New York Bankruptcy Court: Lockup Provision in Proposed Settlement Agreement Violated Bankruptcy Code's Disclosure and Solicitation Requirements
A bedrock principle underlying chapter 11 of the Bankruptcy Code is that creditors, shareholders, and other stakeholders should be provided with adequate information to make an informed decision to either accept or reject a chapter 11 plan. For this reason, the Bankruptcy Code provides that any "solicitation" of votes for or against a plan must be preceded or accompanied by stakeholders' receipt of a "disclosure statement" approved by the bankruptcy court explaining the background of the case as well as the key provisions of the chapter 11 plan. The votes of stakeholders whose votes are solicited outside of this process, and therefore improperly, may be disallowed.
However, to promote communication and negotiation among the debtor and other stakeholders throughout the course of a chapter 11 case, courts generally construe the term "solicitation"—and the remedies for improper solicitation—narrowly. In some cases, courts have even permitted debtors and certain stakeholders to enter into agreements prior to the approval of a disclosure statement in which the signatories agree to support a plan under certain specified conditions.
The U.S. Bankruptcy Court for the Southern District of New York recently addressed the propriety of such agreements in In re GOL Linhas Aéreas Inteligentes S.A., 2024 WL 1716490 (Bankr. S.D.N.Y. Apr. 22, 2024). The court approved a global settlement among the chapter 11 debtors and various aircraft lessors, but denied approval of an impermissible "lockup" provision in the settlement agreements obligating the counterparties to support any chapter 11 plan later filed by the debtors, provided the plan embodied the terms of the settlement. Although the bankruptcy court declined to adopt a "bright-line" prohibition of such agreements in all cases, it emphasized that the Bankruptcy Code's disclosure and vote solicitation requirements are paramount, and concluded that the lockup provision before it failed to pass muster. The court came to this conclusion because, unlike most typical lockup or "plan support agreements" ("PSAs") or "restructuring support agreements" ("RSAs"), the provision did not specify the terms of a proposed chapter 11 plan, but merely the terms of the proposed settlement, together with a requirement that any plan could not be inconsistent with those settlement terms.
Solicitation and Disqualification of Votes on a Chapter 11 Plan
Section 1125(b) of the Bankruptcy Code provides that votes in favor of a chapter 11 plan can be solicited postpetition only after the creditor or shareholder receives a court-approved disclosure document containing "adequate information," a concept defined in section 1125(a). The provision is "designed to 'discourage the undesirable practice of soliciting acceptance or rejection at a time when creditors and stockholders were too ill-informed to act capably in their own interests.'" In re Heritage Org., LLC, 376 B.R. 783, 794 (Bankr. N.D. Tex. 2007) (quoting In re Clamp-All Corp., 233 B.R. 198, 208 (Bankr. D. Mass. 1999)).
In cases where section 1125(b) has been violated, section 1126(e) provides a remedy:
On request of a party in interest, and after notice and a hearing, the court may designate any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.
11 U.S.C. § 1126(e) (emphasis added). "Designation" of an entity under section 1126(e) means that it is disqualified from voting or its vote is disallowed. See Collier on Bankruptcy ¶ 1126.06 (16th ed. 2024). Votes cast by any creditor or interest holder designated under the provision are not counted for the purpose of determining whether the plan has been accepted by a class of creditors or interest holders under sections 1126(c) and 1126(d). See In re DBSD N. Am., Inc., 634 F.3d 79, 106 (2d Cir. 2011).
Designation of a vote under section 1126(e) "is a drastic remedy, and, as a result, designation of votes is the exception, not the rule. The party seeking to have a ballot disallowed has a heavy burden of proof." In re Adelphia Commc'ns Corp., 359 B.R. 54, 61 (Bankr. S.D.N.Y. 2006).
