You Just Can't Give It Away

Armstrong World Industries

Facing significant asbestos liabilities, floor and ceiling products manufacturer Armstrong World Industries, Inc. (Armstrong) and two of its wholly owned subsidiaries voluntarily sought Chapter 11 protection in 2000. Armstrong's creditors included both general unsecured creditors, and those whose claims were based upon injuries sustained due to asbestos exposure.

Armstrong filed its fourth amended Chapter 11 plan in 2003. Under the plan, unsecured creditors (other than asbestos claimants) would recover approximately 59.5% of their claims, and asbestos personal injury creditors would recover approximately 20% of an estimated $3.146 billion in claims. In addition, the plan provided that Armstrong's shareholders would receive warrants to purchase new common stock in the reorganized company valued at $35 million to $40 million. A key provision of the plan was the consent of the class of asbestos claimants to share a portion of its proposed distribution with equity. The plan provided that, if Armstrong's class of unsecured creditors other than asbestos claimants voted to reject the plan, asbestos claimants would receive new warrants, but would automatically waive their distribution of such warrants, causing equity to obtain the warrants that otherwise would have been distributed to the asbestos claimants. The net result of the waiver was that equity holders would receive property on account of their equity interests, although a senior class (ie, the unsecured creditors) was not paid in full.

Of the classes of creditors and shareholders impaired by the plan, only unsecured creditors voted to reject it. Thus, upon referral of proposed findings by the bankruptcy court, the district court had to decide whether the plan could be confirmed over the objection of the unsecured class under section 1129(b). The court denied confirmation, ruling that distribution of new warrants to the class of equity holders over the objection of the unsecured creditors class violated the “fair and equitable” requirement of section 1129(b)(2)(B)(ii).

'Plain Meaning'

The district court began by examining the “plain meaning” of the statute. According to the court, section 1129(b)(2)(B)(ii) unambiguously provides that a plan is not “fair and equitable” if a class of creditors that is junior to the class of unsecured creditors receives property because of its ownership interest in the debtor while the allowed claims of the class of unsecured creditors have not been paid in full. Even if the statute's plain meaning were not evident, the court explained, its legislative history “demonstrates that Congress did not intend for the Bankruptcy Code to allow a senior class to sacrifice its distribution to a junior class when a dissenting intervening class had not been fully compensated.” According to the court, Congress considered and expressly rejected this idea when it enacted the Bankruptcy Code in 1978.

The Senate Report written in anticipation of the enactment of the Bankruptcy Code proposed that a senior creditor be permitted to alter its distribution for the benefit of stockholders under the “fair and equitable” doctrine. It stated in relevant part as follows:

“[I]f a class of claims or interests has not accepted the plan, the court will confirm the plan if, for the dissenting class and any class of equal rank, the negotiated plan provides in value no less than under a plan that is fair and equitable. Such review and determination are not required for any other classes that accepted the plan. [This] would permit a senior creditor to adjust his participation for the benefit of stockholders. In such a case, junior creditors, who have not been satisfied in full, may not object if, absent the 'give up,' they are receiving all that a fair and equitable plan would give them.” S. Rep. No. 95-989, at 127 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5913.

Later, Rep. Don Edwards (D-CA) and Sen. Dennis DeConcini (D-AZ) — key legislators of the Bankruptcy Code — explicitly rejected this example. Both stated that “[C]ontrary to the example contained in the Senate report, a senior class will not be able to give up value to a junior class over the dissent of an intervening class unless the intervening class receives the full amount, as opposed to value, of its claims or interests.” 124 Cong. Rec. S. 34007 (Oct. 5, 1978) (remarks of Sen. DeConcini); 124 Cong. Rec. H. 32408 (Sept. 28, 1978) (remarks of Rep. Edwards). According to the district court, reliance upon statements made by Rep. Edwards and Sen. DeConcini for a determination of congressional intent is particularly appropriate given recognition by the Supreme Court that “[b]ecause of the absence of a conference and the key roles played by Representative Edwards and his counterpart floor manager Senator DeConcini, we have treated [Representative Edwards's and Senator DeConcini's] floor statements on the Bankruptcy Reform Act of 1978 as persuasive evidence of congressional intent.” See Begier v. I.R.S., 496 U.S. 53, 64 n. 5 (1990).

