Gift Plans: Death Knell or Still on Life Support?

Background

On May 15, 2009, DBSD (but not its parent ICO Global), filed a voluntary petition in the United States Bankruptcy Court for the Southern District of New York, listing liabilities of $813 million against assets with a book value of $627 million. The first-lien debt consisted of a $40 million revolving credit facility that DBSD obtained in early 2008 to support its operations, with a first-priority security interest in substantially all of DBSD's assets. The second-lien debt consisted of $650 million in 7.5% convertible senior secured notes that DISH issued in August 2005, due August 2009. These notes held a second-priority security interest in substantially all of DSBD's assets. At the time of filing, the second-lien debt had grown to approximately $740 million. It constituted the bulk of DBSD's indebtedness.

Sprint's claim was an unliquidated, unsecured claim based on a lawsuit against a DBSD subsidiary. Sprint had sued, seeking reimbursement for DBSD's share of certain spectrum relocation expenses under an FCC order. At the time of DBSD's filing, that litigation was pending. In the bankruptcy case, Sprint filed a claim against each of the DBSD entities jointly and severally, seeking $211 million. The bankruptcy court temporarily allowed Sprint's claim in the amount of $2 million for voting purposes only.

The Plan of Reorganization

DBSD proposed a plan of reorganization which, as amended, provided for “substantial de-leveraging,” a renewed focus on “core operations,” and a “continued path as a development-stage enterprise.” The plan provided that the holders of the first-lien debt would receive new obligations with a four-year maturity date and the same 12.5% interest rate, but with interest to be paid in kind. The holders of the second-lien debt would receive the bulk of the shares of the reorganized entity, which the bankruptcy court estimated would be worth between 51% and 73% of their original claims. The holders of unsecured claims, such as Sprint, would receive shares estimated as worth between 4% and 46% of their original claims. Finally, the existing shareholder (effectively just ICO Global, which owned 99.8% of DBSD) would receive shares and warrants in the reorganized entity.

Sprint's Plan Objection

Sprint objected to the plan, arguing, among other things, that the plan violated the absolute priority rule of 11 U.S.C. ' 1129(b)(2)(B). That rule requires that, if a class of senior claim-holders will not receive the full value of their claims under the plan and the class does not accept the plan, no junior claim- or interest-holder may receive “any property under the plan on account of such junior claim or interest.” Sprint asserted that the plan provided for the existing shareholder, whose interest is junior to Sprint's class of general unsecured claims, to receive substantial quantities of shares and warrants under the plan ' in fact, much more than all the unsecured creditors received together. Sprint concluded that “[b]ecause the Plan fails to satisfy” the absolute priority rule, “it cannot be confirmed.”

Bankruptcy Court Ruling

The bankruptcy court disagreed. It characterized the existing shareholder's receipt of shares and warrants as a “gift” from the holders of the second-lien debt, who are senior to Sprint in priority, yet who were themselves not receiving the full value of their claims, and who may therefore “voluntarily offer a portion of their recovered property to junior stakeholders” without violating the absolute priority rule. It held that it would permit such gifting “at least where, as here, the gift comes from secured creditors, there is no doubt as to their secured creditor status, where there are understandable reasons for the gift, where there are no ulterior, improper ends … and where the complaining creditor would get no more if the gift had not been made.” (citations omitted). Sprint appealed, asserting that the plan improperly gives property to DBSD's shareholder without fully satisfying Sprint's senior claim, in violation of the absolute priority rule.

Sprint's Standing to Appeal

In order to have standing to appeal from a bankruptcy court ruling, an appellant must be “'a person aggrieved' ' a person 'directly and adversely affected pecuniarily' by the challenged order of the bankruptcy court.” Int'l Trade Admin. v. Rensselaer Polytechnic Inst., 936 F.2d 744, 747 (2d Cir. 1991) (citation omitted). An appellant like Sprint, therefore, must show not only “injury in fact” under Article III, but also that the injury is “direct[]” and “ financial.” Kane v. Johns-Manville Corp., 843 F.2d 636, 642 & n.2 (2d Cir. 1988).

