Introduction

It is often the case that unsecured creditors of a Chapter 11 proceeding are “out of the money”, where most, if not all of the debtor’s assets are encumbered by a secured creditor’s lien, and, in the absence of a bankruptcy court invalidating or avoiding the lien, all of the proceeds go to the secured creditor is satisfaction of its lien when the debtor’s assets are sold or all of the value is distributed to the secured creditor under a plan of reorganization or liquidation. Recent bankruptcy practice reveals that parties have nevertheless attempted to create a scenario in which unsecured creditors can “share” in the proceeds of the secured creditor’s collateral once the assets securing the secured creditor’s lien have been sold or liquidated. Another way of looking at this arrangement is that the secured creditor agrees to allocate or “carve-out” a portion of the proceeds it receives upon the sale or liquidation of its collateral or distributions received under a reorganization or liquidation plan to be distributed to unsecured creditors.

As will be set forth below, such an arrangement does not violate or derogate from the provisions of the Bankruptcy Code for a number of reasons. First, once the secured creditor’s collateral is sold, the proceeds of such sale are “non-estate assets” and as a matter of law, belong to the secured creditor to do with as it desires, including sharing the proceeds with unsecured creditors. Under a reorganization plan any value distributed belongs to the secured creditor and can be reallocated by the secured creditor as it pleases. Second, the distribution scheme of Section 726, and by implication, the priorities of Section 507 of the Bankruptcy Code, do not come into play until all valid liens on the property are satisfied. Where a secured creditor has the right to receive the full amount of the proceeds or value, it cannot be ordered by the bankruptcy court to distribute such proceeds or value to other creditors. Nor does a bankruptcy court have the authority to direct or control the process by which the secured creditor disposes of the proceeds of its collateral. For these reasons, courts have concluded that since there is nothing in the Bankruptcy Code that prohibits a secured creditor from reallocating monies or value to unsecured creditors, agreements or plans that reallocate or carve-out from the secured creditor’s collateral funds or plan distributions for unsecured creditors are permissible under certain circumstances and should be permitted.

“Carve-Outs”

As recognized in In re White Glove, Inc., 1998 Bankr. LEXIS 1303 (Bankr. E.D.Pa. 1988), the term “carve-out” is one of those distinct bankruptcy terms that do not appear in the Bankruptcy Code but is nevertheless a term that is widely use in bankruptcy practice. Id. at * 22. A “carve-out” is an agreement by a party that is secured by all or some of the assets of the estate to allocate some portion of the proceeds of its lien to be paid to others, or in other words, an agreement by the secured creditor to “carve-out” funds from its lien position to be distributed to other parties. Id. This practice is common where there are no unencumbered assets in the estate and the secured creditor agrees to release a portion of the proceeds of its collateral to unsecured creditors as an incentive for unsecured creditors, or the creditors’ committee with whom it represents, to continue administering the assets of the estate to a conclusion. Id. at * 23. The essential aspect of this practice is two-fold: (a) the carve-out is a product of an agreement between the secured party and the beneficiary of the carve-out and (b) the proceeds from the secured creditor’s collateral are not unencumbered estate assets that are subject to the distribution schemes of the Bankruptcy Code. In the absence of such an agreement, a secured creditor’s collateral may only be charged for administrative expenses to the extent such expenses directly benefited the secured creditor pursuant to Section 506(c) of the Bankruptcy Code.1

SPM Manufacturing Corp.

1. The Facts

The seminal case addressing the validity of asset reallocation is the First Circuit’s decision in Official Unsecured Creditors’ Committee v. Stern (In re SPM Mfg.Corp.), 984 F.2d 1305 (1st Cir. 1993) (“SPM” or the “Debtor”). Upon the filing of its bankruptcy petition the Debtor owed approximately $9 million to Citizens Savings Bank (“Citizens”), which held a perfected first security interest in all of the Debtor’s assets except for some real estate. The Debtor owed approximately $750,000 to the Internal Revenue Service for unpaid withholding taxes, which taxes were entitled to priority status pursuant to Section 507(a) of the Bankruptcy Code and would remain a personal liability of the principals of the Debtor if not paid by the estate. As for unsecured claims, the Debtor owed approximately $5.5 million to general unsecured creditors, which creditors were represented by the creditors’ committee (the “Committee”).

