Contributed by Victoria Vron
Filing a chapter 11 plan is like many things in life. Preparation and careful planning usually leads to a better result than acting on a whim and hoping for the best. A recent decision in Sparkle Stor-All Eaton Township, LLC, reaffirms what most of us risk-averse lawyers already know: to the extent possible, it is better to dot your “i”s and cross your “t”s on a chapter 11 plan to avoid undesired consequences, such as dismissal of a case.
In Sparkle Store-All, four limited liability companies that own and operate storage facilities commenced chapter 11 cases in the United States Bankruptcy Court for the Northern District of Ohio after their bank (which holds a lien on substantially all of the debtors’ assets) obtained a judgment against them with respect to loans aggregating to over $4 million. Less than four months into their chapter 11 cases, the debtors filed their first chapter 11 plan without first negotiating the plan with their main impaired creditor—the bank. The bank objected to the adequacy of the proposed disclosure statement arguing that it failed to provide adequate information as to the treatment of the bank’s claims and that the plan could not be confirmed over the bank’s objection. Faced with this objection, the debtors spent the next three months revising the proposed disclosure statement and the plan only to be ordered by the court each time that the revisions were not sufficient to overrule the bank’s objection. At the end, the debtors had filed a total of four proposed disclosure statements and five proposed chapter 11 plans—all allegedly without engaging, or even attempting to engage, in meaningful discussions with the bank. The United States Trustee and the bank filed motions to dismiss the chapter 11 cases pursuant to section 1112 of the Bankruptcy Code. After the third disclosure statement hearing, the court denied the debtors’ request for leave to further revise the proposed disclosure statement and plan, choosing instead to first hear and rule on the motions to dismiss. Id. at *1-2.
In their motions to dismiss, the United States Trustee and the bank argued that the debtors had not effectively moved forward with the plan and disclosure statement process after a reasonable opportunity to do so, resulting in an unfair delay. The United States Trustee also contended that the dispute between the debtors and their bank was largely a two party dispute that could be resolved outside of the bankruptcy court (i.e., in state court lien foreclosure proceedings).
The court sided with the United States Trustee and the bank in holding that the debtors had been afforded multiple opportunities to file plan documents that at least facially promoted case progress towards confirmation, but had failed from both a substantive and a deadline standpoint to do so. Looking at section 1112 and the standards for conversion or dismissal of a chapter 11 case, the court found that cause existed under section 1112 to either convert or dismiss the cases or appoint a chapter 11 trustee or examiner. Specifically, in looking at the examples of “cause” set forth in section 1112(b)(4), the court held that subsection 1112(b)(4)(J) was satisfied because the debtors failed to file a disclosure statement and confirm a plan within the time fixed by the court to do so and subsection 1112(b)(4)(E) was also satisfied because the debtors failed to comply with the court’s orders to fix the material shortcomings in the proposed disclosure statement and plan. Notably, it was not only the timing of the filing of the proposed disclosure statement and the plan that the court took issue with, but the substance of the filed documents. The court pointed to the lack of progress in getting the proposed disclosure statement and plan in a form that could ultimately be approved by the court. Although the court acknowledged that the hearing on the motion to dismiss was not a confirmation hearing, it nonetheless held that substantial disclosure issues and plan shortcomings are part and parcel of cause for dismissal of the case. Having found that cause existed, the court then gave the debtors an opportunity to show that there was a reasonable likelihood that a plan could be confirmed within a reasonable period of time and that there were unusual circumstances relating to the case that made conversion or dismissal not in the best interests of the estate. The court held that the debtors failed to make either showing. Specifically, the court found that, given the difficult economic conditions, the debtors’ proposed treatment of the bank’s claims was not feasible and thus the plan could not be confirmed within a reasonable period of time.
The court then looked at whether to convert the cases to chapter 7, dismiss them, or appoint a chapter 11 trustee or examiner. (Notably, the United States Trustee and the bank appear to have asked only for dismissal.) Noting again that the primary issue in the cases was essentially a two party dispute that could be resolved in state court, the court determined that dismissal of the cases would be in the best interests of the estates and that the debtors’ few unsecured creditors would not be benefited by conversion to chapter 7 or appointment of a chapter 11 trustee or examiner. Id.
A couple of important points are to be gleaned from the court’s analysis:
First, the Sparkle Store-All decision highlights that Congress’s “technical amendments” to the Bankruptcy Code in 2010 were not merely technical. The Bankruptcy Technical Corrections Act of 2010 made important changes to section 1112 that may affect the outcome of other motions to convert or dismiss. Prior to December 22, 2010 (the effective date of the Act), section 1112(b) provided that after the movant established a prima facie showing of cause for dismissal or conversion, the court had discretion (i) not to dismiss or convert the case if such dismissal or conversion would not be in the best interests of creditors and the estate based on specific unusual circumstances or (ii) to appoint a chapter 11 trustee or examiner instead if it was in the best interests of creditors and the estate. The burden was on the respondent to prove such unusual circumstances. Even if such unusual circumstances could not be shown, however, the debtor or another party in interest could still object to conversion or dismissal by showing, among certain other things, that there is a reasonable likelihood that a plan could be confirmed within the timeframes established in section 1112(b)(2)(A) or that, with certain exceptions, the grounds for “cause” could be cured as provided in section 1112(b)(2)(B).
With Congress’s “technical amendments” of 2010, section 1112(b) now provides that, upon a showing of cause, a court shall convert or dismiss a case or appoint a chapter 11 trustee or examiner, whichever one is in the best interests of creditors and the estate, unless (i) the court specifically identifies unusual circumstances establishing that conversion or dismissal is not in the best interests of creditors and the estate, and (ii) the debtor or another party in interest establishes that there is a reasonable likelihood that a plan will be confirmed within the timeframes established in section 1112(b)(2)(A) or that, with certain exceptions, the grounds for “cause” could be cured as provided in section 1112(b)(2)(B). The effect of these latest revisions to section 1112 is to remove the court’s ability to deny a request to convert or dismiss a case once cause has been shown based only on the best interests of creditors and the estate. In addition to looking at unusual circumstances that would make conversion or dismissal not in the best interests of creditors and the estate, now the debtor or a third party must also demonstrate that there is a reasonable likelihood that a plan will be confirmed within the timeframes established in section 1112(b)(2)(A) or that, with certain exceptions, the grounds for “cause” could be cured as provided in section 1112(b)(2)(B). Sparkle Store-All at *3.
Second, the Sparkle Store-All decision highlights that a debtor’s filing of a proposed plan and disclosure statement by the deadlines set forth by the Bankruptcy Code and the court many not be enough to satisfy section 1112(b)(4)(J) and that the substance of the filed documents matters just as much as the timing of their filing.
Granted that we likely do not know all the facts, and hindsight is 20/20, we question whether the outcome in Sparkle Store-All would have been different had the debtors engaged the bank in negotiations over a consensual chapter 11 plan or at the very least cured the disclosure statement’s deficiencies in describing the plan’s proposed treatment of the bank’s claims. Given that the first proposed plan was filed less than four months into the debtors’ exclusive period to file a plan, it is unclear from the decision why the debtors were in such a hurry to confirm a plan that had little hope of getting approved over the bank’s objection.
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