'Wrongly Decided' Cases

Next, the district court distinguished, or characterized as “wrongly decided,” cases in which the courts have not strictly applied section 1129(b)(2)(B)(ii). It found Official Unsecured Creditors' Committee v. Stern (In re SPM Manufacturing Corp.), 984 F2d 1305 (1st Cir. 1993) (SPM) to be inapposite for “several reasons.” Initially, the district court explained, the distribution in SPM occurred in a Chapter 7 case, “where the sweep of 11 U.S.C. ' 1129(b)(2)(B)(ii) does not reach.” Moreover, the court emphasized, SPM's unsecured creditors, rather than being deprived of a distribution, were receiving a distribution ahead of priority, such that “the teachings of the absolute priority rule — which prevents a junior class from receiving a distribution ahead of the unsecured creditor class — are not applicable.”

Finally, the district court reasoned, the secured lender in SPM held a first priority security interest in substantially all of the debtor's assets. This meant that, although the sharing agreement implicated estate property, the property was not subject to distribution under the Bankruptcy Code's priority scheme. Finally, the district court emphasized, the sharing agreement in SPM might be more properly construed as an ordinary “carve out,” whereby a secured party allows a portion of its lien proceeds to be paid to others as part of a cash collateral agreement.

The district court went on to distinguish other cases that have not strictly applied section 1129(b)(2) (B)(ii), flatly rejecting the contention that creditors, without adhering to the strictures of the statute, are free to do whatever they wish with their distributions under a plan, including sharing them with other creditors, so long as other creditor recoveries are not affected. “Bluntly put,” said the court, “no amount of legal creativity or counsel's incantation to general notions of equity or to any supposed policy favoring reorganizations over liquidation supports judicial rewriting of the Bankruptcy Code.”

Outlook

The ability of senior or secured creditors to give up value to junior or unsecured classes is an important part of the Chapter 11 process. A “gift” of consideration to a junior class may enable the parties to reach agreement on a consensual plan of reorganization, thereby avoiding the need for a contested confirmation hearing. Without the gift, the junior class receiving nothing would have a strong incentive to litigate. The litigation, which often would require expert testimony as to the value of the company, may be expensive and time consuming. Thus, it may be in the interests of the senior creditors to give up some value to get the deal done. In many cases, Armstrong will not impair the ability of senior creditors to do so because in those cases, the absolute priority rule will not be invoked.

Under the Bankruptcy Code, the bankruptcy court must find that the plan is “fair and equitable” and satisfies the absolute priority rule only with respect to classes that do not vote to accept the plan. In many cases, senior creditors (or secured creditors) will be giving up value to the immediately junior class so that the absolute priority rule will not be violated. For example, in a case with secured creditors, unsecured creditors, and equity, the secured creditor can give up value to unsecured creditors without running afoul of the absolute priority rule. In some other cases, the intervening class will accept the plan, so that the absolute priority rule would be inapplicable.

Armstrong's impact will be felt in cases where the absolute priority rule has been invoked and a senior class is not being paid in full. These will be contested confirmation hearings, so the justification for the gift — that it was necessary to get the deal done — would not seem applicable. For example, Armstrong would prevent one class of creditors from giving up value to equity if another class of creditors (whether pari passu or junior to the senior class) was not paid in full and such class did not vote to accept the plan.

Other Scenarios

There are certain scenarios in which the absolute priority rule protects a class of creditors from mischief or a hidden agenda by a senior stakeholder. In those circumstances, the senior stakeholder may be parting with its value to gain an advantage in the pursuit of its own economic interest, or the junior stakeholder may be attempting to gain at the expense of an intermediate stakeholder. Assume there is a senior stakeholder, intermediate stakeholder, and junior stakeholder and that in a valuation dispute in connection with a stand-alone plan of reorganization, the court would likely find that the company has a value sufficient for intermediate stakeholders, but not junior stakeholders, to receive value.

