1. No category

Draft of article published in Ondernemingsrecht 2015/37
PROPOSED RECOMMENDATIONS FOR THE REFORM OF CHAPTER 11 U.S.
BANKRUPTCY CODE
Bob Wessels and Rolef de Weijs*
* Professor Dr. Bob Wessels, emeritus professor international insolvency law, University of Leiden; Dr. Rolef J.
de Weijs, associate professor insolvency law, University of Amsterdam
Abstract
The US Bankruptcy Code’s chapter 11 procedure is both in practice and conceptually the most
important insolvency procedure worldwide. Many countries, including the Netherlands, look
at Chapter 11 for inspiration in revising their own insolvency laws. Chapter 11 is, however,
itself up for revision. On December 4, 2014, the American Bankruptcy Institute (ABI) issued
breaking news for the restructuring and insolvency community in the USA when it presented
its Final Report and Recommendations on the Reform of Chapter 11. This article discusses the
most principled recommendations that will also be of the most relevance for legislatures and
policy makers drawing inspiration from Chapter 11. First of all, the recommendation is
discussed for introducing the figure of a so called ‘estate neutral’ as a supplement to the debtor
in possession model. Secondly, the introduction of significant restrictions on 363 sales; selling
all or nearly of the assets. Restrictions deal both with timing and creditor involvement. As a
third recommendation, we single out the introduction of a so-called ‘redemption option’. This
option seeks to restore in part the balance between secured and unsecured creditors by giving
‘the immediate out of the money creditors’ a claim on encumbered assets equal to a redemption
option. Finally, most novel and most interesting from a company law perspective, is the
introduction of an Equity Retention Plan for Small and Medium sized Enterprises (SME’s).
The plan seeks to strike a balance between protecting the statutory order of distributions which
would normally prevent a distribution to shareholders on the one hand and providing an
incentive to shareholders necessary for the successful reorganisation of the company to remain
involved on the other. This recommendation thereby provides an exception to the Absolute
Priority rule, which usually has as the effect of wiping shareholders out in case of insolvency.
1. Introduction
1. The US chapter 11 procedure 1 is both in practice and conceptually the most important
insolvency procedure worldwide. Many countries look at Chapter 11 for inspiration in revising
their own insolvency laws. Recently, several European countries (such as Italy, Spain and
Germany) have used chapter 11 as an example for the enactment of their insolvency rescue
proceedings. In this respect, one can see a silent convergence on a global level of insolvency
1
Chapter 11 of the U.S. Bankruptcy Code is the US reorganisation procedure, aimed at rehabilitation of a business.
Chapter 7 provides for liquidation and chapter 13 for individuals. A complicating factor is that often liquidation
takes place in chapter 11, by means of a so called 363 sale (referring to its basis in section 363 of the U.S.
Bankruptcy Code), selling all or most of the assets, followed by liquidation of the legal entity. Furthermore, large
personal insolvencies are also conducted through chapter 11.
laws. The general shift in paradigm is from liquidation towards reorganisation2, not only in
individual EU Member States, but also on a European level itself, seen the European
Commission’s ‘Recommendation on a new approach to business failure and insolvency’ of
March 2014.3
2. Chapter 11 is however itself up for revision after serving the US economy for over 35 years.
On December 4, 2014, the American Bankruptcy Institute (ABI) issued ‘breaking news’ for
the restructuring and insolvency community in the USA when it presented its voluminous Final
Report and Recommendations. 4 The ambitions of the revision project are sky high. In the
words of the ABI commission co-chair:
‘The charge of the commission is nothing less than the study of the need for comprehensive
chapter 11 reform, by which we mean consideration of starting from scratch and re-inventing
the statute. Accordingly, the commission’s mission statement is equally ambitious: In light of
the expansion of the use of secured credit, the growth of distressed-debt markets and other
externalities that have affected the effectiveness of the current Bankruptcy Code, the
commission will study and propose reforms to chapter 11 and related statutory provisions that
will better balance the goals of effectuating the effective reorganization of business debtors –
with the attendant preservation and expansion of jobs – and the maximization and realization
of asset values for all creditors and stakeholders.’5
The report for now only has the status of recommendation, and is not a draft legislative bill.
Because of its iconic stature and global influence, it is worthwhile for Europe to understand
the changes that are being proposed.6 Also since it would make little sense to try to catch up
with the US and end up in a place where the US no longer wants to be.
See generally: Bob Wessels, ‘On the future of European Insolvency Law’, INSOL Europe Academic Forum’s
5 Edwin Coe Lecture, in: Rebecca Parry (ed.), European Insolvency Law: Prospects for Reform, INSOL Europe,
Nottingham Paris, 2014, pp. 131-158, also published in International Insolvency Law Review 2014/3, pp. 310332.
3
For the text, see http://ec.europa.eu/justice/newsroom/civil/news/140312_en.htm. For an overview, see Stephan
Madaus, ‘The EU Recommendation on Business Rescue – Only Another Statement or a Cause for Legislative
Action Across Europe?’, in: 27 Insolvency Intelligence 2014, no. 6, 81ff.; Bob Wessels, ‘Business rescue in Europe
– Setting the scene’, see http://bobwessels.nl/2014/12/2014-12-doc6-business-rescue-in-europe-setting-thescene/, and Kristin van Zwieten, ‘Restructuring law: recommendations from the European Commission’, see
http://www.ebrd.com/documents/comms-and-bis/pdf-law-in-transition-online-2014.pdf.
For
the
Dutch
legislator’s response to the recommendation in its recalibration programme of the Dutch Bankruptcy Act, see Ruud
Hermans and Karin Sixma, ‘New restructuring opportunities in the Netherlands: the Dutch scheme of arrangement
is coming’, in: Corporate Rescue & Insolvency, December 2014, 231ff.; A.M. Mennens and P.M. Veder,
Clementie en recht: het dwangakkoord buiten insolventie, in: NTBR 2015/2.
4
See for a link to the full report, titled ‘2012-2014 Final Report and Recommendations’ (‘Report’):
https://abiworld.app.box.com/s/vvircv5xv83aavl4dp4h. It is 395 pages long (including Appendices), contains 241
recommendation and 1225 footnotes.
5
See http://business-finance-restructuring.weil.com/wp-content/uploads/2013/06/Opening_Remarks.Keach-andTogut.pdf.
