Texas Rangers: A Big Change-Up on Impairment?, Jones Day Business Restructuring Review
The concept of "impairment" of a claim under a chapter 11 plan for the purpose of determining whether the claimant has the right to vote on the plan has evolved since the Bankruptcy Code was first enacted in 1978. A noteworthy step in that development was the subject of a ruling handed down earlier this year by the bankruptcy court overseeing the whirlwind chapter 11 case of Major League Baseball's Texas Rangers. In In re Texas Rangers Baseball Partners, the court held that, in order to render a secured creditor's claim "unimpaired," a chapter 11 plan need not honor all of the creditor's contractual rights, so long as the creditor retains the right to sue the debtor for breach of the contract.
Voting Rights and Impairment of Claims
The preferred culmination of the chapter 11 process is confirmation of a chapter 11 plan specifying how the claims and interests of all stakeholders in the bankruptcy case are to be treated going forward. Depending on the provisions of the plan, classes of creditors, shareholders, and other stakeholders are provided with a voice in the confirmation process through the Bankruptcy Code's plan-voting procedures. Generally, holders of allowed claims and interests have the right to vote to accept or reject a chapter 11 plan. Claimants or interest holders whose claims or interests are not "impaired," however, are deemed conclusively to accept the plan, and those who receive nothing under a plan are deemed to reject it; in neither instance are they entitled to vote on the chapter 11 plan.
Section 1124 of the Bankruptcy Code provides that a class of claims or interests is impaired under a chapter 11 plan unless the plan either: (1) "leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest;" or (2) notwithstanding any contractual right to accelerated payment, reinstates the original maturity date of the obligation, cures outstanding defaults (with certain exceptions), compensates the claimant or interest holder for damages suffered in reasonably relying on the default provision, and otherwise leaves unaltered the legal, equitable, or contractual rights of the claimant or interest holder. The plan itself must be the source of the impairment. If a creditor's legal rights or remedies are altered by operation of a provision in the Bankruptcy Code (e.g., the statutory cap on a landlord's claim for damages resulting from the rejection of a lease) rather than the plan, its claim will be deemed unimpaired.
Section 1124 originally included a third option for rendering a claim unimpaired under a chapter 11 plan: by providing the claimant with cash equal to the allowed amount of its claim. This option was removed by the Bankruptcy Reform Act of 1994. The amendment expressly overruled a New Jersey bankruptcy court's 1994 decision in In re New Valley Corp. In New Valley, the court ruled that unsecured creditors of a solvent debtor that are to be paid in full in cash under a chapter 11 plan are unimpaired even though the plan does not provide for the payment of postpetition interest on their claims. The 1994 amendment permits creditors that are not to receive postpetition interest under a plan to vote against the plan. Assuming that the class of creditors rejects the plan, it can be confirmed only if the plan satisfies the "cramdown" standards in section 1129(b). Also, because their claims are impaired, these creditors are entitled to the protection of the "best interests of creditors" test in section 1129(a)(7), which requires that they receive or retain at least as much under a chapter 11 plan as they would receive in a hypothetical chapter 7 liquidation of the debtor. Since the 1994 amendment, most courts considering the issue have held that payment in full in cash with postpetition interest at an appropriate rate constitutes unimpairment under section 1124(1).
Whether or not a claim is impaired, therefore, will determine voting rights, and voting rights can have a significant impact on the ultimate fate of a chapter 11 plan. If a creditor holds a significant bloc of claims in a single class under a plan, it may be able to prevent confirmation of the plan or force the plan proponent to comply with the Bankruptcy Code's "cramdown" requirements to achieve confirmation. Creditors holding a blocking position, or having sufficient influence to create one through dealmaking with other creditors, commonly use the resulting leverage to maximize their recoveries under the plan, sometimes at the expense of creditors that lack the same negotiating power. In some cases, the accumulation of claims and voting power can even be an effective means of gaining control of a company in chapter 11.
