Claims Purchasers Beware, Your Vote Might Not Count

DBSD Case Upholds Designation of Votes Cast By a Claims Purchaser

The right to vote to accept or reject a plan of reorganization is one of the key rights given to impaired creditors in the Chapter 11 bankruptcy process. Generally, in Chapter 11 bankruptcy cases, it is up to the collective opinion of impaired creditors to decide whether a plan is acceptable. While the right to vote on a plan is fundamental, not all creditors are entitled to vote their claims. Notably, creditors whose claims are not impaired by a plan, or who will receive no distribution on a plan, or whose claims are subject to an objection are not entitled to vote. In addition, the Bankruptcy Code allows the bankruptcy court to "designate," or, in effect, to disregard, the votes of any entity whose acceptance or rejection of such plan was not in good faith. The Bankruptcy Code, however, provides no guidance about what constitutes a bad faith vote to accept or reject a proposed Chapter 11 plan.

A recent decision by the 2nd U.S. Circuit Court of Appeals in the In re DBSD North America case sheds new light on certain circumstances that may lead a court to designate the votes of a creditor. It also raises several questions – specifically, where a creditor buys claims against a debtor in bankruptcy with the intention to not maximize its return on the debt, but to gain a blocking position with respect to the debtor's plan of reorganization so that the creditor can gain control of the debtor's assets, it may be appropriate for the bankruptcy court to designate the votes of that creditor. See In re DBSD North America, Inc., 634 F. 3d 79 (2d Cir. 2011). The 2nd Circuit's decision in DBSD should be a significant consideration for any investor that purchases claims against a debtor, or even debt against a company on the eve of its bankruptcy, with the hope of using those claims to acquire the assets of the company or to control its bankruptcy case as it now runs the risk that its vote to accept or reject a plan for the debtor, and thereby control the debtor's reorganization process, will be disregarded.

The Background of the DBSD Case

DBSD was founded in 2004 to develop a mobile communications network that would use both satellites and land-based transmission towers. In its first five years, DBSD made progress toward this goal, successfully launching a satellite and obtaining certain spectrum licenses from the FCC, but it also accumulated a large amount of debt. Because its network remained in the developmental stage and had not become operational, DBSD had little if any revenue to offset its mounting obligations.

On May 15, 2009, DBSD filed a voluntary petition in the U.S. Bankruptcy Court for the Southern District of New York, listing liabilities of $813 million against assets with a book value of $627 million. Of the various claims against DBSD, the principal claims included a $40 million revolving credit facility secured by a first-priority security interest in substantially all of DBSD's assets bearing an initial interest rate of 12.5 percent (the "First Lien Debt"), and $650 million in 7.5 percent convertible senior secured notes due August 2009 (the "Second Lien Debt"). The Second Lien Debt held a second-priority security interest in substantially all of DBSD's assets. At the time of filing, the Second Lien Debt had grown to approximately $740 million.

After negotiations with various parties, DBSD proposed a plan of reorganization which provided that the holders of the First Lien Debt would receive new obligations with a 4-year maturity date and the same 12.5 percent interest rate, but with interest to be paid in kind, meaning that for the first four years the owners of the new obligations would receive as interest more debt from DBSD rather than cash. The holders of the Second Lien Debt would receive the bulk of the shares of the reorganized entity, which the bankruptcy court estimated would be worth between 51 percent...