Here, the circuit court held that Sprint had standing to appeal the confirmation of the plan, noting that before confirmation, Sprint had a claim that the bankruptcy court valued at $2 million for voting purposes. Noteworthy, however, is the fact that while Sprint had standing below based on its challenge to the bankruptcy court's valuation of the estate, Sprint abandoned its position contesting the bankruptcy court's valuation on appeal to the circuit court. For this reason, the question as to whether an out-of-the-money, unsecured creditor with an unliquidated claim had standing was implicated for the first time in the appeal to the circuit court.

However, the majority noted that they did not find the ultimate merits of Sprint's claim against DBSD relevant. Standing to appeal “in no way depends on the merits of the issue appealed, and certainly cannot depend on the merits of an issue that is not before us at all.” Here, the bankruptcy court allowed Sprint's claim against a DBSD entity for voting purposes, see Fed. R. Bankr. P. 3018(a), “which are the only purposes that matter at this stage. The plan's supporters did not object to this ruling, did not appeal it, and do not argue that any uncertainty about the merits of Sprint's underlying claim against the debtor should deny Sprint standing. They have good reason for their silence before us, as the dissent cites no decision where standing turned on the unliquidated status of a creditor's claim, or on an appellate court's assessment of the likely merits of such a claim.” (citation omitted)

Interestingly, however, the circuit court's opinion contains the following footnote: “Sprint's lawsuit against a DBSD entity has not yet been resolved. The claim therefore could turn out to be worth as much as $211 million or as little as nothing, but we follow the bankruptcy court's tentative valuation for the purposes of this appeal.” (Majority Opinion, footnote 5)

In other words, the circuit court seems to have concluded that valuation of claim for voting purposes satisfied the economic pecuniary interest test necessary for standing. In certain mass tort cases claims have been allowed for voting purposes for as little as $1. However, in those mass tort cases there is no question that the tort plaintiff has been injured and therefore has an actual claim. The amount of $1 assigned for voting purposes albeit somewhat arbitrary is used as an efficient way to liquidate claims for “voting purposes” without the bankruptcy court having to separately review and value hundreds, if not thousands, of mass tort claims.

On the other hand, whether Sprint has any injury is entirely speculative as acknowledged by the circuit court in the footnote in question where it states that the claim could be worth “as little as nothing.” Therefore, should assigning an arbitrary value to Sprint's claim for voting purposes also be sufficient to establish 'direct and adverse pecuniary injury for appellate standing'? Or, did the circuit court ignore or misunderstand that allowing a claim for voting purposes is only a tentative finding that bears no relationship on whether Sprint actually held a claim or not?

This distinction was addressed in the dissenting opinion of Judge Pooler, where she stated: “The question before us is whether Sprint, an out-of-the-money unsecured creditor with an unliquidated claim, has standing to challenge a Chapter 11 confirmation plan.”

Judge Pooler noted that before rejecting Sprint's claim of joint and several liability, the bankruptcy court temporarily allowed Sprint's claim for voting purposes only in the amount of $2 million. The bankruptcy court tentatively reached this decision, given that Sprint had not ' and still has not ' provided any documentation of the expenditures it claims it is owed.

The bankruptcy court also noted that the 2 GHz band that Sprint acquired is so valuable that Sprint must make an anti-windfall payment to the United States Treasury in the amount of $2.8 billion. Moreover, the relocation agreement provided that Sprint could deduct any unrecouped band-clearing costs from the $2.8 billion anti-windfall payment; it appeared to the court that Sprint had not taken its ability to offset into account when calculating its damages. Thus, there is a very real possibility that Sprint's as-of-yet-undetermined relocation costs may be paid for in full without necessitating any recourse to DBSD. The bankruptcy court emphasized that Sprint's $2 million claim was temporarily allowed “for voting purposes (and those alone).” (emphasis in original)

Stated differently, the threshold issue is whether Sprint as an out-of-the-money, unsecured creditor with an unliquidated claim had standing to appeal. Judge Pooler noted that the majority relied heavily on the fact that the parties did not brief the absolute priority issue in the specific context of Sprint's standing, and relied emphatically on the bankruptcy court's temporary allowance of Sprint's claim in its decision.

