Contributed by Sara Coelho
In corporate chapter 11 cases it is common practice to file cases for each entity guaranteeing corporate debt to ensure that the guarantee liability is restructured along with obligations of primary borrowers. Restructuring guarantees is usually essential to create a fresh start for an enterprise because the guarantors are typically affiliates that add value to the enterprise — provided they are financially sound. When the guarantors make important contributions to the business but they are not part of a corporate family however, filing chapter 11 cases for guarantors means filing unrelated entities, often with separate and healthy businesses, to the detriment of those businesses and the guarantor’s ability to fund reorganization of the primary borrower. In Linda Vista Cinemas, L.L.C., the Bankruptcy Court for the District of Arizona grappled with this dilemma when it considered whether to confirm a chapter 11 plan that provided for payment of all creditors in full over time, but enjoined collection efforts against guarantors who would contribute capital to the debtor to the extent necessary to ensure that all plan payments were made. The court reluctantly denied confirmation on the grounds that the plan violated section 524(e) of the Bankruptcy Code, which provides that a bankruptcy discharge of a debtor “does not affect the liability of any other entity” on the debt, concluding it was bound to do so by previous precedent.
In Linda Vista, the debtor, a movie theatre operator, had bank debt guaranteed by its owners, and by other businesses owned by the owners, including an L.L.C. that operated a separate theatre business and a construction company. The guarantees were backed by collateral owned by the guarantors. The debtor’s plan would pay the bank’s secured claim in full by extending the loan an additional four years beyond its original term, setting a new 20-year amortization schedule, making interest-only payments for the first two years, making interest and principal payments for five years, setting the interest rate at prime plus 1.5%, and paying the claim in full on the seventh anniversary of the effective date. The plan provided that the guarantors would contribute additional capital when necessary to make the required payments. So long as the terms of the plan were followed, the bank would be enjoined from pursuing its guarantee claim against the guarantors.
The bank argued that the plan could not be confirmed because it violated section 524(e) of the Bankruptcy Code. The court ultimately decided that prior precedent compelled this result, but first, in canvassing the law on the question, it outlined a case for the permissibility of a temporary post-confirmation injunction against enforcement of guarantees in some cases. The court found a sufficient statutory and jurisdictional basis for enjoining post-confirmation collection efforts on the guarantees. It found that section 524(e) of the Bankruptcy Code did not prohibit a temporary injunction against collection and that the court had “related to” jurisdiction over the enforcement of the guarantees because enforcement could affect administration of the plan. In considering whether the debtor met the standard for injunctive relief, it weighed the harm to the bank under the plan (delay in payment) against the risk of harm to the debtor and the guarantors (inability to fund the plan of reorganization, necessity of the guarantors filing their own chapter 11 cases) and found that the balance of hardships favored the injunction.
The bankruptcy court opined that the previous precedents did not necessarily preclude approving the plan’s injunction, but ultimately held that it was, as a matter of law, bound by precedent and was compelled to reject the plan because it violated section 524(e) of the Bankruptcy Code. The Linda Vista court distinguished a prior Ninth Circuit case that prohibited a post-confirmation injunction against suing non-debtors on the basis that the case prohibited permanent relief that had the effect of releasing the non-debtor party from liability. See American Hardwoods, Inc. v. Deutsche Credit Corp. (In re American Hardwoods, Inc.), 885 F.2d 621 (9th Cir. 1989); see also Resorts Int’l v. Lowenschuss (In re Fred Lowenschuss), 67 F.3d 1394 (9th Cir. 1995). It distinguished another case where the Ninth Circuit stated that the maximum injunctive relief a bankruptcy court can grant is a stay through confirmation on the basis that the particular case involved a pre-confirmation controversy. See Solidus Networks, Inc. v. Excel Innovations, Inc. (In re Excel Innovations, Inc.), 502 F.3d 1086 (9th Cir. 2007). It also distinguished two cases where the Ninth Circuit Bankruptcy Appellate Panel and an Arizona District Court respectively denied confirmation of plans with only temporary post-confirmation injunctions against pursuing third parties because these opinions were “not per se rulings” and because those decisions turned on the particular factual circumstances of the cases. See In re Rohnert Park Auto Parts, Inc., 113 B.R. 610 (9th Cir. B.A.P. 1990); In re Regatta Bay, LLC, 2009 WL 5730501 (D. Ariz. 2009). It further argued that the Linda Vista “facts are neither prejudicial nor onerous toward the creditor Bank,” and that the injunction is not permanent and does not release or otherwise change the guarantor’s liability, but rather “simply delays the actions which are preserved.” Despite this extensive analysis suggesting that the injunction could and should be approved, the court nevertheless found that the prior decisional law bound it to find that the plan violated section 524(e). Unfortunately, the court never explained why it concluded it was bound by distinguishable cases that did not establish a “per se” rule against the proposed injunction.
Courts normally will not deprive a guarantee beneficiary of its bargained-for collection rights against a non-debtor after confirmation because the guarantor has not subjected itself to the chapter 11 process and the protections to creditors that it affords. There may be scenarios however where protecting a guarantor from collection efforts enables it to make contributions to a debtor that substantially increase recoveries with insignificant cost to the guarantee beneficiary, and the Linda Vista opinion illustrates that courts may find room in the code and the case-law to approve a temporary injunction against collection efforts in these circumstances. Linda Vista also demonstrates however that it is difficult to get a court to approve an exception to the general rule of section 524(e) that a bankruptcy discharge does not affect the liability of any third party. Stay tuned though. The Linda Vista court said “[d]ue to the evolving state of the law concerning § 524(e), perhaps it is timely for the Circuit to take a fresh look at this issue.” The debtor has taken the court up on this invitation and is currently appealing the decision.