The U.S. Court of Appeals for the Ninth Circuit recently ruled that despite the rejection of a plan by every creditor of a debtor, a plan for such debtor may be confirmed, provided that such debtor is part of a joint plan with one or more of its affiliates and at least one class of any such affiliate's creditors support the plan. Satisfaction of a key statutory predicate for confirming a Chapter 11 plan depends not on support from a debtor's creditors, but on whether there is creditor support for at least one of the debtors in a joint multiple debtor plan. Adopting a literal approach to the Chapter 11 requirement found in §1129(a)(10)—which requires that at least one class of impaired creditors vote to accept the plan before the plan can proceed to confirmation—the Ninth Circuit determined that the affirmative vote of one creditor class of a joint plan is sufficient to permit a plan to proceed to confirmation. Under the Ninth Circuit's interpretation, if every creditor of one debtor rejects the plan, the plan may be still be confirmed over such rejection provided that (1) the plan meets the cramdown standards for the rejecting class and (2) some class of another debtor's creditors accept the plan. In theory, this interpretation could yield different results and extend differing creditor protections depending on whether the debtor is part of a joint plan with its debtor affiliates or proposes its own plan.

In In re Transwest Resort Properties, 881 F.3d 724, 726 (9th Cir. 2018), the Ninth Circuit expressly rejected the “per debtor” interpretation of §1129(a)(10) in favor of a “per plan” approach. Transwest involved five affiliated debtors. One debtor served as a holding company, two debtors were operating hotels, and the remaining two debtors owned the hotel debtors and obtained separate financing secured by the equity of the operating hotels. In that structure, there were no creditors of the debtor that owned the hotel except the rejecting lender.

Through a structure in which the borrower does not (and indeed should not) have independent creditors, lenders expect that they will have a controlling voice in the event of the borrower's bankruptcy, particularly when the lender is secured. While the holding in Transwest does not directly result in the dilution of the rights of secured lenders in their collateral (and indeed, other Bankruptcy Code provisions provide substantive protections in this respect), it may expose nonconsenting senior secured lenders to “cram-up” premised upon support from otherwise junior creditors (and potentially equity) in situations where related debtors file a joint plan. Rather than having the expected control over a bankruptcy case, under Transwest, secured lenders may lose leverage in plan negotiations.

The Transwest decision may significantly impact lenders to businesses with multiple affiliated entities that are separately financed and that, in turn, lease or otherwise permit their assets to be used by an operating affiliate, such as drilling companies, shipping companies, real estate companies, power plant operators, hotels, and retailers, among others. For the time being, the Ninth Circuit is the only circuit court to have ratified the “per plan” approach. In contrast, lower courts in the Third Circuit have determined that even when there is a joint plan for related debtors, there must be an accepting impaired class of creditors in each debtor.

The Transwest Decision

In 2010, following the 2007 acquisition of the Westin Hilton Head Resort and Spa and the Westin La Paloma Resort and Country Club, five related entities commenced Chapter 11 cases and immediately sought to have their cases jointly administered as provided by Bankruptcy Rule 1015 governing two or more cases filed by related debtors. As is typical for related debtors, as a matter of administrative efficiency and case management, the request was granted and their cases were jointly administered.

In order to finance their 2007 acquisition, (1) the two hotel debtors, Transwest Hilton Head Property and Transwest Tucson Property obtained a $209 million loan from a mortgage lender; and (2) the two mezzanine debtors, Transwest Hilton Head II and Transwest Tuscon II, obtained a $21.5 million loan from a mezzanine lender secured by the equity in the hotel debtors. The remaining debtor, Transwest Resort Properties was the ultimate holding company, owning the intermediate mezzanine debtors, who, in turn, were the sole owners of the hotel debtors.

During the Transwest debtors' Chapter 11 cases, the mortgage lender filed a $298 million secured claim against the two hotel debtors and the mezzanine lender filed a $39 million secured claim against the mezzanine debtors. Subsequently, the mortgage lender purchased the mezzanine loan. The debtors and the mortgage lender stipulated that the value of the two resorts was $92 million. Through its purchase of the mezzanine loan, the mortgage lender became the sole creditor of the mezzanine debtors. The mortgage lender elected to have its mortgage loan treated as secured in accordance with Bankruptcy Code §1111(b), thereby retaining its mortgage lien for the full amount of its claim, but which only entitled it to a stream of deferred cash payments with a present value equal to the value of its collateral.

Subsequent to the purchase of the mezzanine loan, the Transwest debtors filed a joint plan of reorganization for five related debtors proposing that a third-party investor acquire the operating debtors for $30 million, thereby extinguishing the mezzanine debtors' ownership interest in the operating debtors. The hotels were to be acquired, subject to the mortgage lien, which secured a restructured mortgage loan with a 21-year term, paying interest only and a balloon payment due at the end of the term. Further, the loan contained a due on sale clause for the first five and the last six years, but not in the intervening 10 years, of the loan. The mortgage lender—which also held the only claim against the mezzanine debtors and thus was their only class of creditors—voted to reject the plan, while several impaired classes at the operating debtors voted to accept it.

