Novinda Corp. v. United States Bankruptcy Court for the District of Colorado , 585 B.R. 145 ( 2018 )

FILED
U.S. Bankruptcy Appellate Panel
of the Tenth Circuit
PUBLISH
May 16, 2018
UNITED STATES BANKRUPTCY APPELLATE PANEL
Blaine F. Bates
OF THE TENTH CIRCUIT Clerk
_________________________________
IN RE NOVINDA CORP., BAP No. CO-17-004
BAP No. CO-17-005
Debtor.
__________________________________
MINERALS TECHNOLOGIES, INC., Bankr. No. 16-13083
COLLOID ENVIRONMENTAL Chapter 11
TECHNOLOGIES COMPANY, LLC, and
AMCOL INTERNATIONAL CORP.,
Appellants, OPINION
v.
NOVINDA CORP.,
Appellee.
_________________________________
Appeal from the United States Bankruptcy Court
for the District of Colorado
_________________________________
Aaron A. Boschee (Christopher Meyer of Squire Patton Boggs LLP, Cleveland, Ohio &
Daniel Slifkin of Cravath, Swaine & Moore LLP, New York, New York, with him on the
brief) of Squire Patton Boggs LLP, Denver, Colorado for Appellants.
Joshua M. Hantman, (Samuel M. Kidder with him on the brief) of Brownstein Hyatt
Farber Schreck, LLP, Denver, Colorado for Appellee.
Before KARLIN, Chief Judge, NUGENT, and MOSIER, Bankruptcy Judges.
_________________________________
MOSIER, Bankruptcy Judge.
_________________________________
Appellants Minerals Technologies, Inc., Colloid Environmental Technologies
Company, LLC, and AMCOL International Corp. were unsuccessful in their efforts to
prevent confirmation of Novinda Corp.’s Chapter 11 plan of liquidation. They have
appealed two Bankruptcy Court orders on plan confirmation: (1) the Order Overruling
Objections to Confirmation, Finally Approving Disclosure Statement, and Denying Motion
to Convert (Order Overruling Objections); and (2) the Order Confirming Second Amended
Plan of Reorganization (Confirmation Order).1 The Appellants contend that the
Bankruptcy Court committed reversible error when it confirmed the Chapter 11 plan,
which separately classified their claims, and that the Bankruptcy Court also erred when it
found that the Chapter 11 plan is feasible. We find that the Bankruptcy Court did not
commit any reversible error when it confirmed Novinda Corp.’s Chapter 11 plan and we
therefore affirm.
I. FACTUAL AND PROCEDURAL HISTORY
Novinda Corp. (Debtor) was an advanced air quality technology company that
developed and produced a product to remove mercury from coal ash waste generated by
coal-fired power plants (Product).2 The Debtor financed the development and production
of the Product through venture capital funding, secured loans, and unsecured loans.3 The
1
Although the plan was a liquidating plan, see Appellants’ App. at 725, the
Confirmation Order referred to it as one of reorganization.
2
Order Overruling Objections at 1, in Appellants’ App. at 751. The Debtor’s product
allowed plant operators to comply with air quality requirements set by the EPA and
Department of Energy.
3
Id., in Appellants’ App. at 751.
2
Appellants were creditors of, and 18% equity holders in, the Debtor.4 The Appellants claim
that by January 2015 they had invested a total of $7.2 million in the Debtor.5 As a
condition of additional funding from the Appellants, Colloid became the exclusive
manufacturer of the Product.6 The Debtor paid Colloid one hundred percent of the actual
manufacturing costs plus an agreed upon profit.7 Colloid manufactured the Product and
then invoiced the Debtor for its costs. In some instances, Colloid converted its receivables
into promissory notes due to the Debtor’s inability to pay.8
The Debtor also received substantial equity from certain investment firms that help
capitalize struggling businesses. These investment firms included Altira Technology Fund
V, LP, NV Partners IV LP, and NV Partners IV-C, LP (Funds). As of the petition date, the
Funds held $654,986 in secured claims and $800,342 in unsecured claims.
The Debtor’s contract with Colloid required the Debtor to pay any increase in
manufacturing costs after Colloid provided a thirty-day notice and supporting
documentation. On February 2, 2016, Colloid gave the Debtor notice of an immediate fifty
percent increase in manufacturing costs and demanded advance payment before
manufacturing any more of the Product.9
4
Id. at 2, in Appellants’ App. at 752.
5
Verified Complaint at 10, in Appellants’ App. at 62.
6
Tr. of Dec. 12, 2016 Hearing at 69-70, in Appellants’ App. at 623-24.
7
Order Overruling Objections at 2, in Appellants’ App. at 752.
8
Tr. of Dec. 12, 2016 Hearing at 95, in Appellants’ App. at 649.
9
Id. at 71-72, in Appellants’ App. at 625-26; Order Overruling Objections at 2, in
Appellants’ App. at 752.