6
After the establishment of an advisory committee structure, in January 2013 the Commission also formed an
international working group consisting of leading practitioners and academics from thirteen different countries
from over the globe. The international working group has studied targeted questions posed by the Commission
and the advisory committees to provide a comparative analysis of the relevant issues. The authors of this article
acted as organising members of the working group. It is noted that the international working groups’ reports will
2
th
3. Below we will highlight the most important suggested changes in Chapter 11 and single out
those features which are of a more principled nature and therefore most relevant for Europe as
well as the Netherlands in coming to a more reorganisation oriented insolvency law. After
briefly presenting the reasons for revising chapter 11 (§ 1.1), we will discuss the most prominent
recommendations that are made and follow the structure of the report.7In § 2 we will discuss
the recommendation under the heading Commencing the case, and focus on the governance
structure of the Debtor in Possession (DIP) model and the introduction of temporal limitations
on selling all or substantially all of the assets. In § 3 we will discuss the recommendations under
the heading Administering the case, and highlight the recommendations as to the selling the
debtor’s assets ‘free and clear’ of interests. In § 4 we will discuss the recommendations under
the heading Exiting the case. Here we will discuss what can be regarded as the heart of the
matter as to any reorganisation procedure, namely the procedure of voting on a plan as well as
rules on distribution, including the ‘absolute priority rule’. In § 5 we will discuss the
recommendation under the heading Small and Medium Sizes Enterprise (SME) cases. Here we
focus on the divergent rules of oversight for SMEs and on the recommendations for rules
allowing for a deviation from the absolute priority rule and the retention of an equity stake for
shareholders. In § 6 we finalise with several conclusions.
4. Before getting to the recommendations, a word on the structure of chapter 11 and the
recommendations and the distinction between small (SME) and ‘big’ cases. Presently, the bulk
(around 85%) 8 of the cases deals with SMEs. In that sense the order both in drafting and
conceptually could and arguable should be the other way around, in the sense of drafting a
statute for SME and then providing separate rules for larger insolvencies. In understanding the
working of chapter 11 and the scope of the recommendations, one has to bear in mind that the
overwhelming majority of European bankruptcies would fall within the category of SME. The
structure is therefore such, that chapter 11 provides rules for large cases and provides an
exception for SME. This means that as to the number of cases dealt with under Chapter 11, the
exception will the rule and the default rule for large cases will be the exception. The structure
of chapter 11 therefore is aimed at high profile cases that make headlines, with more numerous
and more profane cases being treated as the legal exception.
5. Although not anticipating on our conclusions, it should be mentioned that – given the
ambitious goals the ABI Commission set itself – all in all the recommendations very much
remain within the existing structure of the current Chapter 11. There is no new procedure,
starting from scratch. Most interesting and novel, in our eyes, are the following four issues: (i)
the introduction of an ‘estate neutral’, (ii) the introduction of significant restrictions on 363
sales referring of the phenomenon of selling all of the assets akin to a pre-pack sale, (iii) the
implementation of distributing to an otherwise out of the money class of the option redemption
value, and (iv) the introduction of an equity retention plan for shareholders of an SME.
1.1. Need for and process of reform of Chapter 11
be published in: Bob Wessels and Rolef de Weijs (eds.), International Contributions to the Reform of Chapter 11
U.S. Bankruptcy Code, The Hague: Eleven Publishing 2015 (forthcoming).
7
We follow the Report and seek to translate the recommendations to a non-US audience. Several parts of the text
below are therefore derived directly from the Report itself.
8
Report, at 12.
6. In the USA it is generally felt that chapter 11 has served American businesses well for many
years.9 However, after more than thirty years of experience under chapter 11, many practitioners
and commentators agree that it is time for reform.10 The reasoning is that over the last three
decades market and business condition have changed drastically, including the expansion of the
use of secured credit, the growth of derivative products and the distressed-debt market, the fact
companies’ asset values are driven less by hard assets (for instance real estate and machinery)
and more by services, contracts, intellectual property, and other intangible assets. Also
companies’ internal business structures (with affiliates and/or venture partners) and external
business models are increasingly multinational.11 Finally, the original intention of chapter 11,
being the rehabilitation of businesses, and the preservation of jobs and tax bases at state, local
and federal level, is eroded. Presently, the emphasis is on ‘maximization of value’ as an equal,
sometimes competing or even exclusive goal, e.g. by using ‘fire sales’ in the meaning of Section
365 U.S. Bankruptcy Code, as for instance has been the case in well-known examples as
Chrysler and General Motors.12
7. The Report explains that the Code’s rationale of rehabilitation of business does not function
satisfactorily in today’s world. The transformation in these factors most probably will have a
long-lasting effect and will therefore structurally influence the insolvency and rescue
environment going forward. 13 Moreover, from testimony evidence for the U.S. House of
Representatives by the ABI Commission’s reporter, professor Michelle Harner, it can be taken
that in literature it has been submitted that the current Chapter 11 (i) is no longer capable of
achieving certain policy objectives such as stimulating economic growth, preserving jobs and
tax bases at both the state and federal level, and (ii) is no longer helping to rehabilitate viable
companies that cannot afford a Chapter 11 reorganization, particularly small and middle
market companies.14 Her testimony reveals other disadvantages of chapter 11 too: (iii) more
9
Notably, early this century Dutch postponement of payment proceedings (surseance van betaling) have been
used in combination with chapter 11 proceedings. See P.R.W. Schaink, Surseance als vehicle voor debt-to-equity
swaps, in: Ondernemingsrecht 2003, 173ff.
10
See e.g. Stephen J. Lubben, ‘Some Realism About Reorganization: Explaining the Failure of Chapter 11
Theory’, in: 106 Dickinson Law Review 2001, 267ff; Douglas G. Baird & Robert K. Rasmussen, ‘Chapter 11 at
Twilight’, in: 56 Stanford Law Review 2003, 673ff; James H. M. Sprayregen et al., ‘Chapter 11: Not Perfect, but
Better than the Alternative’, ABI Journal October 2005, 1ff; Harvey R. Miller, ‘Chapter 11 in Transition - From
Boom to Bust and into the Future’, in: 81 American Bankruptcy Law Journal 2007, 375ff; Richard Levin &
Kenneth Klee, ‘Rethinking Chapter 11’, written in 2012, available via www.iiiglobal.org/.
11
See on the underlying reasons for reform also, in part similar, our article, B. Wessels and R.J. de Weijs, Revision
of the iconic U.S. Chapter 11: its global importance and global feed back, in: International Insolvency Law
Review, 2014, p. 441-445.
12
See In re Gen. Motors Corp., 407 B.R. 463, 491–92 (Bankr. S.D.N.Y. 2009), aff’d sub nom. In re Motors
Liquidation Co., 430 B.R. 65 (S.D.N.Y. 2010); In re Chrysler LLC, 405 B.R. 84, 96 (Bankr. S.D.N.Y. 2009),
appeal dismissed, 592 F.3d 370 (2d Cir. 2010). In re Lehman Bros. Holdings Inc., Case No. 08-13555 (Bankr.
S.D.N.Y 2008) the sale was approved within seven days after petition date. See generally: Anne M. Anderson and
Yung-Ya Ma, ‘Acquisitions in Bankruptcy: 363 Sales Versus Plan Sales and the Existence of Fire Sales’, in: 22
American Bankruptcy Institute Law Review, Winter 2014, Number 1, 1ff.
13
Don Bernstein et al, ‘United States’, in: Don Bernstein (ed.), The International Insolvency Review, London:
Law Business Research Ltd., 2nd ed. 2014, at 428ff, submits (at 457) that the Commission was largely formed in
response to the expansion of the use of secured credit and the growth of distressed-debt markets. Bernstein was
one of the members of the Commission.
