Restructuring

Contributed by Elisa Lemmer
The recent decision in In re Renegade Holdings confirming a plan of reorganization premised, pursuant to section 1123(a)(5) of the Bankruptcy Code, on preemption of state law has continued to fuel the unresolved circuit split ignited by the Ninth Circuit nearly a decade ago in Pacific Gas & Electric.  Renegade Holdings, like other recent cases outside of the Ninth Circuit, declined to adopt the very narrow view of 1123(a) – a section of the Bankruptcy Code that provides for preemption of applicable nonbankruptcy law in certain circumstances – held by the Ninth Circuit.  Renegade Holdings, however, failed to shed any additional light on the scope of preemption provided by section 1123(a).  The result is that, outside of the Ninth Circuit, where the limits of section 1123(a), are broader but less defined, debtors whose plans are premised on preemption of nonbankruptcy law must continue to tread those proverbial waters carefully.

To be confirmed, a plan must provide, among other things, adequate means for its implementation.  The operative language in the Bankruptcy Code setting forth this requirement provides, in relevant part, “Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall – provide adequate means for the plan’s implementation.”  11 U.S.C. § 1123(a)(5).  Although the “notwithstanding” clause of section 1123(a), by its express terms, appears to have a broad preemptive scope, applying ostensibly to any applicable nonbankruptcy law, some courts – including the Ninth Circuit in In re Pacific Gas & Electric Co. v. California, 350 F.3d 932, 949 (9th Cir. 2003) (“PG&E”) – have interpreted the clause much more narrowly holding that the clause preempts only nonbankruptcy laws relating to the financial condition of the debtor.
In PG&E, the debtors, citing to existing case law in other jurisdictions, argued that section 1123(a)(5) of the Bankruptcy Code enabled their plan to preempt otherwise applicable nonbankruptcy law – including, for example, state laws that would otherwise prevent them from transferring certain assets without the consent of the California Public Utilities Commission – to provide the means for the implementation of their plan.  On appeal, however, the United States Court of Appeals for the Ninth Circuit disagreed.  It interpreted section 1123(a)(5) more narrowly, concluding that the phrase “Notwithstanding any otherwise applicable nonbankruptcy law” in section 1123(a)(5) must be read in conjunction with the phrase “Notwithstanding any otherwise applicable nonbankruptcy law, rule or regulation relating to financial condition” in section 1142(a) of the Bankruptcy Code.  Consequently, even though the proviso in section 1123(a) was not limiting, the Ninth Circuit concluded that the preemptive scope of the “notwithstanding” clause contained in section 1123(a)(5) was the same as that contained in section 1142(a) and, thus, applied only to those laws relating to financial condition.  350 F.3d at 949.
Since PG&E, other courts have rejected the Ninth Circuit’s reasoning and have refused to adopt a narrow interpretation of section 1123(a)’s “notwithstanding” clause.  The Bankruptcy Court for the Middle District of North Carolina, in In re Renegade Holdings, Inc., 429 B.R. 502 (Bankr. M.D.N.C. 2010), is the most recent court to join courts in Delaware and other jurisdictions outside of the Ninth Circuit in concluding that the Ninth Circuit read section 1123(a) too narrowly.
In Renegade Holdings, the debtor, a cigarette and cigar manufacturer, was required under state law to make certain statutory escrow payments.  The debtor’s plan of reorganization proposed to pay past due amounts into escrow over time.  Various states with claims for overdue escrow payments, however, objected to the plan arguing that the payments could not, under applicable law, be made over time.  The bankruptcy court disagreed, referring to section 1123(a)(5) as an “empowering statute” and one that enlarges the scope of the debtor’s prebankruptcy rights.  As with other recent cases, the Renegade court disagreed with the Ninth Circuit’s conclusion that section 1123(a)(5) preempts only those laws that relate to the debtor’s financial condition. Consequently, the court allowed the debtor to implement its plan by making the required statutory payments over time – contrary to the immediate payments that otherwise were required under state law.
The Renegade decision suggests that PG&E is the real renegade, although Renegade fails to examine whether, as its holding might suggest, the “notwithstanding” clause in section 1123(a) is truly boundless.  Because at least some courts have held that the “notwithstanding” clause in section 1123(a) does have certain limitations, even debtors outside the Ninth Circuit may face obstacles in proposing a plan that relies on preemption of nonbankruptcy law.