An Unrung Bell Revocation of an Order Confirming a Reorganization Plan
Section 1144 provides:
On request of a party in interest at any time before 180 days after the date of the entry of the order of confirmation, and after notice and a hearing, the court may revoke such order if and only if such order was procured by fraud. An order under this section revoking an order of confirmation shall—
(1) contain such provisions as are necessary to protect any entity acquiring rights in good-faith reliance on the order of confirmation; and
(2) revoke the discharge of the debtor.
In Trico Marine Services Inc. et al., the debtors filed voluntary petitions on Dec. 21, 2004.3 On the petition date, the debtors owed approximately $400 million to creditors, including $275 million to holders of senior notes. Under a pre-packaged plan, the debtors proposed to exchange the notes for 100 percent of common stock in the reorganized debtors. The proposed plan also cancelled the common stock issued by the debtors, but the debtors and the noteholders agreed that holders of this common stock would receive warrants exercisable for up to 10 percent of the reorganized debtors' common stock.
The case moved quickly to confirmation. The court entered the order confirming the plan on Jan. 21, 2005. The effective date of the plan was March 15, 2005, at which time the reorganized debtor distributed 10 million shares of its new common stock to the noteholders and 998,868 new warrants to the holders of the "old" common stock in the debtors. Thereafter, the reorganized debtors publicly offered for sale an additional 4 million shares of common stock.
The plaintiffs, owners of in excess of 44,000 shares of Trico common stock,4 filed their lawsuit seeking to revoke the order confirming the plan. The plaintiffs alleged that the confirmation order was procured by fraud as a result of the debtors' chief financial officer's testimony at the confirmation hearing. The CFO testified that the debtors' fourth quarter 2004 revenue was "not materially" higher than what was depicted in the disclosure statement; however, the plaintiffs maintained that the fourth quarter revenue exceeded the projected revenue listed in the disclosure statement by 35 percent. The impact of this alleged fraud was said to mislead the court into confirming a reorganization plan as fair and equitable, when in fact the available cash flow of the debtor at the time of confirmation was more than sufficient to service its debt and therefore produce value for the "old equity." Instead, old equity in the aggregate was left with nothing more than warrants to purchase 10 percent of the reorganized common stock, or as specifically alleged in the complaint, "relegation of pre-hearing equityholders to post-confirmation warrant-holders."5
Addressing these allegations, the bankruptcy court considered two approaches. The first was §1144, which provides a court with the discretion to revoke a confirmation order if the order was obtained by fraud. Even if the court determined that the order was obtained by fraud, it had to "consider all of the circumstances and determine 'whether revocation of the confirmation can or would lead to an outcome that is more equitable than leaving the order intact.'"6 Indeed, §1144 provides that an order revoking a confirmation order must, in part, "contain such provisions as are necessary to protect any entity acquiring rights in good-faith reliance on the order of confirmation."
The court also considered whether the doctrine of equitable mootness applied. The reorganized debtors argued that it could and relied on it to assert that the court should dismiss the complaint. The court noted that this doctrine is typically asserted in the context of an appeal of a confirmed plan when, although relief could be fashioned, the implementation of it would be inequitable. Nonetheless, the court acknowledged that some courts used the doctrine when addressing an §1144 complaint.
Without deciding whether equitable mootness applied, the court ruled that it could not revoke the plan under either §1144 or equitable mootness. Because the confirmed plan involved the distribution of new common stock to the noteholders as well as warrants to the DIP's existing shareholders, "it would be exceedingly difficult to unwind and impossible to protect innocent third parties" should the court revoke the confirmation order.7 The court noted that the new common stock traded based on a substantially de-leveraged company, one that improved its ratio of liabilities to equity from 8-to-1 pre-confirmation to 2-to-1 post-confirmation. Revoking confirmation would alter these financial assumptions and potentially leave the common stock valueless. In addition, purchasers of the reorganized debtors' common stock could unknowingly become creditors rather than equity-holders because the reorganized debtors issued common stock in place of notes. Anticipating the upheaval that would be caused by revoking the confirmation order, the court noted that the more practical remedy would be to leave the confirmation order intact and allow the plaintiffs to seek damages through a different cause of action. The court granted the reorganized debtors' motion for summary judgment and provided the plaintiff with 30 days to file an amended complaint.
