The Third Circuit’s ruling in In re Tribune provides important insight on what it means for a plan to unfairly discriminate.

In In re Tribune Company, F.3d, No. 18-2909, 2020 WL 5035797 (3d Cir. Aug. 26, 2020), the United States Court of Appeals for the Third Circuit affirmed the confirmation of Tribune Company’s Chapter 11 plan and identified certain principles to be applied when determining whether a plan unfairly discriminates against a dissenting class of creditors. In particular, the Third Circuit established a new eight-step analysis to be applied in “cramming down” such a dissenting class pursuant to section 1129(b)(1) of the Bankruptcy Code.

Background

Tribune, the largest media conglomerate in the country, filed for bankruptcy in 2008 and proposed a Chapter 11 plan that separated its various unsecured creditors into distinct classes. The senior noteholders, whose unsecured claims totaled over $1 billion, made up Class 1E, and certain other unsecured creditors constituted Class 1F. Pursuant to Tribune’s prepetition loan agreements, certain unsecured debt was subordinated to “senior obligations.” Under the plan, both Class 1E and Class 1F creditors received 33.6 percent of their outstanding claims, and the plan distributions included subordinated sums. The senior noteholders dissented, arguing that the allocation of subordination payments to Class 1F under the plan unfairly discriminated against their Class 1E.

The Bankruptcy Court for the District of Delaware concluded that the senior noteholders’ claims and a portion of Class 1F’s claims qualified as senior obligations. Pursuant to the parties’ stipulations, if the subordination agreements were strictly enforced, the senior noteholders’ recovery would have been 34.5 percent. Applying section 1129(b)(1) of the Bankruptcy Code, the so-called cramdown provision, the bankruptcy court concluded that the difference between Class 1E’s actual and desired recovery—nine-tenths of a percentage point—was immaterial and confirmed the plan over the class’s dissent. The senior noteholders appealed to the Third Circuit.

The Appellate Court’s Analysis

On appeal, the senior noteholders argued that Tribune’s plan improperly failed to fully enforce the company’s subordination agreements per section 510(a) of the Bankruptcy Code, which provides that a subordination agreement is enforceable in bankruptcy to the same extent that it is outside of bankruptcy. The Third Circuit rejected this argument.

In so doing, the court analyzed section 1129(b)(1) of the Bankruptcy Code which provides that “[n]otwithstanding section 510(a)” a court can confirm a plan over a class’s dissent if the plan does not “discriminate unfairly” and is “fair and equitable” with respect to the dissenting class. The Third Circuit concluded that section 1129(b)(1) overrides section 510(a) such that courts need not strictly enforce subordination agreements in cramdown cases.

In its decision, the Third Circuit also rejected the senior noteholders’ unfair discrimination claim. According to the senior noteholders, the bankruptcy court should have compared Class 1E and Class 1F’s recoveries as if no subordination agreements were in effect, not Class 1E’s actual recovery under the plan with its recovery had the subordination agreements been fully enforced.

In rejecting this argument, the Third Circuit looked to the various tests courts have applied to determine whether a plan unfairly discriminates and distilled eight “principles” that should drive an unfair discrimination analysis.

First, plans can treat similarly situated creditors differently (i.e., “discriminate”), but not so much as to be unfair. Second, unfair discrimination only applies to dissenting classes of creditors. Third, unfair discrimination is determined from the perspective of the dissenting class, although what this means is “subject to interpretation.” Fourth, as a precursor to an unfair discrimination analysis, courts must first determine whether creditors are properly classified. Fifth, courts should measure each creditor’s recovery under the plan in terms of (1) net present value of all payments or (2) the allocation of materially greater risk in connection with its proposed distribution. Sixth, courts must establish a 100 percent pro rata baseline distribution and compare that to what actually happens if the plan is implemented. Seventh, unfair discrimination can be presumed if there is either (1) a materially lower percentage recovery for the dissenting class or (2) a materially greater risk to the dissenting class in connection with its proposed distribution, and it should be up to bankruptcy courts to determine what is “material.” And, eighth, a presumption of unfair discrimination can be rebutted.

Applying these principles to the argument articulated by the senior noteholders, the Third Circuit found that courts are not required to conduct a class-to-class comparison under section 1129(b)(1). Rather, under certain circumstances, a court can be “pragmatic” and instead compare the dissenting class’ desired and actual recoveries. Although this is not the preferred approach, it is nevertheless so from the perspective of the dissenting class. The Third Circuit also agreed with the bankruptcy court: the difference between the senior noteholders’ actual and desired recoveries—a difference of 0.9 percentage points—was not material. Although the plan did discriminate against the senior noteholders’ class, it was not presumptively unfair.

Conclusion

The Third Circuit’s ruling in In re Tribune provides important insight on what it means for a plan to unfairly discriminate, an issue that has not been widely reported and one that has been characterized as an “orphan” in reorganization practice. In re Tribune’s eight-step analysis should provide a benchmark for courts and parties in interest in determining whether a case in fact involves a cramdown and whether there is unfair discrimination. Creditors should also be prepared in cramdown cases for courts to disregard subordination agreements and to take pragmatic approaches in determining when a plan unfairly discriminates.

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