A Texas federal judge has reversed parts of reorganized IT group ConvergeOne's Chapter 11 plan, saying an exclusive equity backstop opportunity given to a faction of its secured lenders violated bankruptcy's equal treatment requirements.

U.S. District Judge Andrew S. Hanen in a Thursday opinion sided with a minority group of ConvergeOne's secured lenders who argued an equity pool earmarked for a majority group of secured lenders, who backstopped an equity offering under the Chapter 11 plan, violated Section 1123(a)(4) of the Bankruptcy Code, which requires equally ranked creditors to be treated the same in bankruptcy.

Since the backstop equity deal wasn't open to all of ConvergeOne's first-lien lenders and was not market-tested, Judge Hanen wrote, it treated claims and creditors in the same class unequally.

"The plan offered a valuable and exclusive opportunity to backstop an equity rights offering for a portion of the class of creditors, but not the remaining creditors," the judge wrote, reversing portions of a confirmation order that overruled the minority group of lenders' objections.

The judge remanded the plan, which already took effect, back to the Southern District of Texas' bankruptcy court to be amended to comply with his decision.

David Hillman, a Proskauer Rose attorney who represented the minority lenders, said the ruling will impact the growing practice of liability management transactions, also called LMTs, in bankruptcy.

LMTs see a majority faction of syndicated lenders join forces to restructure existing secured debt. The out-of-court restructuring maneuver has gained steam in recent years and has also sparked so-called "creditor-on-creditor" violence, where lenders left out of the LMT, whose claims are effectively demoted, sue.

"This decision reshapes the liability management playbook. Majority lenders have increasingly demanded exclusive backstop rights in restructuring support agreements as the price of their plan support — a tactic that boosts their recovery while sidelining minority creditors," Hillman said in a statement on Friday.

"The ruling makes clear that these lucrative rights must be shared with all creditors in the same class or exposed to market competition," he continued.

On remand, Hillman said the plan could be revised to comply with Section 1123(a)(4) by reallocating the reserved equity.

Counsel for ConvergeOne declined to comment. Counsel for a group of lenders who intervened in the appeal in support of the plan did not immediately respond to a request for comment on Friday.

ConvergeOne, an international information technology firm, filed for bankruptcy in April 2024 with $1.8 billion in secured debt. It came to court with a restructuring support agreement to quickly confirm a $1.6 billion debt-for-equity swap plan. Its Chapter 11 plan was supported by 100% of its second-lien lenders and about 81% of its first-lien lenders, who were part of the RSA.

Under the plan, ConvergeOne raised $245 million in exit funding through a discounted equity rights offering. About $86 million of the discounted equity was set aside for ConvergeOne's private equity backer, as well as 81% of its first-lien lenders who were part of the RSA and agreed to backstop the new offering.

A group of first-lien lenders, holding about $164 million in claims and who were not part of the RSA, objected to the plan. They argued the exclusive equity pool would give the majority lenders better recoveries on their first-lien claims, in violation of the U.S. Bankruptcy Code.

U.S. Bankruptcy Judge Christopher M. Lopez in May 2024 overruled the objection and confirmed the plan.

The minority lenders appealed, arguing the equity backstop opportunity should have either been market-tested or been made available to all first-lien lenders.

ConvergeOne urged the district court to uphold the plan, saying while the creditors who participated in the RSA did see a higher recovery than others in the same class, the plan did not treat them differently. The creditors who backed the RSA received additional consideration for backstopping the equity offering, not for their claims, ConvergeOne argued.

Judge Hanen rejected that argument on Thursday.

The judge cited the U.S. Supreme Court's 1999 decision in Bank of America v. 203 North LaSalle Partnership , which overturned a bankruptcy plan that gave existing equity holders an exclusive chance to get ownership interests in a reorganized debtor if they invested new money.

While that ruling concerned the absolute priority rule under the Bankruptcy Code, Judge Hanen wrote the decision showed an exclusive opportunity given to one group of creditors without a market test was a property interest deriving from a creditor's claim.

The judge wrote that the minority lenders were shut out from RSA negotiations, ultimately making the backstop equity deal an exclusive opportunity for some of the creditors.

He added that neither the debtors nor the RSA lenders tried to market-test the value of the backstop equity offering, rejecting ConvergeOne's position that analyses of similar offerings and the opportunity for the minority lenders to propose a different Chapter 11 plan constituted a sufficient market test.

"While the minority lenders were permitted the opportunity to propose alternative plans, they were only given a few weeks to provide plans that would both satisfy the debtors' need to raise capital and convince the majority lenders to walk away from the beneficial deal they already had and vote for confirmation," Judge Hanen wrote.

The judge also cited the Fifth Circuit's December 2024 decision that reversed mattress maker Serta Simmons' reorganization plan over unequal treatment of creditors in the same class.

Like Serta Simmons' plan, ConvergeOne's Chapter 11 plan had an unequal effect on creditors within the same class, Judge Hanen ruled.

"While debtors in this case can argue that the plan itself treats all creditors the same, Serta rejects a surface-level or overly formalistic (or simplistic) inquiry into equality," the judge wrote.

ConvergeOne is represented by Bojan Guzina, Andrew F. O'Neill, Erin R. Rosenberg, Adam T. Swingle and Charles R. Koster of White & Case LLP.

The majority lenders are represented by John F. Higgins, Eric M. English and James A. Keefe of Porter Hedges LLP and Scott J. Greenberg, Keith R. Martorana, C. Lee Wilson and Michelle Choi of Gibson Dunn & Crutcher LLP.

The minority lenders are represented by Jason S. Brookner and William N. Drabble of Gray Reed and David M. Hillman, Michael T. Mervis and John E. Roberts of Proskauer Rose LLP.

The appeal is In re: ConvergeOne Holdings Inc., case number 4:24-cv-02001, in the U.S. District Court for the Southern District of Texas.

The bankruptcy case is In re: ConvergeOne Holdings Inc., case number 4:24-bk-90194, in the U.S. Bankruptcy Court for the Southern District of Texas.