When it became apparent that the Debtor’s Chapter 11 reorganization was going to fail, Citizens and the Committee agreed to work together in order to maximize the value of the Debtor’s assets and provide some return to general unsecured creditors. Citizens and the Committee thereafter executed a written agreement (the “Sharing Agreement”) that provided for, among other things, the disposition of Citizens’ collateral, whereby a percentage of the proceeds that Citizens would receive from the satisfaction of its secured claim would be allocated to the claims of general unsecured creditors. The Sharing Agreement was thereafter filed with bankruptcy court, at which time the bankruptcy court expressed its concern that the Sharing Agreement appeared to be a “tax avoidance” scheme, but did not formally approve or disapprove the agreement. At this time no creditor or party in interest objected to the terms of the Sharing Agreement.

During the course of the Chapter 11 proceeding, the bankruptcy court granted a motion by Citizens for the appointment of a receiver with the power to negotiate the sale of the Debtor’s assets. The assets were thereafter sold for a sum below the amount of Citizens’ secured debt under circumstances wherein a previously entered order went into affect granting Citizens relief from the automatic stay and then converting the case to a Chapter 7 liquidation case. Thus, by this conversion, the Debtor’s assets were sold and the Committee and Citizens filed a joint motion requesting a distribution of the sale proceeds to Citizens. The motion recited that the entire amount of the sale proceeds was subject to Citizens’ security interest and that after paying various administrative fees, Citizens would distribute a portion of the proceeds to counsel for the Committee in accordance with the terms of the Sharing Agreement. The bankruptcy court granted the motion to the extent that it requested satisfaction of Citizens’ allowed secured claim but rejected the motion to the extent that it requested approval of the provisions purporting to allocate certain funds to general unsecured creditors, as it viewed such provisions as a form of a proceeds distribution that did not comply with the Bankruptcy Code.

In accordance with its ruling the bankruptcy court issued an order that acknowledged Citizens’ allowed secured claim and ordered that Citizens’ pay a portion of its proceeds to the Chapter 7 trustee to be administered and distributed to creditors in accordance with the provisions of the Bankruptcy Code, including the provisions concerning priority of tax claims. The district court affirmed the bankruptcy court’s order, reasoning that it was a proper exercise of the bankruptcy court’s equitable powers under Section 105(a) of the Bankruptcy Code to “reform” the Sharing Agreement to comply with the distribution schemes of the Bankruptcy Code.

2. Discussion

(A) Section 105 (a) of the Bankruptcy Code

The Court of Appeals for the First Circuit disagreed with the lower courts’ decisions and framed the issue as “whether an order compelling Citizens to pay to the estate from monies realized under its secured interest the amount required by the Agreement to be paid to the Committee is within the equitable powers of the Bankruptcy Court.” SPM Mfg. Corp., 984 F.2d at 1311. After affirming the precept that Section 105(a) of the Bankruptcy Code is not a source of substantive rights and that a bankruptcy has no equitable power to (a) create substantive rights that are otherwise unavailable under the Bankruptcy Code, (b) expand the contractual obligations of parties or (c) deprive creditors of rights or remedies available to them under the Bankruptcy Code, the First Circuit held that “the bankruptcy court’s order was legitimate only to the extent that some other provision of the Code or other applicable law entitled the estate to receive the disputed funds.” Id. (following Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206-207, 108 S. Ct. 963 (1988); In re Grissom, 955 F.2d 1440 (11th Cir. 1992); United States v. Pepperman, 976 F.2d 123, 131 (3d Cir. 1992); United States v. Sutton, 786 F.2d 1305 (5th Cir. 1986); In re Morristown & Erie R.R. Co., 885 F.2d 98, 100 (3d Cir. 1989)).2