However, if there were a sale (as contrasted with a stand-alone plan), there would only be value available for the senior stakeholder. If the senior stakeholder wants a sale (so it gets cash quickly) and is willing to share some of the proceeds with the junior stakeholder, and if the junior stakeholders can exercise influence over the company to encourage a sale, the company may proceed with a sale process that benefits the interests of the senior stakeholder and the junior stakeholder, but not the intermediate stakeholder. As a result of the sharing arrangement, a sale has occurred rather than a stand-alone reorganization, and the junior stakeholder has benefited at the expense of the intermediate stakeholder. If, however, the gift were not permitted, the junior stakeholder would have no incentive to encourage the sale.

For another example, assume a company wants to provide a return for its equity holders, and it has two classes of unsecured creditors, trade and bond debt. The equity holders (and the company) could strike a deal with the trade creditors where the trade creditors will receive a larger distribution than the bondholders. In exchange for the better deal, the trade creditors would agree to share consideration with the equity holders through a gift. Assume further that the plan does not “unfairly” discriminate against the bondholders because the support of the trade creditors is necessary on a going-forward basis. Even though the company can justify the disparate treatment of the two creditor classes under the plan, it cannot justify the extra transfer from trade debt to equity when the bondholders are receiving less than the trade.

By contrast, there are many circumstances in which the senior stakeholder giving a gift to a junior stakeholder over the objections of an intermediate stakeholder class may not raise fairness concerns. In those cases, there may be little to be gained by denying the senior stakeholder the ability to give the gift. If there is no doubt that the company would be valued by the judge at less than the amount of the senior stakeholder's debt, the intermediate class would not be prejudiced by the gift to the junior stakeholder. Or, if the trade creditors and bondholders each received the same percentage recovery, a gift by the trade creditors to equity would not impair the bondholders' proportionate recovery. In such cases, why shouldn't the senior stakeholder be permitted to give up a portion of the recovery to which it is indisputably entitled? Perhaps as a policy matter, it should be. But, according to the Armstrong court, Congress considered but rejected that approach.

A Conundrum

If Armstrong is correct, then SPM's viability in the Chapter 11 plan context is in doubt. SPM has been already challenged, albeit indirectly, in In re Snyders Drug Stores, Inc., 307 B.R. 889 (Bankr. N.D. Ohio 2004). There, the debtor tried to confirm a plan that provided for radically different treatment among classes of general unsecured creditors. Specifically, a secured lender agreed to give up a portion of its recovery to unsecured classes consisting primarily of reclamation claimants, who were to receive a 27% distribution, and vendors and lessors with whom the debtor hoped to continue doing business, who would receive a 6%-7% distribution. A separate class containing the unsecured claims of lessors whose leases were being rejected would receive nothing. The debtor justified the plan by arguing that because the secured lender was undersecured, the general unsecured creditor body as a whole was not entitled to anything, and payments to creditors with whom it wished to continue doing business were critical to the success of the reorganization.

The bankruptcy court ruled that the plan discriminated unfairly. It characterized as “misplaced” the debtor's reliance on SPM as authority for treating the unsecured classes differently. According to the court, the sharing agreement in SPM was not proposed as part of the plan, but “was instead in the nature of a partial assignment or subordination agreement that was not subject to the code's confirmation requirements.” Moreover, the court ruled, unlike in the case before it, the property to be distributed in SPM was not property of the estate.

