12.6 Chapter 6: Critique of the Chapter 11 plan procedure

Chapter 6 contains a comparative analysis and critique of the Chapter 11 plan procedure.

A first point of critique of the American system concerns the complexity, the potential for delay and the costs of the procedure. An important cause of this is the intensive involvement of the court. This is a result of the large number of decisions that the court must or may be asked to take and the large number and the complex nature of the criteria that the court must apply in taking those decisions.

The high degree of court involvement does not only increase the potential for delay and the costs, but also gives the court too much substantive influence over the process. Creditor democracy carries too little weight in the American system. The Court can too often and too readily set aside the majority wish of the creditors.

A related point of critique is that the automatic stay can last too long and that the creditors have no or only limited ability to discontinue the stay. The automatic stay effectively amounts to a statutory obligation of the creditors to continue financing.

This favours lower-ranked creditors and shareholders who no longer have an economic interest, at the expense of creditors who do have an economic interest but are prevented for longer than necessary from exercising their enforcement rights.

A statutory moratorium should not have a structural nature with the purpose of enabling the business to continue its activities without the need for a plan to be implemented. A statutory moratorium should offer short-term relief only for the purpose of implementing or exploring the possibility of implementing a plan. A longer-term solution, if viable, should be provided by a plan that carries the democratic support of the creditors.

I question the usefulness of the best interests of creditors and the feasibility test as general criteria for confirming a plan, i.e. as tests that are also applied to plans that all classes have accepted (consensual plans). The best-interests and feasibility tests do not offer real protection, cause considerable delay and uncertainty, and give rise to significant costs. This equally applies to the requirement for prior court approval of a disclosure statement. There should in any event be no requirement for the court to approve the information provided to creditors before the proponent of the plan can move forward with the process and solicit votes. It should be possible to defer a court test of the adequacy of the provided information to the confirmation stage. In practice, this result is achieved by means of pre-packaged plans. However, it should not be necessary to develop techniques to work around undesirable statutory constraints just to make this possible.

The idea of the absolute priority rule is that it should be possible to confirm a plan over the objections of a dissenting class only if that class receives under the plan its share of the reorganisation value in accordance with its rank. However, the wording of the absolute priority rule is convoluted and unnecessarily complicated. The rule of absolute priority does not accurately express the principle of respecting priority. It should not be followed in the way that it is formulated. The underlying principle, however, is sound, i.e. the principle of respecting priority where classes do not consent to a distribution that is less than what they are entitled to on the basis of their rank. This underlying principle should be followed.

The American criteria for the cram-down of dissenting classes do not afford sufficient protection to classes that would be entitled to a distribution in cash in the event of liquidation. The best-interests test, which is applied to all plans (consensual and non-consensual), only ensures that creditors receive a distribution under the plan with a presumed value equal to the amount they could expect to receive in cash in the event of liquidation. It does not safeguard that creditors actually receive such amount in cash. The cram-down criteria give the court the power to force the members of a dissenting class of creditors who would receive cash in liquidation, to take non-cash under the terms of the proposed plan and thus to keep financing the company against their majority will (and at a rate of return that the court determines to be reasonable but that market participants and the respective creditors do not find adequate). While this may benefit junior stakeholders compared to their position in liquidation, senior creditors can be materially worse off than in liquidation. As noted above, there is insufficient justification for a system that benefits one group at the expense of another. This element of the American system should therefore also not be followed.