(B) The Distribution and Priority Schemes of the Bankruptcy Code

The First Circuit began its analysis by stating that the Bankruptcy Code’s distribution and priority schemes under Sections 726 and 507 of the Bankruptcy Code do not come into play until all valid and perfected liens on the debtor’s property are satisfied.3 Id. at 1312. Since Citizens held an allowed secured claim in the amount of $5 million and the Debtor’s assets were sold for $5 million, the Court explained that the entire $5 million belonged to Citizens is satisfaction of its lien, leaving nothing for the estate to distribute to other creditors, including the IRS, thereby “mooting” Sections 726 and 507 of the Bankruptcy Code. Id. The Court dismissed the notion that the Sharing Agreement improperly distributed proceeds to general unsecured creditors at the expense of priority creditors. The Court reasoned that priority creditors could not have “lost” anything owed to them given the fact that there would have been nothing left to be distributed to priority creditors after the $5 million was distributed to Citizens. Id. The Court further explained that the distribution of the money to general unsecured creditors came entirely from the $5 million belonging to Citizens, “to which no one else had any claim of right under the Bankruptcy Code.” Id. Since any sharing between Citizens and the general unsecured creditors was to occur after the proper distribution of estate property to Citizens, the distribution and priority schemes of the Bankruptcy Code were not triggered and were thus not violated. Id. at 1312-13.

The Court further stated that while Section 726 and other provisions of the Bankruptcy Code governing the priorities apply to distributions of property of the estate, such provisions do not govern the rights of creditors to transfer or receive non-estate property. Id. at 1313. Thus, although a debtor and/or a trustee may not pay non-priority creditors ahead of priority creditors, the Court held that “creditors are generally free to do whatever they wish with the bankruptcy dividends they receive, including to share them with other creditors.” Id. (emphasis added). The Court acknowledged that since the proceeds of the sale of the Debtor’s assets were property of the estate, the Bankruptcy Code governed their use and distribution. However, once the bankruptcy court lifted the automatic stay and ordered the distribution of the proceeds to Citizens in satisfaction of its lien, the money became property of Citizens -- not of the estate. Id. The Court again emphasized that “[t]here is nothing in the Code forbidding Citizens to have voluntarily paid part of these monies to some or all of the general unsecured claims after the bankruptcy proceedings finished.” Id.4

The Court further explained that the theory that non-priority creditors should never receive a return on their claims if priority creditors receive nothing was directly contradicted by the fact that non-priority creditors routinely receive payment from non-debtor third parties for their claims without interference of the bankruptcy court via claims trading, where unsecured creditors often sell their claims to third parties in order to avoid the uncertainty and delay of bankruptcy proceedings. Id. at 1314. Noting that both the Bankruptcy Code and the Bankruptcy Rules provide authority that permits outright transfers resulting in general unsecured creditors receiving some money for their claims irrespective of whether priority creditors receive distributions, the Court held there was nothing to prohibit the same result if produced by a sharing of claims or partial assignment of claims as sought through the Sharing Agreement. Since the Bankruptcy Code provisions and distribution of estate property gave the estate no right to share in the proceeds of from Citizens’ secured claim, the First Circuit held that the bankruptcy court derived no right under those same bankruptcy provisions to order Citizens to pay a portion of its own claim to the estate. Id. 1315.

