In a decision regarding the use of equity rights offerings with potentially significant ripple effects across the restructuring industry, Judge Andrew Hanen of the United States District Court for the Southern District of Texas reversed Bankruptcy Judge Christopher Lopez’s order confirming the plan of reorganization of ConvergeOne Holdings and affiliates (the “Debtors”), holding that the plan violated the requirement of equal treatment of similarly situated creditors under 11 U.S.C. § 1123(a)(4).[1]
The decision calls into question the ability of debtors to utilize the now-common practice of implementing prepackaged bankruptcy cases through plan equity-rights offerings and backstop agreements. Backstop agreements, whereby prepetition investors agree to purchase equity not sold in debtors’ equity rights offerings, are routinely integrated into DIP facilities and negotiated as part of Restructuring Support Agreements (“RSAs”). Such RSAs have become the norm in chapter 11 cases, particularly in prepack cases. However, when the opportunity to participate in those backstop agreements and related fees is not offered to the entire class of creditors, the plan may not be confirmable under section 1123(a)(4).
In ConvergeOne, prior to filing, the Debtors entered into an RSA with approximately 80% of their first- and second-lien debt holders with the intention of filing their prepack plan of reorganization (the “Plan”) immediately thereafter. The key elements of the Plan included the majority of first lien debt holders (the “Majority Lenders”) taking back debt and receiving the right to purchase discounted equity in reorganized ConvergeOne through an equity rights offering while proposing to pay unsecured claims in full. In return, the Majority Lenders received a 10% fee on the total equity raised and discounted equity through the backstop rights agreement. The Plan did not offer all first lien debt holders the opportunity to participate in the backstop, and such holders (the “Minority Lenders”) were excluded from participating in the negotiation of the RSA or the Plan prior to the petition date. The Minority Lenders argued that they were unfairly treated because the Majority Lenders were to receive, on average, a 30% higher recovery for their claims as a result of the discounted equity and backstop fee.
The Minority Lenders objected to confirmation of the Plan, arguing that their exclusion violated the equal treatment requirements of section 1123(a)(4) of the United States Bankruptcy Code, which requires a plan to “provide the same treatment for each claim or interest of a particular class.” The Minority Lenders further argued that the Plan should have either (i) offered the backstop opportunity to all class members or (ii) subjected the exclusive opportunity to a market test. In response, the Debtors and the Majority Lenders argued that the Plan treated all class claims the same because the extra value recovered by the Majority Lenders was consideration for providing the new post-petition backstop agreement.
The Bankruptcy Court confirmed the Plan over the Minority Lenders’ objection, finding that the backstopping opportunity did not violate section 1123(a)(4), as it was not a distribution “on account of” prepetition claims. The Bankruptcy Court reasoned that the “exclusive investment opportunities” were offered to the Majority Lenders as compensation for the new, post-petition backstop commitment and not distributions on account of prepetition claims, and thus, the backstopping opportunity did not have to be shared with the Minority Lenders. The Bankruptcy Court did not apply a market-test requirement. It held that neither the United States Supreme Court nor the Fifth Circuit required a market-test requirement for financing opportunities like the backstopping opportunity at issue because the absolute priority rule did not apply, as the Debtors were not attempting to cramdown the Minority Lenders under section 1129.
The Minority Lenders appealed, asserting that, among other things, the Bankruptcy Court’s section 1123(a)(4) ruling was contrary to the Supreme Court’s dictates in Bank of America National Trust & Savings Association v. 203 N. LaSalle St. Partnership, 526 U.S. 434 (1999). The District Court held that the offering of an opportunity to participate in a backstop to certain creditors within a class to the exclusion of others was unequal treatment in violation of section 1123(a)(4).[2] The District Court reached this conclusion by relying on two key cases. The first is the Supreme Court’s conclusion in LaSalle that an exclusive opportunity to obtain equity in a reorganized entity, without the benefit of market testing, constituted a property interest received “on account of” a claim or interest. The second is In re Serta Simmons Bedding, LLC, 125 F.4th 555 (5th Cir. 2024), published after the submission of the appellate briefs, whose key holdings were that (a) equal treatment prohibits disparate treatment with respect to value, and (b) a plan must provide an equality of opportunity, even if equality of recovery does not necessarily result.