3
The Debtor filed a Chapter 11 petition on April 1, 2016. The parties’
characterizations of the relationship between the Debtor and the Appellants as well as the
causes of the bankruptcy are dramatically different. The Debtor contends that Colloid
failed to provide proper notice and documentation and that the manufacturing cost increase
was fabricated in order to drive the Debtor out of business and usurp its business. The
Debtor maintains it has claims against the Appellants for breach of contract, aiding and
abetting a breach of fiduciary duty, and fraud.10 The Appellants claim that the Debtor
could not operate profitably in the face of a recent Supreme Court decision overturning
EPA regulations on mercury pollution, and therefore the Debtor’s failure was market-
driven.11
Not long after it filed bankruptcy, the Debtor auctioned substantially all of its
assets, including intellectual property, leases, equipment, and accounts receivable. The
only bidder was the Funds, and the assets were assigned to a new entity named Novinda
Holdings, Inc.12 After the sale, the only other material asset of the estate was the potential
litigation against the Appellants (Litigation Claims).13 Without any realistic prospect for
rehabilitation, the Debtor filed a liquidating plan.14 The Appellants objected to
confirmation of the plan and filed a motion to convert the case to one under Chapter 7
10
Appellee’s Br. 4-6.
11
Verified Complaint at 14, in Appellants’ App. at 66-67; Appellants’ Reply Br. 4-5.
12
Order Authorizing and Approving (I) the Sale of Certain Assets Free and Clear and
(II) the Assumption and Assignment of Certain Executory Contracts and Waiving the 14-
Day Stay of Fed. Bankr. P. 6004(h) and 6006(d), in Appellants’ App. at 133.
13
Amended Plan at 5, in Appellants’ App. at 732.
14
Novinda Corp.’s Chapter 11 Plan of Liquidation, in Appellants’ App. at 295.
4
(Motion to Convert).15 The Debtor then amended the proposed plan twice (Amended
Plan).16
The Amended Plan contained twelve different classes of claims, which are
summarized as follows:
Class 1: Class 1 consisted of the priority claims of eight former employees pursuant
to § 507(a)(4) for accrued vacation leave. Class 1 claimants would be paid in full
through 4 quarterly payments. This class was deemed “impaired” because claimants
would not receive interest on the deferred payment of their claims.
Class 2: Class 2 consisted of secured creditors, who would receive the value of the
property securing their claim, with any deficiency treated in Class 3.
Class 3: Class 3 consisted of unsecured trade claims (other than the Appellants) and
the Funds’ unsecured claims. The claims would be paid a pro rata distribution along
with the Class 4 claims of the Appellants from any remaining funds left in the estate
after payment of Classes 1 and 2 and satisfaction of estate expenses. The Funds’
unsecured claims in this class were subordinated to the other Class 3 claims. Once
all non-Funds unsecured trade claims were paid in full, the Funds would receive pro
rata distributions along with Class 4 claims.
Class 4: Class 4 contained the Appellants’ unsecured claims, which were to be paid
a pro rata distribution as determined by the aggregate amount of Classes 3 and 4,
but would not benefit from the Funds’ voluntary subordination to the other claims
in Class 3.
Class 5: Class 5 was the administrative convenience class and consisted of
unsecured claims of $1000 or less, which would be paid at 70% shortly after the
effective date of the Amended Plan. Any Class 3 or 4 claims could have elected to
reduce their claim to $1000 and receive treatment pursuant to Class 5.
Classes 6 – 12: The remaining classes consisted of equity holders, which would be
paid at different rates per share from any remaining funds available after payment
of Classes 3 through 5.17
15
Motion to Convert Proceeding to a Liquidation Under Chapter 7 of the Bankruptcy
Code, in Appellants’ App. at 387.
16
Novinda Corp.’s Second Amended Chapter 11 Plan of Liquidation, in Appellants’
App. at 725.
17
Id. at 9-12, in Appellants’ App. at 736-39.
5
The Amended Plan provided for the appointment of an administrator (Plan
Administrator) to make distributions and investigate and pursue the Litigation Claims.18
The Amended Plan further provided that the Funds would contribute $400,000 to the
estate, which would be used for distributions under the Amended Plan. Up to $25,000 of
the $400,000 could also be used to finance investigation of the Litigation Claims.19
Essentially, Classes 3 and 4 were not guaranteed any distribution and would only recover
meaningfully if the Plan Administrator prevailed on the Litigation Claims.
The Appellants objected to confirmation, arguing that (1) the Plan Administrator
was biased in favor of the Funds; (2) the Plan was not feasible as creditor recovery was
based on the outcome of speculative litigation; (3) Classes 3, 4, and 5 were unfairly
discriminatory and were improperly classified for purposes of gerrymandering; and (4) the
Amended Plan was not proposed in good faith.20 The Bankruptcy Court overruled the
Appellants’ objections to the Amended Plan, denied the Motion to Convert in the Order
Overruling Objections,21 and confirmed the Amended Plan in the Confirmation Order.22
The Appellants timely appealed both the Order Overruling Objections and the
Confirmation Order, which were joined for purposes of briefing and argument.23 The
Appellants sought a stay pending appeal in the Bankruptcy Court, which the Bankruptcy
18
Id. at 1, in Appellants’ App. at 728.
19
Id. at 15, in Appellants’ App. at 742; Tr. of Dec. 12, 2016 Hearing at 102, in
Appellants’ App. at 656.
20
Order Overruling Objections at 4-7, in Appellants’ App. at 754-57.
21
Id. at 1, in Appellants’ App. at 751.
22
Confirmation Order, in Appellants’ App. at 764.
23
Order Joining Appeals, BAP ECF No. 11.
