The Examiners: Make Code More Friendly to Prepacks

If you could make one change to the bankruptcy code, what would it be?

Prepackaged Chapter 11 cases, known as prepacks, allow companies to reorganize more quickly and efficiently than is otherwise possible through Chapter 11. The benefits of prepacks are widely recognized and, for companies with sound operations but overleveraged balance sheets, prepacks are often a preferred course of action. The law should therefore promote the use of prepacks. Unfortunately, certain existing provisions of the bankruptcy code unnecessarily complicate and delay the use of prepacks. The intersection of securities law and bankruptcy law in prepacks is an area of particular uncertainty—and risk—that should be addressed through amendments to the bankruptcy code.

In traditional Chapter 11 cases, a debtor negotiates and solicits creditor acceptance of a plan of reorganization during the Chapter 11 case. The bankruptcy code provides a debtor with a safe harbor from securities law violations in connection with those solicitations. In a restructuring that happens entirely out of court, no such safe harbor exists, and the company must comply with any applicable securities laws or be exempted from them. In prepackaged Chapter 11 cases, however, a company carries out its restructuring by negotiating and soliciting acceptances for its plan of reorganization prior to filing a Chapter 11 petition. The company then files for Chapter 11 to make the plan binding on all parties. Unfortunately, prepacks often have been delayed and made more difficult because of the interplay between bankruptcy law and securities law prior to a filing. For instance, the SEC has taken the position that the bankruptcy code’s safe harbor provision doesn’t apply to prepetition solicitations. The bankruptcy code requires that in prepacks, a bankruptcy court must look first to “applicable nonbankruptcy law” to determine if a solicitation was proper, even though the disclosure statement is being approved, and the plan is being confirmed, while the company is in Chapter 11.

In addition, while the bankruptcy code exempts the offer or sale of a security of the debtor under a reorganization plan from the registration requirements of the Securities Act, the SEC staff has espoused the view that the exemption does not become applicable until the company has actually become a debtor by filing for bankruptcy protection. To date, no company has been willing to challenge that position. As a result, companies attempting to restructure through a prepack based on an exchange of securities have had to either register such securities or qualify for an exemption.

It would be desirable to amend the bankruptcy code to make the following points clear:

• If a company is soliciting votes on a prepackaged plan, it need not comply with any securities laws with respect to that vote if it files a Chapter 11 petition within a reasonable time, whether or not that plan is confirmed; or, even if it does not file for Chapter 11, so long as the company does not complete any exchange offer or other transaction outside of Chapter 11 based upon such solicitation.
• The bankruptcy court should be free to determine that a plan solicitation is appropriate if it complies with any applicable nonbankruptcy law, or satisfies the “adequate information” standard currently in the bankruptcy code.
• There should be no artificial impediments to quickly completing a prepack.

Finally, conforming amendments to the Securities Exchange Act should be implemented to further protect companies seeking to consummate prepacks. These amendments would allow companies to reorganize in a quicker and more cost-efficient manner, while still protecting the rights of individual security holders and the public at large.

Jay Goffman is the global leader of Skadden, Arps, Slate, Meagher & Flom’s corporate restructuring practice. He is based in New York.