Judge Pooler observed that the situation before the court, however, includes an additional wrinkle not addressed in the majority opinion: Sprint is not merely an out-of-the-money unsecured creditor, but its alleged direct and adverse pecuniary effect as the basis for standing is based entirely on an unliquidated claim. That is, not only does Sprint get nothing under the Plan as an unsecured creditor, but as of this writing, Sprint has failed to demonstrate it is entitled to a single cent from DBSD, much less $2 million. Judge Pooler recognized that courts within their jurisdiction have analyzed the “aggrieved person” standard sufficient to confer standing, by looking to whether the appellant at issue would receive any money under the Plan, or under the valuation of the estate.

However, Judge Pooler further noted that any argument that Sprint has standing to appeal the confirmation order because it “might do better still under alternative plans” remains entirely speculative and she challenges Sprint's misguided reliance on Kane. Judge Pooler distinguishes Kane by stating:

First, Kane reiterated the rule that standing in a bankruptcy appeal requires a showing of direct and adverse pecuniary effect. Second, Kane did not disturb the general rule that a showing of pecuniary injury requires more than mere speculation that a party might have been better off with alternatives that could have been pursued. Third, the plaintiff in Kane was not in line behind undersecured senior creditors. In Kane, there was 'a sum well in excess of $600 million' set aside to satisfy the unsecured claims of asbestos victims. Thus, it was not mere speculation in Kane that the plaintiff could have done better under alternative plans because it was undisputed that the plaintiff was entitled to something. Here, in stark contrast, senior creditors are unsecured by over $100 million and Sprint has been unable to demonstrate it is owed anything. (citations omitted)

While stating that it may be true that the court should not bar all appeals from out-of-the-money unsecured creditors, Judge Pooler noted that she could not join an opinion that characterizes Sprint as a run-of-the-mill, out-of-the-money, unsecured creditor that has been “pecuniarily affected.”

Judge Pooler added: “The [Circuit Court's] opinion does not adequately address the facts before the Court, nor a possibility inherent in today's ruling, that a creditor with a claim as tangential as Sprint's may succeed in preventing the reorganization of an entity that may ultimately owe it nothing ' . The answer requires identifying the nexus between Sprint and the bankruptcy proceeding in the first instance, as it is a task of Herculean proportions to find that a pecuniary interest has been adversely affected where no loss has been identified, and no connection to the bankruptcy proceeding established. The silence on this issue is, as the Court indicates, telling ' yet it is more a testament to the oddity of the claim before us, than to the propriety of the standing analysis.”

Indeed, Judge Pooler found it difficult to agree with a rule that disregards the very genesis of the claim upon which Sprint stands before the court in determining how, and to what extent, its interests are directly and pecuniarily affected. Under no reasonable understanding of Sprint's claim can it show that it suffered a pecuniary injury as a result of the confirmation plan.

Conclusion

The adage that bad facts make bad law may be one way to describe the treatment of the standing issue in this case. Certainly, the dissenting opinion highlights the issues that should have been considered, but which were found by the circuit court to have not been raised below or before it. This has to give one pause to consider whether gift plans can be resuscitated from the apparent death knell suffered in this case if the issue of standing were presented and reviewed in a more fulsome way. Stated differently, proponents of gift plans may still be able to argue that standing of a party to object to a gift plan remains an open issue and that gift plans, although beaten up, still remain on life support.

Robert W. Dremluk, a member of this newsletter's Board of Editors. is a partner in the New York office of Seyfarth Shaw LLP. His work focuses on diverse interests in federal and bankruptcy court litigation and advice and risk assessment regarding transactional matters, including asset purchases and structured finance transactions. He may be reached at [email protected].

On Feb. 7, 2011, the United States Court of Appeals for the Second Circuit issued an opinion (In re DBSD North America, Incorporated, No. 10-1352) where the majority held, among other things, that a plan of reorganization violated the absolute priority rule of ' 1129(b)(2)(B) of the Bankruptcy Code where the holders of second-lien debt agreed to voluntarily gift shares and warrants to existing shareholders while the holders of general unsecured claims did not receive full payment of their claims.

This 2-1 decision is the first to directly address the viability of gift plans in the Second Circuit, and has gained much notoriety in the bankruptcy bar. This article, however, does not focus on the circuit court's ruling that the absolute priority rule bars gift plans. Instead, we focus on whether the circuit court's finding that an out-of-the-money unsecured creditor with an unliquidated claim has standing to object to a gift plan, since that issue appears not to have been fully briefed and therefore not fully considered by the circuit court.

