In recent years, Chapter 11 of the Bankruptcy Code has prompted critics to claim that, at least when it comes to large companies, it has become a lawless forum where bankruptcy judges have jettisoned fealty to the code in order to attract cases to their courts. The poster child for the criticism is the recent 16-hour Chapter 11 case of Belk department stores. In a recent article, we take issue with that characterization of the case. When viewed in context, Belk was a commonsense restructuring that, while innovative, adhered to the dictates of the Bankruptcy Code.
Belk had its plan of reorganization confirmed on February 23, 2021. It had filed for Chapter 11 sixteen hours earlier, after a long process involving all affected parties. Belk had been taken private in a leveraged buyout in 2015. The remaining debt from that transaction, coupled with a downturn in revenues caused by COVID, meant that by the fall of 2020 the company’s revenues could not cover its expenses. The company’s financial creditors, institutions that held first-lien debt and second-lien debt, negotiated with the company and its private equity sponsor for months over a new capital structure. The deal that these sophisticated creditors reached had four main components – it injected in money into the business, it reduced the cash needed to service the debt going forward, it restructured the debt, including extending maturities, and it reduced the ownership stake of the sponsor, with the remaining equity going to the financial creditors. This agreement was set forth in a restructuring support agreement – an “RSA” – that was distributed to all the affected creditors well in advance of the planned Chapter 11 filing. The RSA set forth that the reorganization was going to be a prepackaged case, a case where sufficient consents by the affected creditors to confirm the plan had been procured in advance.
The RSA garnered substantial support among the creditor base. The resulting plan of reorganization that was confirmed was a consensual plan under §1129(a)(8) of the Bankruptcy Code, which requires that all classes of impaired creditors approve a plan of reorganization. Yet there was much more than the minimum support necessary to confirm the plan. The vote in favor of the plan was unanimous; there was not a single dissent. No parties with claims against Belk other than the first-lien holders, the second-lien holders, and the sponsor saw their interests in the company affected. All workers, suppliers, and landlords were paid in the ordinary course. All contracts and leases were assumed. No employees were dismissed. Belk left bankruptcy as a less leveraged company, though still a company that had to navigate a challenging environment for department stores.
Despite the seemingly sensible adjustment of interests among the financial creditors, Belk’s sojourn in Chapter 11 has raised protests. The most scathing critique has labelled the case as being “lawless,” with applicable provisions of the Bankruptcy Code being ignored in multiple respects. These contentions, however, cannot withstand close scrutiny. Belk complied with the dictates of the Bankruptcy Code and Rules, all the way down. Perhaps most important, the plan itself complies with Section 1129, which sets forth the requirements for confirming a plan of reorganization. Indeed, no commentator who has objected to Belk has identified any way in which the plan contravened a requirement of the code. To be sure, as with any negotiated plan of reorganization, one can always imagine a different plan that could have been confirmed. Perhaps the sponsor could have been induced to contribute even more funds to the reorganized business, perhaps the new debt could have been divvied up between the first- and second-lien holders slightly differently. But one could imagine different variations for virtually all consensual plans of reorganization.
The genius of the Bankruptcy Code is that it puts these decisions in the hands of the affected parties. Whereas its predecessor, the Bankruptcy Act, allowed individual creditors to object to a plan that did not adhere to absolute priority, under the code only an impaired class can raise this objection. A class can decide that it is better off with a negotiated deal that leaves equity holders with an interest in the reorganized entity than it would be with a plan that eliminated old equity and left the creditors in charge of running the business. This change in the central feature of reorganization law encourages consensual plans. It allows those with their interests being affected, as a group, decide what adjustments should be made, while at the same time discouraging holdout behavior. The plan of reorganization in Belk falls squarely in the space for negotiated restructurings created by the Bankruptcy Code. In this respect, Belk is unremarkable.
Most of the academic objections to Belk focus on whether the procedures set forth in the Bankruptcy Code and Rules were followed. We agree with those who point out that the fact that the plan in Belk was sensible cannot justify departing from the mandates of the code. But speed itself is not an objection. Where we part company with Belk’s critics is that we find that Belk cut square corners at every turn. There is no immutable requirement that a debtor languish in Chapter 11 for a set minimum period. Notice of the case was provided to all parties, even those whose claims were unimpaired, four weeks in advance of filing. In an abundance of caution, the bankruptcy judge issued an order allowing those who were not part of the negotiations time to come forward and press any objections they may have to the plan, even after the plan had been confirmed. None did.
There are default rules in the Bankruptcy Code and Rules that would have prevented a plan being confirmed 16 hours after filing. For example, one rule requires that a confirmation hearing be held at least 28 days after a disclosure statement has been filed, and here the notice was given prior to the disclosure statement being filed with the court. Another rule requires that there be a meeting of creditors after a petition has been filed. But these are just default rules. The code expressly allows the bankruptcy judge to adjust these provisions for cause. The judge in Belk did precisely this.
The other procedural objections commentators have raised to Belk’s bankruptcy proceeding (objections not raised, it should be pointed out, by a single creditor) are of the same tincture. The bankruptcy provisions that they point to could have been used to slow down and perhaps scuttle the deal that every affected creditor agreed to; but they do not mandate such a result. The application of these rules is left to the sound discretion of the bankruptcy judge. Here, the bankruptcy judge understood the reality on the ground and found that cause existed to expedite matters. Using discretion expressly granted by the Bankruptcy Code is an example of a court following the law; it is not an example of a court being lawless.
One can always argue that existing law and practice can be improved. Reasonable people can differ on various issues: the extent to which the Bankruptcy Code should give the debtor control over the agenda, allowing it to structure the negotiations with its creditors; the extent to which bankruptcy law should follow applicable non-bankruptcy law when deferring to independent directors; or whether the bankruptcy court should have the power to excuse compliance with certain rules. Reasonable people can also disagree over how judges use their discretion in any given case.
What cannot be debated, however, is that in Belk lawyers followed the rules as they exist today. They first reached a sensible deal. No doubt they negotiated with an eye on the requirements of the code to ensure that any agreement that they reached could be confirmed in a prepackaged bankruptcy. The bankruptcy judge scrutinized the documents that were filed, held a hearing on the record to ensure that the rules were followed, and, in an abundance of caution, entered an order to ensure that the rights of those not in court were not adversely affected. Belk is a case that is substantively and procedurally sound. It should not be castigated; it should be celebrated.
This post comes to us from Professor Robert K. Rasmussen at the University of Southern California Gould School of Law and Roye Zur, a restructuring and bankruptcy partner at the law firm of Elkins Kalt Weintraub Reuben Gartside. It is based on their recent article, “The Beauty of Belk,” available here.