Opinion ID: 4558816
Heading Depth: 2
Heading Rank: 2

Heading: The Plan’s allocation of a small portion of

Text: subordinated sums to Class 1F creditors does not unfairly discriminate against the Senior Noteholders. As we resolved the first issue in favor of Tribune, we turn to the Senior Noteholders’ alternative argument: The Plan unfairly discriminates against them. The Bankruptcy Court’s unfair-discrimination analysis compared Class 1E’s initial distribution recovery percentage under the Plan—33.6%—to its recovery were there strict enforcement of the subordination agreements—34.5%—and determined that 0.9% was not a material difference in recovery. Allocation Opinion, 472 B.R. at 243 n.21. Thus it held there was no unfair discrimination to bar Plan confirmation. The Senior Noteholders allege two flaws in that analysis. First, they claim the Court failed to compare only recoveries from the Tribune estate. That is, it should have compared Class 1E’s and Class 1F’s Plan recoveries as if no subordination agreements were in effect. As the parties stipulated in the Stipulated Percentage Recovery Table that the Senior Noteholders in Class 1E recovered only 21.9% of their claims absent subordination payments, this meant, they argue, that the rest of their 33.6% recovery under the Plan came from 19 the subordinated creditors and should be excluded from the unfair-discrimination analysis. Second, they claim that the Court’s refusal to compare their Class IE percentage recovery with Class 1F’s percentage recovery, and its decision to compare instead only Class 1E’s recovery under the Plan with its recovery had the subordination agreements been fully enforced, were incorrect. Once these errors are addressed, they assert the difference between Class 1E’s recovery under the Plan absent subordination (21.9%), and the Plan recovery of Class 1F’s non-Swap Claim creditors including subordination benefits (33.6%), is material, evidencing unfair discrimination that should have prevented the Plan’s confirmation. The Bankruptcy Code does not define unfair discrimination. It “is something of an orphan in Chapter 11 reorganization practice. . . . [J]ust what suffices to avoid unfair discrimination is uncertain.” Markell, A New Perspective, supra, at 227. “Generally speaking, this standard ensures that a dissenting class will receive relative value equal to the value given to all other similarly situated classes.” In re Armstrong World Indus., Inc., 348 B.R. 111, 121 (D. Del. 2006) (quoting In re Johns-Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1986)). Since unfair discrimination’s inclusion in the Bankruptcy Code (it appeared for a short time in the 1930s in revisions to the Bankruptcy Act of 1898), courts have relied primarily on one of four tests to determine what unfairness means and, in some of those tests, whether, if a presumption of unfairness exists, it can be rebutted. See generally Denise R. Polivy, Unfair Discrimination in Chapter 11: A Comprehensive Compilation of Current Case Law, 72 Am. Bankr. L.J. 191, 196–208 (1998) (collecting and discussing cases applying the various tests). 20 The “mechanical” test prohibits all discrimination, that is, it requires that similarly situated creditors’ recoveries be 100% pro rata. See In re Greystone III Joint Venture, 102 B.R. 560, 571–72 (Bankr. W.D. Tex. 1989) (reasoning that paying the trade creditors a higher percentage of their claims than other unsecured creditors would constitute unfair discrimination), rev’d on other grounds, 995 F.2d 1274 (5th Cir. 1992). The “restrictive” approach narrowly defines unfair discrimination such that, “[i]n the absence of subordination, . . . no disparate treatment of similarly situated creators would qualify,” Polivy, supra, at 200. Both tests have support in the House Report: it noted “there is no unfair discrimination as long as the total consideration given all other classes of equal rank does not exceed the amount that would result from an exact aliquot distribution,” House Report, supra, at 416, and the examples given involved subordinated creditors, id. at 416– 17; see also In re Acequia, Inc., 787 F.2d 1352, 1364 & n.18 (9th Cir. 1986). Neither of these tests appears to be widely adopted, however. See Polivy, supra, at 200–201 (collecting cases); cf. Aztec, 107 B.R. at 588–89 (rejecting both the restrictive and mechanical tests). The “broad” approach is generally applied as a fourfactor test that originated in the Chapter 13 case In re Kovich, 4 B.R. 403, 407 (Bankr. W.D. Mich. 1980). To determine whether the plan unfairly discriminates, the test considers whether: (1) a reasonable basis for discrimination exists; (2) the debtor cannot consummate its plan without discrimination; (3) the discrimination is imposed in good faith; and (4) the degree of discrimination is directly proportional to its rationale. 