As demonstrated by the bankruptcy court's ruling in Texas Rangers, the impairment question may also have a significant impact on whether the debtor or its assets can be sold as part of an overall chapter 11 restructuring and exit strategy.
Until this year, the Texas Rangers enjoyed the dubious distinction of being one of only three Major League Baseball franchises to have never played in the World Series. On May 24, 2010, the club also became one of only three Major League Baseball teams to file for bankruptcy protection (joining the Baltimore Orioles and the Chicago Cubs, which filed for chapter 11 protection in 1993 and 2009, respectively). The ensuing bankruptcy courtroom drama captivated the U.S. media (sports, financial, and otherwise) during the three months following the filing. It finally culminated on August 5, 2010, when the bankruptcy court approved an auction sale of the ball club for $590 million ($380 million in cash and the remainder in assumed liabilities) to Rangers Baseball Express LLC ("Express"), a consortium headed by Pittsburgh sports lawyer Chuck Greenberg and Rangers team president Nolan Ryan. Express prevailed over the competing bid of Radical Baseball LLC, a group formed by Houston businessman Jim Crane (who had unsuccessfully attempted to buy the Houston Astros) and Dallas Mavericks owner Mark Cuban (who had unsuccessfully attempted to buy the Chicago Cubs). The fireworks along the way, however, included a controversial development in bankruptcy jurisprudence regarding the concept of impairment under section 1124(1) of the Bankruptcy Code.
Texas Rangers Baseball Partners (the "debtor") was a Texas general partnership of which Rangers Equity Holdings GP, LLC ("REHGP"), was a 1 percent general partner and Rangers Equity Holdings, L.P. ("REHLP" and, together with REHGP, the "Rangers Equity Owners"), was a 99 percent general partner. The Rangers Equity Owners are indirect subsidiaries of HSG Sports Group, LLC ("HSG"), which, through other subsidiaries, has interests in other professional sports franchises. HSG is largely owned and controlled by prominent Texas entrepreneur Thomas O. Hicks ("Hicks"), who acquired the debtor in 1998.
HSG is indebted to a consortium of banks (the "lenders") for $525 million. The debtor guaranteed $75 million of that obligation on a secured basis under a pledge and security agreement. The debtor was never profitable after being acquired by Hicks, who determined in 2008 to sell the ball club to avoid additional losses. He eventually identified Express as a potential purchaser, at a purchase price of approximately $463 million.
HSG defaulted on the loans in March 2009. In the meantime, the debtor entered into loan agreements with the Office of the Commissioner of Baseball ("COB") to cover operating shortfalls. The debtor borrowed a total of $20 million from COB. The loan agreements gave COB certain rights regarding any anticipated sale of the debtor. In addition, the Major League Constitution (the "MLC"), which governs Major League Baseball franchises, limits any club's discretion in selecting a prospective purchaser. COB took the position that the MLC and its prepetition loan agreements with the debtor barred any sale of the debtor without the approval of COB and the requisite percentage of owners of other Major League Baseball franchises.
The lenders also claimed the right to pass on any sale of the debtor under the pledge and security agreement, which expressly gave the agent bank: (i) the power to control the equity interests of the Rangers Equity Owners following a default; and (ii) approval rights as to any sale of the debtor. Exercising these rights, the lenders declined to approve the sale of the debtor to Express, claiming that potential purchasers existed that would pay more for the debtor than the $463 million offered by Express. The COB had preliminarily approved the sale to Express, but the transaction still had to be approved by a vote of 75 percent of the Major League Baseball owners.
Faced with an impasse, the debtor filed for chapter 11 protection on May 24, 2010, in Fort Worth, Texas. On the petition date, it also filed a "prepackaged" chapter 11 plan to consummate the sale transaction with Express. The plan provided that the lenders were to be paid $75 million "in full satisfaction" of their secured claims under the pledge and security agreement. It stated that the lenders' claims were unimpaired under section 1124(1) of the Bankruptcy Code, such that the lenders were not entitled to vote on the plan.
