On April 9, 2012, the US Bankruptcy Court for the District of Delaware held in In re Tribune Company that a Chapter 11 cramdown plan of reorganization did not unfairly discriminate against a class of senior noteholders even though they did not receive the full benefit of a subordination agreement they entered into with a class of junior creditors.

At issue in this case is whether a court must consider the effect of a subordination agreement in determining whether a cramdown plan unfairly discriminates against a dissenting class under section 1129(b) of the Bankruptcy Code. Section 510(a) generally provides that subordination agreements are enforceable in bankruptcy to the same extent they are enforceable under nonbankruptcy law. However, section 1129(b) provides that a plan may be crammed down, "notwithstanding section 510(a)," if it does not unfairly discriminate with respect to each class that is impaired under, or objects to, the plan.

The Court also addressed what constitutes unfair discrimination under section 1129(b).

The senior noteholders entered into a subordination agreement with junior creditors. Under the Chapter 11 plan, however, the payments made under the subordination agreement were distributed to both the senior noteholders and general unsecured creditors, resulting in an equal distribution to both classes. The senior noteholders dissented, arguing that the plan unfairly discriminated against them because they should have been the only beneficiaries under the subordination agreement. They argued that this violated section 510(a), which generally provides that subordination agreements are enforceable in bankruptcy to the same extent they are enforceable under nonbankruptcy law.

The Court held that the phrase "notwithstanding section 510(a)" in section 1129(b) means that courts should conduct the unfair discrimination analysis without considering subordination agreements. To determine whether the Chapter 11 plan unfairly discriminated against the senior noteholders, the Court adopted the rebuttable presumption test, under which discrimination is presumptively unfair if the dissenting class receives a materially lower percentage recovery compared with similarly situated creditors. Courts have generally held that unfair discrimination exists if the percentage recovery differed by 50% or more, while no unfair discrimination exists if the difference in recoveries was 4% or less.

Because the senior noteholders and the general unsecured creditors each received an equal distribution under the plan, the Court held that there was no unfair discrimination because the plan treated these classes of equal priority creditors the same. However, it still compared the senior noteholders' recovery under the plan with and without the effect of the subordination agreement. The Court found that their recovery decreased by only 4% without enforcing the subordination agreement and therefore there was no unfair discrimination because this was not a material difference.

The senior noteholders noted that the plan essentially allowed the class of general unsecured creditors to share the benefit of the subordination agreement. This resulted in the general unsecured creditors receiving a 50% increase in their recovery, which the senior noteholders argued was materially more than the amount the general unsecured creditors would have otherwise received but for the subordination agreement. The Court denied this argument, pointing out that the unfair discrimination analysis under section 1129(b) focuses on the effect of the plan on the dissenting class only, regardless of the plan's effects on other classes.

This decision joins a line of cases which hold that subordination agreements are unenforceable in a section 1129(b) unfair discrimination analysis. However, because the Court still considered the subordination agreement and found that enforcing it would have made no material difference, it is unclear how other courts may hold if the analysis resulted in a material disparity. This case also serves as a reminder that a section 1129(b) unfair discrimination analysis will look at the effect of the plan on the dissenting class only, regardless of the plan's effect on other classes.

For more on confirmation of cramdown plans, see Chapter 11 Plan Process: Overview: Confirmation of a Plan: Cramdown Plans. For more information on subordination, see Practice Note, Bankruptcy Provisions in Intercreditor Agreements: Intercreditor Agreements as Subordination Agreements.