14 See, e.g., Aztec, 107 B.R. at 590 (laying out and 14 Some courts, finding the factors redundant, pared down the test to ask whether there is “a rational or legitimate 21 applying the test). Although this analysis has received criticism, see, e.g., In re Dow Corning Corp., 244 B.R. 696, 702 (Bankr. E.D. Mich. 1999); In re Brown, 152 B.R. 232, 235 (Bankr. N.D. Ill. 1993), rev’d on other grounds sub nom. McCullough v. Brown, 162 B.R. 506 (N.D. Ill. 1993); Markell, A New Perspective, supra, at 242–48, 254–55, it has been applied often, see Polivy, supra, at 203 n.102 (collecting cases applying the broad test). 15 In response to criticisms of these tests, Professor Bruce Markell proposed the “rebuttable presumption” test, which was applied by the Bankruptcy Court in this case, 472 B.R. at 242.16 basis for discrimination” and if it is “necessary for the reorganization.” In re Dow Corning Corp., 244 B.R. 696, 701 (Bankr. E.D. Mich. 1999) (citation omitted). 15 These critics reject the application of the broad test because, among other things, it was developed for Chapter 13 cases, which require the protection of all creditors, as they do not have voting rights, and provides amorphous limits on discrimination. Dow Corning, 244 B.R. at 702. The rebuttable presumption test, dealt with below and developed for the Chapter 11 context, is tailored to the specific circumstances of cramdown, where only the interest of the dissenting class is at issue. Id. It also eschews concepts such as reasonableness, whether a plan can be confirmed without discrimination, and good faith. 16 This holding is not before us, as the Senior Noteholders endorse it, Trustees’ Br. 37. Tribune accepts it, Tribune’s Br. 17, as do we. See In re Tribune Media Co., 587 B.R. at 617–18; see also In re Nuverra Envtl. Sols., Inc., 590 B.R. 75, 90 (D. Del. 2018). 22 A rebuttable presumption of unfair discrimination exists when there is (1) a dissenting class; (2) another class of the same priority; and (3) a difference in the plan’s treatment of the two classes that results in either (a) a materially lower percentage recovery for the dissenting class (measured in terms of the net present value of all payments), or (b) regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution. Markell, A New Perspective, supra, at 228, 249; see also Dow Corning, 244 B.R. at 702. Under this test, a presumption of unfair discrimination may be overcome if the court finds that a lower recovery for the dissenting class is consistent with the results that would obtain outside of bankruptcy, or that a greater recovery for the other class is offset by contributions from that class to the reorganization. The presumption of unfairness based on differing risks may be overcome by a showing that the risks are allocated in a manner consistent with the prebankruptcy expectations of the parties. Markell, A New Perspective, supra, at 228; cf. Comm. on Bankr. and Corp. Reorg. of the Ass’n of the Bar of the City of New York, Making the Test for Unfair Discrimination More “Fair”: A Proposal, 58 Bus. Law. 83, 106–07 (2002) (proposing amendments to this test that narrow the 23 circumstances where it is appropriate to overcome the presumption of unfair discrimination). The Senior Noteholders’ unfair-discrimination claim involves mixed questions of law and facts. A bankruptcy court’s initial determination of which test to use is reviewed as “a legal conclusion without the slightest deference.” U.S. Bank Nat’l Ass’n ex rel. CWCapital Asset Mgmt. LLC v. Vill. at Lakeridge LLC, 138 S. Ct. 960, 965 (2018). Reviewing the Bankruptcy Court’s choice of legal test de novo, we agree that it was appropriate in these circumstances to take a pragmatic approach to measure the Plan’s discrimination. Thereafter, Village at Lakeridge asks whether applying the law to the facts “entails primarily legal or factual work.” Id. at 967. This inquiry sounds simple, but often it will depend on how a court approaches its analysis. Our approach here sets up a factspecific question: How does discrimination affect Class 1E’s actual recovery? Thus we review the application of legal precepts to the facts in this instance for clear error. (Even were we instead to apply de novo review, the result would not change). 1. Principles framing the “unfair-discrimination” standard We distill the following principles from the various unfair-discrimination analyses. First, though § 1129(b)(1)’s legislative history speaks of discrimination as unfair once there is breached a pure pro rata division of plan distributions among like-priority creditors, that runs counter to the text. See Aztec, 107 B.R. at 588–89. “Discriminate unfairly” is simple and direct: you can treat differently (discriminate) but not so much as to be unfair. There is, as is typical in reorganizations, a need for flexibility 24 over precision. The test becomes one of reason circumscribed so as not to run rampant over creditors’ rights. This reading is also consistent with our holding in Section A above. A subordination agreement does not need to be enforced to the letter in the case of a cramdown, and subordinated amounts may be allocated to other classes not entitled outside bankruptcy to benefit from subordination agreements as long as that allocation is not presumptively unfair (and, if so, the presumption