Supreme Court curtails “new value” exception

Supreme Court curtails “new value” exception

Bernstein, H Bruce

Supreme Court curtails “new value” exception

In a long-awaited decision, the United States Supreme Court has dramatically curtailed the possible use of the so-called “new value” exception to the absolute priority rule in bankruptcy, by holding that no new value plan could be confirmed unless the “value” to be paid were determined by a market test, rather than a judicial determination. Bank of America NT&SA IS 203 North LaSalle Street Partnership, 119 S. Ct. 1411 (1999). In so doing, the Court has shifted the leverage between debtors and creditors in a way that will be particularly pronounced in real estate and closely held business bankruptcies (including cases involving insolvent subsidiaries of otherwise healthy companies).

203 North LaSalle involved an office building in Chicago in which the equity owners were permitted to confirm a plan of reorganization over the objection of the secured lender, by contributing “new value” worth $4.1 million in exchange for their ownership, and giving the lender, on account of its secured claim, a note equal to the judicially-determined value of the property (which assessment was not challenged on appeal). The Seventh Circuit, by a 2-1 decision, held that the plan complied with the new value exception to the absolute priority rule, under which the debtor’s old equity holders could retain their interests in the debtor by making a substantial contribution of new value which is necessary for the reorganization, notwithstanding the general principle that, in a nonconsensual plan, parties cannot retain any value under a plan unless all senior classes of claims have been paid in full.

The Supreme Court reversed, ruling that, even assuming the Bankruptcy Code retained the new value exception – an issue it was not deciding – no such “new value” plan would be permissible where the old equity was the only entity which has the ability to propose the new value plan. Such exclusivity, the Court held, meant that the old equity was in fact obtaining something of value – the sole right to bid – on account of its prepetition interest, in violation of Bankruptcy Code 1129(b)(2)(B)(ii). The Court also expressed a general distaste for judicial valuations where market tests were available, and stated that absent protection of the market’s scrutiny by means of competing bids or even competing plan proposals (the Court reserving whether the former alone was sufficient), no new value plan could be confirmed. Thus, at a minimum, any new value plan would require a market test, and the bankruptcy court’s determination of value would not suffice.

By limiting the ability of equity holders to cram down new value plans, the decision will affect both pre- and post-petition negotiations and resulting reorganization plans. In the typical real estate context, where the new value plan is motivated by old equity’s desire to avoid tax recapture (as it was in 203 North LaSalle), old equity is still likely to pay the highest price in a market test. However, the requirement that others have an opportunity to bid – including the secured creditor itself, which is likely to get most if not all of the bid proceeds in real estate cases – means that if equity does retain the property, the secured creditor will have obtained some portion of the tax savings. There will be a similar impact in other commercial cases where the threat of a new value plan has been used to extract concessions from creditors, and where creditors will now have an enhanced ability to wrest control of the bankruptcy process and to emerge with control over the reorganized enterprise.

Copyright National Commercial Finance Association Jul/Aug 1999

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