(C) The Committee’s Duties

The First Circuit also rejected the contention that any agreement negotiated by the Committee should have been negotiated to benefit the estate as a whole and that any contractual right to receive payment from Citizens belonged to the estate. The First Circuit confirmed that while a creditors’ committee and its members are required to act in accordance with the provisions of the Bankruptcy Code and with proper regard for the bankruptcy court, the committee is a fiduciary for those whom it represents -- unsecured creditors -- not for the debtor or the estate generally. Id. at 1315 (following In re Microboard Processing, Inc., 95 B.R. 283, 285 (Bankr. D. Conn. 1989); In re Johns-Manville Corp., 60 B.R. 842, 853 (Bankr. S.D.N.Y. 1986), rev’d on other grounds, 801 F.2d 60 (2d Cir. 1986)). Thus, the Committee, whose fiduciary duty only runs to the parties or class is represents, is charged with pursuing whatever lawful course best serves the interests of the class if creditors represented. Id. 1315-1316 (following In re Seascape Cruises, Ltd., 131 B.R. 241, 243 (Bankr. S.D. Fla. 1991)). The First Circuit concluded that the Committee reasonably determined that entering into the Sharing Agreement with Citizens was in the best interests of the class it represented, which conclusion was further supported by the facts (a) no general unsecured creditor objected to the Committee’s decision and (b) no evidence or reason was presented to show that the represented class would have been better off had the Committee not acted as it did. Recognizing that a creditors’ committee may need to be adversarial in order to be effective and fulfill its role in a Chapter 11 case, the court stated that:

[t]he creditors' committee is not merely a conduit through whom the debtor speaks to and negotiates with creditors generally. On the contrary, it is purposely intended to represent the necessarily different interests and concerns of the creditors it represents. It must necessarily be adversarial in a sense, though its relation with the debtor may be supportive and friendly. There is simply no other entity established by the Code to guard those interests. The committee as the sum of its members is not intended to be merely an arbiter but a partisan which will aid, assist, and monitor the debtor pursuant to its own self-interest.

Id. at 1316 (quoting In re Daig Corp., 17 B.R. 41, 43 (Bankr. D. Minn. 1981); see also In re Together Development Corp., 262 B.R. 586, 593 (Bankr. D. Mass. 2001) (“In light of this observation [in SPM] regarding the role of a committee appointed under Title 11, it is not at all unusual to expect the Committee to take a position adversarial to the Debtor or the Debtor's insiders in the course of fulfilling its fiduciary duties to estate constituents. The acts this Committee has taken are not at all inconsistent with those duties.”). These principles are further confirmed by Section 1103(c)(5) of the Bankruptcy Code, which specifically provides a creditors’ committee with the authority to take an active role in many important matters within a bankruptcy case.
Based on the foregoing, the Court held that the bankruptcy court erred as a matter of law insofar as it felt the Committee was under a particular duty to negotiate the sharing and allocation provisions of the Sharing Agreement for the benefit of the estate as a whole. Id.

(D) The Balance of Power in Chapter 11 Proceedings

The Court also rejected the notion that the Sharing Agreement would have the effect in future cases of creditors forming alliances to defeat attempts to reorganize and extort higher payouts from debtors and otherwise creating chaos in Chapter 11. The Court emphasized that its focus was on the particular agreement at issue and to determine whether it conflicted with the Bankruptcy Code. The Court held the parties’ promises in the Sharing agreement were consistent with the parties’ rights afforded to them under the Bankruptcy Code. As for future cases, the Court noted that a bankruptcy court “always retains the power to monitor and control the tenor of reorganization proceedings” and has a number of remedies in the event creditors and or a creditors’ committee are uncooperative or act in bad faith throughout the bankruptcy proceedings, including (a) having the creditors’ committee reconstituted pursuant to Section 1102(a)(2) and (b) disqualifying a party’s vote on a plan if such vote was made in bad faith pursuant to Section 1126(e) of the Bankruptcy Code. Id. at 1317.

In rebuffing the notion that creditors should not do anything to alter the disparate interests between secured and unsecured creditors, the Court validated the reality in bankruptcy proceedings that no two creditors have identical interests, and that while unsecured creditors may at time share common objectives with the debtor, “they are not required to rubber stamp the proposals of the debtor not to support the retention of current management.” Id. at 1317-1318. The Court again reiterated the precept that the duty of a creditors’ committee is to pursue the best interests of the unsecured creditors, which duty may result in the committee taking positions that are different from the those of the debtor and management. Id. at 1318.

