The Ninth Circuit reversed and remanded an Oregon bankruptcy court’s order designating recently acquired claims of a secured creditor for bad faith, holding that a bad faith finding requires “something more.” Specifically, the Court found that a bankruptcy court may not designate claims for bad faith simply because (1) a creditor offers to purchase only a subset of available claims in order to block a plan of reorganization, and/or (2) blocking the plan will adversely impact the remaining creditors. Pacific Western Bank, et al. v. Fagerdala USA-Lompoc, Inc., 2018 WL 2472874 (9th Cir. 2018).

Background

In Pacific Western, a chapter 11 Debtor owned real property worth approximately US$6 million, on which Appellant, Pacific Western, held the senior secured claim. The Debtor’s plan of reorganization placed Pacific’s claim in class 1 and the general unsecured claims in class 4. Because all claims were deemed impaired, the Debtor had to obtain the consent of at least one impaired class in order to “cramdown” the plan under section 1129(a)(10) of the Bankruptcy Code. Therefore, in an effort to block the Debtor’s plan, Pacific purchased unsecured claims constituting a majority of the filed general unsecured claims in the case (the “Purchased Claims”). Importantly, Pacific did not offer to purchase all of the claims in the general unsecured class. As Pacific’s counsel testified, its client’s “motivation was to acquire…a blocking position in the unsecured class,” with the sole goal of doing “what was best for [Pacific] economically.”

Once it obtained a blocking position, Pacific voted against the Debtor’s plan and, because the Purchased Claims constituted at least “one-half in number” of the general unsecured class, Pacific’s votes were sufficient to block confirmation of the plan. In response, arguing that Pacific obtained the Purchased Claims in bad faith, the Debtor moved to “designate” the votes of the Purchased Claims under Section 1126(e). If designated, the votes would not have been counted in determining whether the plan had been accepted by the general unsecured class.

Bankruptcy Court Proceedings

The bankruptcy court granted the Debtor’s motion and subsequently approved the plan. It reasoned that designation was appropriate because otherwise Pacific “will have an unfair advantage over the unsecured creditors who did not receive a purchase offer and who hold the largest percentage of claims…in terms of amount.” The bankruptcy court reached this conclusion despite its finding that “the fact that a creditor purchases claims to take a blocking position is not, per se, bad faith.” The district court affirmed and Pacific appealed to the Ninth Circuit.

The Ninth Circuit's Opinion

The Ninth Circuit reversed and remanded, holding that a bankruptcy court may not designate claims for bad faith simply because (1) a creditor offers to purchase only a subset of available claims in order to block a plan of reorganization, and/or (2) blocking the plan will adversely impact the remaining creditors. Rather, the Ninth Circuit held, “[b]ad faith requires more.” At a minimum, there must be some evidence that a creditor is seeking “to secure some untoward advantage over other creditors for some ulterior motive.” The Court observed that “as ‘fluid’ as the concept of good faith may be, bad faith explicitly does not include ‘enlightened self interest, even if it appears selfish to those who do not benefit from it.’”

Accordingly, the Court found that the bankruptcy court erred when it “refused to analyze whether [Pacific] acted under an ‘ulterior motive,’ beyond its ‘mere enlightened self interest’ in protecting its secured claim.” The Court noted that the bankruptcy court only considered two facts: (1) Pacific did not make an offer to all unsecured creditors; and (2) if Pacific’s Purchased Claims were voted, it would “have an unfair advantage” and be “highly prejudicial” to other creditors. According to the Ninth Circuit, however, “neither of these considerations…are by themselves sufficient to support a finding of bad faith.” Therefore, the mere fact that Pacific’s declared motivation was to acquire a blocking position and that its sole purpose was to gain an economic advantage does not mean that it acted in bad faith. In contrast, the Court provided guidance on what would be considered bad faith, citing “notable examples” such as where a non-preexisting creditor “purchas[es] a claim for the purpose of blocking an action against it.”

The Court concluded that in the absence of some ulterior motive, “the mere failure to make purchase offers to all outstanding creditors does not support a bad faith finding—even if the outstanding creditors will be adversely affected by a decision to block the reorganization plan.”

Implications

The Ninth Circuit’s holding in Pacific Western sends a clear message that when reaching a bad faith finding in a designation context, a bankruptcy court must consider the creditor’s motivation. Absent any “ulterior motive,” a creditor should not be penalized for merely advancing its interests vis-à-vis the other parties of interest affected by a plan of reorganization. Creditors are therefore generally allowed to pursue a blocking position and a “selfish” economic advantage.