Restructuring

Contributed by Nelly Almeida

“If at first you don’t succeed, try, try again.”  W.C. Fields

Sometimes we all need a fresh start . . . or two . . . .  Luckily for Deed and Note Traders LLC (DNT) the Bankruptcy Code does not prohibit serial good faith chapter 11 filings.  In fact, as the Ninth Circuit recently noted in In re Deed & Note Traders, LLC, there is no time limit on successive filings, and “corporate debtors are exempt from even the minimal constraints on serial filings imposed on other kinds of debtors.”  This does not mean, however, that a chapter 22—as a subsequent chapter 11 filing is often called—can’t cause a debtor a few headaches along the way.
DNT was an Arizona limited liability company that purchased, rehabilitated, leased and sold residential properties.  It obtained loans from individual investors to finance its acquisition of properties and used the money to rehabilitate the newly-acquired properties.  DNT would then refinance the loans with traditional lenders—often at market rates.  Once property values increased, DNT would sell the properties at a profit.  A series of unfortunate events created unavoidable financial troubles for the company, which troubles were exacerbated when a large provider of traditional and other residential loan programs in Arizona sought bankruptcy protection.
Its financial predicament led DNT to file its first voluntary petition for relief under chapter 11 of the Bankruptcy Code on September 7, 2007.  DNT’s plan was confirmed on October 23, 2008, and the plan became effective on November 3, 2008.  Despite the quick turn-around, DNT did not quite get the “fresh start” for which it may have been hoping.  The automatic stay appears to have remained in effect, and ”in the year after the effective date, there were almost a hundred motions for relief from stay, notices of default, or associated pleadings filed by secured creditors alleging DNT’s failure to make monthly payments under the [f]irst [p]lan.”  In March of 2009, DNT filed a motion for entry of a final decree and order closing the bankruptcy case.  Despite a number of objections and an attempt by a creditor to convert the case to a chapter 7, the company resolved all outstanding issues.  In February of 2010, the bankruptcy court entered the final decree and order closing the case.
Despite its best efforts, however, DNT was still unable to get a break.  Deteriorating market conditions forced the company to file a second chapter 11 petition just four days after obtaining the final decree.  On April 2, 2010, DNT proposed its second plan of reorganization.  The differences between the first and second plan seemed minor.  In the second plan, DNT proposed to “cram down” certain secured creditors’ allowed claims by reducing the allowed amount of those claims to the “market value” of the properties securing them.  Unsurprisingly, the secured creditors were discontent with this alteration.
A group of dissatisfied secured creditors—holders of loans secured by separate properties—immediately filed a total of ten motions to dismiss the second bankruptcy case, claiming that the second plan “violated section 1127(b), and the principle of finality of orders, and that DNT was attempting to circumvent the prohibition on modification of a confirmed, substantially consummated plan by a subsequent chapter 11 case.”  On top of the dismissal motions, DNT faced over sixty objections to confirmation of its new plan.  DNT then proposed an amended plan that did not cram down on six of the ten loans involved in the dismissal motions and either sought to abandon the properties or consented to relief from stay in favor of the secured creditor.  As for the remaining four loans, DNT claimed that the properties securing those loans were worth more than the amount of the respective debts secured by the properties and that the creditors’ rights were not actually impaired.  After evaluating the amended plan, the bankruptcy court concluded that none of the secured creditors were impaired, denied the motions to dismiss, overruled objections to confirmation, and confirmed the second plan, as amended.  The court noted that the “difficult call” was “for the properties and the creditors secured by those properties who were not crammed down in the first case and are being crammed down in the second.”  However, in determining that the modification in the second plan was justifiable, the bankruptcy court observed that the anti-deficiency statute in Arizona made it so that all the undersecured creditors were ever going to receive on account of their claims was the value of property anyway.   This justification did not stop the appeals.
The case went before the United States Bankruptcy Appellate Panel of the Ninth Circuit where the BAP issued a memorandum addressing 1) whether the bankruptcy court abused its discretion in confirming the second plan and 2) whether the bankruptcy court clearly erred in determining that the second plan was filed in good faith as required under section 1129(a)(3) of the Bankruptcy Code.
Reviewing case law from the Fifth and Seventh Circuits, the BAP concluded that, to propose a second plan, a debtor must demonstrate a genuine need to reorganize resulting from unforeseen changes in circumstances that contributed to the debtor’s default under the earlier plan.  In this case, the BAP found that the worsening market conditions (though potentially foreseeable) surrounding DNT’s reorganization were extraordinary enough to find that the bankruptcy court did not clearly err in determining that DNT’s proposal to cram down secured claims in the second plan was justifiable.
The BAP also found that the plan met the good faith standard set forth in section 1129(a)(3).  Although the Bankruptcy Code does not define “good faith,” courts have held that a plan is proposed in good faith where it achieves a result consistent with the objectives and purposes of the Bankruptcy Code.  The BAP determined that, although the bankruptcy court was correct in noting that the issue of good faith was a “close call,” DNT’s proposal to pay the secured creditors market value was consistent with what they would receive under Arizona’s anti-deficiency law.
DNT was finally able to move forward with its second reorganization.  The case illustrates that, although successive and closely spaced chapter 11 cases are not prohibited by the Bankruptcy Code, courts will undertake a deeper dive in examining the purpose behind a debtor’s “chapter 22” filing.  While DNT ultimately overcame those challenges, in other cases, the “good faith” call may be too close for comfort.