14
In 2014 annual total bankruptcy filings fell for the fifth consecutive year to 910,090 nationwide, which is a 12
percent decrease from the 1,032,572 total filings during 2013. A total of 875,635 non-commercial filings during
companies are liquidating or simply closing their doors without trying to rehabilitate under the
federal bankruptcy laws and (iv) they are waiting too long to invoke the federal bankruptcy
laws, which limits restructuring alternatives and may lead to premature sales or liquidations.15
8. Before turning to the recommendations themselves, a short word on the Committee’s
working process. It clearly departs from what in the Netherlands is the commonly followed
process for amending legislation of installing a committee that at a certain moment publishes
its results. The Commission has implemented an advisory committee structure. It identified
thirteen broad study topics to facilitate a detailed analysis of the various components of chapter
11. Over 150 experts have been selected to compose these committees, including judges,
lawyers, financial advisors, academics, and consultants. The thirteen advisory committees
were formed around the following study topics: administrative expense claims and other
pressures on liquidity; avoiding powers (e.g., preferences and fraudulent conveyances);
bankruptcy-remote entities and bankruptcy proofing; distributional issues under plans;
executory contracts and unexpired leases; financial contracts, derivatives, and safe harbours;
financing issues; governance and supervision of cases; labour and benefits issues; multiple
entities and corporate groups; procedural and structural issues under plans; role of valuation;
and sales in chapter 11.16
9. The ABI Commission also held field hearings (public hearings) during the research period
in over ten different cities in the US, in which almost ninety individuals have testified on the
issues mentioned above. Remarkable here – thus reporter Professor Harner – has been that
witnesses (i) who testified on issues relating to small and middle market companies generally
opined that chapter 11 no longer works for these companies, (ii) cited cost and procedural
obstacles as common barriers, (iii) testified on financial contracts and derivatives generally
and agreed that the safe harbour protections have been extended to contracts and situations
beyond the original intent of the legislation, and (iv) perceive – although highly critical of
certain aspects of chapter 11 – value in the US approach to corporate bankruptcies, including
the debtor in possession (DIP) model.17
We now turn to the Commission’s recommendations.
2. Commencing the Case
calendar year 2014 represented an 11 percent drop; total commercial filings during 2014 were 34,455, a 21 percent
drop from the 44,083 filings during the same period in 2013, according to an ABI press release of January 6, 2015,
mentioning sustained low interest rates and high costs to file to turn consumers and businesses away from the
Bankruptcy Code for a financial fresh start.
15
http://judiciary.house.gov/_cache/files/734d664d-0962-4d17-a3f2-2991727e3adc/harner-testimony.pdf. Prof.
Harner explains that not all commentators agree that significant reform to chapter 11 is necessary. Some suggest
that any changes could have unintended consequences or negatively impact credit markets, whilst others simply
suggest that the system continues to work well enough. In the testimony, given on March 26, 2014, one finds
footnotes to (American) literature.
16
The names and affiliations of members of the advisory committees are listed in Appendix C to the Report.
17
Transcripts and videos of the hearings, and the related witness statements, are available at the Commission’s
website: www.commission.abi.org. For persons involved in these field hearings and a summary of these hearings’
results, see Appendix D and E to the Report.
10. The first recommendations are grouped under the heading Commencing the Case. From the
issues addressed we single out in § 2.1 the oversight of a case as of most interest for Europe,
since it presents a better view on the phenomenon of the debtor in possession18, whilst it also
introduces a new figure, the ‘estate neutral’. We will further discuss in § 2.2 the proposed
temporal limitations on selling all or substantially all of the assets under section 363 U.S.
Bankruptcy Code.
2.1. Oversight of a Case
2.1.1. Debtor in Possession
11. A company’s filing for a chapter 11 case triggers the concept of ‘debtor in possession’
(DIP) which is for over a century a fundamental feature of (what since 1978 is) chapter 11. It
allows a financially distressed company (its board) to remain in control of its assets and to
continue to operate its business as of the moment of the petition date for a chapter 11 case. DIP
therefore has as a legal consequence that the DIP’s pre-petition board of directors and officers
will continue to manage the debtor’s affairs and will make decisions regarding both the
debtor’s business and its reorganization efforts in the chapter 11 case. Where in many
European insolvency proceedings since decades an insolvency office holder (a non-debtor
connected third party) is appointed by a court, already from the moment of the 1898
Bankruptcy Act in the USA boards of directors and management resisted a process that
required them to cede control of their business and restructuring efforts to an outside party.19
We believe in the Netherlands there is still a lot of suspicion towards a debtor in possession
model, of which the underlying sentiment is perhaps best captured by the phrase ‘One should
not keep the fox to guard the henhouse’.20 The tide seems to be changing, however, seen e.g.
the current Dutch proposal for introducing a reorganisation plan outside bankruptcy (WCO I).21
12. Evidently there are pros and cons to the DIP model and the Commission elaborates on
them.22 Proponents of the debtor in possession model highlight (i) the existing knowledge and
expertise of the debtor’s pre-petition directors, officers, or similar managing persons
concerning the debtor’s business and financial affairs, (ii) the ability of the DIP to continue to
operate through its pre-petition management team facilitating the company’s seamless
transition into a chapter 11 case, (iii) the possibility for the DIP to avoid the additional time,
cost and professional fees, and resulting inefficiencies of bringing in and informing an outsider,
who is not familiar with the debtor’s business specifically or the debtor’s industry generally,
and (iv) the continued availability of the pre-petition’s management team which will have its
18
In Article 1 of the Amended Insolvency Regulation (see http://bobwessels.nl/2014/12/2014-12-doc4-text-neweu-insolvency-regulation-available/) the definition of ‘collective insolvency proceedings’ will be extended to
include insolvency proceedings in which the debtor in possession is the person in charge of the administration of
the estate.
19
Report, at 22.
20
Similar hesitations of course exist in the US, and the phrase is taken from the Report. But in the US these
hesitations carry far less weight,
21
See draft Wijziging van de Faillissementswet in verband met de invoering van de mogelijkheid van aanwijzing
door de rechtbank van een beoogd curator ter bevordering van de doelmatige afwikkeling dan wel toepassing van
een eventueel faillissement of surseance van betaling (Wet continuïteit ondernemingen I), in shorthand: WCO I.
22
Report, 22ff.
industry relationships or ‘know-how’ that could benefit the debtor’s restructuring efforts. DIP,
in summary, stays in control of the whole process.
13. On the other hand, critics of the DIP model note (i) that the debtor’s financial or operational
difficulties may relate, at least in part, to the conduct or decisions of the debtor’s pre-petition
directors and officers, (ii) that allowing the management team that was in charge during the
debtor’s financial decline to remain in control rewards a subpar performance and undermines
the confidence in the reorganization process for the debtor’s stakeholders, (iii) that pre-petition
management may be motivated by factors not necessarily aligned with the best interests of the
estate, such as retaining their own jobs or downplaying pre-petition events that may implicate
them in the debtor’s financial distress.