Although Snyder's Drugstores addresses the “unfair discrimination” requirement, its relevance arguably extends further — if a secured creditor cannot “gift” its consideration in contravention of the unfair discrimination requirement, it might not be able to do so in a contravention of the absolute priority rule. However, Armstrong and other cases suggest that there might be a meaningful distinction between SPM's applicability where the senior creditor that is giving up value a portion of its recovery is a secured creditor. There may also be a difference between the ability of a senior creditor to give up a portion of its anticipated recovery under a plan where section 1129(b) is applicable, on the one hand, and in the context of a pre-plan section 363 sale or settlement, on the other. This issue was not addressed in Armstrong.

Armstrong and Snyder's Drugstores are not necessarily inconsistent with SPM as limited to its facts. Those cases do not preclude senior creditors from sharing their recoveries after a distribution is made pursuant to a Chapter 11 plan. They may simply require that the sharing not be dictated by the plan and that the sharing take place after the plan distribution.

This approach may raise other issues for the parties. For example, the gifting party presumably would need to report both the plan distribution and the subsequent gift for tax and accounting purposes.

Furthermore, there are issues regarding the application to the subsequent “gift” of section 1145 of the Bankruptcy Code (governing the circumstances under which securities issued under a plan need or need not be registered under federal securities laws). Additionally, the parties would need to consider disclosing the sharing arrangement to the bankruptcy court and an objecting creditor may seek to have the court disregard the votes of those parties pursuant to section 1126(e) of the Bankruptcy Code.

Conclusion

Armstrong casts some doubt on the extension of SPM as a Chapter 11 plan-structuring device pursuant to which a gift is effectuated pursuant to the plan. Whether other courts will follow Armstrong's approach, or will join those courts that permit creditors to do what they wish with their recoveries, remains to be seen.

Part Two of a Two-Part Article

Last month, we explained that the proposition that a creditor can do whatever it wants with its recovery from a Chapter 11 debtor may seem to be a fundamental right — but that in the context of confirmation of a Chapter 11 plan, that right may not be unqualified. It may, in fact, violate well-established bankruptcy principles. We went on to explain that one such principle that applies only in the context of non-consensual confirmation of a Chapter 11 plan, or “cramdown,” is commonly referred to as the “absolute priority rule,” a pre-Bankruptcy Code maxim that established a strict hierarchy of payment among claims of differing priorities.

We discussed the fact that the concept of allowing a senior creditor or class of creditors to assign part of its recovery under a Chapter 11 plan to junior creditors or stockholders who would otherwise receive nothing by operation of section 1129(b)(2)(B)(ii) is controversial. This was the subject of the Delaware district court's ruling in In re Armstrong World Industries, Inc., 320 B.R. 523 (D. Del. 2005).

Armstrong World Industries

Facing significant asbestos liabilities, floor and ceiling products manufacturer Armstrong World Industries, Inc. (Armstrong) and two of its wholly owned subsidiaries voluntarily sought Chapter 11 protection in 2000. Armstrong's creditors included both general unsecured creditors, and those whose claims were based upon injuries sustained due to asbestos exposure.

Armstrong filed its fourth amended Chapter 11 plan in 2003. Under the plan, unsecured creditors (other than asbestos claimants) would recover approximately 59.5% of their claims, and asbestos personal injury creditors would recover approximately 20% of an estimated $3.146 billion in claims. In addition, the plan provided that Armstrong's shareholders would receive warrants to purchase new common stock in the reorganized company valued at $35 million to $40 million. A key provision of the plan was the consent of the class of asbestos claimants to share a portion of its proposed distribution with equity. The plan provided that, if Armstrong's class of unsecured creditors other than asbestos claimants voted to reject the plan, asbestos claimants would receive new warrants, but would automatically waive their distribution of such warrants, causing equity to obtain the warrants that otherwise would have been distributed to the asbestos claimants. The net result of the waiver was that equity holders would receive property on account of their equity interests, although a senior class (ie, the unsecured creditors) was not paid in full.

Of the classes of creditors and shareholders impaired by the plan, only unsecured creditors voted to reject it. Thus, upon referral of proposed findings by the bankruptcy court, the district court had to decide whether the plan could be confirmed over the objection of the unsecured class under section 1129(b). The court denied confirmation, ruling that distribution of new warrants to the class of equity holders over the objection of the unsecured creditors class violated the “fair and equitable” requirement of section 1129(b)(2)(B)(ii).