3. Other Cases That Validate the Principal of Asset Sharing & Reallocation

Relying on SPM, other courts have approved these types of sharing agreements and arrangements. In White Glove, Inc., 1998 Bankr. LEXIS 1303, the secured creditor agreed to “carve-out” $300,000 from its collateral proceeds to be distributed to the IRS. Relying on SPM, the court held that such arrangement was permissible and that the contemplated distribution was consistent with the statutory priority scheme of the Bankruptcy Code. Id. at *27. In In re Mcorp Financial Inc., 160 B.R. 941 (Bankr. S.D. Tex. 1993), a senior creditor shared the proceeds of its collateral with a junior creditor pursuant to an agreement whereby other junior creditors were not included in the agreement. Also relying on SPM, the court held that [t]he seniors [m]ay share their proceeds with creditors junior to the juniors, as long as the juniors continue to receive as least as much as what they would without the sharing.” Id. at 960. In In re American Resources Management Corp., 51 B.R. 713 (Bankr. D. Utah 1985), a secured creditor holding a senior lien on all assets of the debtor's estate and a super-priority claim for all post-petition advances entered into a stipulation with the trustee whereby the secured creditor agreed to allow a designated amount of its cash collateral to be used for the payment of the fees of the trustee's attorney and accountants, but not for the payment of the fees of the creditors’ committee professionals. The Court held that permitting the secured creditor to selectively waive its liens and super-priority claims in order to allow payment of certain administrative expenses did not subvert the Bankruptcy Code's statutory scheme of priorities nor defeat its twin policies of debtor rehabilitation and fairness to creditors. Id. at 722; see also In re Hagerstown Fiber Limited Partnership, 1998 Bankr. LEXIS 1054, at * 35 (Bankr. S.D.N.Y. 1998) (“bondholders can share the distribution of their secured claims with anyone they chose”); In re Parke Imperial Canton, Ltd., 1995 Bankr. LEXIS 775, at * 9, n4 (Bankr. N.D. Ohio 1995) (“creditors are free to do what they w[a]nt with dividends including sharing them with other creditors”).

Applying the Principles of Asset and Plan Distribution Sharing & Reallocation In Bankruptcy Practice

Now that it is confirmed that in the appropriate circumstances a secured creditor may allocate a portion of the proceeds or the value of its collateral to unsecured creditors, the next step is to implement the terms of such allocation in the form of either a sharing and reallocation settlement agreement, similar to the agreement at issue in SPM, or a reorganization or liquidating plan.

Frequently, a reorganization or liquidating plan will include among its terms a reallocation of value from the secured creditor to unsecured creditors. Often such reallocation is consideration for either a settlement or the treatment of parties’ claims as provided in the plan.5 Such reallocation is also useful in avoiding the consequences of subordination provisions under inter-creditor agreements. Reallocation is a useful tool to bridge the gap between the parties and build a consensus.

Reallocation is particularly advantageous to unsecured creditors when the estate is administratively insolvent. By using reallocation, unsecured creditors can receive a distribution without satisfying the claims of junior lienholders, priority claims or administrative claims. Such reallocation may be achieved through a settlement agreement.

Once the parties have agreed to the terms of such agreement, the agreement should be presented to the bankruptcy court for approval by the debtor (or a joint motion by the debtor and the committee) in the a form a motion to approve a settlement pursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure (“Rule 9019”).6 The motion should include (a) a summary of the events leading up to the negotiations of the settlement, (b) the parties to the settlement agreement, (c) the salient terms of the settlement agreement (with the agreement attached as an exhibit to the motion), (d) the benefits to the estate and unsecured creditors that will result from the settlement, (e) an explanation that the estate is administratively insolvent or how the settlement will enable and facilitate a successful reorganization or liquidation and (f) the negative repercussions to unsecured creditors if the settlement is not approved. The motion should also recite the general standards a bankruptcy court must apply in determining whether to approve the settlement and an application of those standards to the facts of the particular settlement agreement, as well as a discussion of the settlement’s compliance with the Bankruptcy Code, Bankruptcy Rule 9019 and the standards set forth in SPM. The motion should also provide a discussion that (a) the terms of the settlement are fair and reasonable and were negotiated in good faith and at arms length and (b) proper deference should be given to the creditors’ committee who support the settlement since the committee represents the true stakeholders of the bankruptcy case.

