On Aug. 4, 2015, in City of Concord, New Hampshire v. Northern New England Telephone Operations LLC (In re Northern New England Telephone Operations LLC), No. 14-3381 (2nd Cir. Aug. 4, 2015), the U.S. Court of Appeals for the Second Circuit addressed the circumstances under which a creditor's lien on the property of a debtor may be extinguished through a Chapter 11 plan of reorganization. In explaining how liens must be "dealt with" pursuant to a plan in order to be extinguished thereby, the court employed a four-part test to determine whether a creditor's liens are extinguished, or whether they pass through the bankruptcy unaffected. This case provides important guidance for creditors on how best to protect their liens on a debtor's assets, given that the traditional rule—that liens pass through bankruptcy cases unaffected—has been modified by the U.S. Bankruptcy Code.

Facts

The city of Concord, New Hampshire, a creditor in the bankruptcy case of Northern New England Telephone Operations LLC, filed timely proofs of claim for property taxes owed by the debtor for the first two quarters of the 2009 tax year. These taxes had been billed by the city before the debtor filed for bankruptcy protection. The city did not file proofs of claim in the bankruptcy case for the latter two quarters of the same tax year: amounts for those two quarters were billed during the pendency of the bankruptcy case. Pursuant to New Hampshire law, a single tax lien against the taxpayer's real property secured the taxpayer's indebtedness for all property taxes billed in one tax year with respect to the property in question, meaning that the city had a lien on the debtor's property for both the taxes that were subject of the proofs of claim, and those that were not.

After filing its claims, the city did not further significantly participate in the debtor's bankruptcy case. In January 2011, the bankruptcy court confirmed a plan of reorganization, which provided that all of the debtor's property was "free and clear" of all creditors' interests. The bankruptcy court ultimately allowed the city's claims for the taxes due in the first two quarters of the 2009 tax year. However, because the city had not filed claims for the taxes due in the second two quarters of the 2009 tax year, the city filed a motion seeking payment of those amounts in October 2013, nearly two years after plan confirmation. In its motion, the city argued that its claims for the second two quarters of the 2009 tax year were secured by a lien that had not been discharged as part of the confirmed plan. The debtor objected to the motion, arguing that the lien had been extinguished upon confirmation of the plan, pursuant to the provision of the plan that provided that all of the debtor's property would be free and clear of creditors' interests.

Bankruptcy Court Ruling; Parties' Arguments on Appeal

The bankruptcy court agreed with the debtor, and found that the city's lien had been extinguished by the plan. The city appealed to the district court, which affirmed the bankruptcy court's ruling. The city appealed again to the Second Circuit, arguing that, among other things: (1) pursuant to Section 1141(c) of the Bankruptcy Code, a plan only extinguishes a lien if the plan "deals with" the lien, and that the city's lien was not specifically addressed by the plan; (2) a lien may only be extinguished under Section 1141(c) if the creditor "participated" in the bankruptcy case, and the city's level of participation was insufficient to support extinguishment of the lien; (3) equitable considerations required recognition of the city's lien; and (4) the principle of excusable neglect required the court to accept the city's untimely assertion of the lien.

The debtor relied on the terms of the confirmed plan to argue that the city's liens were extinguished by the plan's express terms. The debtor argued that the city had "participated" in the bankruptcy case by filing proofs of claim for the property taxes due in the first two quarters of the 2009 tax year and, therefore, the city's liens had been properly extinguished by the plan pursuant to Section 1141(c) of the Bankruptcy Code.

The Court's Analysis

The Second Circuit started by analyzing the longstanding "background rule" in bankruptcy cases that "liens pass through bankruptcy unaffected." As noted by the court, the enactment of the Bankruptcy Code leaves that general principal intact, but includes a caveat in Section 1141(c). That section provides that unless the subject property is otherwise addressed in a plan, after plan confirmation, property "dealt with" by the plan will be free and clear of all claims and interests of creditors. While Section 1141(c) does not specifically address liens, courts have consistently held that "interests of creditors" includes liens. Accordingly, pursuant to the plain language of Section 1141(c), a lien may be extinguished pursuant to a plan where: (1) neither the plan nor the conformation order preserve the lien; (2) the plan is confirmed; and (3) the property subject to the lien is "dealt with" by the plan.

The appellate court went on to review case law from other jurisdictions related to Section 1141(c) and found that many other courts impose a fourth requirement for lien extinguishment, namely that the lien creditor had "participated" in the bankruptcy case. The court found this requirement consistent with the language of Section 1141(c), and indicated that the property subject to a lien could not be adequately "dealt with" in accordance with that section unless the lienholder had participated in the bankruptcy case. With these four requirements in mind, the court analyzed whether the city's lien could have been properly extinguished by the debtor's plan.

It was undisputed by the parties that the plan had been confirmed, and that neither the plan nor the confirmation order preserved the lien; therefore, the first two requirements for extinguishment had been satisfied. The city argued that neither of the two remaining requirements was satisfied, however, because the debtor's plan did not sufficiently deal with the property subject to its lien, and the city had not participated in the debtor's bankruptcy case to an extent sufficient to meet the fourth condition of extinguishment.

The court disagreed on both points, noting that the plan's blanket statement that "all property of the debtor shall be free and clear of liens" was enough to justify extinguishment. The court found that the term "all property" was clear, and that it would be infeasible and administratively burdensome to require debtors to list each and every piece of property that they own for extinguishment to be valid under Section 1141(c). Additionally, the court found that the city's level of participation in the case was sufficient enough to allow for extinguishment, even though the city's participation was not related to the claims now being asserted by the city, or to the lien securing them. Essentially, the court found that by filing claims for the first two quarters of the 2009 tax year, the city had sufficiently participated in the bankruptcy case to allow its lien to be extinguished pursuant to the plan.

The court also summarily rejected the city's other arguments as to why the lien should not have been extinguished pursuant to the plan, holding that the equities in this case did not favor either the city or the debtor, and therefore did not support the city's position, and that the bankruptcy court had not abused its broad discretion in refusing to find that the city's failure to file a claim for the second two quarters of the 2009 tax year constituted excusable neglect.

Protect Client's Interests

The lesson to be learned from Concord is that if, on behalf of a creditor, counsel intends to file claims or otherwise participate in a bankruptcy case, counsel must proactively protect the client's interests in every aspect of the case. Simply filing claims and hoping for the best is not an option: counsel must review the plan documents (especially if the client is a lienholder), ensure that the client's interests are protected, and keep the client apprised of the progress of the case. In short, counsel should live by the maxim that "bankruptcy is not a spectator sport."

This article originally appeared in The Legal Intelligencer and is republished here with permission from law.com.