14. The Commission understands the criticism raised but juxtaposes three observations. It
opines that frequently a company’s chapter 11 filing is triggered by a downturn in the overall
economy, a fluctuation in market condition, particular to the debtor’s industry (for instance
pricing of a commodity necessary to the debtor’s operations), or a failed (but not negligent or
fraudulent) business strategy, rather than being caused by management. In these instances, thus
the Commission, the debtor’s management team typically maintains the confidence of the
debtor’s stakeholders and can be an asset to the debtor’s reorganization efforts. Additionally,
in some cases, the debtor may have replaced certain (or all) of its directors or officers either
well before or shortly before filing in anticipation of the chapter 11 filing.23 Accordingly, the
debtor’s management immediately preceding the petition date may be completely different
than the one that took the decisions and actions that contributed to the debtor’s distress. Finally,
the Bankruptcy Code also places certain checks on the debtor in possession’s power and
decision making authority in chapter 11.
15. In developing its recommendations, the Commission observed that in recent years many
countries have adopted some form of the debtor in possession model either in lieu of or as an
alternative (at the company’s election) to a receiver or administrator, referring to Belgium,
Canada, Germany and Japan.24 The Commission concludes that this trend ‘… suggests broad
recognition of the potential benefits of allowing the honest-but-unfortunate company debtor to
lead its own restructuring efforts.’
16. Thus, on balance, the Commission concluded that the potential value of mandatory trusteelike actor was significantly outweighed by the potential disruption, costs, and inefficiencies
associated with the displacement of the debtor’s management. Accordingly, the Commission
recommended retention of the debtor in possession model.’ DIP is regarded as to allow the
debtor to continue its operations with minimal disruptions while still serving the interests of
the debtor’s creditors and, in many cases, its equity security holders as well. The DIP model
should therefore, the Commission recommends, continue as the default rule under chapter 11.
23
These management changes may include the appointment of a chief restructuring officer (CRO) who is often an
experienced restructuring professional.
24
Business Continuity Act of 31 Jan. 2009 (Belgium: debtor remains in control during moratorium period with
limited control by the court); Companies’ Creditors Arrangement Act (Canada: debtor remains in control and is
assisted by a courtappointed monitor frequently selected by the debtor); Insolvenzordnung, German Insolvency
Act §§ 80, 270 (Germany: provides for ‘self-administration’ in which the debtor works to reorganize under the
surveillance of a supervisor; debtor may elect selfadministration provided that there are ‘no facts known which
give reason to expect that the order will lead to disadvantages to the creditors’); Civil Rehabilitation Act (Japan:
debtor remains in control and is monitored by a supervisor). See Report, at 24.
2.1.2. Estate neutral
17. As part of the overall governance structure, the Commission recommends the introduction
of a new phenomenon, the ‘estate neutral’, which will replace any reference in the Code’s text
to an ‘examiner.’
18. Presently, next to the relatively rare figure of the chapter 11 trustee, a supplement to the
DIP is an examiner, which may be appointed to investigate the affairs of the debtor. Regarding
its legal powers it is noted that an examiner does not displace the debtor in possession or its
management.25 The Commission presents research from which it follows that since the early
1990s an examiner was appointed in some 7 percent of the larger cases, mainly in ‘huge’,
contentious cases. Allegations of corporate fraud and misconduct by a debtor’s insiders or
affiliates are often cited as reasons for appointing an examiner so that the examiner may
investigate such allegations. The Commission mentions as examples the examiner’s reports in
the chapter 11 cases of Lehman Brothers, Residential Capital, and Tribune Company. These
reports assessed the merits of claims asserted by parties in the case, identified additional
potential claims and causes of action, and provided parties in interest with substantial
information concerning the debtor and its case that otherwise likely would have been
undiscovered or unavailable.26
19. Notwithstanding the merits of the current role of examiners, the Commission determined
that the new concept of an ‘estate neutral’ should replace examiners under the Bankruptcy
Code. The task of such an estate neutral would be very flexible and would depend very much
on the case at hand. The tasks or role would therefore not be clearly outlined or demarcated in
the Code. An estate neutral could be appointed particularly in cases when, for example,
stakeholders found value in leaving the debtor in possession in control, but certain matters in
the case needed an independent assessment either because it was difficult for a debtor to
investigate itself or because the debtor and stakeholders were too vested in their respective
positions to identify areas of potential compromise. In general, an estate neutral could have a
more extensive role from that of a traditional examiner in chapter 11 cases, including roles
such as facilitating dispute resolution and reducing information asymmetries.
2.2. Timing of Section 363 sales
20. Although chapter 11 is in its origin and theoretical underpinning a rehabilitation or
reorganization procedure, it has in part developed as an alternative for liquidation. Chapter 11
allows for sales both in the ordinary course of business as well as outside the ordinary course
of business under section 363. Courts have been increasingly willing to approve expedited
25
Examinership is only available if no trustee has been appointed and only upon request of a party in interest or
the U.S. Trustee and after notice and a hearing. See Clifford J. White III and Walter W. Theus, Jr., ‘Chapter 11
Trustees and Examiners after BAPCA’, in: 80 American Bankruptcy Law Journal 2006, 289ff.
26
Report of Kenneth N. Klee, Examiner, In re Tribune Co., No. 08-13141 (July 26, 2010); Report of Anton R.
Valukas, Examiner, In re Lehman Bros. Holdings, Inc., No 08-13555 (Bankr. S.D.N.Y. Mar. 11, 2010); Report of
Arthur J. Gonzalez, Examiner, In re Residential Capital, LLC, No. 12-12020 (Bankr. S.D.N.Y. May 13, 2013).
The Report discloses that Kenneth N. Klee and Arthur J. Gonzalez are Commissioners.
sales of all or substantially all of a debtor’s assets,27 thus condoning a de facto liquidation of
the company. Several dispersed recommendations in the Report seek to increase creditor
protection against possible suboptimal sales under section 363, referred to in the report as 363x.
The underlying rationale is that it makes little sense to provide ample creditor protection in
coming to a reorganization plan, while excluding such protection from a sale of all or
substantially all assets. Such a sale will be equally decisive for the final outcome for creditors
as any plan.28
21. The first recommendation as to section 363 sales is as to its timing. This recommendation
is of special relevance for the Netherlands, since the Dutch legislator is also proposing its own
version of a 363 sale, by means of a prepack sale, in the WCO I, of which proposal the basic
thrust is that sales should happen as fast as possible. The commission agreed that in many cases
363 sales occur too early and that such a sale may (i) not facilitate a robust action, (ii) not allow
the debtor sufficient time to explore restructuring alternatives, and (iii) take advantage of bad
market conditions. The commission recommends a 60-day moratorium on selling all or
substantially of the assets, unless there is really a clear case of rapid value decrease, also referred
to as ‘the melting ice-cube’. Only on the basis of clear and convincing evidence detailing
extraordinary circumstances, will an earlier sale be allowed by the court.29
3. Administering a Case
22. The Chapter in the Report titled ‘Administering a Case’ includes several quite dispersed
recommendations regarding executory contracts and leases, use, sale or lease of property of
the estate, avoiding powers, labor and benefits and administrative claims. From this chapter
we discuss the theme of transactions ‘free and clear of interests’, since it illustrate the cleansing
function insolvency procedures often perform. In the Netherlands it is quite common and we
believe increasingly so, that buyers prefer to buy out of an insolvency procedure instead from
a distressed debtor himself, since any risks for claims arising out of transaction avoidance are
excluded. In the US, chapter 11 can serve a similar purpose, but in addition to removing any
concerns as to the avoidability of the sale itself, it also serves the purpose to ensure a sale free
and clear of all possible interest.
