LEGAL NOTE—NOVEMBER/DECEMBER 2019
CASE: In re Peabody Energy Corp., 933 F.3d 918 (8th Cir. 2019)
QUESTION: May a bankruptcy debtor finance its reorganization plan through rights offerings subject to backstop commitments from a subset of its impaired creditors over the objection of a minority of its other creditors?
ANSWER: Yes; however, backstopping creditors and debtors are well-advised to consider and address the concerns recently raised by the Eighth Circuit in In re Peabody Energy Corp., 933 F.3d 918 (8th Cir. 2019) to make sure that the fees and other benefits paid to backstopping creditors do not violate the Bankruptcy Code’s requirements of good faith to all similarly situated claimants. Go here for a copy of this case.
FACTS: The plan of reorganization in In re Peabody provided for exit financing commitments of $1.5 billion in new money, consisting of $750 million to be raised from a private placement of preferred equity at a 35% discount, and $750 million to be raised from a rights offering of common stock at a 45% discount. The prepetition creditors who consented to this plan agreed to provide a full backstop of the rights offering and to vote in favor of the plan subject to bankruptcy court approval. Ultimately, about 95% of the prepetition creditors supported the plan; however, a small group of creditors objected to the plan arguing that the plan: (a) violated Bankruptcy Code §1123(a)(4) by treating claims in the same class unequally; and (b) violated the good faith requirement in Bankruptcy Code §1129(a)(3) by failing to maximize the value of the debtor’s estate by offering a substantial portion of the new equity at a below-market price and conditioning this discount price on an agreement to support the plan of reorganization. Both the Bankruptcy Court and the District Court overruled the minority creditors’ objections and affirmed the plan of reorganization. An appeal was taken to the Eighth Circuit; after raising several potential concerns with the plan, the appellate court affirmed the lower courts’ ruling in a reported decision rendered on August 9, 2019.
DISCUSSION: In general, a rights offering is a category of exit financing which offers a debtor’s existing creditors an opportunity to invest new money in the reorganized debtor, typically at a discount price. Often creditors who choose to participate in such a plan guarantee this financing mechanism by making a “backstop”commitment; that is, a promise, in exchange for a fee, to purchase any unsold equity if the offering is undersubscribed.
Although the use of such backstop commitments for a fee appears to be growing in practice, the Eight Circuit raised several concerns that should be considered and addressed by any debtor considering this exit strategy. These concerns include: (a) whether the additional value conferred upon participating creditors was actually given in exchange for new value; and (b) whether conditioning additional payments upon support of the plan constitutes “bad faith” or “vote buying.” Even though the Eight Circuit was troubled that creditors who wanted to participate in the offering had to approve of the plan prior to judicial review, given that only about 5% of existing creditors objected to the plan and that any significant delay in implementing the plan might jeopardize market success, the appellate court affirmed the ruling below finding no “clear error.”
Given the concerns raised by the Eighth Circuit in In re Peabody, the fees and other benefits paid to backstopping creditors may be subject to judicial scrutiny or challenge by non-participating creditors in the future. The fees paid to backstopping creditors should be provided because of the creditors’ new money commitments (rather than their prepetition claims), and all benefits made available to participants should be comparable to similar market transactions.