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Media Alerts - Sixth Circuit -- Bad-faith Chapter 11 plan not rescued by "friendly" creditors' approval
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March 7, 2016
  Sixth Circuit -- Bad-faith Chapter 11 plan not rescued by "friendly" creditors' approval
Case: In re Village Green I -- Sixth Circuit

Area of law: Bankruptcy; Chapter 11 Reorganization

Issue presented: Can a Chapter 11 reorganization plan proposed in bad faith be confirmed based on votes of "friendly" creditors?

Brief summary: For a bankruptcy court to approve a reorganization plan under Chapter 11 of the Bankruptcy Code, the debtor must propose the plan in good faith, and at least one class of creditors whose interests are impaired by the plan must vote to accept it. Here, the only creditors who voted in favor of the bankruptcy debtor's plan were its own former lawyer and accountant, to whom the debtors owed less than $2,400, and whose interests were impaired only because they'd receive the unpaid balance over 60 days, rather than up front. The bankruptcy court approved the plan. The debtor's mortgagor appealed to the district court. The case bounced back and forth between the bankruptcy court and the district court, with the district court finding that this arrangement was merely a way to get around the Code's good-faith requirement. The bankruptcy court dismissed the case, and the debtor appealed. The Sixth Circuit affirmed.

Extended summary: The debtor, who owed a mortgagor $8.6 million for the purchase of an apartment building, filed for bankruptcy under Chapter 11 of the Bankruptcy Code. The bankruptcy court stayed any creditor action against the debtor and held up foreclosure proceedings. The building was the only asset in the bankruptcy. Apart from the mortgage, the debtor's only creditors were its former lawyer and accountant.

The debtor's proposed reorganization plan included paying down the mortgagor's claim relatively slowly, leaving a balance of $6.6 million after 10 years. If the mortgagor foreclosed, however, the balance would immediately drop to $3.2 million. The plan would also remove several protections found in the loan agreements, including the requirement that the debtor properly maintain the building and obtain adequate insurance for it. Finally, though the debtor would pay the minor claims of the accountant and lawyer in full, it would do so in two payments over 60 days.

That 60-day delay in paying the accountant and lawyer, the bankruptcy court held, meant that their minor claims were "impaired" under the plan. That qualification, in turn, meant that acceptance by the lawyer or accountant alone would satisfy the requirement that "at least one class of claims that is impaired under the plan has accepted the plan." The bankruptcy court thus confirmed the plan. The mortgagor appealed to the district court, which remanded the case to bankruptcy court on two occasions. Finally, the bankruptcy court dismissed the case and lifted the automatic stay.

The Sixth Circuit noted that two of the bankruptcy court's decisions were at issue. The first was whether the lawyer's and accountant's minor claims were "impaired" under the Bankruptcy Code. A claim is impaired under a plan if it alters "the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest." Here, the plan altered the minor claimants' rights because they were legally entitled to payment immediately rather than in two installments over 60 days. Although the alteration appeared trivial, the Sixth Circuit agreed that these claims technically did qualify as "impaired."

The Sixth Circuit then considered whether the debtor's plan was proposed in good faith. First, it found no reason for the 60-day payment plan on the minor claims given the debtor's monthly net income from apartment rentals. Second, it noted that the former lawyer and accountant were closely allied with the debtor. In fact, when the mortgagor sought to pay the minor claimants up front - by tendering each of them checks for full payment of their claims - they refused to accept payment. This compounded the appearance that the debtor was acting in bad faith by trying to circumvent the Code with the help of its former lawyer and accountant. Therefore, the Sixth Circuit held that the reorganization plan was not made in good faith, affirming the district court.

Panel: Circuit Judges Ralph B. Guy, Karen N. Moore, and Raymond M. Kethledge

Date of issued opinion: January 27, 2016

Docket number: 14-6521

Decided: Affirmed

Counsel: ARGUED: John L. Ryder, HARRIS SHELTON HANOVER WALSH, P.L.L.C., Memphis, Tennessee, for Appellant. Daniel H. Slate, BUCHALTER NEMER, Los Angeles, California, for Appellee. ON BRIEF: John L. Ryder, Michael F. Rafferty, HARRIS SHELTON HANOVER WALSH, P.L.L.C., Memphis, Tennessee, for Appellant. Daniel H. Slate, BUCHALTER NEMER, Los Angeles, California, Mark Warren Bailey, Jr., HUSCH BLACKWELL, LLP, Memphis, Tennessee, for Appellee.
Author of opinion: Circuit Judge, Raymond M. Kethledge

Case alert author: Luciana Viramontes, Western Michigan University Cooley Law School

Case alert circuit supervisor: Professor Mark Cooney

Link to the case:

    Posted By: Mark Cooney @ 03/07/2016 03:16 PM     6th Circuit  

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