The plaintiffs filed a motion to supplement the record, which the court treated as a motion for reargument.8 The court granted the motion, but it adhered to its original decision. It explained that relief under §1144 required a revocation of the discharge, protection of those who acquired rights in good-faith reliance on the confirmation order and the reinstatement of the status quo ante. "[U]nless [the court] can fashion an order that would revoke the debtor's discharge, restore the status quo existing before confirmation and protect those who relied in good faith on confirmation," the court could not revoke the confirmation order.9 Examining the status quo ante prong, the court noted that in some instances, this step can be accomplished easily. For example, if the plan simply provided for a money distribution to creditors, the reinstated DIP could sue to recover these distributions. That said, the court noted that things are trickier with complex plans. If stock is issued under a plan, restoration of the status quo ante would require debts to be reinstated and stock to be cancelled. Moreover, innocent purchasers of this stock would have to be protected as well.
Parties in interest must understand that even if fraud is subsequently discovered, §1144 may not serve as a means for relief if unscrambling the egg...isn't possible.
Given the facts in this case, the court reiterated that it could not revoke the confirmation order. The court reasoned that any relief it constructed could not restore the status quo as of the confirmation order because the court could not cancel any stock sold through the reorganized debtors' secondary offering. The court also reiterated its concern for protecting shareholders who purchased the stock based on the financial status achieved by emerging from bankruptcy. That said, the plaintiffs suggested that the shareholders could return to noteholder status and obtain reinstated net operating losses (NOLs) with a present value in excess of $90 million, which could be used to offset past or future income and reduce income tax liability. The court did not accept this argument, finding that the NOLs were irretrievably lost under the tax laws and that rescission of the transaction would not undo the tax effect of the initial transaction.
Thus, the court concluded that even if the plaintiffs proved fraud, it was unable to fashion a remedy that would satisfy the requirements of §1144. It dismissed the complaint and provided the plaintiffs with 30 days to amend their complaint and seek other appropriate relief.
While these cases involved an attack to confirmation by former equity, as opposed to unsecured creditors, the critical point is that even though the Code provision emphasizes that a confirmation order can be revoked "if and only if such order was procured by fraud," the court's first step will likely be an examination into what was accomplished in the reorganization plan. Although courts will not countenance fraud, little will be accomplished under §1144 in proving that the debtor was a bad actor if the plan involved an intricate reorganization that would be cumbersome—if even possible—to unwind. Creditors and parties in interest should be mindful of this when faced with a complicated plan, particularly when involving payment via the distribution of equity. Parties in interest must understand that even if fraud is subsequently discovered, §1144 may not serve as a means for relief if unscrambling the egg (i.e., returning parties who relied on the confirmation order in the position they were in prior to the order's entry) isn't possible. If there is any question, committee counsel or other counsel involved in the confirmation process would do well to press for specifics from those testifying as to the financial condition of the debtor at the time of confirmation.
1 Douglas E. Wedge, an associate in Moore & Van Allen PLLC's Charleston, S.C., office, made significant contributions to the research and writing of this column, which the author gratefully acknowledges.
2 Further references to the Bankruptcy Code shall be by section number only.
3 Salsberg v. Trico Marine Services Inc. (In re Trico Marine Services Inc.), 337 B.R. 811 (Bankr. S.D.N.Y. 2006).
4 See Complaint of Steven Salsberg and Gloria Salsberg, Bankr. S.D.N.Y. Case No. 04-17985(SMB), Adv. Pro. No. 05-2313.
6 337 B.R. at 814.
7 Id. at 815.
8 Salsberg v. Trico Marine Services Inc. (In re Trico Marine Services Inc.), 2006 Bankr. Lexis 724, Case No. 04-17985 (SMB), Adv. Pro. No. 05-2313 (Bankr. S.D.N.Y. May 5, 2006).
9 Id. at *5.