The hard work has been done – the plan has been negotiated and confirmed, the confirmation order has been entered, and holders of allowed claims (and maybe even interest holders) await their distribution under the plan. A plan, however, may require that creditors or equity holders take certain acts prior to participation in the plan distribution, or forfeit their right to participate. Practitioners, therefore, should take note of section 1143 of the Bankruptcy Code, which sets an outside time limit for surrender or presentment of a security or the taking of an act as a condition to participation in distribution under the chapter 11 plan. Today’s installment of our “Breaking the Code” series delves into this provision.
Section 1143 of the Bankruptcy Code provides as follows:
If a plan requires presentment or surrender of a security or the performance of any other act as a condition to participation in distribution under the plan, such action shall be taken not later than five years after the date of the entry of the order of confirmation. Any entity that has not within such time presented or surrendered such entity’s security or taken any such other action that the plan requires may not participate in distribution under the plan.
Section 1143 essentially functions as a post-confirmation bar date to take certain actions. For example, if a junior lienholder is determined not to have a secured claim because of the low value of its collateral, then the confirmed plan may require that the junior lienholder execute a formal lien release before the junior lienholder receives a distribution as an unsecured creditor. Even though the plan and the confirmation order should be sufficient to effectuate such a lien release, the plan proponent may prefer to receive a formal lien release because that will be more readily understandable to parties that may not have been involved in the bankruptcy process. The junior creditor must deliver the lien release within the statutory five-year period in order to obtain a distribution. A plan proponent may select an earlier date, but if the plan is silent, then section 1143 automatically establishes a five-year limitation. It’s also worth noting that the five-year period runs from entry of the plan confirmation order; thus, this period will run notwithstanding any appeal from entry of the confirmation order or other conditions precedent that may delay the effective date of the plan.
Relationship to Other Code Sections
Section 1143 operates in tandem with section 347(b) of the Bankruptcy Code, which states as follows:
Any security, money or other property remaining unclaimed at the expiration of the time allowed in a case under chapter 9, 11 or 12 of this title for the presentation of a security or the performance of any other act as a condition to participation in the distribution under any plan confirmed under section 943(b), 1129, 1173 or 1225 of this title, as the case may be, becomes the property of the debtor or the entity acquiring assets under the plan, as the case may be.
If the plan sets an earlier date than the five years provided in section 1143, then that time period will also govern when unclaimed property automatically becomes the property of the debtor or the entity acquiring assets under the plan, pursuant to section 347(b).
Together, these Bankruptcy Code provisions establish the outer limit of five years from entry of the plan confirmation order within which a creditor or holder of an equity interest must perform an act required under the plan, or risk forfeiting its right to receive a distribution. The statutes also control the disposition of unclaimed funds in chapter 11 cases. The purpose of these provisions is to achieve “finality, judicial economy and the avoidance of disruptive, wasteful litigation over funds which remain unclaimed.” Nonetheless, the finality of sections 347(b) and 1143 has been litigated in the context of liquidating chapter 11 plans, with the majority of courts holding in that context, in the absence of a provision in the plan providing for an alternative disposition of assets before section 347(b) would be effective and where no entity acquires most of the debtor’s assets, shareholders’ interests are extinguished, and the debtor essentially ceases to exist, that the unclaimed funds do not revert to the debtor. For example, in In re Premier Holdings of Texas, where the debtor was dissolved and the liquidating trust that acquired the debtor’s assets would also dissolve, the court found it “simply impossible” to comply with section 347(b). Unintended consequences might also prevent funds from reverting to the debtor – the same court also denied the return of residual funds to the debtor because it was the perpetrator of a Ponzi scheme.
What constitutes “performance of any other act as a condition to participation in distribution under the plan”? Courts have acknowledged that section 1143 does not impose implicit requirements on creditors and security holders; that is, once a creditor has done what the plan requires to qualify to receive a distribution, section 1143 does not impose any other requirement to take any further action. Nonetheless, courts have considered whether “any other act” referred to in section 1143 includes cashing distribution checks received.
