On December 21, 2009, in the DBSD North America, Inc. chapter 11 case, Bankruptcy Judge Robert Gerber (Southern District of New York) designated the voting rights of DISH Network Corporation (“DISH”), a creditor, for lacking good faith and disqualified its “no” vote on the DBSD Chapter 11 plan. In the Court’s view, DISH did not purchase and vote the claims to recover on the claims, per se, but in an effort to defeat confirmation of the plan so it could gain control of DBSD’s assets.
DBSD (the “Debtor”) is in the business of developing wireless satellite communication services. DISH is a major investor in a competitor of the Debtor. Internal documents of DISH, obtained through discovery, explain DISH’s desire to purchase claims in the Debtor in order to “establish control of this strategic asset [(i.e., DBSD)]”.
DISH first purchased second lien debt claims against the Debtor that were not subject to a plan support lock-up. DISH purchased these claims after DBSD had proposed its plan. DISH then purchased first lien claims against the Debtor and required the sellers to object to the DBSD plan. After the objections and prior to a vote on the plan, DBSD amended the plan; however, DISH voted against the amended plan with all its acquired claims. The Debtor then filed a motion to designate (i.e., disqualify) DISH’s votes. Prior to the designation hearing, DISH proposed its own plan, which would give DISH control of the reorganized company.1
Under section 1126(e) of the Bankruptcy Code, the court can disqualify votes if the creditor lacks good faith (or displays bad faith) in voting its claims. “Badges” of bad faith that have justified disqualification include efforts to: (1) assume control of the debtor; (2) put the debtor out of business or otherwise gain a competitive advantage; (3) destroy the debtor out of pure malice; or (4) obtain benefits available under a private agreement with a third party which depends on the debtor’s failure to reorganize.
In DBSD, the Court held that in voting its claims to get control of the Debtor, not to recover on its claims like an ordinary creditor, DISH crossed the line. The Court relied upon the disqualification doctrine expressed in In re Allegheny Int’l, Inc., 118 B.R. 282 (Bankr. W.D. Pa. 1990) (“Allegheny”). Similar to the disqualified creditor in Allegheny, DISH purchased debt at a price that was not justified by the Debtor’s plan and prospects. Also, DISH purchased only those second lien claims that were not subject to a plan support agreement. And, the purchases were made after the Debtor had proposed its plan. The Court determined that DISH voluntarily became a creditor, knowing the proposed plan treatment of the claims did not justify the purchases and, therefore, purchased the claims not to maximize the return on its claims but to advance an ulterior motive. This determination was supported by discovered documents from DISH that established its purpose in acquiring and voting the claims.
Strategic buying of claims to gain a controlling stake in a reorganized debtor is not uncommon. However, the DBSD court was troubled by what it viewed as a brazen and abusive attempt at a hostile M&A transaction. DBSD is a warning to strategic distressed investors about the risks in the process. It also lays out some guideposts that can instruct efforts at a hostile control transaction in bankruptcy.
The DBSD decision is on appeal and we will be monitoring it.
If you would like to discuss these issues, please contact one of the attorneys listed below.
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1 See Appellee’s Brief, In re DBSD, Inc. (Case no. 09-10372, Doc. No. 209).