The lenders argued that, due to HSG's default, no sale of the debtor could be agreed to by the Rangers Equity Owners without their acquiescence. They also contended that payment under the plan of the capped guarantee amount of $75 million would not equate to unimpaired treatment under section 1124(1). To render their claims unimpaired, the lenders claimed, the debtor was required to comply with all of the terms of the pledge and security agreement, including the agent bank's right to veto a sale in the event of a default.
The Bankruptcy Court's Ruling
For the typical unsecured creditor, the bankruptcy court explained, compliance with section 1124(1) requires only that the creditor receive full payment of its claim on the effective date of the plan plus interest—precisely as if a judgment on the debt were "entered immediately following the plan's effective date." However, the court noted, the lenders in this case had rights vis-à-vis the debtor, which, as part of the HSG family of entities, assumed obligations to the lenders in addition to guaranteeing up to $75 million of HSG's debt. "In order for the Lenders to be unimpaired," the court wrote, "their treatment under a plan must recognize and preserve those rights."
Even so, the court concluded that section 1124(1) does not require the plan to grant the lenders an effective veto right over any proposed sale. First, the court explained, unlike section 1124(2), which demands a cure of defaults, section 1124(1) is "prospective," requiring merely that an unimpaired creditor be able to exercise all of its rights vis-à-vis the debtor after the effective date:
Under the Plan . . . , the sale of the Rangers will occur on the effective date. . . . Thereafter, the Lenders, if treated under section 1124(1), must be able to exercise their rights under their loan documents vis-à-vis Debtor (though those rights may have lost much of their usefulness) and other members of the HSG family.
As the sale of the Rangers will have been consummated at that point, however, the Lenders' rights under the Pledge Agreement will not affect the sale. As would be the case with a breach outside of bankruptcy, except to the extent the Code excuses such a breach as a matter of law, if the Lenders are damaged by the actions of Debtor or the Rangers Equity Owners or their parents through a pre-effective date failure to honor the Lenders' rights under [the loan documents] . . . , they may assert in this court a claim against Debtor for their damages or pursue its affiliates in an appropriate forum.
The court explained that, if the veto powers of the lenders were deemed "interests" in property within the meaning of section 363(f) or (h) of the Bankruptcy Code, "the court might conclude that unimpairment requires recognition of those rights in connection with any transaction consummated pursuant to the Plan." However, it emphasized, because the trustee could sell the debtor's assets under section 363(b) without complying with those veto rights and "without protecting the Lenders as to such provisions under section 363(f) or (h), the court concludes that a failure to honor those provisions in the Plan or the . . . [asset purchase agreement] does not alone amount to impairment."
Next, the court reasoned, rules of statutory construction support its conclusion that section 1124(1) does not require the lenders' veto rights to be honored. According to the court, the fact that, unlike in section 1124(1), Congress expressly provided in section 1124(2) that unimpaired treatment must include a cure of defaults indicates that "the intent of legislators was that unimpaired treatment under [section 1124(1)] . . . would include . . . allowing the class so treated to pursue remedies not otherwise in conflict with the Code, the plan, or bankruptcy court orders for defaults existing as of the effective date."
Third, the court noted, permitting the agent bank to exercise its veto power would give the lenders "a degree of control over the conduct of this case that is inconsistent with the Code and contrary to public policy." A sale of the debtor, the court emphasized, whether under section 363 or a plan, is a transaction undertaken by the debtor in possession in its role as a fiduciary. It would be "inconsistent with the authority and responsibility conferred on that fiduciary by law," the court wrote, "to give effect to a contractual provision that would frustrate its performance of its fiduciary duties."
Fourth, the court explained, in order for the agent bank to exercise its veto rights prior to confirmation, it would need to obtain relief from the automatic stay. To construe section 1124(1) as permitting the lenders to invoke those rights prior to the effective date of the plan, the court observed, "would be tantamount to requiring . . . allowing enforcement by a creditor of its ‘legal, equitable, and contractual rights' prior to confirmation of the plan by the court and the binding effectiveness of the creditor's plan treatment."
