A 7th Circuit opinion authored by Chief Judge
Easterbrook last week had me again looking across the street at 203 North
LaSalle and wondering whether the US Supreme Court will ever finally decide
whether there is a "new value" exception to the absolute priority rule (which
requires that when an unsecured creditor class objects to a plan of
reorganization, it must be paid in full before junior claims or interests get
The question of whether there's a "new value" exception
to the absolute priority rule (i.e., whether
old equity can contribute new capital and receive new equity interests in the
reorganized entity) was expressly left open by the US Supreme Court in Bank of America National Trust & Savings
Ass'n v. 203 North LaSalle Street Partnership, 526 U.S. 434
(1999). Before the case went to the
Supreme Court, the 7th Circuit ruled in 203 N. LaSalle that the
oft-ignored decision in Case v. Los
Angeles Lumber Products Co., 308
U.S. 106 (1938), provided the basis for the new value exception in cases
where the equity interest holder contributes new value that is both reasonably
equivalent to the value of the equity interest and necessary for the debtor's
successful reorganization. In re 203 N. LaSalle St. P'ship, 126
F.3d 955 (7th Cir. 1997).
While refusing to specifically endorse a new value exception or
"corollary" to the absolute priority rule, the Supreme Court in 203 N. LaSalle held: "[A]ssuming a new
value corollary [exists], [then] plans providing junior interest holders with
exclusive opportunities free from competition and without benefit of market
valuation" violate the absolute priority rule."
203 N. LaSalle, 526 U.S. at
In In re Castleton
12-2639 (7th Cir. Feb. 14, 2013), the 7th Circuit Court of
Appeals faced an issue never before addressed by a Court of Appeals, that being
whether "an equity investor can evade the competitive process by arranging for
the new value to be contributed by (and the new equity to go to) an 'insider'
[as defined in the Bankruptcy Code]"?
The 7th Circuit found no difficulty in answering this
question with a resounding "NO"!
Notably, instead of chopping through the bramble bush of nuanced
statutory interpretation, the Court's opinion relied principally on broad
bankruptcy policy objectives. The Court stated:
In 203 North
LaSalle the Court remarked on the danger that diverting assets to
insiders can pose to the absolute-priority rule. 526 U.S. at 444. It follows that plans giving insiders
preferential access to investment opportunities in the reorganized debtor
should be subject to the same opportunity for competition as plans in which
existing claim-holders put up the new money....
Nor does the rationale of 203 North LaSalle depend on who proposes the plan. Competition
helps prevent the funneling of value from lenders to insiders, no matter who
proposes the plan or when. An impaired
lender who objects to any plan that leaves insiders holding equity is
entitled to the benefit of competition.
If, as [the debtor and insiders] insist, their plan offers creditors the
best deal, then they will prevail in the auction. But if, as [the objecting secured lender]
believes, the bankruptcy judge has underestimated the value of [the debtor's]
real estate, wiped out too much of the secured claim, and set the remaining
loan's terms at below-market rates [via cramdown], then someone will pay more
than $375,000 (perhaps a lot more) for the equity in the reorganized firm.
The judgment of the bankruptcy court is reversed and the
case is remanded with directions to open the proposed plan of reorganization to
But if the plan was confirmed, how is it that the direct
appeal of the plan confirmation order to the 7th Circuit did not get
mooted out through substantial consummation of the plan? Simple.
The parties in this
motion stipulated to entry of this
order by the Bankruptcy Court, thereby staying the effectiveness of the
confirmation order pending resolution of the issue on appeal. Of course, since the only major creditor in
the case was the senior secured lender (with a large unsecured deficiency
claim) who was objecting to the plan, it had a lot more flexibility in respect
of the bonding requirement necessary to stay the effectiveness of the
confirmation order pending appeal.
Indeed, as the Court-approved
disclosure statement demonstrates, the secured lender appealing the
decision was virtually the only creditor of significance in this single asset
real estate case. As such the lender
here really didn't have much to lose by appealing the order since obtaining a
stay of the confirmation order pending appeal likely would not have required it
to dig very deep to come up with the funds necessary to post a bond and obtain
a stay pending appeal.
Is this decision significant? You bet, and I expect it to reverberate
loudly as time progresses. Before this decision,
creative lawyers could reach into their trick bag and try to evade 203 N. LaSalle's competitive bidding
requirements by arguing that the statute doesn't apply to "new value"
contributors who held no equity interests prepetition. They then could solicit the support of senior
secured creditors and propose a "new value" plan acceptable to the secured
lender that would call for "new value" contributions from friendly sources and
thereby squeeze value to which the intervening unsecured class would be entitled
under the absolute priority rule. And
since unsecured creditors in more complex business reorganizations-unlike
secured lenders in single asset real estate cases-generally lack the financial
incentive or wherewithal to obtain a stay of a plan confirmation order pending
appeal, they are swiftly mooted out in the process, leaving equity to walk away
with the value while unsecureds are left "holding the bag" (as our founding fathers
were wont to say).
Now, however, with the 7th Circuit's decision
in the books, there's no authority for filing such plans in the first place (at
least in the 7th Circuit, though I expect other Courts and Circuits
will follow its lead). Of course,
there's always the hope that the Supreme Court will take this case up on appeal
given how rarely such issues wind their way through the appeals process without
getting mooted out along the way. That
was a good reason for the Court to take up RadLAX and
is an equally good reason to take up this decision too (particularly since, as
the 7th Circuit noted, "[b]ankruptcy judges have disagreed on the
answer" to the question posed by the case).
Finally, it's worth noting how a rather simple and
seemingly straightforward Supreme Court decision like the one in RadLAX can never be underestimated. To the 7th Circuit, RadLAX established a policy directive of
"protect[ing] creditors against plans that would give competing claimants too
much for their new investments and thus dilute the creditors' interests." That's the first time I've seen RadLAX being cited for such a broad
policy objective. It is a principle
worth remembering, however, especially when responding to legal gimmickry that
attempts to grind Bankruptcy Code provisions like trees in a wood chipper. Such gimmicks simply won't carry the day,
regardless of their artfulness and basis in principles of statutory
construction, where they undermine important policy objectives established in
Supreme Court precedent.
subscribers can access enhanced versions of the opinions cited in this article:
Bank of America National Trust & Savings Ass'n v. 203 North
LaSalle Street Partnership, 526 U.S. 434 (1999)
Case v. Los Angeles Lumber Products Co., 308
U.S. 106 (1938)
In re 203 N. LaSalle St. P'ship,
126 F.3d 955 (7th Cir. 1997)
In re Castleton Plaza, No. 12-2639, 2013
U.S. App. LEXIS 3185 (7th Cir. Feb. 14, 2013)
RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 2012 U.S. LEXIS 3944 (May 29, 2012)
To read more items by Steve Jakubowski, visit the
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