The Hidden Cost of a Roll-Up: Why Claim Classification Can Decide Chapter 11 Plan Confirmation

In Chapter 11, classification is sometimes treated as a technical exercise that comes late in the plan process. But how claims are classified determines who votes, whose acceptance counts, whether a debtor can satisfy the requirements for confirmation and how much leverage a creditor has in negotiating a plan. Judge Christopher M. Lopez’s recent First Brands ruling in the Southern District of Texas illustrates why the issue should be considered at the beginning of a case: a roll-up of prepetition secured debt into debtor-in-possession financing can provide valuable priority protections but, depending on how the DIP order is structured, may come at the cost of the lenders’ ability to vote that debt as an impaired class under a Chapter 11 plan. In other words, a roll-up can be a double-edged sword.

Classification Is More Than an Organizational Exercise

Chapter 11 operates through classes. A plan separates creditors and equity holders into classes based upon their legal rights, provides treatment for those classes, and, where applicable, solicits votes from impaired classes.

Section 1129(a)(10) requires, when a plan contains impaired classes, acceptance by at least one impaired class of claims, determined without including the acceptance of insiders. That requirement often becomes especially important in difficult cases where a debtor expects to confirm a plan through cramdown under section 1129(b).

A debtor therefore cannot simply ask whether enough creditors support the deal economically. It must ask whether the support comes from a class that the Bankruptcy Code recognizes as a proper voting class.

The proposed plan separately treated the DIP lenders’ approximately $3.3 billion of roll-up claims and their remaining new-money DIP claims. The roll-up claims were placed in a class, deemed impaired, and permitted to vote, while the other DIP claims were not classified.

For most debtors, the plan had multiple impaired accepting classes. Two debtors, however, were different. At First Brands Group Holdings and Viceroy Private Capital, LLC, the only impaired accepting class was the class consisting of the DIP roll-up claims. The other voting class had rejected the plan.

Thus, the classification of the roll-up claims was not merely a drafting issue. For Holdings and Viceroy, it determined whether the plan could satisfy section 1129(a)(10).

The Roll-Up Bargain

Roll-ups have become a familiar feature of large Chapter 11 DIP financings.

In the basic structure, some portion of a lender’s prepetition debt is “rolled” into the postpetition DIP facility. From the lender’s perspective, the attraction is obvious. Instead of continuing to hold only prepetition secured claims, the lender receives the benefits associated with court-approved DIP financing, often including administrative expense status, superpriority treatment, enhanced liens, and other protections authorized by the financing order.

The First Brands DIP order did precisely that. Judge Lopez found that the roll-up obligations had been transformed into DIP obligations and expressly granted administrative expense treatment under section 503 and superpriority status.

The lenders therefore obtained what roll-ups are designed to provide: elevated priority.

But that elevation had an unintended consequence.

Administrative Priority Comes With a Voting Cost

The Bankruptcy Code treats administrative expense claims differently from ordinary prepetition claims.

Section 1123(a)(1) requires a plan to designate classes of claims, but expressly excludes certain priority claims, including administrative expenses under section 507(a)(2), from plan classification. Administrative claims instead receive the statutory treatment prescribed by the Code, generally payment in full in cash on the effective date unless the holder agrees to different treatment.

That structure matters for voting.

Judge Lopez concluded that because the roll-up claims had become postpetition administrative expense claims, they could not also function as an impaired voting class. He reasoned that administrative expense claims are excluded from plan classification and receive their statutory treatment without voting, and that an administrative creditor’s agreement to receive different treatment does not transform the claim into a voting claim.

The court therefore rejected the attempt to use the roll-up class to satisfy section 1129(a)(10).

That conclusion captures the central tradeoff for prepetition lenders considering a roll-up:
To the extent a DIP order exchanges prepetition debt for postpetition administrative expense obligations, improving the debt’s priority may eliminate the prepetition claim that otherwise could have been classified, impaired and voted.

A DIP Order Cannot Rewrite the Confirmation Requirements

The First Brands lenders had another argument. The final DIP order itself contemplated that the roll-up claims could be classified and voted.

Judge Lopez held that this was not enough.

The relevant DIP-order provision could restrict the DIP lenders’ own ability to object to specified treatment, but it could not decide in advance whether the resulting class satisfied section 1129(a)(10). Confirmation remains governed by the Bankruptcy Code, regardless of what the parties negotiated at the DIP financing stage.

That aspect of the ruling is particularly significant for practitioners.

DIP orders are frequently negotiated under enormous time pressure at the beginning of a case. They allocate liens, priorities, adequate protection, milestones, repayment obligations, waivers, and numerous other rights that can substantially shape the remainder of the restructuring.

But there are limits. Parties cannot use a DIP order to predetermine whether a future Chapter 11 plan satisfies statutory confirmation requirements. The financing order may govern the lender’s rights, but it cannot manufacture a qualifying impaired accepting class if the Bankruptcy Code does not recognize the underlying claims as claims entitled to classification and voting.

The Consequence in First Brands

The consequence was significant.

Once the roll-up votes were removed from the calculation, First Brands Group Holdings and Viceroy had no impaired accepting class. Their only other voting class had rejected the plan. Accordingly, those debtors could not satisfy section 1129(a)(10).

The court was careful to distinguish the problem from a defect in solicitation generally. Judge Lopez found that notice, solicitation, and voting procedures were proper. The problem was narrower and more fundamental: the roll-up claims were not legally entitled to serve as the impaired accepting class the plan needed.

The Strategic Lesson: Plan the Classification Before You Need the Vote

The lesson is not that lenders should avoid roll-ups. Roll-ups can provide substantial economic benefits and may be an important component of the financing necessary to preserve enterprise value during Chapter 11. The lesson is that classification should be part of restructuring strategy from the beginning of the case.

A lender considering a roll-up should ask not only:
How much additional priority and protection will the roll-up provide?

It should also ask:
What claim will I have left to vote?

If the lender rolls its entire prepetition position into a DIP facility and that resulting obligation is granted administrative expense status, the lender may have improved its payment priority while simultaneously surrendering a potentially important source of plan voting leverage.

That may not matter if there are other impaired accepting creditor classes. But it can matter enormously in a closely contested restructuring, particularly where the debtor expects to rely on cramdown or where the senior lenders are the principal constituency supporting the proposed plan.

A partial roll-up may therefore have different strategic consequences from a complete roll-up. Lenders and debtors should identify early whether other legitimate impaired classes are expected to exist and whether those classes are likely to support a contemplated restructuring. A debtor contemplating a plan should also understand which obligations will become administrative or priority claims; which claims are substantially similar and may properly be classified together; which classes are expected to be impaired; which impaired classes are actually entitled to vote; and, most importantly, whether at least one non-insider impaired class is realistically expected to accept the plan.

This analysis should take place when the DIP facility is negotiated, not months later when ballots are being counted. For debtors and lenders alike, the safest approach is to treat classification, financing, and confirmation as parts of a single restructuring strategy. A DIP financing decision made on the first day of a Chapter 11 case can determine who has a vote on the last.