6
Court denied.24 The Appellants also filed a motion for a stay pending appeal before the
Bankruptcy Appellate Panel and that motion was denied.25
II. JURISDICTION AND STANDARD OF REVIEW
This Court has jurisdiction to hear appeals of final orders.26 An order overruling
objections to confirmation and confirming a Chapter 11 plan is a final order for purposes
of 28 U.S.C. § 158(a).27 This appeal raises four issues: (1) claims classification; (2) good
faith; (3) feasibility: and (4) unfair discrimination.
A. Claim Classification and Designation
There is no clear Tenth Circuit authority on the appropriate standard of review for
claims classification. Other circuits appear to have reached divergent conclusions on this
point.28 The determination of the factors that justify separate classification of claims is a
24
Order Denying Stay Pending Appeal, Bankr. ECF No. 368.
25
Order Denying Motion for Stay Pending Appeal, BAP ECF No. 31 (denying motion
for stay pending appeal finding Appellants made no showing that irreparable harm would
occur absent a stay).
26
28 U.S.C. § 158(a)(1), (b)(1), and (c)(1).
27
Interwest Bus. Equip., Inc. v. U.S. Trustee (In re Interwest Bus. Equip., Inc.), 23
F.3d 311, 315 (10th Cir. 1994) (quoting Kham & Nate’s Shoes No. 2, Inc. v. First Bank of
Whiting, 908 F.2d 1351, 1355 (7th Cir. 1990)).
28
Compare Steelcase Inc., v. Johnson (In re Johnston), 21 F.3d 323, 327 (9th Cir.
1994) (“We thus reaffirm our rule that a bankruptcy court’s finding that a claim is or is not
substantially similar to other claims, constitutes a finding of fact reviewable under the
clearly erroneous standard.”), with Phoenix Mut. Life Ins. Co. v. Greystone III Joint
Venture (In re Greystone III Joint Venture), 995 F.2d 1274, 1281 n.7 (5th Cir. 1991)
(“Issues such as the similarity in priority and legal attributes and the ultimate question
whether treatment in the same or separate classes is necessary, are legal issues reviewable
by our court de novo.”).
7
question of law reviewed de novo, but whether the requisite factors have been established
is a question of fact reviewed for clear error.29
B. Good Faith
Whether a plan has been proposed in good faith under § 1129(a)(3) is a factual
finding that this Court reviews for clear error.30
C. Feasibility
“Whether a plan is feasible is a question of fact, subject to the clearly erroneous
standard on appeal from an order confirming the plan.”31
D. Unfair Discrimination
The Bankruptcy Court’s factual findings on the issue of unfair discrimination are
reviewed for clear error, but if those “factual findings are premised on improper legal
standards or on proper ones improperly applied, they are not entitled to the protection of
the clearly erroneous standard, but are subject to de novo review.”32
29
Lenox MacLaren Surgical Corp. v. Medtronic, Inc., 847 F.3d 1221, 1230 (10th Cir.
(2017) (reviewing de novo trial court’s determination of the correct legal standard); Jobin
v. McKay (In re M & L Business Mach. Co., Inc.), 84 F.3d 1330, 1338 (10th Cir. 1996)
(reviewing for clear error whether facts satisfy proper legal standard).
30
Search Mkt. Direct, Inc. v. Jubber (In re Paige), 685 F.3d 1160, 1178 (10th Cir.
2012) (citing In re 203 N. LaSalle St. P'ship, 126 F.3d 955, 969 (7th Cir.1997)).
31
F.H. Partners, L.P. v. Inv. Co. of the Sw., Inc. (In re Inv. Co. of the Sw., Inc.), 341
B.R. 298, 310 (10th Cir. BAP 2006) (citing In re Pine Mountain, Ltd., 80 B.R. 171, 172
(9th Cir. BAP 1987)).
32
Osborn v. Durant Bank & Tr. Co. (In re Osborn), 24 F.3d 1199, 1203 (10th Cir.
1994), abrogated in part on other grounds by Eastman v. Union Pac. R.R., 493 F.3d 1151
(10th Cir. 2007).
8
III. PRELIMINARY MATTERS
A. Equitable Mootness
The Debtor has not filed a separate motion to dismiss the appeal, but in its brief, the
Debtor argues this appeal is equitably moot and should be dismissed.33 Although the Tenth
Circuit has articulated a standard for application of the equitable mootness doctrine,34 none
of the Debtor’s arguments are particularly compelling. More importantly, the Debtor has
failed to properly place the issue before this Court. There is no motion to dismiss this
appeal on equitable mootness grounds, and we will not address the issue further.
B. Attempts to Supplement to the Record on Appeal
The Appellants filed a supplemental appendix which contains, in part, a Motion for
Stay Pending Appeal Pursuant to Bankruptcy Rule 8007 and a Post Confirmation
Quarterly Report, which are not properly part of the record on appeal.35 The Debtor has not
requested that these documents be stricken from the record.
After this appeal was fully briefed and taken under submission after oral argument,
the Appellants filed a Motion to Supplement the Appendix (Motion),36 requesting that the
Court include in the record on appeal the Debtor’s January 30, 2018 Post Confirmation
Quarterly Report. The Debtor subsequently filed its objection to the Motion,37 which
33
Appellee’s Br. 10.
34
See Search Mkt. Direct, Inc. v. Jubber (In re Paige), 584 F.3d 1327, 1339 (10th Cir.
