they arose from a postpetition transaction between the creditors and the debtors and were actual and necessary to preserve the estate, as the RSA parties played a central role in the formulation of the plan and in the general progress of the case. Therefore, there was no disparate treatment within a class of creditors because the payments to Fortress were not enhanced distributions made on account of its claim.
Lack of corporate authority, because a special committee was properly formed and carried out its duties in accordance with its powers and purpose.
The plan's third-party releases, which the Court held were consensual because the plan provided a mechanism for opting out of granting the releases, whether or not the creditor voted on the plan.

Practical Implications

This decision illustrates that courts may narrowly construe the definition of solicitation to facilitate negotiations between sophisticated creditors and debtors to arrive at a plan that is acceptable to all parties. Courts may decline to place form over substance in the context of postpetition solicitation. The Bankruptcy Code's disclosure requirements exist to prohibit soliciting the votes of creditors before they receive a court-approved disclosure statement, not to prohibit negotiations between fully-informed creditors and debtors on the best way to resolve a Chapter 11 bankruptcy case. Consequently, if a fully-informed sophisticated creditor negotiates a plan with the debtor that is in its financial interests, and pledges in writing to vote for that plan before receiving a court-approved disclosure statement, courts may decline to designate that creditor's vote on the basis of improper solicitation and allow it to vote in favor of the plan.

For more on vote designation, see Practice Note, Disenfranchising Creditors: Designating Votes on Chapter 11 Plans.

For more on the Chapter 11 plan process, see Practice Note, Chapter 11 Plan Process: Overview.

Court Documents

In re Indianapolis Downs, LLC., 11-11046 (BLS), (Bankr. D. Del. Jan. 31, 2013).

In re Indianapolis Downs: Court Declines to Designate Votes of Parties to Restructuring Support Agreement | Practical Law