For example, in the Chapter 11 cases of (i) In re Scient, Inc., et al., in the United States Bankruptcy Court for the Southern District of New York, Case Nos. 02-13455 through 02-13458 (AJG); (ii) In re Apple Capital Group, LLC, et al., in the United States Bankruptcy Court for the Southern District of Florida, Fort Lauderdale Division, Case No. 02-25275; and (iii) In re Insilco Technologies, Inc., et al., in the United States Bankruptcy Court for the District of Delaware, Case No. 02-13672 (KJC),7 after the debtors sold substantially all of their assets, the debtors, the committee and the secured creditors entered into a global settlement pursuant to which the secured creditor agreed to allocate a portion of the sale proceeds of its collateral for the benefit of and to be distributed to general unsecured creditors pursuant to asset reallocation and settlement agreements. Each settlement agreement has or will be part of a liquidating plan.8 These motions and settlement agreements were approved by the bankruptcy courts.

The reallocation process can also avoid the effects of structural subordination -- debt at the holding company level rather than operating subsidiaries -- or in the case of multi-debtors, the effect of different creditors having claims against different debtors. The consequences of multi-debtors are avoided by distributing the reallocated value as though the estates are substantively consolidated. By the settlement agreement or reorganization or liquidating plan containing among its terms that the estates are substantively consolidated for distribution purposes only, all creditors can be treated equally.

Conclusion

Where there exists a formally executed sharing or “carve-out” agreement between a creditors’ committee and a secured creditor and the parties are working together towards formulating a joint plan and maximizing the liquidation value of the estate to provide some return to general unsecured creditors, a secured creditor should be permitted to dispose of its collateral and allocate a portion of the proceeds of its collateral to unsecured creditors without interference from the bankruptcy court. This process will enable unsecured creditors to receive value where is none. The reallocation mechanism is also useful in avoiding the effects of contractual and structural subordination and disputes arising in multi-debtor cases.

1Another context where carve-outs are commonly utilized is where a secured creditor agrees to “carve-out” from its collateral funds to pay the professional fees of the debtor’s and/or the creditors’ committee as part of the secured creditor’s cash collateral and/or financing agreements. Id.

2Although Section 105(a) of the Bankruptcy Code provides that a bankruptcy court has the equitable power to “issue any order, process, or judgment that is necessary or appropriate to carry out provisions” of the Bankruptcy Code, see 11 U.S.C. § 105(a), “whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code.” Norwest Bank Worthington v. Ahlers, 485 U.S. at 206-07; In re Plaza de Diego Shopping Ctr., Inc., 911 F.2d 820, 830-31 (1st Cir. 1990) (“[T]he bankruptcy court's equitable discretion is limited and cannot be used in a manner inconsistent with the commands of the Bankruptcy Code.”)

3Section 726 provides, in relevant part, that:

Property of the estate shall be distributed -- --

(1) first, in payment of claims of the kind specified in, and in the order specified in, section 507 of the title;
(2) second, in payment of any allowed unsecured claim, other than a claim of a kind specified in paragraph (1), (3), or (4) of this subsection, proof of which is [timely filed.]

11 U.S.C. § 726(a). Section 507 of the Code identifies those expenses and claims which have priority over other claims, including administrative expenses allowed under section 503(b), claims for wages, and unsecured tax claims. See 11 U.S.C. §§ 507(a)(1), (3), (7).

4The Court stated that another way of looking at the Sharing Agreement was that the parties’ agreement to share the proceeds was a partial assignment by Citizens and the general unsecured creditors of their rights to receive bankruptcy distributions, where the right to receive payment was feely transferable and assignable under the relevant Massachusetts state law without the consent of the Debtor and without affecting the Debtor’s obligation to pay the underlying debt. Id. at 1313.