2009).
35
Appellants’ Supp. App. at 883, 894.
36
BAP ECF No. 69.
37
BAP ECF No. 72.
9
requested that the Court deny the Motion or, if the Court granted the Motion, allow the
Debtor to also supplement the record with an affidavit from the Plan Administrator.
None of the documents in the supplemental appendixes existed at the time the
Bankruptcy Court entered the Confirmation Order, which is on appeal, and therefore those
documents could not have been considered by the Bankruptcy Court in issuing that
decision. BAP Local Rule 8018-1(g) provides that “[o]nly documents properly before the
bankruptcy court may be included in the appendix and considered by this Court.”38 The
Tenth Circuit has made it clear that appellate courts should not review documents that
were not before the trial court when the rulings at issue were made.39 Accordingly, it is
improper for this Court to review the documents supplementing the appendixes on appeal
and the requests to supplement the appendix will be denied.
IV. DISCUSSION
The Appellants assert that the Bankruptcy Court committed a number of errors
when it confirmed the Amended Plan in the hope that this Court will find at least one of
those asserted errors necessitates a reversal of the Bankruptcy Court’s order. The
Appellants assert that the Bankruptcy Court erred by permitting the separate classification
of their claims, and argue that their treatment under the Amended Plan constitutes unfair
discrimination prohibited by § 1129(b)(1).40 They also contend that the Bankruptcy Court
erred in finding the Amended Plan was feasible.
38
10th Cir. BAP L.R. 8018-1(g).
39
Boone v. Carlsbad Bancorporation, Inc., 972 F.2d 1545, 1549 n.1 (10th Cir. 1992).
40
Section 1129(b)(1) requires a bankruptcy court to confirm a Chapter 11 plan with
non-accepting, impaired classes as long as the plan “does not discriminate unfairly, and is
10
A. Classification of Claims – § 1122(a)
The Appellants maintain that “[t]he Bankruptcy Court erred in holding that a
chapter 11 liquidating plan that separately classifies one unsecured trade creditor from all
others in order to facilitate an intra-class gift that excludes that unsecured trade creditor
does not unfairly discriminate.”41 In so arguing, the Appellants conflate claims
classification issues with unfair discrimination issues and mistakenly characterize the
separate classification of their claims as unfair discrimination under § 1129(b). The
Appellants mistakenly argue that before a court approves a classification scheme it must
consider whether the classification complies with § 1129(b). But § 1129(b) does not
address classification of claims; it focuses instead on whether a plan unfairly discriminates
and is fair and equitable with respect to each “class of claims.”42 By contrast, claim
classification is addressed in § 1122. In other words, § 1122 deals with the creation of
classes of claims, while § 1129(b) deals with the treatment of those classes. While
§ 1123(a)(4) requires each creditor in a class to receive the same treatment—unless a
creditor agrees to less favorable treatment—there is no requirement that creditors in
different classes receive the same treatment.
In reviewing classification schemes, bankruptcy judges are given limited guidance
from the Bankruptcy Code itself. Section 1122(a) provides that “a plan may place a claim
or an interest in a particular class only if such claim or interest is substantially similar to
fair and equitable, with respect to each class of claims . . . that is impaired under, and has
not accepted, the plan.”
41
Appellants’ Br. 1.
42
11 U.S.C. § 1129(b)(1).
11
the other claims or interests of such class.”43 As a result, a plan proponent cannot place
dissimilar claims together in the same class, such as secured claims with unsecured claims,
or priority unsecured claims with non-priority unsecured claims. But § 1122(a) does not
require the converse—that similar claims be placed in the same class.44 Accordingly,
courts generally permit separate classification of similar claims, subject to certain caveats,
the most prominent of which is the axiom that separate classification may not be used to
gerrymander the vote on plan confirmation. Bankruptcy courts have consistently adhered
to this “one clear rule,”45 i.e., debtors may not separately classify claims under § 1122 for
the purposes of obtaining an impaired consenting class under § 1129(a)(10).46 Some courts
have reasoned that once a plan proponent has shown that substantially similar claims were
not separately classified to gerrymander a consenting class of impaired claims, the court
need not make any further inquiry into whether the separate classification of similar claims
violates § 1122(a) and the remaining confirmation issues should be addressed under
43
11 U.S.C. § 1122(a).
44
In re City of Colo. Springs Spring Creek Gen. Improvement Dist., 187 B.R 683, 687
(Bankr. D. Colo. 1995) (“There is no requirement that all substantially similar claims be
placed in the same class nor is there a prohibition against classifying substantially similar
claims separately.”).
45
Phoenix Mut. Life Ins. Co. v. Greystone III Joint Venture (In re Greystone III Joint
Venture), 995 F.2d 1274, 1279 (5th Cir. 1991) (holding that one clear rule has emerged
from § 1122(a) case law).
46
In re Autterson, 547 B.R. 372, 397-98 (Bankr. D. Colo. 2016); see also CRE/ADC
Venture 2013, LLC v. Rocky Mountain Land Co. (In re Rocky Mountain Land Co.), No.