What constitutes "solicitation" of a vote on a plan is unclear. Most courts agree that the term "solicitation" "must be read narrowly … because [a] broad reading of § 1125 can seriously inhibit free creditor negotiations." Century Glove, Inc. v. First Am. Bank of New York, 860 F.2d 94, 101 (3d Cir. 1988); accord In re Heritage Org., L.L.C., 376 B.R. 783 (Bankr. N.D. Tex. 2007) (holding that certain plan-proponent creditors that negotiated a term sheet for a liquidating chapter 11 plan containing a plan support provision and later jointly filed a disclosure statement for the plan did not violate section 1125(b)). Relevant case law suggests that the term "should relate to the formal polling process in which the ballot and disclosure statement are actually presented to creditors with respect to a specific plan, and the term should not be read so broadly as to chill the debtor's postpetition negotiations with its creditors." In re Residential Capital, LLC, 2013 WL 3286198, *19 (Bankr. S.D.N.Y. June 27, 2013) ("ResCap") (quotations and citations omitted).
RSAs, PSAs and Lockup Agreements
In keeping with a series of court decisions beginning with the bankruptcy court's ruling in Trans World Airlines, Inc. v. Texaco, Inc. (In re Texaco, Inc.), 81 B.R. 813 (Bankr. S.D.N.Y. 1988), RSAs and PSAs have generally been deemed not to run afoul of the Bankruptcy Code's solicitation requirements. See, e.g., Heritage Org., 376 B.R. at 792; In re Kellogg Square Partnership, 160 B.R. 336 (Bankr. D. Minn. 1993). Among other reasons, courts have noted that such agreements, which outline the basic elements of a chapter 11 plan and provide a roadmap for confirmation, typically contain provisions allowing signatories to back out of their commitments where: (i) their fiduciary obligations require it; or (ii) the plan actually proposed by the debtor is materially different from what was agreed upon. See Kellogg Square, 160 B.R. at 340.
However, in a pair of unpublished bench rulings handed down in 2002, U.S. Bankruptcy Judge Mary F. Walrath held that postpetition lockup agreements violate section 1125(b), and she consequently disallowed the votes of the signatories under section 1126(e). See In re Station Holdings Company, Inc., No. 02-10882 (MFW) (Bankr. D. Del. 2002) (transcript of Sept. 30, 2002, hearing) (Doc. No. 177); In re NII Holdings, Inc., No. 02-11505 (MFW) (Bankr. D. Del. 2002) (transcript of Oct. 22, 2002, hearing) (Doc. No. 367). Both cases involved prepackaged chapter 11 plans, but certain supporting creditors signed lockup agreements after the petition date but before the court approved a chapter 11 plan disclosure statement. The transcripts of the proceedings indicate that Judge Walrath laid particular emphasis on the absence of any provision in the lockup agreements permitting the signatories to change their votes if the information contained in the disclosure statement turned out to be different from what they had received previously. In NII Holdings, Judge Walrath even announced a "bright line" rule prohibiting postpetition lockup agreements in cases before her. (Id. at 62:1–6.)
Another Delaware bankruptcy judge, Brendan L. Shannon, revisited this issue in In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013). In that case, the court rejected arguments that a postpetition RSA was impermissible, adopting a narrow interpretation of "solicitation" in section 1125(b) in accordance with the Third Circuit's ruling in Century Glove. Id. at 294. The court rejected the argument that provisions in the RSA requiring the signatories to vote in favor of a conforming plan and providing for the remedy of specific performance amounted to solicitation. According to the court, the specific performance provision in the RSA was appropriate because the parties "were entitled to demand and rely upon assurances that accepting votes would be cast." Id. at 297.
