Blogs

Ongoing Civil Litigation Does Not Defeat Chapter 11 Plan Feasibility

By: Kaitlin Fitzgibbon

St. John’s Law Student
 
American Bankruptcy Institute Law Review Staff
 
 
In In re RCS Capital Development,[1] the Bankruptcy Appellate Panel of the Ninth Circuit Court of Appeals affirmed the bankruptcy court’s finding that the debtor’s, RCS Capital Development (“RCS”), chapter 11 plan was feasible notwithstanding ongoing civil litigation between RCS and potential creditor ABC Learning (“ABC”).[2]  RCS filed its chapter 11 case, while it was simultaneously involved in two lawsuits[3] against ABC.  Ultimately, as a result of these actions, RCS had an enforceable claim against ABC for $57 million, and ABC had an enforceable claim against RCS for $41 million.[4]  In its proposed chapter 11 plan, RCS explained that it intended to use the $57 million as a setoff to pay ABC the full amount of its claim.[5]  However, the plan did not include a provision that accounted for the possibility that an appeal of the Nevada civil suit might result in ABC obtaining a judgment against RCS, thereby negating RCS’s right to setoff.[6]  Nevertheless, the BAP found that RCS’s plan was feasible, even though it did not factor in the possibility of an unfavorable appeal.

S-Corp and QSub Tax Status Do Not Constitute Property of the Bankruptcy Estate

By: Ryan Jennings

St John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In In re Majestic Star Casino, LLC, the Court of Appeals for the Third Circuit held as a matter of first impression that a Chapter 11 debtor’s status as a pass-through entity for taxation purposes did not constitute “property” of the bankruptcy estate.[1] The debtors, Majestic Star Casino II (“MSC II”) and other subsidiaries and affiliates, were wholly owned by a non-debtor corporation called Barden Development, Inc. (“BDI”).[2]  Don H. Barden (“Barden”) was the sole shareholder, CEO, and president of BDI.[3]  In November of 2009, the debtors filed for bankruptcy under chapter 11 of the Bankruptcy Code.[4]  Later that year, Barden chose to revoke BDI’s status as an “S” corporation (“S-Corp”) for tax purposes, thus forfeiting the company’s pass-through tax status.[5]  As a result of that election, MSC II’s status as a qualified subchapter S subsidiary (“QSub”) was also automatically revoked.[6]  Thus, MSC II was now subject to federal and state taxes that it used to pass on to Barden.[7]  MSC II asserted that the revocation of BDI’s S-Corp status constituted an unlawful postpetition transfer of property of MSC II’s bankruptcy estate.[8]  The Third Circuit reversed the decision of the bankruptcy court, holding that MSC II’s status as a QSub for tax purposes was not property, and even if it was, it would belong to the shareholders of its non-debtor parent corporation and not to MSC II.[9]

Does the Absolute Priority Rule Apply to Individual Debtors

By: Colin Coburn

St. John’s Law Student

American Bankruptcy Law Review Staff

 

The Arizona Bankruptcy Court recently held, in In re Sample, that the absolute priority rule does not apply to individual debtors because it was bound by the Ninth Circuit Bankruptcy Appellate Panel’s decision in P + P LLC v. Friedman (In re Friedman).[1]  Section 1129(b)(2)(B)(ii) of the Bankruptcy Code defines the absolute priority rule,[2] which mandates that under a chapter 11 plan of reorganization, a dissenting class of unsecured creditors must be paid in full before the holder of any junior claim or interest receives or retains any property on account of such junior claim or interest.[3]  In In re Friedman, the court stated that Congress, in passing BAPCPA, intended Chapter 11 individual bankruptcy to resemble Chapter 13 bankruptcy.[4]  In Friedman the court held that §1129(a)(15)(B),[5] replaced §1129(b)(2)(B)(ii) in cases involving individual debtors, thereby abrogating the absolute priority rule in individual chapter 11 cases.  Section 1129(a)(15)(B) states that a court can only confirm an individual debtor’s plan, to which an unsecured creditor objects, when, “the value of the property to be distributed . . . is not less than the projected disposable income of the debtor” for the first 5 years after payments begin.[6]  The Friedman court reasoned that this fact, combined with the plain meaning of sections 541, 1115, and 1129(b)(2)(B)(ii), dictated that the absolute priority rule does not apply to individual debtors.[7]  The Sample court disagreed with the reasoning of the Friedman opinion, but held that it was bound to follow that holding.[8]

Article III Standing to Object to a Companys Bankruptcy Reorganization Plan

By: James Scahill

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Adhering to the constitutional limits on a particular party’s standing to object, the Third Circuit in In re W.R. Grace & Co. affirmed the district court’s ruling and held that Garlock Sealing Technologies, LLC, (“Garlock”), did not have standing to object to W.R. Grace & Co.’s (“Grace”) proposed chapter 11 plan of reorganization.[1] Grace filed for chapter 11 bankruptcy protection after being threatened by numerous asbestos-related personal injury lawsuits.[2]  Since Garlock often purchased materials from Grace, the two companies were named as co-defendants in thousands of personal injury lawsuits.[3]  Garlock objected to Grace’s reorganization plan, alleging that as a former, current, and potential co-defendant, it had suffered injury because its contribution rights would be denied under the plan.[4]  But, the Third Circuit ruled that those future claims were insufficient to establish Article III standing because they were entirely speculative.  In particular, the court found that Garlock failed to introduce any evidence that it ever sought contribution from Grace, implied Grace in any claim, or suffered any judgment that would have entitled Garlock to assert contribution or setoff rights.[5]  Moreover, the court noted that Garlock had not even filed a claim in Grace’s bankruptcy case.[6]  The Third Circuit opined that for Garlock to have standing to assert contribution claims, the plaintiffs must either win or settle their cases, thereby giving rise to a contribution claim against Grace. Instead, the court noted that Garlock’s alleged injury was contingent on plaintiff verdicts or settlements, which made it more conjectural or hypothetical than actual or imminent, especially given that no such contribution claims had ever been asserted notwithstanding the thousands of ongoing cases involving Grace and Garlock.[7]

Establishing the Requirements Necessary in order to Enforce Setoff in Bankruptcy Proceedings

By:  Maria Ehlinger

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Affirming the ruling in the Unites States Bankruptcy Court for the District of Arizona, The United States Bankruptcy Appellate Panel of the Ninth Circuit, in In re RCS Capital Development, LLC, held that a debtor may setoff pre-petition claims against post-petition obligations that it owes because section 558 of the Bankruptcy Code does not contain any restrictive language confining setoffs to pre-petition obligation.[1] The court found that the setoff was valid because all of the requirements of section 558 were met. Specifically, the court found that it was a valid setoff under Nevada law because there was mutuality of claims, debts, and parties, and each party had an enforceable debt against the other.[2] The issue arose after ABC Developmental Learning Centers (U.S.A.), Inc. (“ABC”) filed a proof of claim in the jointly administered chapter 11 bankruptcy cases of RCS Capital Development, LLC (“RCS”) and ACCP LLC (“ACCP”). ABC’s claim was based on an ongoing Nevada lawsuit against ACCP and RCS.[3] RCS objected to ABC’s proof of claim and then moved for summary judgment, arguing that RCS was entitled to set off the post-petition debt it owed to ABC, arising out of the Nevada action, against a debt ABC owed to RCS arising from a separate pre-petition Arizona judgment for breach of contract.[4]  The bankruptcy court granted RCS’s motion, finding that the requirements for setoff were met.[5] On appeal, the BAP affirmed the bankruptcy court and held that the setoff was valid.[6]

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