'Plain Meaning'

The district court began by examining the “plain meaning” of the statute. According to the court, section 1129(b)(2)(B)(ii) unambiguously provides that a plan is not “fair and equitable” if a class of creditors that is junior to the class of unsecured creditors receives property because of its ownership interest in the debtor while the allowed claims of the class of unsecured creditors have not been paid in full. Even if the statute's plain meaning were not evident, the court explained, its legislative history “demonstrates that Congress did not intend for the Bankruptcy Code to allow a senior class to sacrifice its distribution to a junior class when a dissenting intervening class had not been fully compensated.” According to the court, Congress considered and expressly rejected this idea when it enacted the Bankruptcy Code in 1978.

The Senate Report written in anticipation of the enactment of the Bankruptcy Code proposed that a senior creditor be permitted to alter its distribution for the benefit of stockholders under the “fair and equitable” doctrine. It stated in relevant part as follows:

“[I]f a class of claims or interests has not accepted the plan, the court will confirm the plan if, for the dissenting class and any class of equal rank, the negotiated plan provides in value no less than under a plan that is fair and equitable. Such review and determination are not required for any other classes that accepted the plan. [This] would permit a senior creditor to adjust his participation for the benefit of stockholders. In such a case, junior creditors, who have not been satisfied in full, may not object if, absent the 'give up,' they are receiving all that a fair and equitable plan would give them.” S. Rep. No. 95-989, at 127 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5913.

Later, Rep. Don Edwards (D-CA) and Sen. Dennis DeConcini (D-AZ) — key legislators of the Bankruptcy Code — explicitly rejected this example. Both stated that “[C]ontrary to the example contained in the Senate report, a senior class will not be able to give up value to a junior class over the dissent of an intervening class unless the intervening class receives the full amount, as opposed to value, of its claims or interests.” 124 Cong. Rec. S. 34007 (Oct. 5, 1978) (remarks of Sen. DeConcini); 124 Cong. Rec. H. 32408 (Sept. 28, 1978) (remarks of Rep. Edwards). According to the district court, reliance upon statements made by Rep. Edwards and Sen. DeConcini for a determination of congressional intent is particularly appropriate given recognition by the Supreme Court that “[b]ecause of the absence of a conference and the key roles played by Representative Edwards and his counterpart floor manager Senator DeConcini, we have treated [Representative Edwards's and Senator DeConcini's] floor statements on the Bankruptcy Reform Act of 1978 as persuasive evidence of congressional intent.” See Begier v. I.R.S. , 496 U.S. 53, 64 n. 5 (1990).

'Wrongly Decided' Cases

Next, the district court distinguished, or characterized as “wrongly decided,” cases in which the courts have not strictly applied section 1129(b)(2)(B)(ii). It found Official Unsecured Creditors' Committee v. Stern (In re SPM Manufacturing Corp.), 984 F2d 1305 (1st Cir. 1993) (SPM) to be inapposite for “several reasons.” Initially, the district court explained, the distribution in SPM occurred in a Chapter 7 case, “where the sweep of 11 U.S.C. ' 1129(b)(2)(B)(ii) does not reach.” Moreover, the court emphasized, SPM's unsecured creditors, rather than being deprived of a distribution, were receiving a distribution ahead of priority, such that “the teachings of the absolute priority rule — which prevents a junior class from receiving a distribution ahead of the unsecured creditor class — are not applicable.”

Finally, the district court reasoned, the secured lender in SPM held a first priority security interest in substantially all of the debtor's assets. This meant that, although the sharing agreement implicated estate property, the property was not subject to distribution under the Bankruptcy Code's priority scheme. Finally, the district court emphasized, the sharing agreement in SPM might be more properly construed as an ordinary “carve out,” whereby a secured party allows a portion of its lien proceeds to be paid to others as part of a cash collateral agreement.

