Texas Bankruptcy Court Warns: Don’t Be Left “Straightjacketed” By Ambiguous Reservation Provisions In Your Plan!

Contributed by Amanda M. Hendy
It is indisputable that hindsight is 20/20, but that is a lesson that the debtors in In re MPF Holdings US , LLC, Case No. 08-36084 (Bankr. S.D. Tex. February 11, 2011) had to learn the hard way when the Bankruptcy Court for the Southern District of Texas held that the language in their plan was not sufficient to enable them to retain the right to bring post-confirmation actions against certain defendants.
Section 1123(b)(3)(B) of the Bankruptcy Code states that a plan may provide for the retention or enforcement by the reorganized debtor or by the trustee of any claim or interest belonging to the estate.  The Bankruptcy Code is silent, however, with respect to how much detail a plan must actually contain to preserve effectively pre-confirmation causes of action for post-confirmation prosecution.  Thus, the level of specificity required in a plan’s reservation provision is a decision left to the courts.  As various approaches have emerged, one thing is clear – broad reservations of causes of action will not suffice in all circuits.
In MPF Holdings, the court considered whether the debtors’ plan of reorganization properly preserved certain preference suits brought by the litigation trustee following confirmation of the plan.  The plan provided that, subject to certain exceptions, the litigation trustee would have the right to pursue any avoidance action that “may” exist against certain specified defendants and the right to prosecute any cause of action that the debtors “may” hold against any person.  Following confirmation of the plan, the litigation trustee filed several lawsuits for preferences.  One of the defendants filed a motion seeking to enforce the terms of the confirmation order.  At its core, the dispute concerned whether the plan had properly reserved the litigation trustee’s rights to sue those defendants.
Before delving into the issue at bar, the bankruptcy court reviewed what it determined to be the three general approaches courts have taken with respect to the specificity required in a plan’s reservation provision.  First, the bankruptcy court noted that some courts, including the Seventh Circuit, find that broad, categorical language is sufficient to preserve causes of action.  Other courts take a more middle-of-the-road approach, based on the nuances of a specific bankruptcy case and plan.  Finally, the Fifth Circuit, as well as the Eighth Circuit, among other courts, take a third approach, requiring that a reservation provision be more precise.
The bankruptcy court noted that the Fifth Circuit has held that, for a plan of reorganization to effectively preserve a cause of action, the plan must “expressly retain the right to pursue such causes of action” and the retention language must be “specific and unequivocal.”  The bankruptcy court reasoned that the heightened notice requirement serves an important purpose, according to the Fifth Circuit.  Absent specific and unequivocal retention language in the plan, creditors lack sufficient information regarding their benefits and potential liabilities to cast an intelligent vote to approve or disapprove it.
Applying the Fifth Circuit’s standard, the bankruptcy court concluded that the phrase “specific and unequivocal” meant that a proper reservation provision must expressly state: (1) the name of the putative defendant; (2) the basis on which the putative defendant will be sued; (3) that the putative defendant will be sued; and (4) that the suit will definitely be filed following confirmation – not that the defendant may be sued, could be sued or might be sued.  According to the bankruptcy court, “the language must be so Shermanesque that anyone who reads the proposed plan knows that if the plan is confirmed, the putative defendant will unquestionably be sued post-confirmation under a particular legal theory or statute.”
Ultimately, the plan met the “specific” requirement because it expressly identified the putative defendants by referencing “any party” identified on certain exhibits to the debtors’ statements of financial affairs, which schedules listed the names of the putative defendants, their addresses, and the amounts that the debtors paid to such defendants within 90 days prior to the commencement of the debtors’ cases.  However, the bankruptcy court concluded that the language in the plan was not “unequivocal” for several reasons.  First, the plan reserved all causes of action “that may exist” against any party identified on certain exhibits to the debtors’ statements of financial affairs.  The bankruptcy court found that the use of the phrase “that may exist” created an ambiguity as to what causes of action were reserved for the litigation trustee, and essentially acts as a blanket reservation, which contradicted Fifth Circuit precedent.  Second, although the plan identified the name of the putative defendants and the basis of the putative suits (preferences), the plan failed to state that the causes of action “do exist and will be prosecuted,” but, rather stated that these causes of action “may exist.”  Because the conflicting language prevented creditors from knowing precisely what causes of action were being preserved and would be prosecuted, the language not “unequivocal.”
The court also held that the language in the plan, which provided that the litigation trustee “shall have the right to prosecute and enforce any rights to payment of claims or other rights and Causes of Actions that the [debtors] may hold,” similarly, was not unequivocal due to the use of the word “may.”  Furthermore, the disclosure statement contained ambiguities and contradictions that rendered the reservation causes of action not unequivocal.  For example, the disclosure statement stated that the debtors had not identified or fully investigated potential avoidance actions.  Such a statement, among others, led to the bankruptcy court’s conclusion that the plan and the disclosure statement did not unequivocally preserve causes of action for the litigation trustee to recover preferences.
Consequently, the bankruptcy court determined that the language in the plan and disclosure statement did not satisfy the standard established by the Fifth Circuit for reserving causes of action.  As a result, the litigation trustee did not have standing to prosecute the preference action, and the bankruptcy court did not have subject matter jurisdiction over the suits.
Notably, the bankruptcy court recognized two recent cases from the United States Bankruptcy Court for the Northern District of Texas, In re Manchester, Inc. andIn re Tex. Wyo. Drilling, Inc., in which the court was critical of the Fifth Circuit’s bright-line test.  The bankruptcy court also observed that the vast majority of chapter 11 debtors’ attorneys believe that reservation provisions in plans should be broadly drafted to preserve as much post-confirmation flexibility as possible.  Moreover, it goes without saying that if a debtor must determine with 100% certainty whether it will sue a particular defendant prior to confirming its plan, the plan confirmation process will be delayed.  While the bankruptcy court appreciated the logic and merit of crafting broad reservation provisions, it stated, nonetheless, that the Fifth Circuit seems to placing a premium on the need for complete disclosure as to who will definitely be sued post-confirmation and on what specific legal basis cautioning, “[A]mbiguous reservation provisions will no longer suffice. . .[e]ither be straightforward in the proposed plan, or be straightjacketed after confirmation of the plan.”