Vol 8 (2011) - Issue 3

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Sprint Nextel Corp. v DBSD North America Inc.: The Second Circuit Rejects Plan’s Use of the Gifting Exception to the Absolute Priority Rule and Upholds Designation of Strategic Investor’s Votes

Introduction

One of the cornerstones of the United States Bankruptcy Code is equality of distribution to similarly situated creditors. This objective leads to negotiation, creative settlements and free enterprise among interested parties with the goal of maximising value to creditors within the Bankruptcy Code’s framework. To further this purpose, bankruptcy courts are courts of equity enjoying significant flexibility to promote consensual resolutions among competing interests. As a result, despite often contentious gamesmanship among various factions, parties frequently reach compromises enabling debtors to reorganise and emerge quickly from bankruptcy. And often when a debtor and all of its creditor constituencies agree to support a consensual plan, a bankruptcy court will defer to the business judgment of the debtor and the willingness of the debtor’s claim and interest holders to cooperate.

But as capital structures have become more complex and the market for trading claims has become more robust across such capital structures, it has become increasingly more challenging to consensually resolve the various layers and divergent interests in a manner that satisfies all interested parties and complies with the Bankruptcy Code’s statutory requirements for plan confirmation. In these circumstances, debtors are often left with no choice but to garner support from, and create a strategy with, some parties and fight it out with the rest. In this regard, the bankruptcy of DBSD North America, Incorporated, and its various subsidiaries (‘DBSD’) has many elements present in the post-economic meltdown bankruptcy era: a debtor with a valuable asset, a plan supported by certain parties, a sidedeal between two classes, a game-changing debt trade attracting other interested parties and forcing initial bids significantly higher.

DBSD’s fate is a common story. Taking advantage of a strong lending market, it significantly leveraged its assets. In early 2008, DBSD borrowed USD 40 million under a revolving credit facility (the ‘First Lien Debt’) and USD 650 million in 7.5% convertible senior secured notes (the ‘Second Lien Debt’). Then, in addition to this substantial leverage, an unfavourable decision by the Federal Communications Commission (‘FCC’) in the litigation between DBSD and Sprint Nextel Corporation (‘Sprint’) regarding a 2004 arrangement with the FCC to clear a spectrum band threatened DBSD with a possible USD 300 million – 1.9 million judgment. Like many others, DBSD was unable to sustain its debt level long enough to become operational. Coupled with the Sprint litigation, bankruptcy became inevitable.

Shortly before the bankruptcy in an attempt to maximise the chance of an organised and consensual proceeding, DBSD negotiated with and entered a plan support agreement with some, but not all, of its key constituents. The plan support agreement obligated the parties thereto, DBSD, a majority of the holders of the Second Lien Debt and ICO, to support a plan that would replace the First Lien Debt with a new credit agreement and distribute the equity of the reorganised DBSD to claimants under the Plan. The holders of the Second Lien Debt would receive approximately 95% of the new equity, the general unsecured creditors would receive approximately 0.15% and DBSD’s existing shareholders would receive approximately 4.99%. Importantly, the holders of the Second Lien Debt that executed the plan support agreement agreed to give part of their recovery to equity under a seemingly well-established doctrine and practice of gifting. This doctrine presents an exception around the absolute priority rule, which requires that all creditors be paid in full before equity holders receive anything. The doctrine would be applicable under this Plan as the Second Lien Debt and the general unsecured creditors would not be paid in full, but equity would receive a large portion of the reorganised DBSD.