Restructuring

Contributed by Victoria Vron
Bankruptcy practitioners often struggle with the level of disclosure required in a plan or a disclosure statement.  For example, how specifically should the plan and disclosure statement describe the claims and causes of actions to be retained by the debtor post-effective date?  How precise should be the estimates of total claims against the estate?  How accurate should be the projected distributions to creditors?  In re Multiut Corporation, Case No. 09-17575 (Bankr. N.D. Ill. Apr. 19, 2011), explores how one debtor’s approach to these questions led to the denial of confirmation of its chapter 11 plan.
The debtor in Multiut was a provider of energy consulting services.  It commenced the chapter 11 case to stay collection of a roughly $15 million judgment entered against it in a litigation with one of its clients, Dynegy Marketing and Trade, and to give the debtor an opportunity to prosecute its own claims against Dynegy through a multidistrict litigation with the goal of offsetting any recovery against the judgment.  At the time of the filing, Dynegy’s judgment against the debtor was not yet final and was likely going to be appealed.  Indeed, the debtor’s and Dynegy’s claims against each other were still not fully adjudicated by the time of the confirmation hearing.  The class of claims that included Dynegy’s disputed claim voted to reject the debtor’s proposed chapter 11 plan, and Dynegy filed a vociferous objection to confirmation of the chapter 11 plan.  In a detailed opinion, the bankruptcy court analyzed each of Dynegy’s objections to the plan, sustained certain of the objections and overruled the others.  As a result, the bankruptcy court denied confirmation of the debtor’s chapter 11 plan and set a hearing to determine whether the case should be converted to chapter 7 or dismissed because by that time the case had already been pending for approximately two years.  Although the bankruptcy court found a number of reasons for denying confirmation of the plan, this article focuses on one notable one:  the court’s finding that the debtor had not proposed its plan in good faith.
Section 1129(a)(3) of the Bankruptcy Code requires that a chapter 11 plan be proposed in good faith and not by any means forbidden by law.  Although the Bankruptcy Code does not define “good faith,” courts have developed a variety of definitions and tests for determining if a plan was filed in good faith.  Notably, in Multiut, the court looked to the totality of circumstances test the Seventh Circuit has adopted in chapter 13 cases in determining whether the plan was filed in good faith.  Specifically, the Multiut court found that the following factors, although typically considered in chapter 13 cases, are still relevant and inform part of the court’s inquiry in a chapter 11 case: (i) whether the plan states secured and unsecured debts accurately; (ii) whether expenses are accurately disclosed; (iii) whether the percentage distribution to unsecured claimants is accurate; (iv) whether inaccuracies in the plan amount to an attempt to mislead the court; and (v) whether the proposed payments show fundamental fairness in dealing with one’s creditors.
The Multiut court ultimately found that the debtor’s plan was not proposed in good faith because (i) it failed to adequately reserve claims and causes of action the debtor may have against third parties (including insiders), (ii) it failed to accurately state the value of unsecured claims, and (iii) it contained a substantially inaccurate calculation of the plan’s minimum percentage distribution to unsecured creditors.   Each of these is discussed below.
Reservation of Claims and Causes of Action
The debtor’s plan contained a typical blanket reservation of rights language that provided that the debtor will retain any and all claims and causes of action it has against third parties post-effective date.  Although courts have recently required debtors to include more specificity about which claims and causes of actions are being retained, they either have done so prior to confirmation to ensure that such claims and causes of action would be properly preserved post-effective date or to determine after confirmation that the reorganized debtors were barred from pursuing the claims.  The Multiut court, however, went a step further holding that the debtor’s failure in the plan to properly preserve claims, including potential claims against the debtor’s insiders, bore directly on the plan’s good faith.  It is unclear from the decision whether the debtor knew that its blanket reservation would not have preserved the debtor’s claims against insiders and whether such blanket reservation was intentional. Regardless, the Multiut  court’s decision is yet another reason for practitioners to pay closer attention to this often overlooked section of the plan and make sure that the debtor’s reservation of claims and causes of actions is stated with enough specificity as to be properly preserved under applicable law.
Value of Unsecured Claims
In its plan and disclosure statement, the debtor estimated Dynegy’s disputed claim at approximately $15 million, the amount of the judgment as of the petition date.  In the disclosure statement, the debtor discussed the Dynegy claim and the attendant litigation in detail and noted that Dynegy’s ultimate claim may be as high as $22 million.  After the debtor filed its plan and proposed disclosure statement (both of which occurred prior to June 2010) and almost three months before the bankruptcy court approved the disclosure statement in October 2010, an amended judgment was entered against the debtor by the non-bankruptcy court increasing the $15 million judgment to approximately $22 million.  The debtor, however, did not amend the plan or update the proposed disclosure statement to reflect this increase in Dynegy’s claim.  In addition, between the filing of the proposed plan and the confirmation hearing, a second disputed claim that was mentioned in the plan (but for which no value was listed) was resolved for $200,000, but the debtor again did not amend the plan or update the disclosure statement to list its value.  The bankruptcy court found that the failure to correct the estimates for these two claims demonstrated that the debtor’s plan was not proposed in good faith.  Based on the court’s calculations, total unsecured claims (including the disputed claims) should have been approximately 30% greater than what the debtor estimated.
Although the court’s decision does not discuss this, presumably this increase in total claims would have resulted in a decrease in the pro rata distribution to other unsecured creditors and could have affected the class of general unsecured creditors’ vote on the plan (they had voted to accept).  If this was the bankruptcy court’s impetus for denying confirmation of the plan, the court could have just required the debtor to amend the disclosure statement and afford accepting creditors an opportunity to change their votes.  Instead, the bankruptcy court adopted a broad, extreme view of “good faith” that may have been warranted based upon other facts known to the court but not discussed in the opinion, thus establishing a dangerous and unwarranted precedent for future cases.  Nonetheless, this decision raises the question of at what point does a disclosure statement become so misleading or the factual predicates of a plan so inaccurate that the debtor should make a supplemental disclosure.  Multiut, however, fails to provide guidance on this point as the court simply concluded that an increase in potential claims of about 30% from the debtor’s estimate in its disclosure statement demonstrated a lack of good faith on the part of the debtor.
Minimum Percentage Distributions
The third factor to which the Multiut court pointed as evidencing lack of good faith was the accuracy (or more precisely, the lack thereof) of the debtor’s disclosure of the percentage distribution to unsecured creditors.  Using certain budget projections and the $15 million estimate for Dynegy’s claim, the debtor’s plan stated that unsecured creditors would receive a 20% percent recovery if all the disputed claims, including Dynegy’s, were disallowed, and “likely” a 5% recovery if such disputed claims were allowed.  In addition to taking issue with the debtor’s projections, the bankruptcy court determined that the debtor should have used the $22 million amount for Dynegy’s claim in its calculation because by the time of the confirmation hearing (and even the disclosure statement hearing), such number was already known.  Using its own calculation of the funds that would be available to pay unsecured creditors and the higher amount for total unsecured claims, the bankruptcy court calculated recoveries to unsecured creditors in the event disputed claims were allowed to be approximately 0.3318%  — which, using the court’s words, is “a far cry” from the plan’s suggested minimum distribution of 5%.
Creditors have come to expect ranges of potential recoveries in a disclosure statement, and adopting a rule that punishes debtors for attempting to estimate recoveries seems more likely to lead to overly cautious and less useful disclosures.  One would hope that the real effect of Multiut will be to encourage efforts by debtors to set forth clearly the assumptions on which their estimates are based, as well as the risk factors associated with those assumptions, so that creditors may make an informed decision when voting on a plan.