In relevant part, the mortgage lender objected to the plan on the basis that it did not satisfy §1129(a)(10) of the Bankruptcy Code. In order to move to confirmation in the face of a dissenting class of creditors, a plan proponent must establish that (1) the requirements of §1129(a)(10) are satisfied and (2) the plan meets the “cramdown” requirements of §1129(b). The latter is the more common cause of plan litigation with a dissenting secured lender, usually involving valuation of collateral and such lender's proposed plan treatment. This case, however, involved the former: that at least one impaired class of creditors vote to accept the plan.

The mortgage lender, given its mezzanine position, argued that, with respect to the mezzanine debtors, the plan failed to meet this requirement and could not be confirmed without regard to the cramdown requirements. In support of its plan objection, the mortgage lender argued that Congress meant for §1129(a)(10) to apply on a “per debtor” basis, not a “per plan” basis. That shorthand description sets the dichotomy between the view that a plan must meet the requirements of §1129 and the view that the plan for each debtor must meet all of the confirmation requirements of §1129. Under the mortgage lender's interpretation, the plan did not satisfy the requirements of §1129(a)(10)—and thus was unconfirmable—because the mortgage lender (as the only class of creditors at the mezzanine debtors) did not vote in favor of the plan.

The Bankruptcy Court confirmed the plan over the objection of the mortgage lender, and it appealed. Id. at 726. After denying an emergency motion for stay pending appeal, the District Court denied the appeal as equitably moot. The mortgage lender appealed to the Ninth Circuit, which reversed that decision in 2015 and directed the District Court to evaluate the mortgage lender's objections on the merits. On remand, the District Court held, in relevant part, that §1129(a)(10) applies on a “per plan” basis.

In affirming the District Court's decision on remand, the Ninth Circuit began with the plain language of §1129(a)(10): A plan is only confirmable, in relevant part, only if at least one class of claims that is impaired under the plan has accepted the plan. The Ninth Circuit found that a plain reading of the statute supported the “per plan” approach. Transwest, 881 F.3d at 729. Specifically, it found that §1129(a)(10) “makes no distinction concerning or reference to the creditors of different debtors under 'the plan,' nor does it distinguish between single-debtor and multi-debtor plans.” Id.

In so ruling, the Ninth Circuit further disagreed with the approach advanced in In re Tribune Co., 464 B.R. 126, 182-83 (Bankr. D. Del. 2011), which held that §1129(a)(10) applies on a “per debtor” basis. In rejecting Tribune's interpretation of §1129(a)(10), the Ninth Circuit found unpersuasive that other subsections of 1129(a)(10), such as §1129(a)(3)—which requires that the plan be proposed in good faith—apply on a “per debtor” basis. It found such an argument problematic for two reasons: (1) nothing in the plain language of the text of subsection (a)(3) supported such an inference and (2) upon reading the statute as a whole, it was apparent that Congress phrased each subsection differently, rendering any “per debtor” inferences unavailing. The Ninth Circuit found that the mortgage lender's argument in this respect were nothing more than “a regurgitation of a summary of the Tribune decision unsupported by argument or other case law.” Id. at 730.

Finally, the Ninth Circuit summarily rejected the mortgage lender's argument that the plan was effectively substantively consolidated. It instead concluded that (1) the mortgage lender had failed to object to the plan on that basis and accordingly, the issue was not properly before the court and (2) to the extent that the mortgage lender was arguing that the “per plan” approach would result “in a parade of horribles for mezzanine lenders, such hypothetical concerns are policy considerations best left for Congress to resolve.” Id. There was no discussion regarding the principle that secured claims are unaffected by substantive consolidation. There was no discussion regarding the value of the lender's collateral, i.e., the equity in the hotel debtors, presumably because that value was provided by the plan.

Conclusion

It is clear that Transwest dilutes the control of secured lenders in a structured or project finance setting involving related borrowers. While it is not clear that Transwest affects the secured lender's entitlement to its collateral or its value, there may be two other significant consequences of Transwest. First, the initial application for joint administration of the cases of related debtors in accordance with Bankruptcy Rule 1015 may no longer be viewed as routine. Indeed, courts may find that parties argue that the rule, which, in part, provides that “[p]rior to entering an order the court shall give consideration to protecting creditors of different estates against potential conflicts of interest,” permits creditors to request protections such as independent directors in the early days of a case in order to avert the Transwest situation. For example, when that relief initially was sought in In re Energy Future Holdings Corp., No. 14-10979 (CSS) (Bankr. D. Del. Apr. 29, 2014), it was denied; later, however, such relief was granted when additional actions by the related debtors demonstrated and resolved the previous failure to take into account the potential and actual conflicts as among the related debtors being jointly administered. Second, creditors must be alert and active in respect of any developments which suggest that the differing interests as among related debtors are not being respected. Waiting to oppose a plan may be too late. One might suggest that even proposing a joint plan presents the need to examine conflicts as among the related debtors. Such joint action as well as other related affiliate actions, such as a sale process or intercompany funding, may prompt creditors to call for protection against conflicts as among the related debtors.

It is surprising that an administrative convenience born in the quest for efficiency, embodied in a procedural rule, that also finds expression in many steps taken during a complex Chapter 11 case involving related debtors, including without limitation a joint plan of reorganization, should have such a significant impact. Transwest places a greater burden upon creditors to be vigilant in advocating the interests of their debtor vis-à-vis other related debtors in the debtors' decision making process.

Corinne Ball is a partner at Jones Day.