In re Adelphia Communications Corp.,1 the United States Bankruptcy Court for the Southern District of New York recently held that neither a creditor’s aggressive litigation tactics resulting in the creditor’s prospective receipt under a proposed plan of special consideration for voting in favor of the plan, which special consideration other members of the same class that voted against the plan would not obtain, nor the creditor’s ownership of claims in several debtors, in a multi-debtor Chapter 11 case, was a sufficient basis for the “draconian sanction” of disallowing such creditor’s votes to accept a plan.

Background

Adelphia Communications Corporation (“ACC”) and its subsidiaries (together, the “Debtors”), including Arahova Communications Corporation (“Arahova”), an indirect Adelphia subsidiary,2 recently completed distributions to creditors pursuant to their Modified Fifth Amended Joint Chapter 11 Plan of Reorganization, which was confirmed in what has been characterized as one of the most complex Chapter 11 bankruptcy cases in United States history. The bankruptcy judge overseeing the case, Judge Robert E. Gerber of the United States Bankruptcy Court for the Southern District of New York, considered the case “among the most challenging—and contentious—in bankruptcy history.” Contributing to the complexity and contentiousness of the case was the inter-creditor dispute between the holders of ACC Senior Notes and the holders of Arahova Notes. The inter-creditor dispute between these parties was especially acrimonious since, in nearly all respects, any increase in the recovery on the Arahova Notes could be obtained only at the expense of a decreased recovery on the ACC Senior Notes, and vice versa.

The ongoing dispute between the opposing creditor constituencies boiled over during the plan solicitation process when a group of holders of ACC Senior Notes (the “ACC Bondholders Group”) brought a motion to designate (disqualify) the votes of three creditor groups (the “Targeted Creditors”)3 that held and voted claims in both the ACC and Arahova bankruptcy cases. A central feature of the Debtors’ plan of reorganization was the settlement of disputes relating to the intercompany relationships among the Debtors. The plan also included provisions for fee reimbursements, exculpation and releases (the “benefits”) for the Targeted Creditors accepting the plan4 and for the same releases to go to any and all holders of ACC Senior Notes that supported the plan. The Targeted Creditors voted all of their claims, including any ACC claims, in support of the Plan. The ACC Bondholders Group vehemently opposed the plan and the underlying settlement and, thus, voted against the Plan.

Motion to Designate

The ACC Bondholders asked the court, under section 1126(e) of the Bankruptcy Code, to designate the votes of the Targeted Creditors because of their alleged bad-faith conduct.5 Section 1126(e) of the Bankruptcy Code allows a court, upon a request of a party in interest, to designate an entity’s votes whose acceptance or rejection of a plan is not in “good faith.”6 In Adelphia, the court stated that, under section 1126(e), an entity has the right to vote on a plan except where the entity has engaged in “highly egregious conduct.”7 The court explained that the reason for the high bar is that, under Chapter 11, a creditor’s right to vote is one of its “most sacred entitlements” in pursuing its interests.8 The court stated that parties face a heavy burden when challenging this right.9

To illustrate what may constitute highly egregious conduct, the court cited to In re Dune Deck Owners Corporation,10 a prior case from the same district.11 In that case, the court had found that the requisite conduct may be found where: (1) a creditor “attempts to extract or extort a personal advantage not available to other creditors in the class;” or (2) “a creditor acts in furtherance of an ulterior motive, unrelated to its claim or its interests as a creditor.”12 The court noted that the ACC Bondholders Group needed to show “more than a mere selfish motive” on the part of the Targeted Creditors.13 The ACC Bondholders Group had to show that the Targeted Creditors were using the reorganization and its voting process to pursue ulterior interests that were only “incidentally” related to their claims as creditors.14

