USA Trends and Developments Contributed by: Ronald R. Rossi, Daniel J. Koevary, Jonathan L. Shapiro and Matthew B. Stein, Kasowitz LLP
the most part, courts have refrained from challenging such justification. But questions remain, including: • whether the “additional” consideration offered to majority groups is actually necessary to incentivise participants to implement the underlying restructur- ing transaction; and • whether the leniency of the courts in enforcing the equal treatment provisions of the Bankruptcy Code have altered the balance of power allowing credi- tors to extract such value at the expense of simi- larly situated minority holders. Viewed through the prism of value extraction, the ConvergeOne decision extends beyond the narrow issue of the legitimacy of a rights offering. Instead, the ConvergeOne decision is the latest in a line of recent cases issued by appellate courts attempting to draw the line between financial reorganisation transactions permitted by contract and those prohibited by opera- tion of the Bankruptcy Code and state law. Indeed, the extra consideration sought by the majority lenders in ConvergeOne through the rights offering resembles the additional consideration sought by creditors in other aspects of a restructuring, including liquidity management exercises, backstop commitments, and DIP financing. In each of these cases, the same fact pattern exists: • a lack of a market test; • transfer of materially greater value; • no additional consideration for the offered opportu- nity; and • illusory alternatives. All purportedly justified by the often stated, never tested principle of necessity.
The implications of ConvergeOne and similar deci- sions restricting a debtor’s flexibility are widespread and yet, at the same time, overblown. For debtors, although the decision seemingly restricts their use of a valuable restructuring tool, it does not eliminate it. Rather, the decision will push debtors to establish support for the need to provide incentives in connec- tion with the implementation of a restructuring plan. In doing so, the decision should help shift the balance of power back from majority fulcrum creditors to the debtors to maximise distributions to all creditors. This could provide debtors with the leeway to explore non- discriminatory mechanisms to raise capital that previ- ously were blocked by majority groups. Similarly, majority lenders should begin to question whether they can extract a control premium from the debtor without incurring legitimate litigation risk and robust judicial scrutiny. And minority creditors can use the decision as leverage to get a seat at the negoti- ating table. Collectively, this should lead to a more competitive environment that elevates restructuring over the enhancement of investment returns.
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