As the circuit court observed: “[e]ven if it were appropriate for us to consider the merits or ultimate worth of Sprint's claim, we would have no way to make that determination, lacking any briefing from the parties or much information in the record on appeal regarding the merits of that claim, which will turn not only on the potential offset of its obligations to the government (as the dissent recognizes) but also on the date that the relevant DBSD subsidiary occupied a specific band of the transmission spectrum. Because the parties do not brief the issue and did not raise it below, moreover, our evaluation of Sprint's claim would require piecing together the evidence without a guide.” (citation omitted)

Background

On May 15, 2009, DBSD (but not its parent ICO Global), filed a voluntary petition in the United States Bankruptcy Court for the Southern District of New York, listing liabilities of $813 million against assets with a book value of $627 million. The first-lien debt consisted of a $40 million revolving credit facility that DBSD obtained in early 2008 to support its operations, with a first-priority security interest in substantially all of DBSD's assets. The second-lien debt consisted of $650 million in 7.5% convertible senior secured notes that DISH issued in August 2005, due August 2009. These notes held a second-priority security interest in substantially all of DSBD's assets. At the time of filing, the second-lien debt had grown to approximately $740 million. It constituted the bulk of DBSD's indebtedness.

Sprint's claim was an unliquidated, unsecured claim based on a lawsuit against a DBSD subsidiary. Sprint had sued, seeking reimbursement for DBSD's share of certain spectrum relocation expenses under an FCC order. At the time of DBSD's filing, that litigation was pending. In the bankruptcy case, Sprint filed a claim against each of the DBSD entities jointly and severally, seeking $211 million. The bankruptcy court temporarily allowed Sprint's claim in the amount of $2 million for voting purposes only.

The Plan of Reorganization

DBSD proposed a plan of reorganization which, as amended, provided for “substantial de-leveraging,” a renewed focus on “core operations,” and a “continued path as a development-stage enterprise.” The plan provided that the holders of the first-lien debt would receive new obligations with a four-year maturity date and the same 12.5% interest rate, but with interest to be paid in kind. The holders of the second-lien debt would receive the bulk of the shares of the reorganized entity, which the bankruptcy court estimated would be worth between 51% and 73% of their original claims. The holders of unsecured claims, such as Sprint, would receive shares estimated as worth between 4% and 46% of their original claims. Finally, the existing shareholder (effectively just ICO Global, which owned 99.8% of DBSD) would receive shares and warrants in the reorganized entity.

Sprint's Plan Objection

Sprint objected to the plan, arguing, among other things, that the plan violated the absolute priority rule of 11 U.S.C. ' 1129(b)(2)(B). That rule requires that, if a class of senior claim-holders will not receive the full value of their claims under the plan and the class does not accept the plan, no junior claim- or interest-holder may receive “any property under the plan on account of such junior claim or interest.” Sprint asserted that the plan provided for the existing shareholder, whose interest is junior to Sprint's class of general unsecured claims, to receive substantial quantities of shares and warrants under the plan ' in fact, much more than all the unsecured creditors received together. Sprint concluded that “[b]ecause the Plan fails to satisfy” the absolute priority rule, “it cannot be confirmed.”

Bankruptcy Court Ruling

The bankruptcy court disagreed. It characterized the existing shareholder's receipt of shares and warrants as a “gift” from the holders of the second-lien debt, who are senior to Sprint in priority, yet who were themselves not receiving the full value of their claims, and who may therefore “voluntarily offer a portion of their recovered property to junior stakeholders” without violating the absolute priority rule. It held that it would permit such gifting “at least where, as here, the gift comes from secured creditors, there is no doubt as to their secured creditor status, where there are understandable reasons for the gift, where there are no ulterior, improper ends … and where the complaining creditor would get no more if the gift had not been made.” (citations omitted). Sprint appealed, asserting that the plan improperly gives property to DBSD's shareholder without fully satisfying Sprint's senior claim, in violation of the absolute priority rule.