First Argument—Benefits Unavailable to Other Class Members

To meet this burden, the ACC Bondholders Group made two principal arguments, and the Court addressed each of the arguments in turn. Their first argument was that the Targeted Creditors had used aggressive and improper litigation techniques to gain certain benefits under the plan for themselves and for other creditors holding claims in the same class that supported the plan.15 These benefits were not available to other members of the class who did not vote for the plan.16

The court rejected this argument, stating that, although the ACC Bondholders Group’s argument might give rise to valid objections at the confirmation stage, it did not constitute bad faith under section 1126(e).17 The court cited to precedent identifying factors commonly seen as “badges” of bad faith with respect to section 1126(e); the court focused on situations where the creditor seeks “to (1) assume control of the debtor; (2) put the debtor out of business or otherwise gain a competitive advantage; (3) destroy the debtor out of pure malice or (4) obtain benefits available under a private agreement with a third party which depends on the debtor’s failure to organize.”18 Because the Targeted Creditors’ actions did not fall under these categories, the court found designation to be an inappropriate remedy.19

The court further stated that the Targeted Creditors’ actions were aimed at maximizing their recoveries under the reorganization plan, a course of action that has consistently been viewed as acceptable by the courts.20 Interestingly, the court also commented specifically on the aggressive litigation tactics used by the Targeted Creditors, some of whom were represented by White & Case. The court reiterated its disapproval of what it called “overly aggressive and overreaching” tactics and its view that these tactics have become part of a culture that uses litigation “as a means to assert or follow through on threats, and to seek various kinds of relief, to secure leverage in efforts to increase recoveries.”21 Despite its disapproval, however, the court emphasized that, so long as “creditors are acting to maximize their recoveries, their overly aggressive conduct in the Chapter 11 process is not a basis for disqualifying their votes.”22

Second Argument—Ulterior Motive

The ACC Bondholders Group’s second argument was that the Targeted Creditors voted their ACC claims for the plan, not for the benefit of the ACC estate, but “for the ulterior purpose of benefiting their Arahova claims and the Arahova estate.23 By voting their ACC claims for the Plan, the ACC Bondholders’ Group argued, the Targeted Creditors sought to maximize their overall recovery at the expense of ACC creditors.24 The ACC Bondholders Group argued that this was the type of ulterior motive that constitutes bad faith, because the Targeted Creditors’ decision to vote their ACC claims in favor of the plan was based on their recovery under their Arahova claims and on their attempts to maximize their recovery, and therefore it was unrelated to their claims or interests as ACC creditors.25 The ACC Bondholders Group also argued that holding claims of different debtors with conflicting interests “represents a kind of per se ulterior motive”26 that should result in the disqualification of the holders’ votes.

The court disagreed. It stated that a “creditor’s ownership of claims in several debtor entities does not, by itself, amount to bad faith under 1126(e), and does not afford a sufficient basis on which to disqualify votes of creditors who have voted to accept the plan.”27 The court once again listed ulterior motives that have led courts to find bad faith leading to designation, including a creditor’s intention to “assume control of the debtor; to put the debtor out of business or otherwise gain a competitive advantage; to destroy the debtor out of pure malice; or to obtain benefits available under a private agreement with a third party which depends on the debtor’s failure to reorganize.”28 The court did not find these situations arising in the case at hand.29 The court also noted that the conflicts of interest of the nature at bar are present “in many, if not most, Chapter 11 cases...”30

Conclusion

Under the court’s approach, for purposes of the determination whether the court should designate a creditor’s votes under section 1126(e), the creditor has every right within a bankruptcy case to maximize its recovery by taking advantage of the rights and remedies provided in the Bankruptcy Code. The court suggested that the ACC Bondholders Group might find relief elsewhere (for instance, at the plan confirmation stage) for their complaints about the treatment of the Targeted Creditors under the plan.31 The court stated that, despite its finding of “inherent conflicts of interest” in the Targeted Creditors’ positions, there was no indication that Congress drafted section 1126(e) to allow designation of votes in such situations, and, in the absence of such intent, the court refused to grant the requested relief.32