3.1. Transactions ‘free and clear’ of interests
23. In many chapter 11 cases, some or all of the debtor’s property is encumbered or subject to
the liens, interests, and claims of various stakeholders. The holders of these liens, interests, and
claims will have rights under nonbankruptcy law or prepetition agreements that make the
transfer of the debtor’s assets difficult or less attractive to prospective lessees and purchasers.
These liens, interests, and claims can be rather broad. They may include mortgages, security
interests, easements, or successor liability claims. Under the current section 363(f), a DIP may
sell its assets ‘… free and clear of any interest in such property of an entity other than the
estate’ under certain conditions.
27
Report, at 84.
Report, at. 84.
29
Report, at 86-87. For a Dutch approach to melting ice-cube cases see J.M. Hummelen, Het verkoopproces in
een pre-packaged activatransactie, Tijdschrift voor Insolventierecht 2015/2.
28
Section 363(f) is limited to ‘… any interest in such property.’ In their interpretation U.S. courts
generally follow two ways of interpretation: (i) the ‘narrow’ view, limiting the application of
section 363(f) to liens, security interests, mortgages, and money judgments, and (ii) a ‘broad’
view of interests which also captures claims against the debtor or the estate property, including
successor liability claims, discrimination claims and personal injury claims. The broader
approach is by some seen as necessary to facilitate sales under section 363(f) and to achieve
the underlying policy objectives of the Bankruptcy Code.
24. The Commission recommends following the broad view to section 363(f) as it fosters more
competition for the debtors’ assets and is likely to enhance the value of the assets sold through
the section 363(f) sale process. The Commissioners further considered whether any particular
liens, interests, or claims should be excluded from section 363(f) under this expansive approach
and decided that the DIP should be able to transfer property free and clear of all liens, interests,
and claims, including without limitation: civil rights liabilities; successor liability in tort; and
successor liability in contract. In the context of a section 363x sale, a trustee should be able to
sell assets free and clear of any successor liability claims (including tort claims) other than
those specifically excluded from free and clear sales by these principles. The Commission
however also concluded that the DIP should not be able to transfer property free and clear of
the following: ‘… easements, covenants, use restrictions, usufructs, or equitable servitudes that
run with the land; environmental liabilities and related social policies that run with the land;
successorship liability under federal labor laws; and partial, competing or disputed ownership
interests’.30
4. Exiting a Case
25. The proposed recommendations in the Chapter ‘Exiting the Case’ include the general
authority of the DIP and its board of directors, the approval of Section 363x sales, value
determinations, allocation, and distributions, disclosure and use of postconfirmation entities
and claims trading, the general plan content, and plan voting and confirmation issues. We focus
first on the approval of 363 sales (§ 4.1) and then on the novel instrument of a pay out to
otherwise out of the money creditors based on a so called Redemption Option Value (§ 4.2).
We end this subsection with the recommendation of codifying the New Value Exception to the
Absolute Priority Rule (§ 4.3).
4.1. Creditor involvement in section 363x sales
26. Although chapter 11 is conceived as a rehabilitation or reorganisation procedure, it
frequently serves as a liquidation procedure facilitating a sale of all or substantially all of the
debtor’s assets under section 363. Concerns regarding section 363 sales under the current statute
are that these sales skirt the notice and due protection of a plan process and are often pursued
before parties in interest have adequate information to assess the sale and a debtors’
restructuring alternatives.31 This practice is disadvantageous to creditors as these sales may
30
Moreover, the Commissioners recognised that a debtor in possession should not be able to sell or transfer assets
under section 363(f) in a manner that violates or impedes the police or regulatory power of the federal government
or a state government to the extent that such government could enforce those rights against the debtor in possession
or estate property during the case.
31
Report, at 202.
determine distributions to creditors without creditors having a vote or the protection of the fair
and equitable standard which is applicable under a normal plan procedure.32
27. In addition to the 60 day moratorium recommendation (discussed above in § 2.2) and the
recommendation on ‘free and clear of interest sales (discussed above in § 3),33 the Commission
makes further recommendations as to the requirements for courts to lend their approval to such
sales. This recommendation is also of special relevance for the Netherlands, since in the Dutch
legislative proposal for prepack sale, creditors are excluded from the process as it takes place
and will only be informed afterwards, 34 whereas the recommendations introduces notice
requirements to the creditors. In short, the Commission recommends that in case of a 363 sale,
creditors should have similar protection as under adopting a reorganisation plan under section
1129 of the Code.35 For example, to sell all or substantially all of its assets, the debtor would
be required to make certain evidentiary showings, provide broader notice to creditors, and pay
certain administrative expenses, all similar to a plan proponent’s obligations under section
1129(a).36
4.2. The Redemption Option Value
28. One of the overarching goals of the reform is to provide a response to the problem that
because of the spread of secured credit there is all too often nothing left for unsecured
creditors.37 Nowadays, the value commonly ‘breaks’ within the class of secured creditors.38
One of the most novel and prominent recommendations in the report is to provide for a means
of allocating some value to the unsecured creditors if the value breaks just above them. The
class that just misses out is referred to as the ‘immediately junior class’. The basic idea of the
recommendation here is that the immediately junior creditors are entitled to the value of a
redemption option.
29. In order to understand the recommendation of the redemption value option, one best starts
with an analysis of the position of unsecured creditors that just missed out on payments out of
the chapter 11 procedure and understand how their reasoning goes. In case of reorganization
and distributing value, there is an incentive for secured creditor to ensure that any deal yields
sufficient to cover their claim in full. There is however little incentive on their end to ensure
that there are also surplus funds to cover the claims of lower ranking creditors. Secured creditors
might therefore relatively easy concede to a quick deal which ensures they are paid 98% on
their claim and will be reluctant to have the debtor engage in lengthy and unsure negotiations
32
Report, at 202.
In order to distinguish the different recommendations and their goals as to selling assets, the following can be
said. The 60 day moratorium seeks to provide a true breathing spell. The sale free and clear of all interest, seeks
to ensure a maximum return on the assets, while ensuring protection of lienholders and specific creditors with a
specific right, whereas the recommendation as to court approval of 363x sales seeks to ensure meaningful creditor
involvement in general.