Sprint's Standing to Appeal

In order to have standing to appeal from a bankruptcy court ruling, an appellant must be “'a person aggrieved' ' a person 'directly and adversely affected pecuniarily' by the challenged order of the bankruptcy court.” Int'l Trade Admin. v. Rensselaer Polytechnic Inst. , 936 F.2d 744, 747 (2d Cir. 1991) (citation omitted). An appellant like Sprint, therefore, must show not only “injury in fact” under Article III, but also that the injury is “direct[]” and “ financial.” Kane v. Johns-Manville Corp. , 843 F.2d 636, 642 & n.2 (2d Cir. 1988).

Here, the circuit court held that Sprint had standing to appeal the confirmation of the plan, noting that before confirmation, Sprint had a claim that the bankruptcy court valued at $2 million for voting purposes. Noteworthy, however, is the fact that while Sprint had standing below based on its challenge to the bankruptcy court's valuation of the estate, Sprint abandoned its position contesting the bankruptcy court's valuation on appeal to the circuit court. For this reason, the question as to whether an out-of-the-money, unsecured creditor with an unliquidated claim had standing was implicated for the first time in the appeal to the circuit court.

However, the majority noted that they did not find the ultimate merits of Sprint's claim against DBSD relevant. Standing to appeal “in no way depends on the merits of the issue appealed, and certainly cannot depend on the merits of an issue that is not before us at all.” Here, the bankruptcy court allowed Sprint's claim against a DBSD entity for voting purposes, see Fed. R. Bankr. P. 3018(a), “which are the only purposes that matter at this stage. The plan's supporters did not object to this ruling, did not appeal it, and do not argue that any uncertainty about the merits of Sprint's underlying claim against the debtor should deny Sprint standing. They have good reason for their silence before us, as the dissent cites no decision where standing turned on the unliquidated status of a creditor's claim, or on an appellate court's assessment of the likely merits of such a claim.” (citation omitted)

Interestingly, however, the circuit court's opinion contains the following footnote: “Sprint's lawsuit against a DBSD entity has not yet been resolved. The claim therefore could turn out to be worth as much as $211 million or as little as nothing, but we follow the bankruptcy court's tentative valuation for the purposes of this appeal.” (Majority Opinion, footnote 5)

In other words, the circuit court seems to have concluded that valuation of claim for voting purposes satisfied the economic pecuniary interest test necessary for standing. In certain mass tort cases claims have been allowed for voting purposes for as little as $1. However, in those mass tort cases there is no question that the tort plaintiff has been injured and therefore has an actual claim. The amount of $1 assigned for voting purposes albeit somewhat arbitrary is used as an efficient way to liquidate claims for “voting purposes” without the bankruptcy court having to separately review and value hundreds, if not thousands, of mass tort claims.

On the other hand, whether Sprint has any injury is entirely speculative as acknowledged by the circuit court in the footnote in question where it states that the claim could be worth “as little as nothing.” Therefore, should assigning an arbitrary value to Sprint's claim for voting purposes also be sufficient to establish 'direct and adverse pecuniary injury for appellate standing'? Or, did the circuit court ignore or misunderstand that allowing a claim for voting purposes is only a tentative finding that bears no relationship on whether Sprint actually held a claim or not?

This distinction was addressed in the dissenting opinion of Judge Pooler, where she stated: “The question before us is whether Sprint, an out-of-the-money unsecured creditor with an unliquidated claim, has standing to challenge a Chapter 11 confirmation plan.”

Judge Pooler noted that before rejecting Sprint's claim of joint and several liability, the bankruptcy court temporarily allowed Sprint's claim for voting purposes only in the amount of $2 million. The bankruptcy court tentatively reached this decision, given that Sprint had not ' and still has not ' provided any documentation of the expenditures it claims it is owed.