is not rebutted). Second, the cramdown provision’s text also makes plain that unfair discrimination applies only to classes of creditors (not the individual creditors that comprise them), and then only to classes that dissent. Thus a disapproving creditor within a class that approves a plan cannot claim unfair discrimination, and the standard does not “apply directly with respect to other classes unless they too have dissented.” Klee, Cram Down, supra, at 141 n.67. Third, unfair discrimination is determined from the perspective of the dissenting class. House Report, supra, at 416–17. What this means, however, is subject to interpretation. Courts and commentators nearly always consider this a comparison between the allegedly preferred class and the dissenting class. See, e.g., In re Greate Bay Hotel & Casino, Inc., 251 B.R. 213, 231 (Bankr. D.N.J. 2000) (collecting cases comparing the recovery of the dissenting class to that of the preferred class or classes); Klee, Cram Down, supra, at 142 (“[I]f the plan protects the legal rights of a dissenting class in a manner consistent with the treatment of other classes . . . , then the plan does not discriminate unfairly with respect to the dissenting class.”). However, as was done in this case, a court may in certain circumstances consider the difference between what the dissenting class argues it is entitled to recover and what it actually received under the plan. 25 In other words, a comparison between the recovery of the preferred class and the dissenting class is by far the preferred but not always the only acceptable approach. Other measures that allow courts to assess the magnitude of harm to the dissenting class may also be appropriate in some cases. Fourth, the need for classes to be aligned correctly is a precursor to an effective assessment. A typical refrain in bankruptcy is that many plan disputes in § 1129 begin as misclassifications under § 1122. 17 See, e.g., In re Woodbridge Assocs., 19 F.3d 312, 317–321 (7th Cir. 1994) (considering both the dissenting creditors’ misclassification and unfairdiscrimination claims); In re Unbreakable Nation Co., 437 B.R. 189, 200–202 (Bankr. E.D. Pa. 2010) (same); Greate Bay Hotel, 251 B.R. at 223–32 (same); see generally G. Eric Brunstad, Jr. and Mike Sigal, Competitive Choice Theory and the Unresolved Doctrines of Classification and Unfair Discrimination in Business Reorganizations Under the Bankruptcy Code, 55 Bus. Law. 1, 72–73 & n.289, 78 (1999) (discussing the need to enforce subordination principles at classification to avoid “perverse incentives” and unfairdiscrimination claims). 17 Technically a plan objection, if made, would be under § 1129(a) by claiming that the plan did not comply with the classification requirements of § 1122(a), which requires that “substantially similar” claims be placed in the same class. Markell, A New Perspective, supra, at 238 n.56. Where subordination agreements are in play, a gateway to unfairdiscrimination determinations is to separate those whose claims benefit from the agreements from those who do not. Placing a subordination beneficiary with a non-beneficiary in a single class bleeds over clear analysis. 26 Fifth, courts should resolve how a plan proposes to pay each creditor’s recovery “measured in terms of the net present value of all payments” or the “allocation . . . of materially greater risk . . . in connection with its proposed distribution.” Markell, A New Perspective, supra, at 228. This allows future distributions to be made reasonably equivalent to the actual value distributed at the time of the unfair-discrimination comparison. Sixth, in making an unfair-discrimination determination, start by adding up all proposed plan distributions from the debtor’s estate and divide by the number of creditors sharing the same priority. This provides a pro rata baseline. Then look at what actually happens if the plan is implemented. Where there are no subordination agreements involved, the analysis is simple: look at the difference between the recovery percentage under the plan of a preferred class and that of a dissenting class. Where subordination agreements are involved, courts should resolve in the first instance which creditors are entitled to benefit from those agreements. They should make their comparisons after including subordinated sums in the plan distributions, for what may be in dispute often is the amount the dissenting class would be entitled under full enforcement of § 510(a) but did not get under the plan. Seventh, to presume unfair discrimination, there must be “a ‘materially lower’ percentage recovery for the dissenting class or a ‘materially greater risk to the dissenting class in connection with its proposed distribution.’” Greate Bay Hotel, 251 B. R. at 229 (quoting Dow Corning, 244 B.R. at 702). The rebuttable presumption test intentionally leaves opaque what is, under the circumstances, “material.” Such line drawing has been left primarily to bankruptcy courts. See Bruce A. Markell, Slouching Toward Fairness: A Reply to the ABCNY’s Proposal on Unfair Discrimination, 