Contributed by Doron P. Kenter.
Several weeks ago, we wrote about a recent decision that held that courts may deem parties who become involved in a chapter 11 case to have waived certain protections otherwise afforded to them under the Bankruptcy Code. A new decision from the Eleventh Circuit Court of Appeals may already cast doubt on that proposition. At a minimum, the Eleventh Circuit has suggested that certain provisions of the Bankruptcy Code may never be waived. In fact, the decision suggests that confirmation orders (and perhaps other orders) may be subject to new challenges on appeal even where the appellant could have raised – but did not raise – any such argument before the bankruptcy court.
In Alabama Dept. of Econ. & Comm. Affairs v. Lett (In re Lett), the debtor filed an individual chapter 11 petition to reorganize and to “adequately handle” his creditors – particularly the Alabama Department of Economic and Community Affairs (“ADECA”), which asserted a claim in the amount of about $3 million. ADECA’s claim was secured by a judgment lien on all of the debtor’s real or personal property (subject to existing liens and encumbrances). In each of Lett’s first two proposed plans of reorganization, he proposed to pay ADECA less than $5,000, based on Lett’s valuation of his unencumbered property. The circuit court decision does not discuss these plans in great detail, but it appears that the bankruptcy court did not hold a confirmation hearing on these proposed plans and that each of these plans allowed Lett to retain certain assets without paying unsecured creditors in full. The Bankruptcy Administrator objected to each of these plans on the basis that they violated the absolute priority rule under section 1129(b)(2)(B) of the Bankruptcy Code, which provides that a plan is not “fair and equitable” with respect to a dissenting class of creditors unless the creditors in the class are paid in full or no junior creditor or interest holder receives or retains property under the plan.
Lett later filed a third amended plan, this time proposing to classify ADECA separately and to pay ADECA approximately $236,000 (in installments) on account of its $3 million secured claim. The plan also provided for a one percent distribution to all other unsecured creditors, payable six months after confirmation, and a one percent distribution to ADECA on account of the undersecured portion of its claim, payable in two annual installments. The plan also stated that on the effective date, “all property of the Estate shall revest in the Reorganized Debtor, all free and clear of all claims, liens, encumbrances and other interests of creditors.”
The bankruptcy court then held a confirmation hearing on Lett’s third proposed plan. While one class of creditors – comprised only of the Federal Land Bank Association of South Alabama, an impaired secured creditor – voted to accept the plan, ADECA voted against Lett’s plan, thereby triggering the cramdown requirements under section 1129(b) of the Bankruptcy Code. Lett testified (without any objection) that his plan met each of the requirements under section 1129(b). Although ADECA objected to the plan on a number of grounds, it did not object to the plan on the basis of the absolute priority rule. The bankruptcy court overruled ADECA’s objections to the plan and confirmed Lett’s plan, ruling specifically that the debtor’s plan “met the absolute priority requirements embodied in § 1129(b)(2).”
ADECA appealed from the confirmation order on several bases, though the only issue ultimately taken up by the appellate courts was the issue ADECA had not raised below – the failure of the plan to satisfy the absolute priority rule. On appeal, the Eleventh Circuit found that, despite ADECA’s failure to obtain a stay pending appeal and even though payments had been made under the plan, ADECA’s appeal was not equitably moot. Though the Bankruptcy Code contemplates equitable mootness of such appeals if the plan has been substantially consummated, the circuit court (and the district court below), relying on the Eleventh Circuit’s doctrine that an appeal of a confirmation order is not equitably moot until the plan is “so substantially consummated that effective relief is no longer available,” concluded that Lett had not consummated his plan to the extent that it had become “legally and practically impossible” to unwind that which has already been done. Though the circuit court did not offer a solution as to how Lett’s plan could have been unwound and confirmed anew without significant prejudice to parties in interest, it concluded that the plan “could be restructured to comport with the Bankruptcy Code without requiring wholesale disgorgement” of the distributions that had already been made and noted that it “trust[ed] the wisdom of the bankruptcy court in supervising such a delicate endeavor.” Accordingly, the circuit court concluded that an appeal was not equitably moot.
Largely ignoring many of ADECA’s arguments on appeal, the Eleventh Circuit focused on its new argument that the plan violated the absolute priority rule by providing that Lett himself would retain assets when his unsecured creditors were not being paid in full. In deciding whether ADECA could raise such an argument on appeal, the circuit court looked to the “civil plain error rule,” which provides that an appellate court should not ordinarily consider issues not raised below and that review of any such argument should be limited to issues of pure law, and to circumstances where “refusal to consider [such argument] would result in a miscarriage of justice.”
The Eleventh Circuit ultimately concluded that the district court had erred in relying on the civil plain error rule in declining to address whether the plan complied with the absolute priority rule. Relying on a footnote in a previous case, the circuit court noted that “the Bankruptcy Code envisions a bankruptcy court exercising an independent duty to ensure that the strictures of § 1129(b) are met with regard to a Chapter 11 cram down.” In allowing ADECA to appeal on those grounds, the circuit court was careful to note that it was not basing its decision on a conclusion that a failure to hear argument regarding the absolute priority rule would lead to a miscarriage of justice. Rather, the circuit court noted that, notwithstanding ADECA’s failure to challenge the plan on these grounds, the issue had been preserved for appeal because the requirements of section 1129(b) had “sufficiently present[ed] the absolute priority rule in the bankruptcy court as to preserve the issue for review. . .” Agreeing with the Ninth Circuit’s decision in In re Perez, the circuit court concluded that the debtor himself had placed the absolute priority rule squarely before the court when he proffered compliance with section 1129(b) and sought confirmation of the plan in a cramdown scenario.
In Lett, the Eleventh Circuit adopted the principle that uncontested matters may be “fair game” for appeal, at least as long as such appeal would not be moot. By holding that uncontested matters (or insufficiently contested matters) may be successfully challenged on appeal, notwithstanding a party’s failure to register a timely (or untimely!) objection and failure to request a stay pending appeal, the Eleventh Circuit has cast some doubt on the finality of confirmed plans and other settlements in bankruptcy court. Because the absence of a specific objection to a plan does not preclude later challenges to that plan on appeal, plan proponents and bankruptcy courts (at least in the Ninth and Eleventh Circuits) should take care to present as sufficiently detailed a record as possible, showing that the proposed plan (or settlement, or request for relief) satisfies each and every requirement under the Bankruptcy Code. While such a record may be burdensome on the court and on the parties, it may be the only way to ensure that the order entered by the court will resist any unforeseen challenges brought on appeal and to ensure the finality of such order with any certainty.