First, the District Court considered whether the Plan’s backstopping opportunity excluded the Minority Lenders. The Majority Lenders had argued that the Minority Lenders were not truly excluded from the Plan’s backstopping opportunity because they were free to propose alternatives after the Plan was filed. In finding the argument unpersuasive, the District Court highlighted that the Debtors filed a pre-packaged plan, which the Debtors and Majority Lenders negotiated months prior to the petition date – all while the Minority Lenders were expressly excluded – and confirmed only weeks after the petition date. The District Court found that the pre-packaged Plan and quick confirmation intentionally and effectively restricted the Minority Lenders from participating in the deal.
After determining that the Minority Lenders were excluded from the backstopping opportunity, the District Court looked to whether the backstopping opportunity was market tested. The District Court highlighted that the parties did not offer a clear definition of “market test,” and found that the opportunity to propose alternative plans did not satisfy such definition. The court ultimately held that no matter the definition, the Plan did not satisfy the test in this case, because the Minority Lenders did not have a real opportunity to propose such an alternative. The District Court stated, “[t]o put it bluntly, at the time the bankruptcy petition was filed, the train had already left the station, and the Minority Lenders were never permitted to board.” Since the Debtors had already secured the requisite votes prior to the petition date, the District Court reasoned that there was no incentive to consider alternative plans, rendering any “opportunity to propose an alternative . . . illusory at best.”
Having determined that no market test was conducted, the District Court then considered the treatment of the class under the factors enunciated in Serta, which require that a court “look below the surface to determine whether distributions were in fact equal in value.” The District Court disposed of this issue quickly, as it reasoned that since the Majority Lenders were not only getting an eight-figure backstop fee, but they were also receiving discounted equity that the Minority Lenders were not, the distributions were not equal in value.
Guided further by Serta, the Court analyzed whether the Plan had inequality in both opportunity and result. As discussed, the parties did not dispute that the Minority Lenders were excluded from negotiations of the RSA and Plan and were never provided the opportunity to participate in the backstopping. Accordingly, the District Court found that there was “not even any pretense of equal participation.”
Finally, the District Court held that this denial of a real opportunity for the Minority Lenders to access the opportunity caused a distinction among the class members. Moreover, as noted by the District Court, a key factor is that the Majority Lenders did not provide adequate consideration for the opportunity, which distinguished it from the Eighth Circuit’s decision in In re Peabody Energy Corp., 933 F.3d 918,925-26 (8th Cir. 2019), where each creditor had the opportunity to participate in the equity purchase and provide consideration for such opportunity. In this regard, the District Court drew a key distinction between paying value for the opportunity and paying value for a higher return, the two being separate transactions subject to scrutiny under section 1123(a)(4). The District Court reasoned that while the Majority Lenders’ consideration in the form of backstopping funds entitled them to discounted equity, such consideration was a separate transaction from the initial opportunity to participate in the first instance, for which no consideration was given. This was precisely the disparity not only in outcome but also in the opportunity that Serta found to violate section 1123(a)(4). For these reasons, the District Court reversed the Bankruptcy Court’s confirmation order and remanded it for further proceedings.
The ramifications of this decision could be significant, including, but not limited to (a) the need to find alternative funding mechanisms that are made available all creditors in a class, or putting the opportunity through a meaningful market test, (b) discriminatory backstop agreements may thwart confirmation of a plan, and (c) the potential need to include all class members in negotiations of plan RSAs.
[1] The Court recognized that LaSalle addressed the absolute priority rule under section 1129(b) and not section 1123(a)(4), but noted that LaSalle’s dictates were instructive to an application of section 1123(a)(4).
[2] ConvergeOne Holdings, Inc. v. Ad Hoc Group of Excluded Lenders (In re ConvergeOne Holdings, Inc.), Order [Docket No. 54], Case No. 24-02001 (S.D. Tex. Sept. 25, 2025).