Many other courts have similarly concluded that the negotiation of postpetition RSAs or PSAs prior to approval of a disclosure statement does not amount to improper solicitation under section 1125. See In re Fin. Oversight & Mgmt. Bd. for Puerto Rico, 637 B.R. 223, 284 (D.P.R. 2022) ("The process of negotiation and solicitation of assent to the plan support agreements prior to the approval and distribution of the disclosure statement did not constitute improper solicitation of votes with respect to the Plan."); COMM 2013 CCRE12 Crossings Mall Rd., LLC v. Tara Retail Grp., LLC, 591 B.R. 640, 651 (N.D.W. Va. 2018) (drawing the distinction between plan support agreements that permit a signatory to change its vote under appropriate circumstances and prohibited lockup agreements that do not and therefore violate section 1125); In re Grupo Aeroméxico, S.A.B. de C.V., No. 20-11563 (Bankr. S.D.N.Y. 2021) (transcript of Nov. 16, 2021, hearing at 39:22-25; 36-18; 36:15-16; 53-17-22) (approving plan support provisions in claim settlement agreements because the counterparties were sophisticated, the court had already approved similar agreements without objection, and not all agreements included the provision, cutting against any indication of coercion or that the debtors had conditioned the settlement on the inclusion of the provision); ResCap 2013 WL 3286198, at *20 (ruling that a complex and highly negotiated RSA embodying numerous settlements and resolving complicated legal and factual disputes necessary to formulate a confirmable chapter 11 plan did not amount to improper solicitation because there were "numerous termination events that allow a party to withdraw" and the agreement to vote was conditioned on the approval of a disclosure statement); see also In re LATAM Airlines Grp. S.A., 2022 WL 2206829 (Bankr. S.D.N.Y. June 18, 2022) (unpublished opinion) (overruling an objection to confirmation of a chapter 11 plan based on the debtors' alleged violation of the plan solicitation requirements by entering into PSAs with certain creditors, prior to the court's approval of a disclosure statement, that obligated them to vote in favor of a plan in exchange for allowance of their claims, and holding that, even if those PSAs were improper (and the court did not reach that question), the only remedy for the violation was disallowance of the creditors' votes, which would not change the outcome of the voting process), as amended, 2022 WL 2541298 (Bankr. S.D.N.Y. July 7, 2022), aff'd, 643 B.R. 756 (S.D.N.Y. 2022). But see In re SAS AB, No. 22-10925 (Bankr. S.D.N.Y. 2022) (transcript of Sept. 28, 2022, hearing at 10:5-9; 18:1-5; 19:25) (Doc. No. 434) (ruling that a lockup provision denominated as an RSA contained in a lease assumption agreement obligating creditors to vote for any plan that the debtors might propose violated section 1125(b), and rejecting the "naked voting requirement" as an attempt to use "the claims process to buy a vote with no particular plan terms and without regard to whether there might be aspect[s] of the plan that the claimant might legitimately have other opinions about").
GOL Linhas
Brazilian low-cost airline GOL Linhas Aéreas Inteligentes S.A. and its affiliates (collectively, the "debtors") filed for chapter 11 protection on January 25, 2024, in the Southern District of New York with the intention of achieving a consensual restructuring of its fleet obligations with aircraft lessors. To that end, in March 2024, the debtors filed several motions seeking court approval of agreements and stipulations (the "stipulations") with various aircraft lessors resolving certain disputes relating to, among other things, unpaid rent, maintenance reserves, security deposits, and the amendment and assumption of various aircraft and engine leases.
Each of the stipulations included the following provision (the "lockup provision") stating that the lessors would support any chapter 11 plan later proposed by the debtors as long as the plan embodied the terms of the stipulations:
If a disclosure statement for a Chapter 11 Plan is approved by the Bankruptcy Court, [the lessor] agrees that, after its vote has been properly solicited, it shall vote (a) to accept the Chapter 11 Plan so long as (i) the Chapter 11 Plan, and a disclosure statement filed by the Debtors (the "Disclosure Statement") (A) is not inconsistent with the terms contained in the Term Sheet, the Definitive Documentation or the Approval Order; (B) no Events of default have occurred and are continuing in respect of any postpetition obligations of the applicable Debtor under the Leases (as amended herein, as applicable), the Definitive Documentation or any other lease ("Other Lease") entered into by Debtors and [the lessor]; (C) the Chapter 11 Plan provides for the vesting of the Definitive Documentation, including each of the Leases and guarantees, and any Other Lease or other agreement or guarantee in the applicable reorganized Debtor; and (D) the Chapter 11 Plan provides for the exculpation of [the lessor]; and (ii) (x) as of the effective date of the Chapter 11 Plan, the Debtors' Liquidity shall be no less than US$500,000,000 and (y) as of the effective date of the Chapter 11 Plan, the Projected Leverage Ratio for the calendar year ending 2026 shall be equal to or less than 3.5:1; and (b) against any other plan of reorganization filed by any party other than the Debtors, and shall not, in any material fashion, directly or indirectly support the filing of any such plan of reorganization by any party other than the Debtors….