The district court went on to distinguish other cases that have not strictly applied section 1129(b)(2) (B)(ii), flatly rejecting the contention that creditors, without adhering to the strictures of the statute, are free to do whatever they wish with their distributions under a plan, including sharing them with other creditors, so long as other creditor recoveries are not affected. “Bluntly put,” said the court, “no amount of legal creativity or counsel's incantation to general notions of equity or to any supposed policy favoring reorganizations over liquidation supports judicial rewriting of the Bankruptcy Code.”

Outlook

The ability of senior or secured creditors to give up value to junior or unsecured classes is an important part of the Chapter 11 process. A “gift” of consideration to a junior class may enable the parties to reach agreement on a consensual plan of reorganization, thereby avoiding the need for a contested confirmation hearing. Without the gift, the junior class receiving nothing would have a strong incentive to litigate. The litigation, which often would require expert testimony as to the value of the company, may be expensive and time consuming. Thus, it may be in the interests of the senior creditors to give up some value to get the deal done. In many cases, Armstrong will not impair the ability of senior creditors to do so because in those cases, the absolute priority rule will not be invoked.

Under the Bankruptcy Code, the bankruptcy court must find that the plan is “fair and equitable” and satisfies the absolute priority rule only with respect to classes that do not vote to accept the plan. In many cases, senior creditors (or secured creditors) will be giving up value to the immediately junior class so that the absolute priority rule will not be violated. For example, in a case with secured creditors, unsecured creditors, and equity, the secured creditor can give up value to unsecured creditors without running afoul of the absolute priority rule. In some other cases, the intervening class will accept the plan, so that the absolute priority rule would be inapplicable.

Armstrong's impact will be felt in cases where the absolute priority rule has been invoked and a senior class is not being paid in full. These will be contested confirmation hearings, so the justification for the gift — that it was necessary to get the deal done — would not seem applicable. For example, Armstrong would prevent one class of creditors from giving up value to equity if another class of creditors (whether pari passu or junior to the senior class) was not paid in full and such class did not vote to accept the plan.

Other Scenarios

There are certain scenarios in which the absolute priority rule protects a class of creditors from mischief or a hidden agenda by a senior stakeholder. In those circumstances, the senior stakeholder may be parting with its value to gain an advantage in the pursuit of its own economic interest, or the junior stakeholder may be attempting to gain at the expense of an intermediate stakeholder. Assume there is a senior stakeholder, intermediate stakeholder, and junior stakeholder and that in a valuation dispute in connection with a stand-alone plan of reorganization, the court would likely find that the company has a value sufficient for intermediate stakeholders, but not junior stakeholders, to receive value.

However, if there were a sale (as contrasted with a stand-alone plan), there would only be value available for the senior stakeholder. If the senior stakeholder wants a sale (so it gets cash quickly) and is willing to share some of the proceeds with the junior stakeholder, and if the junior stakeholders can exercise influence over the company to encourage a sale, the company may proceed with a sale process that benefits the interests of the senior stakeholder and the junior stakeholder, but not the intermediate stakeholder. As a result of the sharing arrangement, a sale has occurred rather than a stand-alone reorganization, and the junior stakeholder has benefited at the expense of the intermediate stakeholder. If, however, the gift were not permitted, the junior stakeholder would have no incentive to encourage the sale.

For another example, assume a company wants to provide a return for its equity holders, and it has two classes of unsecured creditors, trade and bond debt. The equity holders (and the company) could strike a deal with the trade creditors where the trade creditors will receive a larger distribution than the bondholders. In exchange for the better deal, the trade creditors would agree to share consideration with the equity holders through a gift. Assume further that the plan does not “unfairly” discriminate against the bondholders because the support of the trade creditors is necessary on a going-forward basis. Even though the company can justify the disparate treatment of the two creditor classes under the plan, it cannot justify the extra transfer from trade debt to equity when the bondholders are receiving less than the trade.