34
See WCO I, most notably article 364 sub 3 WCO I proposal.
35
Report, at 206
36
See M. Harner on http://www.creditslips.org/creditslips/2015/01/the-melting-ice-cube-fallacy.html
37
See also the Commission’s mission statement cited in the Introduction.
38
Report, at 217. The Commission provides: ‘Although in 1978 the fulcrum security was almost always general
unsecured claims, in more recent cycles, the fulcrum security was increasingly often at the senior creditor or
subordinated senior creditor level.’
33
that provide for payment of 100% of the secured creditors and also results in proceeds available
for the unsecured creditors. At the same time, the unsecured creditors might view this process
and its dynamics as grossly unfair and feel that their interests have been squandered. They may
especially reason that any sale or reorganization plan is untimely, since it is conducted at a
historic market low.39 The redemption option seeks to recognize that the immediately junior
class might have been in the money or at least have received a greater recovery if the business
had been valued at a later date.40 The immediately junior would be entitled to the value of the
option, regardless of whether there would be an actual plan adopted or whether a 363x sale
would be conducted.41 SMEs would however be excluded.42
30. The redemption value option seeks to remedy the divergence of interests between creditors
or at least appease the immediate out of the money group of creditors and thereby prevent
lengthy and costly litigation. It introduces the entitlement of the immediately junior class to the
value of a redemption option. The value of the option would need to be calculated as what a
party would pay if he could buy all the assets in three years time against paying in full the senior
class.43
31. The envisioned working of a redemption option would not actually grant an option to the
unsecured creditors. It rather entitles the immediately junior class to the value of such an option.
The value should be provided not by the buyer, but by the higher ranking creditors or at least
paid out of the estate.44 The Commission stresses that in any given case the redemption value
may be negligible or non existent and that it does not provide for a percentage or fixed payment
to junior creditors.45 The report itself provides as an example where the redemption value does
come into play a situation where secured creditors receive 90%. Depending most notably on
the actual recovery rate of the senior class, the option value would be higher or lower. The
higher the pay out to secured senior creditors, the more valuable the redemption option. Given
a certain market volatility and a specific risk free rate,46 the Commission calculates the value
of the redemption option under a 80% recovery on senior debt to be 2% of the reorganisation
value, increasing to 5.3% of the reorganisation value in case of a recovery rate of 90%. The
sums of money involved might be significant. In case of a reorganisation with assets worth €
200 million, € 10 million would go to unsecured creditors if the senior creditors receive 90%.
In the bigger picture, the redemption option however does not provide a real shift in the relative
positions of secured and unsecured creditors, especially not since the option only comes into
play in case of high pay outs to secured creditors.
32. A likely argument against the redemption option would be that if the valuation has actually
been subject to competitive market testing, all future market developments have already been
39
Report, at 214.
Report, at 214 and 218.
41
Report, at. 224.
42
Report, at. 219.
43
The redemption price of the option would therefore be the full face amount of the claims of the senior class. See
Report, at. 221.
44
Report, at 223, The Commission expects that any redemption option value would not be in the form of an actual
option, rather in the form of cash, debt, stock or warrants (with the form of such consideration being at the sole
election of the senior class being required to give up such value) and that the redemption option value in any given
case may be negligible or non existent, as it is not a percentage or fixed payment to junior creditors.
45
Report, at 208.
46
The Commission applies a volatility rate of 15% and a risk free rate based on the US Treasury rate of 2.2%.
40
actually factored in.47 The commission seeks to counter this by reasoning that the economy
shows cycles of three to five years, and that the fixed redemption period of three years should
therefore adequately address potential unfairness.48
The recommendation on the redemption value option does leave us with the idea that the
measure provides a remedy against a different problem than identified by the Commission. We
believe the following quote to best capture the underlying rationale of the Commission
proposing the redemption option: ‘Outside bankruptcy, the secured lender may have
considerable difficulty capturing anything above liquidation value. If the bankruptcy process
itself allows the recovery of more value, why should all of that bankruptcy-enables excess go
to the secured lender.’49 The real problem, we believe, is probably not so much the realization
of value and the timing thereof, but the general spread of secured credit increasingly leaving
unsecured creditors with nothing at all too often. A much easier way to remedy this would be
to go back to the debate of full priority conducted in the US some twenty years ago. 50 The
question of full priority turns on whether secured creditors receive 100% of the encumbered
assets up to the value of their claims. It would be conceptually and practically much easier to
limit secured creditors claims to 90% and always providing a part for the estate to be distributed.
A fixed percentage as prescribed part would adequately and under all circumstance provide for
a sharing in the benefits of the bankruptcy process.51
4.3. Absolute Priority Rule and the new value exception
33. An important element of Chapter 11 is the Absolute Priority Rule (APR). It is an important
instrument of creditor protection. In the global move towards more reorganisation friendly
insolvency laws, the topic of whether and how to implement an APR rule is a hotly debated
topic.52 The short hand version of describing the APR is often something as the following and
also used by the commission in its recommendations: ‘The absolute priority rule as applied
under Section 1129(b) in essence provides that a dissenting class of creditors must be paid in
full before junior creditors or interest-holders may receive any distributions under the plan.’
See also the Commission itself with an immediate rebuttal (Report, at 214): ‘Although the price being offered
for a debtor’s assets in a section 363 sale arguably reflects the current market value of those assets, to the extent
the market is dysfunctional at the time of the sale, or economic or industry factors are negatively impacting
valuations, the debtor’s estate may be monetized at value far below what the estate could be worth at a later date
to the prejudice of stakeholders lower in the pecking order of priorities.’
48
Report, at 220.
49
See Commission (Report, at 223) quoting C.J. Tabb, ‘The Bankruptcy Clause, the Fifth Amendment, and the
limited rights of secured creditors in Bankruptcy’, Illinois Law Review 2015, p. 5. At the moment of finalising the
report this article was forthcoming.
50
See most notably L.A. Bebchuk and J.M. Fried, ‘The Uneasy Case for the Priority of Secured Claims in
Bankruptcy’, in: 105 Yale Law Journal 857 (1996) and from the same authors ‘The Uneasy Case for the Priority
of Secured Claims in Bankruptcy: Further Thoughts and a Reply to Critics,’ in: 82 Cornell Law Review 1279
(1997).
51
The debate on full priority resurfaces in the Netherlands in the 2013 Dutch Insolad proposal for a prescribed
part, requiring secured creditors to disgorge a fixed percentage of the proceeds out of encumbred assets. See
Insolad, December 13, 2012, Voorstellen wijzigingen Faillissementswet.
52
See Stephan Madaus, ‘Rescuing companies involved in insolvency proceedings with rescue plans’, in:
Corporate Rescue, Reports 2012 of the Netherlands Association for Comparative and International Insolvency
Law, available via www.naciil.org.
