Ongoing Civil Litigation Does Not Defeat Chapter 11 Plan Feasibility

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.

 

Section 1129 of the Bankruptcy Code requires that, among other things, the debtor’s plan of reorganization must be feasible in order to be confirmed.[7] In determining the feasibility of a plan, a court will consider whether the debtor has the means to execute the plan, and if, upon execution, whether the plan will allow the debtor to emerge from bankruptcy as a viable entity.[8]  Therefore, the court must consider whether a debtor is involved in any ongoing civil litigation when making these feasibility determinations.[9]  However, ongoing civil litigation is only one of many factors the court considers when determining whether a plan is feasible.[10] 

Just because there is pending civil litigation with a potential creditor, it does not necessarily follow that the plan is not feasible.  Therefore, the debtor does not have an obligation to include a provision in their plan for every possible outcome of a civil case.[11]  In examining how a civil case affects the feasibility of a debtor’s reorganization plan, a court will first consider the merits of both parties’ arguments in the lawsuit to determine what is likely to transpire, and then look to the effect that outcome will have on the debtor’s ability to execute its reorganization plan.[12]  The mere possibility of an unfavorable outcome in a civil case, which would negatively affect a debtor’s plan and may cause it to fail, is not enough to disprove feasibility, especially when the merits of an adverse party’s claim are weak.[13]  Although bankruptcy courts in the Ninth, Seventh and Third circuits have all embrace this approach, in practice they have more often than not found that ongoing litigation renders a chapter 11 plan not feasible because the outcome of such litigation is uncertain, which therefore, renders the success of the plan to not be reasonably likely.[14]

 

However, if the court determines that the potential creditor has a sufficiently small chance of succeeding on their claim, then the court will likely confirm the debtor’s plan, holding that it has met the Section 1129(a)(11) feasibility requirement even if the debtor has not included a provision in its plan for the possibility of the creditor’s success.  Using the rationale of the Bankruptcy Appellate Panel of the Ninth Circuit, whenever the court determines that there is a strong possibility that civil litigation will result in the debtor being required to pay a large sum to a creditor, the debtor will most likely be required to include a provision in its plan outlining how it will make that payment.  Ultimately, as a result of the Court’s decision, a debtor does not have to account for every possible outcome when drafting its chapter 11 plan of reorganization.  This has important ramifications for debtors who are parties in many ongoing civil lawsuits; since such debtors will not have to add provisions for every outcome their chapter 11 plans will be shorter and less complex.  As such, many debtors may be able to avoid unnecessarily burdening their respective estates with the extra costs associated with drafting plans of reorganization that account for every possible outcome of ongoing litigation.

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