58 Bus. Law. 109, 116 (2002) (“Congress has left the important area of nonconsensual 27 confirmation to the common law method of incremental decision-making.”). We too leave this for judicial development. Eighth, if courts find plans materially discriminate against the dissenting class and follow the rebuttable presumption test or some variation, that finding is by definition presumptive and can be rebutted. Though we could make general suggestions for what qualifies as an adequate rebuttal (e.g., contributions to the reorganization by a preferred class may rebut unfair discrimination), those determinations are for bankruptcy courts to decide initially. Id. 2. Application of the principles To review, the Bankruptcy Court compared Class 1E’s recovery under the Plan (33.6%) to its recovery if it and the Swap Claim were the only creditors to benefit from the subordination agreements (34.5%). 472 B.R. at 243 n.21. The Senior Noteholders point out that typically a court will compare the recovery percentages of the dissenting and preferred classes and ask whether the difference in recovery, if any, is material. Trustees’ Br. 41. If that analysis had been applied here, the Court would have needed to resolve the relative priority of all the creditors in Classes 1E and 1F to determine which creditors qualified as Senior Obligations under the PHONE and EGI Notes before comparing the treatment of the two classes under the Plan. Yet neither the text of 11 U.S.C. § 1129(b)(1) nor the rebuttable presumption test explicitly limits the unfairdiscrimination analysis to only a class-to-class comparison. As the Bankruptcy Court noted, unfair discrimination requires that a court evaluate whether “there was a materially lower percentage recovery for the dissenting class.” 472 B.R. at 244 (internal quotation marks omitted) (quoting Greate Bay Hotel, 28 251 B.R. at 231). In cases where a class-to-class comparison is difficult—for instance, here 57% of Class 1F (the Swap Claim) is entitled to benefit from the subordination of the PHONES and EGI Notes, while the Trade Creditors (and perhaps the Retirees) are not—a court may opt to be pragmatic and look to the discrepancy between the dissenting class’s desired and actual recovery to gauge the degree of its different treatment. Either way the perspective remains that of the dissenting class. The Senior Noteholders argue that the Court should have compared their recovery from the estate absent subordination (21.9%) to the Trade Creditors’ recovery under the Plan with the reallocated subordination payments (33.6%). To measure discrimination this way is to ignore that the Plan brought into the Tribune estate not only the subordinated sums distributed to non-beneficiaries of that subordination, but all payments from the subordinated creditors (and indeed it allocated the overwhelming majority of those sums to the Senior Noteholders and the Swap Claim). In this context, the Bankruptcy Court did not necessarily err when it compared the Senior Noteholders’ desired recovery under the fourth row of the Stipulated Recovery Percentage Table (34.5%) to their actual recovery under the Plan (33.6%). To repeat, this is not the preferred way to test whether the allocation of subordinated amounts under a plan to initially non-benefitted creditors unfairly discriminates. It may, however, be an appropriate metric (or cross-check) given the circumstances of a case. This is such a case. Because the claims of the Retirees ($105M) and Trade Creditors ($8.8M) are so substantially smaller than the Senior Noteholders’ claims ($1.283B), the increases in the recovery percentage for the Retirees’ and Trade Creditors’ claims from reallocated subordinated 29 amounts result in only a minimal reduction of the recovery percentage for the Senior Noteholders. Specifically, the subordinated sums allocated to the Retirees and Trade Creditors comprised 11.7 percentage points toward their 33.6 percentage recovery, but only reduced the Senior Noteholders’ recovery by nine-tenths of a percent. Thus we agree with the Bankruptcy and District Courts that this difference in the Senior Noteholders’ recovery is not material. Although the Plan discriminates, it is not presumptively unfair when understood, as ruled above, that a cramdown plan may reallocate some of the subordinated sums. As an aside, we note that the Bankruptcy Court looked to cases comparing the differences in the dissenting class and the preferred class recoveries as a baseline for its materiality determination. See Allocation Opinion, 472 B.R. at 243 (collecting cases). Because it adopted a different framework for its analysis than the courts it cited, id. at 242–43, it did not need to apply their metric for materiality. What constitutes a material difference in recovery when analyzing the effect of a plan on the dissenting class is a distinct and context-specific inquiry. We do not address the outer boundary of that inquiry here. Wherever it may lie, the nine-tenths of a percentage point difference in the Senior Noteholders’ recovery is, without a doubt, not material.