Contributed by Doron P. Kenter.
Last week, we wrote about a decision in the chapter 11 case of Charles Street African Methodist Episcopal Church of Boston, in which the court declined to subordinate a bank’s secured claim against the debtor. The court denied the motion to subordinate despite the fact that the bank had filed a patently unconfirmable “draft” plan during the debtor’s exclusivity period in an effort to dissuade creditors from supporting the debtor’s plan – and instead fashioned a remedy that was appropriate under the circumstances to penalize the bank for its “knowing and deliberate violation of the right of exclusivity . . . made only the more egregious by the falsity of the hope and pretense of the ploy.” More about that decision is available here. This week, we devote our attention to a prior decision in the same case, in which the bankruptcy court declined to designate the bank’s claims, holding that designation is only warranted where it fits within the specific parameters contemplated by the Bankruptcy Code.
Section 1126(e) of the Bankruptcy Code provides that a court may designate (i.e., not count) the votes cast to accept or reject a plan “by any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.” (Notably, the remedy is discretionary – the court may designate votes under those circumstances – but it is not required to do so.)
Citing section 1126(e), the debtor moved to designate the bank’s claims for two reasons: First, the bank had prematurely solicited votes for its own chapter 11 plan, in violation of section 1125(b) of the Bankruptcy Code. And second, the bank had cast its votes against the debtor’s plan out of an ulterior motive – namely, to shore up its own ailing liquidity and balance sheet.
In denying the debtor’s motion, the court looked to each of the two stated grounds for designation. First, the court observed that the debtor had alleged that the bank had solicited other parties’ votes in bad faith and in violation of the provisions of the Bankruptcy Code. The Bankruptcy Code, however, only authorizes designation of votes cast by an entity whose own votes are improperly cast, solicited, or procured – and does not authorize designation as a personal punishment for an entity that had done the improper soliciting and/or procurement. Because the bank had not “cast or procured its own vote improperly,” the court held that subsection 1126(e) did not authorize designation on these grounds.
Second, the court considered whether the bank had cast its own votes with an ulterior and illegitimate motive – in which case its votes could have been designated by virtue of having not been cast “in good faith.” The court concluded that the bank had demonstrated no such motive. Instead, it had voted to reject the debtor’s plan because it wanted to compel payment of its debt in a large, up-front deposit of cash, rather than through monthly payments over a period of thirty years. Indeed, even if the bank’s own financial difficulties had compelled it to press for immediate payment (and to reject the debtor’s plan), that motivation would not have been improper, because, as the court held, a lender’s attempt to “obtain immediate payment on a loan because it needs the cash is self-interest, perhaps even ‘selfishness’ . . . but the Bankruptcy Code does not expect creditors to act self-sacrificially to avoid the stigma of bad faith.” In other words, personal interests must be separated from bad faith, with the former being insufficient to warrant the rare remedy of designation.
It is clear from the bankruptcy court’s various decisions in the church’s bankruptcy case that the bank’s actions have been less than wholesome. Nevertheless, the court’s decisions remind us that the Bankruptcy Code has limits, and that those limits must be respected. Importantly, the bank was eventually required to pay for its misconduct (in the form of the debtor’s attorneys’ fees, $50,000 toward an examiner, and a prohibition on filing its own plan). But the punishment must not only fit the crime – it must also be within the court’s powers and within the four corners of the Bankruptcy Code.
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