12-21643, 2014 WL 1338292, at *15 (Bankr. D. Colo. Apr. 3, 2014). But see In re City of
Colo. Springs Spring Creek Gen. Improvement Dist., 187 B.R at 689 (explaining that
gerrymandering is an issue addressed under the unfair discrimination analysis
of § 1129(b)). A prerequisite to plan confirmation, § 1129(a)(10) requires that if there is an
impaired class, at least one non-insider impaired class must accept the plan.
12
§ 1129. 47 But most courts impose the additional requirement that there be a reasonable
basis or legitimate business or economic justification for the separate classification of
similar claims.48 There is no controlling Tenth Circuit law on this issue, but that is not
critical to our decision because the Debtor has shown a reasonable basis to separately
classify the Appellants’ claims.
1. The Debtor Has Shown That Unsecured Claims Were Not Separately
Classified to Gerrymander an Impaired Consenting Class
The Appellants contend that the Debtor gerrymandered voting on the Amended
Plan by separately classifying their claims. They object to both the establishment of an
administrative convenience class in Class 5 and the separate classification of their claims
in Class 4. They further contend that the creditors in Classes 3, 4, and 5 should all be
placed into the same class and that they have been separated only to manipulate voting
results. The Bankruptcy Court was not persuaded by this argument. It instead correctly
concluded that the Debtor did not have to separately classify the claims in Classes 3, 4, and
5 in order to satisfy § 1129(a)(10) because the Debtor was reasonably certain it could
fulfill this requirement through an affirmative vote of Class 1.
The separate classification of the priority wage claims in Class 1 was completely
appropriate—even necessary—because the wage claims were not substantially similar to
other claims. Since Class 1’s claims, consisting of employee priority claims pursuant to
47
In re Deming Hospitality, LLC, No. 11-12-13377TA, 2013 WL 1397458, at *3
(Bankr. D.N.M. Apr. 5, 2013); see also In re Rocky Mountain Land Co., 2014 WL
1338292, at *15 (agreeing with Deming).
48
See In re Hyatt, 509 B.R. 707, 715 n.8 (Bankr. D.N.M. 2014) (collecting cases).
13
§ 507(a)(4), should not be classified with general unsecured claims, the Appellants cannot
seriously contend that Class 1 was created to gerrymander voting on the plan. The
Bankruptcy Court found that Class 1 served as the impaired consenting class for purposes
of § 1129(a)(10).49 It also determined the employees in the class were not insiders.50
Evidence in the record supports this finding.51 In fact, the Appellants even stipulated that
the Debtor’s evidence met § 1129(a)(10)’s burden to obtain the accepting vote of at least
one impaired class.52 Once a plan has been accepted by an impaired class of claims that
was not created for gerrymandering purposes, any claims of gerrymandered voting have
little relevance under § 1129(a)(10).
2. The Administrative Convenience Claims Are Properly Classified in a
Separate Class
Section 1122(b) expressly permits a plan proponent to “designate a separate class of
claims consisting only of every unsecured claim that is less than or reduced to an amount
that the court approves as reasonable and necessary for administrative convenience.”53 The
Amended Plan designated Class 5 as the administrative convenience class.
Notwithstanding the Bankruptcy Code’s express authorization of convenience class claims,
the Appellants contend that Class 5 was established for vote manipulation purposes rather
than to serve a legitimate need for administrative convenience.
49
Order Overruling Objections at 9, in Appellants’ App. at 779.
50
Id., in Appellants’ App. at 779.
51
Tr. of Dec. 12, 2016 Hearing at 49-51, in Appellants’ App. at 603-05.
52
Id. at 124, in Appellant’s App. at 678.
53
11 U.S.C. § 1122(b).
14
While the Bankruptcy Court acknowledged that nine creditors is a relatively small
number and understood why the Appellants questioned whether this separate class was
truly necessary, it expressly found that there was no gerrymandering purpose behind the
Debtor’s creation of this separate class. After considering the testimony of the Debtor’s
witnesses, the Bankruptcy Court was convinced that a separate class would be beneficial to
the estate, if for no other reason than to eliminate meddlesome interference absorbing the
Plan Administrator’s time. The Bankruptcy Court concluded that the record established
that the Plan Administrator agreed to his compensation structure based in part on the
understanding that the small claims would be repaid quickly. Moreover, although Class 5
voted in favor of the Amended Plan, the Debtor did not need the class to satisfy the
requirement of an impaired accepting class. The Debtor was reasonably certain that it
could fulfill this requirement with the Class 1 vote. The record supports the conclusion that
Class 5’s creation did not violate the one clear rule prohibiting gerrymandering.
3. There Is a Reasonable Basis for the Classification of Claims in Class 3 and
Class 4
After finding that the Debtor did not separately classify Classes 1 or 5 to obtain an
impaired accepting class, the Bankruptcy Court also determined there were sound business
reasons to separately classify Classes 3 and 4.
a. The Appellants’ Non-Creditor Interest Justified Separate Classification
The Appellants argue that the Bankruptcy Court erred in allowing the separate
classification of Class 4 as a “bypass”54 of designation under § 1126(e), which permits a
54
Appellants’ Br. 7.
15
bankruptcy court “to disqualify . . . any acceptance or rejection that was not made in good
faith.”55 Essentially, the Appellants contend that the Debtor was first required to classify
their claims with the other unsecured creditors and then had to separately move to
designate their votes, with the attendant evidentiary hearing such a motion would require.