Finally, the court wrote, if the lenders were allowed to block a sale by exercising their veto rights, the debtor, "a solvent entity, notwithstanding payment in full of all of its monetary obligations, could only confirm a plan that was acceptable to the Lenders or through cramdown by artificial impairment of another class of creditors." According to the court, it would be "inconsistent with public policy to construe the Code in a fashion that encourages debtors to deal with creditors by artificial impairment when such creditors could otherwise be left unimpaired."
The court ultimately ruled that, in order for the plan to be confirmed without the lenders' acceptance, or absent compliance with the cramdown requirements of section 1129(b), "the treatment of the Lenders must be modified to allow them to exercise their rights under the loan documents following the effective date."
The bankruptcy court approved procedures to govern an auction of the ball club shortly afterward. Express was the prevailing bidder but ended up paying $130 million more for the debtor than its original $463 million offer. After approving the sale, the court confirmed the debtor's chapter 11 plan on August 23. The court found that only the classes of equity (consisting of the interests of REHLP and REHGP) were impaired by the plan. Thus, even though the lenders were not permitted to exercise their sale-veto rights, their claim under the pledge and security agreement was deemed unimpaired.
The court's analysis and conclusions concerning this issue leave a number of important questions unresolved. For example, according to the court, any claim for damages that the lenders might have for breach of the pledge and security agreement can be prosecuted against the debtor in the bankruptcy court or against the Rangers Equity Owners in an appropriate forum. This claim could be a prepetition claim (because it arises under a prepetition contract), a postpetition claim (as the breach did not occur until approval of the sale), or a claim against the reorganized debtor.
The court did not offer any guidance on this issue. It may have believed that any such claim—regardless of its legal character from a bankruptcy perspective—is meritless. The court observed in a footnote that "[t]he court does not mean to imply that it believes that the Lenders have such a claim." The debtor's chapter 11 plan ignores it altogether. Neither the plan, its accompanying disclosure statement, nor the order confirming the plan discusses the possibility (as part of the feasibility of the plan or otherwise) that the lenders might be awarded a substantial judgment on such a damages claim.
The court's observations concerning the possibility that the lenders' claim might be impaired if their veto powers were deemed "interests" within the meaning of section 363(f) or (h) are also curious. Sections 363(f) and (h) address, respectively, sales "free and clear of any interest in such property of an entity other than the estate" and sales of an "interest" of a co-owner in property jointly owned by the debtor. It is difficult to determine how the lenders' sale-veto power would qualify as an "interest" under either of these provisions. Moreover, the idea that the trustee could sell the debtor's assets under section 363(b) "without protecting the Lenders as to such provisions under section 363(f) or (h)" flatly contradicts the express language of those provisions as well as accepted practice and case law.
The court's ruling would appear to have been motivated partially by its perception that the lenders were using the veto rights as leverage to hold up the sale process and extract more value than the $75 million to which they were entitled because they realized that REHGP and REHLP were empty pockets. Regardless, on the issue of impairment under section 1124(1), Texas Rangers raises more questions than it answers.
In re Texas Rangers Baseball Partners, 434 B.R. 393 (Bankr. N.D. Tex. 2010).
In re Texas Rangers Baseball Partners, 2010 WL 3377594 (Bankr. N.D. Tex. Aug. 23, 2010).
In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1984).
Solow Building Co. v. PPI Enters. (U.S.), Inc. (In re PPI Enters. (U.S.), Inc.), 324 F.3d 197 (3d Cir. 2003).
In re Pilgrim's Pride Corp., No. 08-45664 (Bankr. N.D. Tex. Dec. 10, 2009) (order confirming chapter 11 plan with findings of fact and conclusions of law).
In re South Canaan Cellular Investments, Inc., 427 B.R. 44 (Bankr. E.D. Pa. 2010).
In re G-I Holdings, Inc., 420 B.R. 216 (Bankr. D.N.J. 2009).
A version of this article was published in the December 2010 edition of The Bankruptcy Strategist. It has been reprinted here with permission.