Restructuring

Contributed by Adam Lavine
Recently, you may have read that Houghton Mifflin Harcourt Publishing Company and twenty-four of its affiliates confirmed their prepackaged plan of reorganization.  What you might not know, however, is that the United States Bankruptcy Court for the Southern District of New York confirmed the Houghton Mifflin plan, despite finding, the very next day, that venue in the Southern District was improper.  Specifically, in In re Houghton Mifflin Harcourt Publishing Co., the court ruled that the statutory requirements for venue under 28 U.S.C. § 1408 were not met and that, as a result, a transfer of the case was necessary.  Nevertheless, to avoid prejudice to the debtors and their creditors in light of the prepackaged plan’s unanimous approval, the court chose not to effect a transfer of the case until the earlier of the effective date of the plan or three weeks from the date of entry of the confirmation order.
Venue for cases under the Bankruptcy Code is governed by 28 U.S.C. § 1408.  Pursuant to that section, a debtor may commence a case in a district where such debtor has (1) domicile, (2) residence, (3) a principal asset, or (4) a principal place of business.  28 U.S.C. § 1408(1).  A debtor may also commence a case in a district where there is a pending case “concerning such person’s affiliate, general partner, or partnership.”  28 U.S.C. § 1408(2).  Although a bankruptcy case must typically meet one of these five enumerated bases for venue, improper venue may be waived if no party in interest objects.
In Houghton Mifflin, no creditors of the debtors objected to venue in the Southern District of New York.  In fact, creditors unanimously approved the debtors’ prepackaged plan of reorganization and signed plan support agreements that required the cases to be filed in the Southern District of New York.
Despite unanimous creditor support for both the plan and the filing of the case in the Southern District of New York, the United States Trustee filed a venue objection. The court was both surprised by, and critical of, the U.S. Trustee’s decision to file a venue objection.  After all, the court noted that “a transfer would be more expensive and much less convenient for the Debtors’ creditors – especially since we here have a prepack, where the case would otherwise be over in 30 days.”
Despite its criticism of the U.S. Trustee’s prosecutorial discretion, the court, of course, was obligated to examine whether venue was proper.  If the debtors were not able to satisfy one of the five enumerated bases for venue established by section 1408, the court would be obligated to transfer the case.  More specifically, the court determined, like a majority of courts have, that 28 U.S.C. § 1406 applies to bankruptcy cases, and that this section requires the transfer or dismissal of a case when the debtor cannot satisfy one of the five bases for venue and a party in interest objects.  Accordingly, the court engaged in an analysis of whether the Houghton Mifflin debtors met one of the five enumerated bases for venue.
The debtors argued that venue was proper in the Southern District of New York because one debtor had a “residence” in New York and a second debtor had its “principal asset” in New York.  If the court had been swayed by just one of these arguments, then all twenty-five cases would have had proper bases for venue pursuant to section 1408(2), which provides venue for all corporate affiliates if venue is proper for any of them.  Unfortunately, the court sided with the U.S. Trustee, holding that (i) the “residence” basis for venue only applies to natural persons and thus could not apply to the first debtor, and (ii) the second debtor’s principal asset was its ownership interest in its subsidiaries and such property was located outside of New York.
Having determined that venue in the Southern District of New York was improper and that a transfer of the case was, therefore, mandatory under the statute, the court was faced with a problem.  On the one hand, the court recognized that “a transfer would be destructive to creditor interests, to the great expense and inconvenience of the parties (especially creditors), and the exact opposite of the interests of justice.” On the other hand, the court determined that it was bound by sections 1406 and 1408 to transfer the case to another jurisdiction.
In response to this problem, the court developed a clever two-part solution.  First, the court chose to confirm the plan of reorganization while the Trustee’s objection was still pending.  Second, the court noted that although section 1406 requires the court to transfer the case, section 1406 does not say when the court must order such a transfer.  Accordingly, to avoid prejudice to the debtor and creditors, the court chose not to effect a transfer of the case until the earlier of the effective date of the plan or three weeks from the date of entry of the confirmation order.  In so doing, the court attempted to ensure that the Houghton Mifflin debtors would be out of bankruptcy before the case was out of the Southern District.
Houghton Mifflin is a great example of a bankruptcy court exercising its discretion to promote the interests of justice.  Although some observers might worry that a decision such as Houghton Mifflin might open the door for future debtors to skirt venue requirements by allowing them to ask a court to delay the transfer of their case until a plan can be confirmed and/or go effective, the Houghton Mifflin decision may be limited to a rather unique set of facts.  For example, the court placed significant emphasis on the fact that (i) the case involved a prepackaged plan, (ii) the plan received unanimous support from creditors, and (iii) no creditor had filed an objection to venue.  It is unclear whether the court would have confirmed the plan and delayed the transfer if any of these facts had been different.  Even if a debtor finds itself in the same unique position as the Houghton Mifflin debtors did, it should continue to be mindful of the factors set forth in 28 U.S.C. § 1408 and be prepared with a “Plan B” if it does not survive a venue challenge.