This Term Sheet is not intended, and shall not be deemed or construed to be, a solicitation for votes in favor of the Chapter 11 Plan for purposes of sections 1125 and 1126 of the Bankruptcy Code or otherwise. The votes of holders of claims and interests in the Chapter 11 Cases will not be solicited until such holders who are entitled to vote on the Chapter 11 Plan have received the Chapter 11 Plan, the Disclosure Statement and related ballots, and other solicitation materials or the equivalent. For the avoidance of doubt, [the lessor] shall not be obligated to support any Chapter 11 Plan filed by the Debtors if such plan, related Disclosure Statement, proposed confirmation order, or other related document (by amendment or otherwise) is not consistent with the terms of the Term Sheet, the leases (as amended herein, as applicable) or the other Definitive Documentation…. [T]he foregoing provision shall not be enforceable if the Court determines at the hearing to approve the motion in respect of this Term Sheet that such provision violates applicable law, or declines to approve the motion because of this provision.
The debtors' official unsecured creditors' committee objected to approval of the lockup provision. The committee argued that the provision, which obligated lessors to support any chapter 11 plan before a plan term sheet or disclosure statement had been filed, was an improper vote solicitation designed to thwart a potential bid from a competitor. The committee also argued that the debtors' motion to approve the settlements in the stipulations should be evaluated by a stricter standard than the deferential "business judgment" standard traditionally applied to a proposed use of estate property outside the ordinary course of a debtor's business under section 363(b) of the Bankruptcy Code.
According to the committee, the court should instead evaluate whether the inclusion of the lockup provision in the stipulations was reasonable under the circumstances—an "entire fairness" standard. The committee argued that it was not, and should be stricken from the agreements, because: (i) it improperly transferred the lessors' right to vote to the debtors, thereby impairing the rights of other unsecured creditors; (ii) the terms of the stipulations, which provided that the settlements could be approved even if the lockup provision were stricken by the court, indicated that the lockup provision was not a critical component of the agreements; and (iii) the debtors' efforts to buy votes in support of a nonexistent plan constituted a bad faith solicitation of votes in violation of section 1126(e).
The Office of the U.S. Trustee largely echoed these objections, adding that unlike permissible PSAs or RSAs in other cases, the lockup provision in this case lacked a "meaningful out" and "offer[ed] no protection at all" to the lessors.
The Bankruptcy Court's Ruling
The bankruptcy court approved the stipulations, but without the lockup provision.
Initially, because the stipulations were settlements, Chief U.S. Bankruptcy Judge Martin Glenn considered whether the stipulation satisfied the standard applied to proposed settlements under Rule 9019(a) of the Federal Rules of Bankruptcy Procedure in accordance with the seven-factor test articulated in In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007). In that case, the Second Circuit considered:
(1) the balance between the litigation's possibility of success and the settlement's future benefits; (2) the likelihood of complex and protracted litigation, "with its attendant expense, inconvenience, and delay," including the difficulty in collecting on the judgment; (3) "the paramount interests of the creditors," including each affected class's relative benefits "and the degree to which creditors either do not object to or affirmatively support the proposed settlement"; (4) whether other parties in interest support the settlement; (5) the "competency and experience of counsel" supporting, and "[t]he experience and knowledge of the bankruptcy court judge" reviewing, the settlement; (6) "the nature and breadth of releases to be obtained by officers and directors"; and (7) "the extent to which the settlement is the product of arm's length bargaining."
GOL Linhas, 2024 WL 1716490, at **5-6 (quoting Iridium, 478 F.3d at 462). According to Judge Glenn, although a debtor's business judgment should not be ignored in assessing the propriety of a proposed settlement, "settlements cannot be allowed to trample on the rights and protections expressly created by section 1125 of the Bankruptcy Code." Id. at *6.