The bankruptcy court also noted that the 2 GHz band that Sprint acquired is so valuable that Sprint must make an anti-windfall payment to the United States Treasury in the amount of $2.8 billion. Moreover, the relocation agreement provided that Sprint could deduct any unrecouped band-clearing costs from the $2.8 billion anti-windfall payment; it appeared to the court that Sprint had not taken its ability to offset into account when calculating its damages. Thus, there is a very real possibility that Sprint's as-of-yet-undetermined relocation costs may be paid for in full without necessitating any recourse to DBSD. The bankruptcy court emphasized that Sprint's $2 million claim was temporarily allowed “for voting purposes (and those alone).” (emphasis in original)

Stated differently, the threshold issue is whether Sprint as an out-of-the-money, unsecured creditor with an unliquidated claim had standing to appeal. Judge Pooler noted that the majority relied heavily on the fact that the parties did not brief the absolute priority issue in the specific context of Sprint's standing, and relied emphatically on the bankruptcy court's temporary allowance of Sprint's claim in its decision.

Judge Pooler observed that the situation before the court, however, includes an additional wrinkle not addressed in the majority opinion: Sprint is not merely an out-of-the-money unsecured creditor, but its alleged direct and adverse pecuniary effect as the basis for standing is based entirely on an unliquidated claim. That is, not only does Sprint get nothing under the Plan as an unsecured creditor, but as of this writing, Sprint has failed to demonstrate it is entitled to a single cent from DBSD, much less $2 million. Judge Pooler recognized that courts within their jurisdiction have analyzed the “aggrieved person” standard sufficient to confer standing, by looking to whether the appellant at issue would receive any money under the Plan, or under the valuation of the estate.

However, Judge Pooler further noted that any argument that Sprint has standing to appeal the confirmation order because it “might do better still under alternative plans” remains entirely speculative and she challenges Sprint's misguided reliance on Kane. Judge Pooler distinguishes Kane by stating:

First, Kane reiterated the rule that standing in a bankruptcy appeal requires a showing of direct and adverse pecuniary effect. Second, Kane did not disturb the general rule that a showing of pecuniary injury requires more than mere speculation that a party might have been better off with alternatives that could have been pursued. Third, the plaintiff in Kane was not in line behind undersecured senior creditors. In Kane, there was 'a sum well in excess of $600 million' set aside to satisfy the unsecured claims of asbestos victims. Thus, it was not mere speculation in Kane that the plaintiff could have done better under alternative plans because it was undisputed that the plaintiff was entitled to something. Here, in stark contrast, senior creditors are unsecured by over $100 million and Sprint has been unable to demonstrate it is owed anything. (citations omitted)

While stating that it may be true that the court should not bar all appeals from out-of-the-money unsecured creditors, Judge Pooler noted that she could not join an opinion that characterizes Sprint as a run-of-the-mill, out-of-the-money, unsecured creditor that has been “pecuniarily affected.”

Judge Pooler added: “The [Circuit Court's] opinion does not adequately address the facts before the Court, nor a possibility inherent in today's ruling, that a creditor with a claim as tangential as Sprint's may succeed in preventing the reorganization of an entity that may ultimately owe it nothing ' . The answer requires identifying the nexus between Sprint and the bankruptcy proceeding in the first instance, as it is a task of Herculean proportions to find that a pecuniary interest has been adversely affected where no loss has been identified, and no connection to the bankruptcy proceeding established. The silence on this issue is, as the Court indicates, telling ' yet it is more a testament to the oddity of the claim before us, than to the propriety of the standing analysis.”

Indeed, Judge Pooler found it difficult to agree with a rule that disregards the very genesis of the claim upon which Sprint stands before the court in determining how, and to what extent, its interests are directly and pecuniarily affected. Under no reasonable understanding of Sprint's claim can it show that it suffered a pecuniary injury as a result of the confirmation plan.

Conclusion

The adage that bad facts make bad law may be one way to describe the treatment of the standing issue in this case. Certainly, the dissenting opinion highlights the issues that should have been considered, but which were found by the circuit court to have not been raised below or before it. This has to give one pause to consider whether gift plans can be resuscitated from the apparent death knell suffered in this case if the issue of standing were presented and reviewed in a more fulsome way. Stated differently, proponents of gift plans may still be able to argue that standing of a party to object to a gift plan remains an open issue and that gift plans, although beaten up, still remain on life support.

Robert W. Dremluk, a member of this newsletter's Board of Editors. is a partner in the New York office of Seyfarth Shaw LLP. His work focuses on diverse interests in federal and bankruptcy court litigation and advice and risk assessment regarding transactional matters, including asset purchases and structured finance transactions. He may be reached at [email protected].