Unsecured Creditors and Postpetition Interest – the EFH Court’s Analysis

In part 4 of Scott Bowling’s series on the EFH rulings, Delaware Bankruptcy Court Addresses When and Whether Creditors Are Entitled to Postpetition Interest in Chapter 11, Scott discussed Judge Sontchi’s holding that the failure of a chapter 11 plan to provide postpetition interest on an unsecured claim at the contract rate (rather than the Federal Judgment Rate) does not render that claim impaired under the plan.  Judge Sontchi’s conclusion was based upon the Third Circuit precedent in In re PPI Enterprises (U.S.), Inc., which provided that payment in full of a landlord’s claim, but only as capped by section 502(b)(6) of the Bankruptcy Code, does not constitute impairment.  As a result, impairment by operation of the Bankruptcy Code, as opposed to the plan itself, does not constitute impairment within the meaning of section 1124(1) of the Bankruptcy Code.  Because the unsecured claims of EFH’s PIK Noteholders had been impaired by the operation of section 502(b)(2) of the Bankruptcy Code, which disallows claims for unmatured interest, Judge Sontchi reasoned that the PIK Noteholders had no “legal . . . rights” to postpetition interest at their contract rate and were unimpaired under section 1124(1). 

Here’s a Twist – a Debtor Trying to Appeal From Confirmation of Its Own Plan

Brenda Funk asked the question, Can a Debtor Appeal Confirmation of its own Plan? The Eighth Circuit Applies the Person-Aggrieved Doctrine.  The bottom line – maybe, but not under the facts of O&S Trucking.  During the pendency of the debtor’s appeal from a bankruptcy court order valuing a secured creditor’s claim, the debtor filed a plan of reorganization that incorporated the bankruptcy court’s order, but noted in the plan that the claim was subject to adjustment based on the pending appeal of that order. The bankruptcy court valued the secured claim based upon its previous valuation order and confirmed the debtor’s plan.  The debtor appealed from the confirmation order, but the Eighth Circuit found that the debtor lacked standing to appeal under the “person-aggrieved doctrine.”  This doctrine requires an appellant to demonstrate that the order being appealed directly and adversely affects its interests.  Although a debtor generally may not appeal from a plan confirmation order, the debtor may do when the court makes an error that is prejudicial to the debtor or when the debtor requested, but did not receive, all the relief to which it was entitled.  To take advantage of the exception, however, the debtor must object to confirmation of its own plan, which the O&S debtor failed to do.  The Eighth Circuit found that the language the debtor included in the plan regarding adjustment of the amount of the secured claim was imprecise and insufficient to meet the requirement that the debtor object to the plan to preserve the issue for appeal.

The First Shoe Drops in Delaware After Baker Botts v. ASARCO

When the Weil Bankruptcy Blog reported on the U.S. Supreme Court’s decision in Baker Botts LLP v. ASARCO, which held that the estate may not compensate professionals under section 330(a)(1) of the Bankruptcy Code for fees incurred in defending fee applications, we suggested as a potential work-around that estate professionals could seek contractual language in their engagement letters and retention orders providing that the estate would compensate the professionals for any fees associated with defending fee applications.  As Katherine Doorley reported in Bankruptcy Court Holds That Committee Professionals Cannot Contract Around Baker Botts v. ASARCO, Judge Walrath, the first Delaware bankruptcy judge to address this approach, has rejected it.  Judge Walrath rejected the argument by proposed professionals for a creditors’ committee that the bankruptcy court may approve such an indemnification provision pursuant to section 328 of the Bankruptcy Code.  Judge Walrath concluded that section 328, like section 330, was not a “specific and explicit” statute authorizing the award of defense fees to a prevailing party.  Judge Walrath also rejected the argument that the Supreme Court in Baker Botts expressly recognized the possibility of a contractual exception to the American Rule.  Judge Walrath agreed that the Baker Botts decision acknowledged a contractual exception to the American Rule, but nonetheless determined that any such contract was required to be consistent with the other provisions of the Bankruptcy Code.  In doing so, the court reasoned that, although the retention agreement was a contract between two parties (the Committee and the Committee’s counsel), in the event counsel won a challenge to their fees, a third party (the estate) would pay the fee defense costs, even if the estate is not the party objecting.