The Debtor argues that it is the Appellants’ “non-creditor”56 interest that justifies the
separate classification of their claims and the Debtor did not rely on a bypass of § 1126(e)
to justify the separate classification of those claims. We agree with the Debtor.
The Bankruptcy Court did discuss § 1126(e) but did not attempt to apply this
section as part of the justification for separate classification of the Appellants’ claims. The
Bankruptcy Court did not make a specific finding that the Appellants’ votes were not cast
in good faith but simply noted that their actions might provide a basis to seek designation
of their claims. What the Bankruptcy Court did acknowledge is that “courts have
recognized that separate classification of a claim [whose holder’s vote] would likely be
cast for ‘ulterior motives’ is permissible. They have done so specifically when the creditor
was a litigation target.” 57 The Bankruptcy Court then made specific factual findings of its
definite and firm conviction that [the Appellants’] motivations in this case
have been two-fold. [They] sought for a long period of time to force the
55
7 Collier on Bankruptcy ¶ 1126.06 (Richard Levin & Henry J. Sommer eds., 16th
ed.). The good faith inquiry asks whether the creditor cast its vote “for the ulterior purpose
of securing some advantage to which [it] was not otherwise entitled.” Id. at ¶ 1126.06[1].
56
Appellee’s Br. 19.
57
Order Overruling Objections at 10, in Appellants’ App. at 760. (first citing Save
Our Springs (S.O.S.) Alliance, Inc. v. WSI (II)-COS, L.L.C. (In re Save Our Springs
(S.O.S.) Alliance, Inc.), 632 F.3d 168, 174-75 (5th Cir. 2011) (acknowledging that the
desire to avoid litigation can be a non-creditor interest justifying separate classification,
but finding no evidence that such a motivation existed in that case) and then citing In re
Heritage Org., L.L.C., 375 B.R. 230, 300 (Bankr. N.D. Tex. 2007)).
16
Debtor into a position where its business would fold and [they] could usurp
[it]. Most recently, [the Appellants] ha[ve] attempted to thwart the Debtor’s
reorganization in order to avoid becoming a litigation target.58
The Bankruptcy Court based its conviction on evidence of the Appellants’ dealings with
the Debtor prepetition, as well as its own observations of their actions in the bankruptcy
case. The Bankruptcy Court then specifically found that “[the Appellants’] actions in this
bankruptcy case have demonstrated that [they have] not been pursuing a legitimate interest
in maximizing [their] recovery as a creditor. Thus, separate classification of [their]
claim[s] was warranted under the circumstances of this case.”59 We find no error in the
Bankruptcy Court’s legal conclusion that a creditor voting a non-creditor interest may be
separately classified and its factual finding that the Appellants were not voting their
creditor interests.
b. Preserving the Potential Equitable Subordination of the Appellants’ Claims
Supports Separate Classification
The Debtor articulated a legitimate concern that placing the Appellants in Class 3
might inadvertently waive any claim the Debtor has for equitable subordination of their
claims. Section 1123(a)(4) states that a plan shall “provide the same treatment for each
claim or interest of a particular class, unless the holder of a particular claim or interest
agrees to a less favorable treatment of such particular claim or interest.”60 The Funds have
agreed to less favorable treatment within Class 3 by means of consensual subordination.
The Appellants have not agreed to subordination of their claims. If the Appellants’ claims
58
Id. at 11, in Appellants’ App. at 781.
59
Id., in Appellants’ App. at 781.
60
11 U.S.C. § 1123(a)(4).
17
were placed in Class 3, § 1123(a)(4) would require the Debtor to provide them with the
same treatment as the trade debt. If the Debtor did so, the Plan Administrator may later be
estopped from attempting through litigation to undo the Amended Plan’s binding treatment
of these claims.
The Bankruptcy Court considered the potential impact that the precedents of County
of Orange61 and Chateaugay62 may have on the Debtor’s subordination claims against the
Appellants. In these cases, the court refused to entertain post-confirmation subordination
claims where the plan provided for the same treatment for all claims in the class. As the
Appellants argue, County of Orange and Chateaugay may be distinguishable in that the
debtors there did not mention their intent to pursue equitable subordination claims in the
plan or disclosure statement. But the Appellants’ argument is of little importance. The
Bankruptcy Court expressed no opinion as to whether the separate classification of the
Appellants’ claims would avoid waiver issues. However, the Bankruptcy Court concluded
that placing the Appellants in the same class would likely create a waiver issue and, thus,
there was a sufficient justification for the separate classification. In other words, all the
Bankruptcy Court determined was that these cases create a potential barrier to
subordinating the Appellants’ claims, which separate classification may avoid, and that
concern was a reasonable basis to separately classify those claims.
61
In re Cty. of Orange, 219 B.R. 543 (Bankr. C.D. Cal. 1997).
62
LTV Steel Co. v. Aetna Cas. & Sur. Co. (In re Chateaugay Corp.), No. 93-8444A,
1993 WL 563068 (Bankr. S.D.N.Y. Dec. 27, 1993).
18
The Appellants contend that the Bankruptcy Court erred when it found that the
Funds’ desire to create goodwill with trade creditors was one of the reasons the Debtor
articulated for separately classifying their claims. The Debtor does not argue that this
reason supports separate classification of the Appellants’ claims. The Bankruptcy Court
recognized that this business justification is not akin to those cases in which the debtor
itself has a strong business reason to provide preferential treatment to certain creditors in
order to enhance its reorganization prospects.63 The Bankruptcy Court also observed that
maintaining goodwill was “of vital concern to the Funds[,] and the Debtor needs the Funds
in order to fund its plan obligations.”64 However, it is not clear that the Bankruptcy Court
held that this reason, articulated by the Debtor, justified separate classification. Any error
in the Bankruptcy Court’s ruling on this issue is harmless error because the Debtor had
already demonstrated other reasonable grounds for separately classifying the Appellants’
claims.