For example, in In re IBIS Corporation, the debtor asserted that all the money in the court’s registry belonged to the debtor under sections 347(b) and 1143 of the Bankruptcy Code because the “other acts” under section 1143 that creditors were required to perform included cashing distribution checks received; creditors had not satisfied such requirement within five years after confirmation, so the debtor asserted that the funds became its property. The creditors, on the other hand, asserted that no act was required as a condition precedent to participation in the distribution under the confirmed plan, and, to the extent uncashed checks existed, the funds should be redistributed to the remaining creditors because the plan provided that all distributions would be pro rata among the creditors. The court agreed with the creditors that, under the terms of the confirmed plan, the creditors were not required to do anything to participate in the distribution. The court further held that cashing distribution checks was not the kind of requirement that section 1143 addresses. The checks would never have been mailed to creditors if they were not eligible to receive a distribution, and whether the uncashed or undelivered checks were unclaimed was a separate issue.
What happens if distributions are not even made within the five-year post-confirmation period? This was the situation in In re Goldblatt Brothers, Inc., in which the creditors’ committee (the entity responsible for making distributions under the plan) had failed to make timely distributions, with the majority of distributions coming after the fifth anniversary of the confirmation order. The court found that the creditors, who were still awaiting dividend checks, had no “act” to perform as a condition to participation in the plan distribution. The court further explained that it would be inequitable “to allow a debtor to receive a windfall for its own negligence in failing to diligently complete the distributions under the plan, or here for delay occasioned by the Creditors’ Committee in carrying out its duties.” To hold otherwise would provide a debtor with incentive to delay distributions.
The court in In re TLI, Inc. reached the opposite conclusion from the IBIS and Goldblatt courts. Instead, the TLI court found that the cashing of a check is of necessity an act within the meaning of both sections 347(b) and 1143 of the Bankruptcy Code. The court determined that such a reading of those sections supports the policy of finality, judicial economy, and avoidance of protracted litigation underlying those sections. If cashing a check were not within the meaning of those Code provisions, then courts could not determine what funds were unclaimed and subject to sections 347(b) and 1143.
It is worth noting, though, that these disputes typically arise when the plan is silent on the issue of what happens to uncashed checks, and when. For that reason, it is good practice to state clearly in a plan what the consequences are of a failure to cash a check that was mailed to a creditor or equity interest holder. Often, plans treat uncashed checks as unclaimed funds after a certain period of time passes following distribution of the check. That addresses the issue of finality, but also does not set an arbitrary deadline for treating uncashed checks as unclaimed.
Does a court have authority to extend the five-year time period under section 1143, or such other time limit as provided in the confirmed plan? At least one court has answered in the affirmative with respect to the deadline set forth in a confirmed plan, holding that it had discretion to extend the time for surrender of a security where the security holder demonstrated that she did not receive adequate notice of the surrender date. In that case, although the surrender date provided for under the plan had passed, the five-year time period under section 1143 had not lapsed, which the court decided weighed in favor of extending the deadline. The court also found that the impact of the delay in distribution on the debtor did not outweigh the corresponding impact on the movant.
If, as a result of the operation of sections 347(b) and 1143, there is unclaimed property in a liquidating chapter 11 case, what happens to this “spare change”? The Bankruptcy Code does not provide guidance on what should become of surplus funds that remain after all funds have been distributed under a liquidating chapter 11 plan. The funds could be donated to charity. This option might even be authorized under a bankruptcy court’s local rules. Or the funds might become property of the U.S. Treasury. See 28 U.S.C. § 2041 (“All moneys paid into any court of the United States, or received by the officers thereof, in any case pending or adjudicated in such court, shall be forthwith deposited with the Treasurer of the United States or a designated depositary, in the name and to the credit of such court.”). In the absence of language in a plan to the contrary, states may also take the position that the funds should escheat to the applicable states, with any right to receive those funds subject to the state’s escheat laws.
Practitioners representing creditors in a chapter 11 case should be aware of the time frames set forth in a confirmed plan for the actions required under section 1143 of the Bankruptcy Code, as the deadline for any required action is unlikely to be extended unless a creditor or interest holder is not provided with the requisite due process. Plan proponents of a liquidating chapter 11 plan should also include a provision that addresses the distribution of surplus funds that may remain in a liquidating chapter 11 trust, as a practical way to avoid litigation over creative ways to distribute the funds in the future.
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