5Some plans refer to this reallocation as a “gift.” Denominating such reallocation as a “gift” may raise other issues and consequences. This could include adverse tax consequences. The use of the term “gift” should be avoided.

6Rule 9019 provides:

(a) Compromise. On motion by the trustee and after notice and a hearing, the court may approve a compromise or settlement. Notice shall be given to creditors, the United States trustee, the debtor, and indenture trustees as provided in Rule 2002(a) and to any other entity as the court may direct.

U.S.C.S. Bankruptcy R.9019(a).

7Mr. Silfen and Ms. Eisenberg represented the committees in these cases.

8 In the case of an administratively insolvent estate, the distributions can be achieved either through a structured dismissal or a “Teligent” plan, which under certain circumstances, may be confirmed notwithstanding the fact that the debtor is administratively insolvent. In In re Teligent, Inc., et al., Chapter 11, Case No. 01-12974 (SMB), 282 B.R. 765 (Bankr. S.D.N.Y., Sept. 13, 2002), the debtors were administratively insolvent and were precluded from being able to confirm a plan of reorganization as they could not satisfy Section 1129(a)(9) of the Bankruptcy Code, which requires that a debtor pay all administrative and priority creditors in full on the plan’s effective date unless an administrative creditor agrees to different treatment. The debtors’ secured lenders and creditors’ committee nevertheless negotiated and drafted a plan of reorganization which provided for, among other things, a potential distribution to general unsecured creditors wherein the secured lenders agreed to assign their collateral, which consisted of avoidance claims, to an unsecured claims estate representative, and assign funds to the unsecured claims estate representative to fund the investigation and prosecution of such avoidance actions. With regard to administrative and priority claims, the plan provided for a claim fund in the amount of $3.25 million available for distribution, as well as a convenience class for holders of administrative and priority claims who had claims in an amount of $3,000 or less or that opted in the convenience class. There were a total of 2,006 administrative and priority creditors, of which approximately 75% held convenience class claims and did not have to be solicited for plan voting purposes. As for the remaining 454 administrative and priority creditors, the debtors prepared a consent form which was sent to administrative and priority creditors as part of their disclosure statement which explained that the debtors were unable to pay administrative and priority claims in full and that unless they agreed to accept the different treatment as proposed by the debtors under the plan, administrative and priority creditors would most likely not receive any distribution and that the debtors’ bankruptcy cases would most likely be dismissed or converted. The consent from gave administrative and priority creditors the following three choices: (i) agree to accept the plan’s proposed treatment of a pro-rata share of the claim fund; (ii) opt into the convenience class; or (iii) decline to accept the plan’s treatment.

The most significant aspect of the consent form was that it contained a clear and conspicuous notice that the debtors intended to ask the court to rule that any administrative or priority creditor who failed to return the consent form will be deemed to have accepted the plan’s treatment of his or her claims. Of the 454 administrative and priority creditors that did not agree to accept the plan’s treatment, opt into the convenience class or settle their claims with the debtors, a total of 107 administrative and priority creditors did not return the consent forms to the debtors. The debtors nonetheless continued to followed up with each creditor who did not return his or her consent form, during which time not one creditor objected to the debtors’ proposed treatment under the plan.

The legal issue presented to the court was whether, under Section 1129(a)(9), it was appropriate to deem the silence of the creditors who did not return the consent forms to the debtors -- but, at the same time, did not object to the consent forms or object to the debtors’ stated intention to ask the court to treat their silence as consent -- as consent to the debtors’ proposed treatment of their claims under their plan. The court ultimately held that the failure of those administrative and priority creditors to return their consent forms implied their agreement to the debtors’ proposed treatment to their claims within the meaning of Section 1129(a)(9) of the Bankruptcy Code. A copy of an article discussing the Teligent case written by Mr. Silfen and Ms. Eisenberg is attached at the end of these materials for your review.