47
34. This shorthand version, however, is too strong to properly describe what the APR stands
for. The APR should be understood as a protection against cram down and overruling classes
of creditors. The quintessential example of the APR is the situation where shareholders retain
part or all of their equity, while creditors remain unpaid. In such a case, junior interestholders
such as shareholders retain a stake, although creditors have not been paid in full. This would be
clearly at odds with the basic premise that in case of insolvency equity is wiped out first.
However, if the qualified majority of creditors (two-thirds in amount and a majority in number)
were to accept such a plan, such a plan is not forbidden and basically perfectly fine. The
Absolute Priority Rule as codified in section 1129(b) comes into play if the debtor would
request the court to overrule a dissenting class and basically substitute creditors vote with a
court order. A reason therefore could be that it is clear that the creditors are not worse off under
the plan than they would be in case of a straightforward liquidation and that the creditors are
displaying harmful hold out behaviour. Section 1129(b) provides possibilities to substitute
creditors vote by court order. This can, however, not be done, if the plan would violate the
Absolute Priority Rule. It is only at this stage that the Absolute Priority Rule comes into play,
with Section 1129(b) stating that a plan will not be made binding on dissenting creditors if they
are not paid in full and at the same time more junior interest-holders receive payment under the
plan.53
35. The Absolute Priority Rule can provide obstacles for a successful restructuring. Distressed
companies often need additional finance and often no outside parties are willing to provide new
finance. The question arises whether old shareholder can provide new finance and in return
demand retention of their equity stake. Unsecured creditors may be sceptical as such a finance
– since this may consist of a relatively small additional loan – would allow the shareholders to
write down significant amounts of debts, while holding on to the entire equity stake. Already
in the 203 North LaSalle-case, the US Supreme Court54 held: ‘A debtor’s pre-Bankruptcy equity
security holders may not, over the objection of a senior class of impaired creditors, contribute
new capital and receive ownership interests in the reorganized entity, when that opportunity is
given exclusively to the old equity security holders under a plan adopted without consideration
of alternatives.’ The Supreme Court thereby accepted a new value exception to the Absolute
Priority Rule, thereby allowing old equity holders to retain an equity stake also if the senior
creditors were not paid in full. It did not, however, specify the conditions for this exception. In
line with subsequent case law, the Commission recommends a codification of the new value
exception that requires: (i) new money or money’s worth; (ii) in an amount proportionate to the
equity received or retained by prepetition equity security holders; and (iii) that would be subject
to a ‘reasonable’ market test.
5. Small and medium-sized enterprise cases
36. Chapter VII of the Report contains a specific section with recommendations on Small and
Medium-Sized Enterprise (SME) Cases. It kicks off with a definition of a SME, develops socalled SME Principles, provides for a system of oversight of SME Cases, and recommends on
the timing of a plan, its content and the confirmation process. A federal bankruptcy system that
effectively and efficiently rehabilitates distressed small and middle-market companies has been
53
Section 1129 provides that a dissenting class will only be overruled if the plan is fair and equitable, meaning
that ‘… the holder of any claim or interest that is junior to the claims of such class will not receive or retain under
the plan on account of such junior claim or interest any property,’
54
Bank of Am. Nat’l Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434 (1999).
seen by the Commission as essential, but research of literature and many testimonies suggests
exactly the opposite: that the current system does not work for SMEs, is it is cost-prohibitive
and ineffective for many companies. The Commission seeks to reduce the cost of bankruptcy,
to provide more effective tools for navigating the chapter 11 bankruptcy process, to allow the
families and founders who own these companies an opportunity to retain that ownership interest
after the bankruptcy is completed, and to maximize value for all stakeholders. The
Commission’s proposal would automatically apply to nonpublic companies that file for
bankruptcy with assets or liabilities of less than $10 million. The SME-framework is optional.
Nonpublic companies with assets or liabilities between $10 million and $50 million also could
seek court approval to qualify for the small and medium-size enterprises framework. It is
important to understand that the SME proposal would be available for around 85% of the
companies which are now in chapter 11. We here discuss the recommendations on oversight
(§5.1) and (§5.2) the introduction of an equity retention plan.
5.1. Oversight in SME cases
37. The approach as to oversight is different in SME than in large cases. It is recalled that the
overwhelming majority in number of cases under Chapter 11 would qualify as SME. The
system for oversight in large cases takes as a starting point the debtor in possession and active
creditor involvement. In small cases, it will often not be worth the creditors’ effort to get
involved.
38. In the recommendations for SME the bankruptcy court is rather active, applying realistic
deadlines and timely communications among stakeholders in a way tailored to the specific
needs of a case. The need for the appointment of a creditors’ committee in every case is
eliminated: there is often no appetite to be appointed, it may work ineffective, is time
consuming and costly, as the debtor must pay for committee expenses in the Chapter 11 case.
The court can also appoint – on its own motion or upon the request of the debtor or another
stakeholder – a neutral third party to assist the company in the process (see § 2.1.2 above). He
could assist the debtor negotiate with creditors, develop a plan of reorganization or analyze the
company’s basic financial or operational issues.
39. One could therefore summarize the approach of checks and balances as a system of
communicating vessels. Starting point of Chapter 11 is the debtor in possession. The basic
model presumes creditor involvement as the most important check. However, if the creditors
do not get involved, the debtor is not left to its own devices and vices. In such a case, creditor
involvement is replaced by court oversight, with the possibility of appointing an estate neutral.
5.2. Absolute priority rule and SME equity retention plan
40. Above in § 4.3 the Absolute Priority Rule has already been discussed in relation to the new
value exceptions. It has been explained that its usual shorthand version of the APR not allowing
any distributions to lower ranking stakeholder until higher ranking creditors have been paid in
full, is insufficiently clear. The APR is a protection against cram down.