B. The Amended Plan Does Not Unfairly Discriminate Against the Appellants’
Claims
Although the Appellants have raised several issues, the overarching complaint that
they have with the Amended Plan is that they don’t like their treatment and believe it is
unfair. In their appellate brief, the Appellants have misstated the Bankruptcy Court’s
ruling. They accuse the Bankruptcy Court of bypassing the prohibition against unfair
discrimination in § 1129(b)(1) by “reading language into [§] 1123(a)(4) . . . that a creditor
63
See, e.g., In re Bernhard Steiner Pianos USA, Inc., 292 B.R. 109, 114 (Bankr. N.D.
Tex. 2002).
64
Order Overruling Objections at 10, in Appellants’ App. at 760.
19
who agrees to less favorable treatment can dictate the beneficiaries of that treatment.”65 It
appears that the Appellants’ position is that a creditor’s agreement to less favorable
treatment, as permitted by § 1123(a)(4), necessarily requires an analysis of unfair
discrimination under § 1129(b)(1). The record shows that the Amended Plan is consistent
with § 1123(a)(4), which requires a plan to “provide the same treatment for each claim . . .
of a particular class, unless the holder of a particular claim . . . agrees to a less favorable
treatment.”66 A creditor’s agreement to less favorable treatment pursuant to § 1123(a)(4)
necessarily results in more favorable treatment of other creditors in the class, but that does
not necessarily implicate § 1129(b)(1).
Even so, the Amended Plan is also consistent with § 1129(b)(1). Section 1129(b)
states that “the court . . . shall confirm the plan notwithstanding the requirements of
[§ 1129(a)(8)] if the plan does not discriminate unfairly, . . . with respect to each class . . .
that is impaired under, and has not accepted, the plan.”67 The Code does not define unfair
discrimination, and the Tenth Circuit has not spoken on what constitutes unfair
discrimination, but the language of the Code dictates that unfair discrimination is more
than simply making a distinction between claims. As a general rule, the unfair
discrimination standard “ensures that a dissenting class will receive relative value equal to
65
Appellants’ Br. 7.
66
11 U.S.C. § 1123(a)(4).
67
11 U.S.C. § 1129(b).
20
the value given to all other similarly situated classes.”68 Several courts have adopted a test
that creates a rebuttable presumption of unfair discrimination when there is:
(1) a dissenting class; (2) another class of the same priority; and (3) a
difference in the plan’s treatment of the two classes that results in either (a)
a materially lower percentage recovery for the dissenting class (measured in
terms of the net present value of all payments), or (b) regardless of
percentage recovery, an allocation under the plan of materially greater risk
to the dissenting class in connection with its proposed distribution.69
The Bankruptcy Court found that the Funds’ agreement to subordinate payment of
its claim may allow the other Class 3 claimants to be paid sooner than they would be
absent subordination, but also found that the Appellants’ distribution would not be
diminished or delayed by this provision. In other words, Class 4’s percentage recovery will
not be lower than Class 3’s, and Class 4 does not bear a materially greater risk than Class
3. Class 4 will receive the same pro rata distribution that Class 3 will receive at the same
time. Both classes must still be paid in full before any equity interest classes will receive
anything. The Appellants will not receive the same treatment that Class 3 trade creditors
will receive, but that is not inequitable or unfair to Class 4, and the Amended Plan does not
unfairly discriminate between Class 3 and Class 4.
The Appellants have also argued that the Amended Plan was not proposed in good
faith. They assert that the separate classification and the different treatment of their claims
68
In re Armstrong World Indus., Inc., 348 B.R. 111, 121 (D. Del. 2006) (quoting In re
Johns–Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1986) (emphasis added); see
also In re Stratford Assocs. Ltd. P’Ship, 145 B.R. 689, 700 (Bankr. D. Kan. 1992) (“While
the Plan discriminates, to violate § 1129(b)(1), the discrimination must be unfair.”).
69
In re Armstrong World Indus., Inc., 348 B.R. at 121 (quoting In re Dow Corning
Corp., 244 B.R. 696, 702 (Bankr. E.D. Mich. 1999)).
21
establish a lack of good faith. But the separate classification of the Appellants’ claims was
appropriate and there was no unfair discrimination with respect to Class 4. The Appellants
cannot rely solely on these arguments to establish that the Amended Plan was not proposed
in good faith and they have not advanced any other arguments on this issue. The
Bankruptcy Court found that the Amended Plan was proposed in good faith, and we do not
find clear error in that finding.