Turning to the requirements of section 1125, Judge Glenn carefully examined decisions addressing whether postpetition PSA, RSA, or lockup agreements violated the Bankruptcy Code's vote solicitation requirements. He concluded that the hallmarks of permissible PSAs, such as those approved as part of settlement agreements in Kellogg Square and Grupo Aeroméxico, included: (i) creditors' receipt of "meaningful information"; and (ii) a "meaningful choice" to rescind the agreement if the actual plan terms were materially different. Id. at **9-10.
Judge Glenn ruled that the economic terms of the stipulations satisfied the Iridium factors because they were reasonable, did not generate any objections, and "resolve a host of issues with critical counterparties and move the Debtors towards their DIP milestones." Id. at *11. However, he concluded that the lockup provision contained "neither (1) adequate (or any) information about the plan terms, nor (2) any evidence of meaningful choice." Id. at *10. In so ruling, Judge Glenn noted that the court need not decide whether the stipulations should be evaluated under the business judgment rule or the heightened entire fairness standard.
According to Judge Glenn, the lockup provision was clearly not a garden-variety RSA of the sort approved in cases like Heritage, Indianapolis Downs, or ResCap because it did not outline the broad features of a chapter 11 plan around which creditors could rally or facilitate the flow of information. Instead, he characterized the provision as a "bonus feature, affixed to unrelated stipulations regarding aircraft and engine leases, of the type that reach mixed results under judicial scrutiny." Id. at *11. Because the aircraft lessors had neither adequate information about the terms of a chapter 11 plan nor meaningful "outs," Judge Glenn concluded that the lockup provision "undoes the Bankruptcy Code's careful allocations of creditor rights and ultimately constitutes an improper solicitation in violation of section 1125(b)." He declined, however, to adopt the same bright-line prohibition of post-petition PSAs adopted by the court in NII Holdings. Id. at *8 n.11.
In particular, Judge Glenn explained, the debtors' chapter 11 cases were in their infancy, and the debtors were months away from filing a disclosure statement. He further noted that the court would not opine at that stage of the case on the amount of information necessary to qualify as meaningful disclosure. "[T]he lack of any adequate information about plan terms," he wrote, "clearly runs head-on into the purpose and goals of section 1125(b)." Id.
The bankruptcy court found that the lockup provision had no meaningful "outs" for the lessors "to void the blank check they are writing." Among other things, Judge Glenn noted: (i) the requirement in the lockup provision that the debtors satisfy certain liquidity and leverage ratios was to be measured as of the effective date of a chapter 11 plan, after the plan had been solicited, confirmed, and implemented; (ii) the stipulation only required the debtor to list the ratios in the disclosure statement as targets or projections, but there was "no way to unscramble the egg" if those projections were not met; and (iii) even though the lessors might have objections on grounds other than liquidity and leverage, the lockup provision "snuffs out the ability to vote accordingly." Id. at *12.
According to the bankruptcy court, although the sophistication of the aircraft lessors was relevant in assessing whether the lockup provision was permissible, the level of their sophistication did not allow the debtors to circumvent the Bankruptcy Code's solicitation requirements or "use its provisions as bargaining chips," particularly when it might "trample the statutory rights of other creditors." Id. Finally, the court dismissed as speculative the debtors' concerns that, without the certainty of the lockup provision, the lessors might demand additional concessions in exchange for their votes. "These speculative concerns," Judge Glenn wrote, can be addressed in other ways, and in any event, "do not trump the statute." Id. at *13.
Outlook
GOL Linhas is a significant development in the evolving jurisprudence regarding the permissibility of RSAs, PSAs, and lockup agreements in chapter 11 cases. Whatever denominated, such agreements are generally regarded by bankruptcy courts as a violation of the Bankruptcy Code's disclosure and vote solicitation requirements if they skirt those rules by failing either to impart adequate information to the affected signatories or to give such parties an opportunity to withdraw their support of a chapter 11 plan that fails to reflect their reasonable expectations. As indicated in GOL Linhas, the utility of PSAs, RSAs, and lockups in advancing a chapter 11 case to confirmation of a plan and the sophistication of the parties involved are relevant considerations in the analysis, but they do not trump the Bankruptcy Code's disclosure and vote solicitation requirements.