This is but the first shoe to drop in Delaware, and soon we will be publishing an entry discussing another Delaware bankruptcy judge’s approach to the issue.  [Spoiler alert:  So far, the Delaware court does not seem to be terribly sympathetic to the plight of retained professionals.]

SDNY Bankruptcy Court Rejects Use of Involuntary Filing to Enforce Creditor’s Claim

It seems as if involuntary filings are becoming an increasingly popular litigation strategy, but Hannah Geller discussed one situation in which that strategy did not succeed in Southern District Bankruptcy Court Dismisses for Cause Involuntary Bankruptcy Filed By Single Creditor for Purpose of Enforcing a Debt in a Two-Party Dispute.  In that case, Judge Gerber held that the use of an involuntary chapter 7 bankruptcy filing as an enforcement tool by a law firm seeking to recover a judgment against an individual was improper and dismissed the filing for cause under section 707(a) of the Bankruptcy Code.  The law firm commenced the involuntary because, under section 363(h) of the Bankruptcy Code, a chapter 7 trustee could sell the debtor’s apartment in its entirety and not just the debtor’s 50% interest in the apartment that he shared with his wife.  The debtor had no other creditors and sought dismissal of the case for cause.  Judge Gerber agreed, noting that “just as ‘the bankruptcy court is not a collection agency,’ bankruptcy is not a judgment enforcement device.’” The court dismissed the petition, leaving the law firm and its judgment debtor to sort out their differences under state law.

Clever Classification or Artificial Impairment?  The Sixth Circuit Weighs in

Jessica Diab addressed when a plan proponent crosses the fine line separating strategic classification decisions and improper classification as a result of artificial impairment in The Sixth Circuit’s Take on Artificial Impairment.  The case, as it often does, involved a single asset real estate debtor with a grand total of three creditors:  its undersecured mortgage lender, its former accountant, and its former lawyer.  The debtor’s plan proposed to classify its lender’s deficiency claim separately from those of the two other unsecured creditors.  Whereas the lender’s unsecured claim would be paid in full with interest over ten years (and a significant balloon payment at maturity), the other two creditors would be paid in full within 60 days after the plan’s effective date.  The Sixth Circuit held that a debtor’s motives regarding impairment, including considerations of whether a class of creditors has been artificially impaired for the purposes of contriving an impaired accepting class, are appropriately addressed under the requirement in section 1129(a)(3) of the Bankruptcy Code that a plan be proposed in good faith and not necessarily classification.  The Sixth Circuit determined that the debtor’s plan was not proposed in good faith, especially given that the debtor’s own projections showed that it would have generated enough cash to pay the lawyer and accountant in full on the effective date.  Moreover, the close alliances between the debtor, on the one hand, and its accountant and lawyer, on the other hand, as well as these creditors’ rejection of the lender’s offer to pay them in full, suggested that certain bad faith acts had occurred between the debtor and these creditors in an effort to circumvent the purposes of section 1129(a)(10).

Subordination Under Section 510(c) When the Debtor May Be Liable for Claims Relating to an Affiliate’s Securities

In Don’t Go Chasing (Debtor-Affiliate) Waterfalls: Second Circuit Applies 510(b) Subordination to Contribution Claims Arising from the Securities of an Affiliate of a Debtor, Adam Lavine explained the Second Circuit’s recent decision stemming from the Lehman Brothers, Inc. (“LBI”) liquidation.  In the decision, the Second Circuit held that contribution claims arising from the purchase and sale of a security of an affiliate of the debtor can and should be subordinated under section 510(b) of the Bankruptcy Code.  The claimants in the case had been co-underwriters with LBI for certain notes issued by another Lehman debtor.  They sought reimbursement from LBI for defense and other costs that they claimed they incurred when the investors in the notes commenced lawsuits against them.  The claimants argued that, because their claims were for contribution and not actually “represented” by the underlying securities, section 510(b) should not apply.  In upholding the lower courts’ decisions subordinating the claims, the Second Circuit focused on the type of security at issue to determine the effect of the subordination (e.g., subordinated or unsubordinated), and not on whether claims exist within the case based on the specific security issued by the affiliate.