Restructuring

Contributed by Laura Napoli
The United States Bankruptcy Court for the District of Arizona recently had to decide whether a vote from an impaired, accepting creditor who was “friendly” to the debtor should be disqualified as being in bad faith in In re Bataa/Kierland, LLC.  In this single asset real estate case, the debtor, Bataa/Kierland LLC, owned an office building and parking lot, both of which secured amounts owed by the debtor to its lender.  Although the lender rejected the debtor’s plan of reorganization, two other secured creditors in separate impaired classes voted to accept the plan.  In an attempt to avoid cramdown, the lender moved to “designate,” or disqualify, one creditor’s acceptance of the plan pursuant to section 1126(e) of the Bankruptcy Code, alleging both that the creditor should be considered an insider of the debtor because he was friendly with the debtor and that the acceptance of the plan by such creditor otherwise was not in good faith.  The lender also argued that the plan’s treatment of a taxing authority’s claim did not constitute impairment.  Because the bankruptcy court overruled both objections, it confirmed the plan over the lender’s rejection.
The accepting “friendly” creditor, Joseph Annoreno, was the CEO of a tenant of a building adjacent to the debtor’s, was friends with the debtor’s principal, and had made a prepetition loan to the debtor for the purchase of computer equipment.  Annoreno had both a secured claim and an unsecured deficiency claim in the bankruptcy, and Annoreno voted to accept the debtor’s plan of reorganization.
The lender argued that Annoreno’s vote should be designated because the debtor could have paid Annoreno’s claim in full prior to the commencement of its chapter 11 case, but had not done so in order to artificially impair the claim for the purpose of obtaining an impaired, accepting class under section 1129(a)(10) of the Bankruptcy Code.  The lender also argued that, because of Annoreno’s relationship with the debtor, Annoreno was an insider whose vote could not be counted as the vote of an impaired accepting class under section 1129(a)(10).  Notably, the lender’s objection, which was filed several months before the final confirmation hearing, did not include a motion to designate Annoreno’s vote; instead, the lender filed a motion to designate just minutes before the final evidentiary hearing on confirmation was to begin.
In reviewing the lender’s motion to designate, the bankruptcy court observed that the lender’s objection to plan confirmation could not serve as a motion to designate because it did not provide Annoreno notice that the lender was challenging his vote.  Because Annoreno was entitled to notice and a hearing prior to the conclusion of the plan confirmation hearing, the court concluded that the Lender’s motion to designate was untimely, having been filed just minutes before the final confirmation hearing was to begin.  Nevertheless, the bankruptcy court addressed the merits of the lender’s argument.
The court first addressed the lender’s gerrymandering argument.  The bankruptcy court held that its role was not to determine whether alternative payment structures under which Annoreno’s claim could have been paid in full existed.  Indeed, the court expressed the view that, in light of Ninth Circuit precedent, it need not consider the concept of “artificial” impairment – as long as the creditor’s claim was classified properly, and the treatment it was receiving constituted impairment, then the standard was satisfied.  Annoreno’s claim was a secured claim, which was substantially different from the other, unsecured claims in the case.  Thus, the court determined that Annoreno’s claim had to be classified separately from the other claims pursuant to section 1122 of the Bankruptcy Code.  Because the Bankruptcy Code required a separate classification for Annoreno’s claim and the claim was impaired under the plan, the court overruled the lender’s gerrymandering objection, finding no reason to consider any other motives the debtor may have had for making the classification.
The court next considered whether Annoreno’s acceptance of the plan was in good faith under section 1126(e) of the Bankruptcy Code.  To analyze this issue, the court looked at the Ninth Circuit’s Figter decision, which held that bad faith occurs when a creditor seeks to secure an untoward advantage over other creditors for some “ulterior reason.”  An analysis of the case law led the court to determine that a creditor’s motives are “ulterior” only when they are ulterior to the creditor’s capacity as a creditor.  The court determined that Annoreno’s motive was to see the Debtor succeed in bankruptcy by supplying the acceptance that section 1129(a)(10) requires for plan confirmation.  The lender had presented no evidence that Annoreno was motivated to vote for reasons outside his capacity as a creditor; indeed, the lender had not presented any evidence of Annoreno’s motives at all.  Applying the Figter decision to the facts of the case, the bankruptcy court concluded that it is not an “ulterior motive” for a creditor to be “friendly” to the reorganization, and thus, Annoreno did not act in bad faith.
After concluding that Annoreno had acted in good faith, the court next considered whether the debtor had acted in bad faith by creating the Annoreno secured claim on purpose in contemplation of the bankruptcy filing in order to create an accepting impaired class.  The court first noted that section 1126(e) only applies to bad faith in the solicitation or procurement of a creditor’s vote, not to the creation of the claim on which the vote is cast.  Because the creation of the Annoreno debt had occurred months before the bankruptcy filing, the court concluded that it was unlikely that the debtor’s actions months before the filing could somehow have influenced the solicitation or procurement of Annoreno’s vote.  Further, even if the debtor’s purpose for creating the debt was to create a class that would render the plan confirmable, the court concluded that, under Figter, the debtor’s motive would not be considered “ulterior” because the debtor was a proponent of its plan of reorganization and, as a plan proponent, naturally would want the plan to be confirmed.  Further, the debtor’s prepetition creation of a potentially accepting impaired class did not give the debtor any advantage that it wouldn’t otherwise have, because the debtor would still have to comply with all of the other confirmation requirements.  For these reasons, the court found that there was no bad faith in the debtor’s solicitation or procurement of Annoreno’s acceptance, even if the Debtor had created Annoreno’s claim with the intent to use it to satisfy section 1129(a)(10).
The court’s decision reflects its reluctance to investigate further the motives of a debtor or creditor once it is shown that the debtor or creditor is acting in accordance with its respective role in the case.  It is not clear, though, how much of this reluctance stems from Ninth Circuit precedent or from the court’s conclusion that the lender’s challenge was untimely, coupled with the complete failure of the lender to present any evidence to support its challenge.  One thing is clear – the court was unwilling to draw any inference of bad faith simply on the basis of the debtor having a friendly creditor.