Page 110 - Bankruptcy Volume 1

becomes solvent as a result of an out-of-court workout, the income it realizes from the cancellation of
debt is taxable. In contrast, in Chapter 11, the debtor frequently can avoid taxes on gains resulting from
the cancellation of debt.

Nonetheless, a pre-negotiated plan has several disadvantages as compared to a prepackaged plan. First, a
pre-negotiated plan typically requires the debtor to remain in bankruptcy longer than a prepackaged
plan. Second, although the substantive negotiation of the reorganization is concluded prepetition, the
formal solicitation of votes in a pre-negotiated case does not occur until after the debtor commences its
Chapter 11 case. Therefore, the debtor must comply with all of the Bankruptcy Code’s requirements
governing disclosure and solicitation, which can be more onerous and time-consuming. Third, because
solicitation of votes for a pre-negotiated plan of reorganization does not occur until the debtor has en-
tered Chapter 11, the debtor cannot be certain that it has sufficient votes in favor of its plan at the time
its Chapter 11 case commences. In contrast, in a prepackaged case, the debtor solicits votes in favor of
its plan before commencing the Chapter 11 case and therefore can be reasonably assured that it has
enough votes to confirm the plan at the time the case begins.

Exchange Offers

A reorganization often involves an "exchange offer" — the exchange of one security for another. For
example, debt holders may receive equity in the reorganized entity in exchange for their claims against
the estate in what is known as a "debt-for-equity swap." Similarly, a debt holder may exchange its exist-
ing debt securities for debt securities bearing different terms, for instance, a later maturity date. This is a
"debt-for-debt exchange." In an exchange offer, the debtor typically offers additional consideration to
the exchanging security holders, often in the form of equity or equity derivatives. An exchange offer can
be structured as an independent, out-of-court restructuring alternative, or (as discussed in following text)
it can be combined with a prepackaged plan of reorganization.

Whatever the precise form of the exchange offer, attention must be given to its treatment under the secu-
rities laws. Securities regulations generally treat exchange offers in one of several different ways, in-
cluding a registered exchange offer, a Section 3(a)(9) exchange offer, and a Section 4(2) private ex-
change.

A registered exchange offer constitutes an "offer" and "sale" under federal securities regulations. The is-
suer must comply with the registration requirements of Section 5 of the Securities Act of 1933 and asso-
ciated tender offer rules. Of the various forms of exchange offers, the registered exchange offer reaches
the widest audience, including shareholders. New securities are freely tradable. Prepackaged plans of re-
organization frequently involve registered exchange offers.

A Section 3(a)(9) exchange offer occurs when the issuer exchanges new securities for its own existing
securities (or its existing securities plus cash). Existing security holders may not provide any considera-
tion other than the surrender of old securities. The securities retain the same character before and after
the exchange — that is, restricted or freely tradable.

A Section 4(2) exchange offer is an offer that is restricted to qualified offerees — accredited investors or
qualified institutional buyers. The issuer may not offer the securities by general solicitation. Newly is-
sued securities may not be resold without first being registered.

A debtor designing a prepackaged plan of reorganization generally will assess the following considera-
tions relevant to the treatment of the plan under the relevant securities regulations: Will the offer be
open to all holders of the subject class, or only a subset? Will the company offer inducements to partici-

108 © 2020 Association of International Certified Professional Accountants