41. In practice, the APR does make it very difficult for the shareholders to retain an equity stake
in the company as long as creditors are not paid in full. In case shareholders are interchangeable,
this does not immediately causes problems, as long as there is new value exception. However,
if the old shareholders are somehow instrumental to the success of the company, this becomes
problematic. If the value of the company is closely related to the persons of the shareholders,
who are possibly also the managers of the company, it becomes difficult to reorganize the
company without their continued involvement. This becomes problematic if a reorganization
procedure would completely wipe them out (with reference to ‘equity is wiped out first’). The
need for an exception to the APR in SME cases is summarized in the following rhetorical
question in a written statement, also quoted by the Commission: ‘Inclusion of limited
exclusivity and the implementation of the absolute priority rule in the bankruptcy regime make
the most sense with respect to large public entities whose creditors and equity holders made
informed investment decisions and understood their risk and relative priorities. I am not sure
that the considerations are the same with respect to smaller businesses. Should entrepreneurs
and families who are involved in the day to day operations of their businesses be provided some
level of protection not available to holders of securities in public companies?’55
42. The Commission has sought to find a balance between providing a continued equity stake
for the old shareholders and a protection of creditors facing a write off of their claims in
violation of the absolute priority rule.56 The recommendations taken together lead to an SME
Equity Retention Plan. The requirements are to be understood as allowing for a cram down of
a class of dissenting creditor, while the old equity holders retain part of the equity. The
requirements for allowing an Equity Retention Plan are the following: (i) The prepetition equity
security holders will continue to support the debtor’s successful emergence from chapter 11 by
remaining involved, on a basis reasonably comparable to their prepetition involvement, in the
ongoing operations of the reorganized debtor; and (ii) the reorganized debtor will pay to the
holders of unsecured claims, no less often than annually, its excess cash flow calculated in a
manner reasonable in relation to the company’s operating cash flow for each of the three full
fiscal years following the effective date of the chapter 11 plan.57
43. The working of the SME equity retention plan is quite elaborate and will be of interest for
both insolvency and corporate lawyers. It provides that the old shareholders retain 100 percent
of the common stock and are entitled to receive 15 percent of any dividends. At the same time
the unpaid creditors receive 100 percent of a class of preferred stock and are entitled to receive
85 percent of dividends.58 This is however a temporary situation and therefore not the end. The
creditors’ preferred interests mature after four years at which time their interests convert into
85 percent of the common stock. At that moment there is a new status quo in which the old
equity holders have 15 percent of the shares and the old creditors are the majority shareholder
with 85 percent of the shares. 59 Any old shareholder can prevent this conversion after four
years, by ensuring repayment of the creditors’ original claims in full.60
44. Taken together, we wonder whether this would provide sufficient stimulus for equity
holders to continue to work for the rescue and reorganisation of the company. From a Dutch
55
Written statement made by R. Mikels, Nov., 3, 2012, TMA Field Hearing Before the ABI Commission to Study
the Reform of Chapter 11, see Report, at 299.
56
For another fair and equitable solution to creditors and equity holders both, see Stephan Madaus, ‘Reconsidering
the Shareholder’s Role in Corporate Reorganisations under Insolvency Law’, in: 22 International Insolvency
Review 2013, 106 et seq.
57
Report, at 297.
58
Report, at. 297 and 301.
59
Report, at. 297.
60
Report, at. 297.
perspective one feels that there is not much equity left for the old shareholder. At first glance,
the outcome looks like old shareholders are only entitled to 15 percent of the profits and 15
percent of the shares. This is also not how the working of the Equity Retention Plan should be
understood. The Commission believes that the proposed structure will provide appropriate
incentives and protections, basically giving prepetition shareholders four years after
confirmation to repay the prepetition unsecured creditors in full. If the old shareholders succeed,
all issued preferred shares are redeemed. 61 However, if the old shareholders fail, after four
years, they are diluted to having only 15 percent.
45. Remarkably enough in the report no mention is made of a slide clause, e.g. that if the
company manages to pay up to 90 percent, that for example the creditors only get 30 percent
of the company. The equity retention plan is set up in such a way that it will likely be only
attractive if the company files in a timely manner, which is of course the preferred course of
action. However, if the problems have already grown to large proportions, the equity retention
plan would seem to provide little incentive if there is not a realistic projection of repaying the
outstanding debts. In practice, a solution should be possible in which creditors discharge parts
of the debt, bringing it back to manageable proportion so that these can be repaid over the course
of four years. Here again it should be borne in mind, that the Absolute Priority Rule is less
absolute than its name suggest. Parties can negotiate differently and agree on the equity holders
to retain a larger stake or to negotiate a different plan and repayment scheme all together. The
absolute priority rule only prevents a cram down over a dissenting class if the parties cannot
reach the required majorities. Therefore, the SME Equity Retention Plan only provides the
possibility to force a plan upon a dissenting class of creditors even if the shareholders hold on
to a portion of the shares which would otherwise not be possible.
6. Conclusions
Having studied the Commission’s output, our first general conclusion is that the Report reflects
an enormous wealth of materials, insights and observations, leading to one of the most
comprehensive studies of its kind.62 Our second general conclusion relates to the method chosen
by the Commission, including advisory committees and public hearings. Having chosen this
path it ensures that ‘all’ experts, professions and stakeholders have been able to express their
experiences and view. The draw back of such an approach is that it – by its nature – may lead
to recommendations in which a middle way is suggested in an effort to combine different
positions and ideas. In all, the Commission does not present what it originally intended: a
comprehensive chapter 11 reform, starting from scratch and re-inventing the statute. Our third
general conclusion is that the Commission was ready for recommending sweeping reforms,
coming from the commonly held view that the chapter 11 process has become to slow and too
costly to provide small and medium sized enterprises any meaningful way of reorganising
successfully. Many of the suggestions respond to this view and have led the Commission to
conclude – as many regulators in the insolvency area would confirm – that a ‘one-size fits all’
approach does not work. In its handling of this structural reform, however, the Commission
remains ambivalent, by recommending a renewed structure for chapter 11 cases as the main
core for a renewed chapter 11, whilst around 85% of the present cases are seen as the exception
and dealt with in some ten percent of the entire report.
61
Report, at 302.
We also feel that for non-US restructuring and insolvency professionals the Report serves as a very good
introduction to the key issues of Chapter 11.
62
We view the following as the most principled recommendations that are of the most relevance
for legislatures and policy makers drawing inspiration from Chapter 11. First of all, the
introduction of the estate neutral as a supplement to the debtor in possession model (discussed
in § 2.1.2). The estate neutral is by its very nature flexible and has no pre-ordained task. The
estate neutral can be seen as a remedy to overcome a case specific problem related to leaving
the debtor in possession, gearing its specific task to the case at hand, without removing the
debtor and thereby the benefits of the DIP model all together. In addition, we view as valuable
the introduction of significant restrictions on 363 sales, selling all or nearly of the assets.
Restrictions deal both with timing (discussed in § 2.2) and creditor involvement (discussed in
§ 4.1). First, a general moratorium on 363 sales of 60 days is introduced, with a limited
exception for the true melting ice cube cases. Secondly, creditor involvement and participation
is increased. The main idea hereof is that transparency of available information and the level of
protection should be basically the same under accepting a plan and effectuating a 363 sale. As
a third conclusion we feel a workable break trough to the close to a dead-lock position between
secured and unsecured creditors has been proposed with the recommendation to increasing pay
out to unsecured creditors by giving ‘the immediate out of the money creditors’ an entitlement
to the value of a so called redemption option (discussed in § 4.2). The introduction of the
redemption option value does not apply to SMEs. Finally, from the selection of topics we
commented upon, a conceptual novel recommendation is the introduction of an Equity
Retention Plan for SMEs (discussed in § 5.2). The plan seeks to strike a balance between
protecting the statutory order of distributions which would normally prevent a distribution to
shareholders on the one hand and providing an incentive to shareholders necessary for the
successful reorganisation of the company to remain involved on the other. This
recommendation thereby provides an exception to the Absolute Priority rule, which usually has
as an effect of wiping shareholders out in case of insolvency. This last recommendation is from
a company law perspective probably the most interesting one.
For over 30 years Chapter 11 U.S. Bankruptcy Code has been seen as an icon for legislative
changes in insolvency law all over the world. It remains to be seen whether the Commission’s
recommendations will function as the same beacon of light.