In the latest chapter of more than a decade of contentious litigation surrounding the 2007 leveraged buyout ("LBO") and ensuing bankruptcy of media conglomerate Tribune Co. ("Tribune"), the U.S. Court of Appeals for the Third Circuit affirmed lower court rulings that Tribune's 2012 chapter 11 plan did not unfairly discriminate against senior noteholders who contended that their distributions were reduced because the plan improperly failed to strictly enforce pre-bankruptcy subordination agreements. In In re Tribune Co., 972 F.3d 228 (3d Cir. 2020), the Third Circuit held that, according to a plain reading of the relevant provisions of the Bankruptcy Code, a nonconsensual chapter 11 plan that does not strictly enforce a subordination agreement does not necessarily discriminate unfairly against a class of creditors that would otherwise benefit from subordination. In this case, the Third Circuit agreed with the lower courts that the "immaterial" reduction in the senior noteholders' recovery did not rise to the level of unfair discrimination. In reaching this conclusion, the Third Circuit appears to have become the first court of appeals in a published ruling to adopt the "Markell test" for assessing unfair discrimination.
Cramdown Confirmation of a Chapter 11 Plan
Section 1129(a)(8) of the Bankruptcy Code requires that, for a chapter 11 plan to be confirmable, each class of claims or interests must either accept the plan or not be "impaired." However, "cramdown" confirmation is possible in the absence of plan acceptance by impaired classes under section 1129(b)(1), which provides as follows:
Notwithstanding section 510(a) of this title, if all of the applicable requirements of subsection (a) of this section other than paragraph (8) are met with respect to a plan, the court, on request of the proponent under the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.
11 U.S.C. § 1129(b)(1) (emphasis added).
The Bankruptcy Code does not define "unfair discrimination." As noted by a leading commentator, "Courts have struggled to give the unfair discrimination test an objective standard." Collier on Bankruptcy ("Collier") at ¶ 1129.03[a] (16th ed. 2020). Nevertheless, most courts agree that the purpose underlying the requirement is "to ensure that a dissenting class will receive relative value equal to the value given to all other similarly situated classes." In re LightSquared Inc., 513 B.R. 56, 99 (Bankr. S.D.N.Y. 2014); accord In re SunEdison, Inc., 575 B.R. 220 (Bankr. S.D.N.Y. 2017); In re 20 Bayard Views, LLC, 445 B.R. 83 (Bankr. E.D.N.Y. 2011); In re Johns-Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1986), aff'd, 78 B.R. 407 (S.D.N.Y. 1987), aff'd, 843 F.2d 636 (2d Cir. 1988).
Courts historically have relied on a number of tests to determine whether a plan discriminates unfairly. These include: (i) the "mechanical" test, which prohibits all discrimination and requires that the recoveries of similarly situated creditors be identical; (ii) the "restrictive" approach, which narrowly defines unfair discrimination to mean that, absent subordination, disparate treatment of similarly situated creditors is not permitted; and (iii) the "broad" approach, which considers whether (1) a reasonable basis for discrimination exists, (2) the debtor can consummate a plan without discrimination, (3) the discrimination is proposed in good faith, and (4) the extent of discrimination is directly proportional to its rationale. 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) (discussing cases applying the various tests).
Several courts have adopted some form of the unfair discrimination test (the "Markell test") articulated by Bruce A. Markell in his article A New Perspective on Unfair Discrimination in Chapter 11, 72 Am. Bankr. L.J. 227, 249 (1998). See, e.g., In re Armstrong World Indus., Inc., 348 B.R. 111 (D. Del. 2006); In re Quay Corp., Inc., 372 B.R. 378 (Bankr. N.D. Ill. 2007); In re Exide Techs., 303 B.R. 48 (Bankr. D. Del. 2003). The Markell test was first applied by a bankruptcy court in In re Dow Corning Corp., 244 B.R. 705 (Bankr. E.D. Mich. 1999), aff'd in relevant part, 255 B.R. 445 (E.D. Mich. 2000), aff'd in part and remanded, 280 F.3d 648 (6th Cir. 2002). Under the Markell test, a rebuttable presumption that a plan unfairly discriminates will arise when the following elements exist:
(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.
Id. at 710. The burden then lies with the plan proponent to rebut the presumption by demonstrating that "outside of bankruptcy, the dissenting class would similarly receive less than the class receiving a greater recovery, or that the alleged preferred class had infused new value into the reorganization which offset its gain." Id.
Enforceability of Subordination Agreements in Bankruptcy
As noted previously, even if not all classes vote to accept a plan, section 1129(b)(1) states that it can be confirmed "notwithstanding section 510(a)" of the Bankruptcy Code, provided the plan complies with all of the other confirmation requirements, does not discriminate unfairly, and is fair and equitable with respect to impaired dissenting classes. Section 510(a) deals with contractual subordination agreements. It provides that, if the claims of one creditor or group of creditors are subordinated in accordance with the provisions of a valid and enforceable agreement, the subordination agreement is enforceable in a bankruptcy case "to the same extent that such agreement is enforceable under applicable nonbankruptcy law."
Thus, in construing...
