In a case that should cause lenders heartburn, the United States District Court for the Western District of North Carolina recently ruled that common provisions in a Chapter 11 plan prevented the debtor’s lender from executing on a judgment against the non-debtor owner of the debtor.1 Biltmore is a corporation2 that operates manufactured home parks and sells and rents manufactured homes. McGee is the president and controlling shareholder of Biltmore. Biltmore filed Chapter 11 in January of 2011, and TD Bank was Biltmore’s largest secured creditor. In November of 2012 Biltmore filed its Chapter 11 plan which contained standard retention of jurisdiction provisions and stated that the shareholders and management, including McGee, would remain in place after confirmation. TD Bank filed an objection to confirmation of the plan on feasibility and fair and equitable grounds. The plan was confirmed in April of 2012 over TD Bank’s objection, and TD Bank did not appeal the confirmation.

In July of 2012 TD Bank obtained a judgment against McGee for more than $2.5 million in state court and proceeded to execute on the judgment, including requesting the state court to “set a hearing for Biltmore Investments to respond regarding the assets of Mr. McGee that it held – particularly the number of shares of stock in the name of Walter T. McGee” and to require McGee and Biltmore to refrain from transferring any McGee-owned stock until a hearing could be held. Biltmore contended that the automatic stay of §362 of the Bankruptcy Code prohibited granting TD Bank’s requested relief. TD Bank then filed a motion with the bankruptcy court requesting an order clarifying that the §362 stay did not apply to McGee or his Biltmore stock.

The bankruptcy court concluded that the §362 stay did not apply because the stay only covers property of the estate and McGee’s stock is not an asset of Biltmore. The bankruptcy court declined to issue an order imposing a stay under §105 of the Bankruptcy Code. The District Court reversed, concluding that the facts met the “unusual circumstances” test of A.H. Robins Co. v. Piccinin,3 finding “such identity between the debtor and the third party defendant that the debtor may be said to be the real party defendant and a judgment against the third party defendant will in effect be a judgment against the debtor.” The court concluded that TD Bank’s actions amounted to an action to obtain possession of, or exercise control over, property of the debtor’s bankruptcy estate (McGee’s stock) which is, in effect, an action against the debtor. The court found that if TD Bank’s collection efforts resulted in a sale of the Biltmore stock, a third party purchaser might not act in the best interests of Biltmore by failing to comply with the terms of the plan or liquidating the company. The District Court concluded that stay protection is needed to accomplish Biltmore’s reorganization.

It appears that neither court noticed that the automatic stay of §362 terminated on confirmation of the plan4 and was replaced by the injunction created by §524(a). In addition, McGee’s stock would not generally be considered property of the Biltmore estate which was divested of all property on confirmation of the plan.5It can also be questioned whether the routine plan provisions noted by the District Court regarding jurisdiction and retention of management rises to the level of “unusual circumstances” contemplated byRobins since those circumstances exist in many Chapter 11 reorganizations. Finally, the potential “harm” which the District Court noted (a potential stock sale to a party that might violate the plan) is just conjecture and does not appear to provide justification for the ruling. Perhaps the District Court was influenced by the equities of this case since it appears that the plan provided for eventual full payment of all creditors and the bankruptcy court had required additional protections for TD Bank and other creditors regarding the use by Biltmore of an unanticipated $1.3 million recovery from litigation.

Attorneys for debtors should keep this ruling handy to fend off litigation against officers and directors, and lenders should prepare themselves to counter this extension of the Robins “unusual circumstances” doctrine.