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Defense to Chapter 22

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Since the Bankruptcy Code was enacted in 1978, many debtors have filed for bankruptcy under chapter 11. While most chapter 11s are unsuccessful and either convert to chapter 7 or are dismissed, a number of debtors successfully confirm a plan of reorganization that allows the debtor (or its successor in interest) to continue the business operations with restructured payments to creditors. Some of these reorganized debtors, however, fail to complete their payments under the plans of reorganization and refile for bankruptcy (i.e., "chapter 22 debtors" or "serial debtors"). Examples of corporate serial debtors include Braniff, which has filed for bankruptcy several times, and Pan Am, which just recently filed its second case.

Creditors who find themselves in a second chapter 11 with the same debtor are immensely frustrated, and the question arises about the possibility of dismissing the second case. Recently, the bankruptcy court for the Eastern District of New York addressed the question of whether a second chapter 11 was proper and dismissed the second bankruptcy petition on the grounds that the second chapter 11 was an attempt to improperly modify a substantially consummated plan in violation of §1127.1 Northtown Realty Co., L.P., 215 B.R. 906, 1998 W.L. 15085 (Bankr. E.D.N.Y. Jan. 9, 1998).

In Northtown Realty, the debtor ("Northtown II") was a real estate limited partnership that owned as its sole asset a shopping center. According to the court, the dispute arose in a chapter 11 case filed by the debtor’s predecessor ("Northtown I"). Northtown I filed for bankruptcy to resolve certain disputes with its secured lender, Metropolitan Life Insurance ("Met Life"). As a result of negotiations, Northtown I successfully confirmed a plan of reorganization that provided for 1) a restructuring of the Met Life debt; 2) a sale of the property to Northtown II; and 3) a payment plan for unsecured creditors.2

For four years after confirmation of the plan, Northtown II complied with the provisions of the plan by making payments to Met Life and to the unsecured creditors of Northtown I, and, as a consequence, the plan confirmed by the court in the bankruptcy case of Northtown I was "substantially consummated."3 However, as a result of weakness in the retail industry evidenced by the bankruptcies of major tenants, Northtown II’s cashflow was negatively affected, and it did not meet the obligations under the plan to Met Life. Met Life subsequently commenced foreclosure proceedings. In response, Northtown II filed for bankruptcy and stated its intent to reorganize rather than to liquidate.4


...if faced with a chapter 22, a creditor should consider filing a motion to dismiss due to the prohibition of §1127 to modifying a substantially consummated plan.

Met Life filed a motion to dismiss because 1) the Northtown I plan was substantially consummated within the meaning of §1101(2); 2) a substantially consummated plan cannot be modified pursuant to §1127; and 3) thus, the debtor cannot confirm a plan within the meaning of §1112.5 The court agreed.6

The first issue addressed by the court was whether a debtor can propose in a second chapter 11 a new plan to modify obligations that were assumed as part of a confirmed and substantially consummated plan in the first chapter 11 in light of §1127. The court found several cases prohibiting a debtor from filing a second chapter 11 case to modify the terms of a previously confirmed plan.7 The court stated:

The basis for these decisions has been that the filing of a second chapter 11 whose purpose is to modify a prior plan is an act "so akin to modifying the previous plan within the meaning of §1127(b) that the new filing is viewed as a post-substantial consummation modification prohibited by the statute. In re Worthington Corp., 39 B.R. [955], 956 [(Bankr. E.D. Pa.); aff’d, 59 B.R. 963 (E.D. Pa. 1984)]; see, also, In re Delray Assocs. Ltd. Partnership, 221 B.R. [511], 516 [(Bankr. D. Md. 1997)]. Section 1127(b)’s prohibition of modi-fication after substantial consum-mation provides both the debtor and creditors with finality as to the confirmation orders. To allow continual modification of substantially consummated plans, by a new chapter 11 case or otherwise, would create uncertainty among creditors.8

The court reasoned that allowing a second chapter 11 plan would render §1127 meaningless and would cause uncertainty in the marketplace about the finality

of confirmation orders.9 Thus, since Northtown II would not be allowed to confirm a reorganization plan because of §1127, the court must dismiss the case pursuant to §1112 because Northtown II could not confirm a plan.10

The court noted that in certain limited circumstances a debtor would be permitted to file a second chapter 11 case. The first situation was when a debtor intended to liquidate. The court reasoned that a liquidating plan could be confirmed because the second chapter 11 would not result in the modification of the creditors’ rights under the first plan.11 The second situation in which a second chapter 11 would be permitted was if there is an unanticipated change in circumstances, such as change in the law that made the debtor’s operations economically unfeasible.12 The court noted, however, that a change in economic conditions is not a sufficient basis for a second chapter 11.13 The court reasoned that Northtown II’s financial problems were caused by the normal risks associated with being in commercial real estate and, as a consequence, a second chapter 11 was unjustified.

The Northtown Realty court highlights a defense to the serial debtor seeking to amend a previously confirmed plan of reorganization with a second chapter 11 plan. Thus, if faced with a chapter 22, a creditor should consider filing a motion to dismiss due to the prohibition of §1127 to modifying a substantially consummated plan. The motion will not be successful if the debtor intends to liquidate. However, if the debtor intends to reorganize, the court may dismiss, thereby terminating the threat of multiple restructurings.


Footnotes

1The relevant provisions of §1127 states:

"(b) The proponent of a plan or the reorganized debtor may modify such plan at any time after confirmation of such plan and before substantial consummation of such plan,..." Return to text.

2Northtown Realty, 1998 WL 15085, p. 1. Return to text.

3According to §1101, substantially consummated means:

"(A) transfer of all or substantially all of the property proposed by the plan to be transferred;

(B) assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan; and

(C) commencement of distributions under the plan." Return to text.

4Northtown Realty, 1998 WL 15085, p.2. Return to text.

5According to §1112:

(b) ...upon request of a party in interest..., and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title, or may dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause, including —

(2) inability to effectuate a plan, . . . Return to text.

6Northtown Realty, 1998 WL 15085, p. 2-3. Return to text.

7Northtown Realty, 1998 WL 15085, p. 4. Cases cited by Northtown Realty include In re Northampton Corp., 39 B.R. 995 (Bankr. E.D. Pa.), aff’d, 59 B.R. 963 (E.D. Pa. 1984); In re AT of Maine Inc., 56 B.R. 55 (Bankr. D. Me. 1985); In re Roxy Real Estate Co. Inc., 170 B.R. 571 (Bankr. E.D. Pa. 1993); In re Delray Assoc. Ltd. Partnership, 212 B.R. 511 (Bankr. D. Md. 1997). Return to text.

8Northtown Realty, 1998 WL 15085, p. 4. Return to text.

9Id. Return to text.

10 Id., p. 5. Return to text.

11 Id., p. 5. See, also,Fruehauf Corp. v. Jartran Inc. (In re Jartran Inc.), 886 F.2d 859, 867 (7th Cir. 1989). Return to text.

12 Northtown Realty, p. 6. See, also,CFC 78 Partnership, B. v. Casa Loma Assocs. (In re Casa Loma Assoc.), 122 B.R. 814, 818 (Bankr. N.D. Ga. 1991). Return to text.

13 Northtown Realty, p. 6. See, also, In re Buoy, Hall & Howard and Assoc., 208 B..R 737, 745 (Bankr. S.D. Ga. 1995); Roxy Real Estate, 170 B.R. at 576. Return to text.

Journal Date: 
Wednesday, April 1, 1998

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