Federal Court limits LME tactic in Chapter 11 context: ConvergeOne Holdings

U.S. District Court for the Southern District of Texas decision

On September 25, 2025, Judge Andrew Hanen of the United States District Court for the Southern District of Texas reversed the bankruptcy court’s confirmation of ConvergeOne Holdings Inc.’s prepackaged Chapter 11 plan. The ruling centered on the plan’s exclusive equity issuance backstop rights granted to a subset of majority lenders, which resulted in materially higher recoveries—approximately 30% more—than those available to similarly situated minority lenders. The Court found this arrangement violated Section 1123(a)(4) of the Bankruptcy Code, which mandates equal treatment for claims within the same class.

The Court’s reasoning

The Court’s decision hinged on several key points:

• The backstop rights were granted exclusively to the subset of majority lenders in the context of their support for the reorganization plan
• The minority lenders were affirmatively excluded from negotiations and participation
• The backstop rights were not subjected to a market test (meaning that there was no objective process used to determine whether the value accorded to the select group of backstop lenders was fair)

Weighing these factors, the Court reached the conclusion that the select lenders received an exclusive opportunity to provide the backstop which provided them with extra value, but those lenders did not provide any new value in exchange for that exclusive opportunity. The Court rejected the majority lenders’ justification that minority lenders had the opportunity to propose an alternative plan (which they argued would mean both that the minority lenders were not excluded from the process and that the process included an implicit market test). In the context of a fast-track prepackaged case with requisite plan votes in hand at the time the case was filed, the Court concluded that there was no meaningful alternative opportunity for minority lenders (stating that “the train had already left the station….”).

The Court concluded that this violated Section 1123(a)(4) of the Bankruptcy Code because certain similarly situated creditors were being treated differently from (and better than) others. In doing so, the Court looked to the Supreme Court’s decision in Bank of America National Trust & Savings Association v. 203 N LaSalle St. Partnership, 526 U.S. 434 (1999), and the Fifth Circuit’s recent decision in In re Serta Simmons Bedding, LLC, 125 F.4th 555 (5th Cir. 2024).

The Court contrasted this arrangement with the transaction upheld by the 2019 decision of the United States Court of Appeals for the Eighth Circuit rendered in the Peabody Energy Chapter 11 case. There, the Eighth Circuit reasoned in Peabody Energy that the favorable treatment for participating creditors was not on account of their existing claims but instead constituted compensation for distinct new commitments, such as assuming risk in the backstop arrangement. However, Judge Hanen distinguished Peabody Energy, concluding that unlike the situation in ConvergeOne, in Peabody Energy, the preferred creditors had to provide additional consideration to obtain the benefits in question, and all similarly situated creditors had the opportunity to participate.

Key takeaway: Heightened risk for exclusive rights LMEs implemented through Chapter 11

• Sponsors and majority lenders often attempt to provide greater benefits to select creditor groups in a restructuring where they believe contractual arrangements do not restrict such terms
• However, for restructurings to be implemented via a Chapter 11 process as opposed to out of court, the Bankruptcy Code itself may pose an additional restriction on such arrangements if not structured properly
• Chapter 11 may render exclusive benefits for select creditors impermissible
• Market testing and incorporation of new consideration in exchange for the exclusive benefits may be a path forward
• Such transactions may be more permissible with extended Chapter 11 timelines that permit alternate proposals versus prepacked plans

Authored by Ronald Silverman, David Simonds, and Matthew Schernecke.