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'Redemption Option Value'
On Dec. 8, 2014, the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 (the Commission) issued its 2012-2014 Final Report and Recommendations (the Report) proposing numerous changes to Chapter 11 of the Bankruptcy Code (the Code). This article focuses on the Commission's proposal to compel senior creditors to pay a mandatory “tax,” or so-called “redemption option value” (ROV), to junior stakeholders. Simply put, this proposal, if enacted, would force senior creditors to give a portion of the value of their collateral to out-of-the-money stakeholders even if the senior creditors are not being paid in full. The proposal is a significant departure from fundamental bankruptcy principles, including the “absolute priority rule,” and would in many cases impair the expected recoveries of secured creditors.
What Is the ROV Proposal Generally?
Senior creditors would be required to share a portion of their distributions from the debtor's estate, whether received under a plan or in connection with a sale of substantially all of the debtor's assets (referred to as a Section 363x sale), with certain junior stakeholders, regardless of whether the senior creditors are paid in full. The amount senior creditors would be required to share would be based on the value of a hypothetical option to acquire the company within a reasonable period of time after the effective date of a Chapter 11 plan or a Section 363x sale order. Report, at 218. The proposal also includes certain elements designed to discourage junior stakeholders from litigating the value of the debtor's business. Report, at 209.
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