By contrast, there are many circumstances in which the senior stakeholder giving a gift to a junior stakeholder over the objections of an intermediate stakeholder class may not raise fairness concerns. In those cases, there may be little to be gained by denying the senior stakeholder the ability to give the gift. If there is no doubt that the company would be valued by the judge at less than the amount of the senior stakeholder's debt, the intermediate class would not be prejudiced by the gift to the junior stakeholder. Or, if the trade creditors and bondholders each received the same percentage recovery, a gift by the trade creditors to equity would not impair the bondholders' proportionate recovery. In such cases, why shouldn't the senior stakeholder be permitted to give up a portion of the recovery to which it is indisputably entitled? Perhaps as a policy matter, it should be. But, according to the Armstrong court, Congress considered but rejected that approach.

A Conundrum

If Armstrong is correct, then SPM's viability in the Chapter 11 plan context is in doubt. SPM has been already challenged, albeit indirectly, in In re Snyders Drug Stores, Inc., 307 B.R. 889 (Bankr. N.D. Ohio 2004). There, the debtor tried to confirm a plan that provided for radically different treatment among classes of general unsecured creditors. Specifically, a secured lender agreed to give up a portion of its recovery to unsecured classes consisting primarily of reclamation claimants, who were to receive a 27% distribution, and vendors and lessors with whom the debtor hoped to continue doing business, who would receive a 6%-7% distribution. A separate class containing the unsecured claims of lessors whose leases were being rejected would receive nothing. The debtor justified the plan by arguing that because the secured lender was undersecured, the general unsecured creditor body as a whole was not entitled to anything, and payments to creditors with whom it wished to continue doing business were critical to the success of the reorganization.

The bankruptcy court ruled that the plan discriminated unfairly. It characterized as “misplaced” the debtor's reliance on SPM as authority for treating the unsecured classes differently. According to the court, the sharing agreement in SPM was not proposed as part of the plan, but “was instead in the nature of a partial assignment or subordination agreement that was not subject to the code's confirmation requirements.” Moreover, the court ruled, unlike in the case before it, the property to be distributed in SPM was not property of the estate.

Although Snyder's Drugstores addresses the “unfair discrimination” requirement, its relevance arguably extends further — if a secured creditor cannot “gift” its consideration in contravention of the unfair discrimination requirement, it might not be able to do so in a contravention of the absolute priority rule. However, Armstrong and other cases suggest that there might be a meaningful distinction between SPM's applicability where the senior creditor that is giving up value a portion of its recovery is a secured creditor. There may also be a difference between the ability of a senior creditor to give up a portion of its anticipated recovery under a plan where section 1129(b) is applicable, on the one hand, and in the context of a pre-plan section 363 sale or settlement, on the other. This issue was not addressed in Armstrong.

Armstrong and Snyder's Drugstores are not necessarily inconsistent with SPM as limited to its facts. Those cases do not preclude senior creditors from sharing their recoveries after a distribution is made pursuant to a Chapter 11 plan. They may simply require that the sharing not be dictated by the plan and that the sharing take place after the plan distribution.

This approach may raise other issues for the parties. For example, the gifting party presumably would need to report both the plan distribution and the subsequent gift for tax and accounting purposes.

Furthermore, there are issues regarding the application to the subsequent “gift” of section 1145 of the Bankruptcy Code (governing the circumstances under which securities issued under a plan need or need not be registered under federal securities laws). Additionally, the parties would need to consider disclosing the sharing arrangement to the bankruptcy court and an objecting creditor may seek to have the court disregard the votes of those parties pursuant to section 1126(e) of the Bankruptcy Code.

Conclusion

Armstrong casts some doubt on the extension of SPM as a Chapter 11 plan-structuring device pursuant to which a gift is effectuated pursuant to the plan. Whether other courts will follow Armstrong's approach, or will join those courts that permit creditors to do what they wish with their recoveries, remains to be seen.