C. The Bankruptcy Court Properly Determined That the Amended Plan Is
Feasible
Section 1129(a)(11) requires a finding that confirmation “is not likely to be
followed by the liquidation, or the need for further financial reorganization, . . . unless such
liquidation or reorganization is proposed in the plan.”70 “In determining whether a plan is
feasible, the Bankruptcy Court has an obligation to scrutinize the plan carefully to
determine whether it offers a reasonable prospect of success and is workable.”71 “The
purpose of the feasibility test is to determine whether there is a reasonable probability that
creditors will receive the payments provided for in the plan.”72 One school of thought is
that feasibility need not be established whenever liquidation is proposed in the plan.73
“Other courts take a broader approach and apply the feasibility test to plans of liquidation,
focusing their analysis on whether the liquidation itself, as proposed in the plan, is
70
11 U.S.C. § 1129(a)(11).
71
Travelers Ins. Co. v. Pikes Peak Water Co. (In re Pikes Peak Water Co.), 779 F.2d
1456, 1460 (10th Cir. 1985) (quoting Prudential Ins. Co. of Am. v. Monnier (In re Monnier
Bros.), 755 F.2d 1336, 1341 (8th Cir. 1985)).
72
In re Trenton Ridge Inv’rs., LLC, 461 B.R. 440, 478 (Bankr. S.D. Ohio 2011)
(citing In re G-I Holdings Inc., 420 B.R. 216, 267 (D.N.J. 2009)).
73
In re Heritage Org., L.L.C., 375 B.R. 230, 311 (Bankr. N.D. Tex. 2007).
22
feasible.”74 The Bankruptcy Court determined that the Amended Plan proposed liquidation
and, despite noting case law suggesting that a feasibility inquiry is unnecessary for a
liquidating plan, considered whether the proposed liquidation was feasible.
The Appellants assign error based on the speculative nature of recovery on the
Litigation Claims, relying on the Third Circuit’s In re American Capital Equipment,
LLC.75 The Appellants contend that creditor recovery is based on litigation outcomes and,
as a result, the Amended Plan is per se too speculative to be confirmed. Although
American Capital was similar to this case in that the plan included sum certain sources of
funding, American Capital involved more moving parts than just successful litigation—it
required asbestos claim litigants to settle their claims and consent to a portion of the
debtors’ insurance recovery being paid to other creditors, and the debtors admitted that
they could not fund any repayment of creditors without the imposition of the surcharge.
The court found such a funding source to be “wholly speculative.”76
Here, the Bankruptcy Court found that the Amended Plan was feasible because it
was not contingent on the Plan Administrator bringing the Litigation Claims or the
outcome of any litigation. As the Bankruptcy Court noted, in this case $400,000 would be
made available to the Plan Administrator for payment of priority claims. This funding may
be augmented by recovery of alleged overpayments of sales taxes and certain refunds
74
Id.
75
Appellants’ Br. 28 (quoting In re Am. Capital Equip., LLC, 688 F.3d 145, 156 (3d
Cir. 2012) (stating “a plan is not ‘feasible if the success hinges on future litigation that is
uncertain and speculative’”)).
76
In re Am. Capital Equip., LLC, 688 F.3d at 156.
23
allegedly due from the Appellants, but whether the Debtor is successful in recovering
overpayments, it has the certainty of plan funding from the Funds. The only restriction on
the use of these funds is to limit to $25,000 any investigation of claims against the Funds.
The Bankruptcy Court also relied on In re Heritage Organization, L.L.C.,77 to reach
the conclusion that the liquidating Amended Plan is feasible because “the successful
performance of its terms is not dependent or contingent upon any future, uncertain
event.”78 This Court holds that the Bankruptcy Court did not commit clear error in
concluding that the Amended Plan is feasible. While other courts have held that Chapter
11 plans that rely on litigation settlements or judgments as the primary sources of funding
are likely not feasible,79 in this case the Bankruptcy Court found the primary source of
funding was the Funds’ $400,000 contribution. That was not clear error.
V. CONCLUSION
In the end, it is clear that the Appellants’ real complaint is that a plan they did not
want was confirmed. The Appellants would rather the case be converted to Chapter 7
where unsecured claims would not receive anything unless the trustee were successful in
pursuing litigation against them. A Chapter 7 trustee, however, would not have the benefit
of the $400,000 contribution to fund payment of Classes 1, 2, and 5, nor a war chest for
77
375 B.R. 230 (Bankr. N.D. Tex. 2007).
78
Id. at 311.
79
E.g., In re WR Grace & Co., 729 F.3d 332, 348-49 (3d Cir. 2013) (stating court will
not find plan feasible if it hinges on speculative litigation); In re Slabbed New Media, LLC,
557 B.R. 911, 916-17 (Bankr. S.D. Miss. 2016) (citing numerous cases suggesting plans
relying on litigation proceeds are not feasible); In re Applied Safety, Inc., 200 B.R. 576,
584 (Bankr. E.D. Penn. 1996) (explaining that plan was likely unconfirmable where debtor
could not evidence capital to fund litigation).
24
litigation. Perhaps this is why the Appellants so adamantly seek conversion over
confirmation. As the primary litigation target, they would undoubtedly prefer a trustee
unfamiliar with the case and without any kitty to pursue litigation.
The record supports the Bankruptcy Court’s findings regarding the separate
classification of Class 3 and Class 4. The Amended Plan was proposed in good faith, does
not unfairly discriminate against the Appellants’ claims, and is feasible. Accordingly, the
Bankruptcy Court did not err. The Bankruptcy Court’s decision is AFFIRMED.
25