I. Introduction
On July 25, 2012, the Court of Appeals for the Third Circuit Court in In re American Capital Equipment, LLC1affirmed the bankruptcy court's decision finding (a) at the disclosure statement stage, that the debtors' chapter 11 plan was patently unconfirmable and (b) converting the chapter 11 case to chapter 7. While bankruptcy courts in various jurisdictions already have widely recognized the authority to deny approval of a disclosure statement where a plan is patently unconfirmable, the Third Circuit has become the first circuit court to explicitly confirm such authority. Moreover, in its decision, the Third Circuit cautioned that courts must protect due process, including by ensuring that plan proponents have sufficient notice that confirmation issues will be determined at the disclosure statement hearing.
II. Background
After four failed attempts to confirm a plan and after having spent eight years in bankruptcy, the chapter 11 debtors Skinner Engine Companies, LLC and its parent American Capital Equipment, LLC (collectively, "Skinner") sought approval of the disclosure statement with respect to their fifth plan (the "Plan") in the spring of 2009. At its heart, the Plan contemplated an optional settlement process to resolve claims of asbestos litigants.2 To fund payments to Skinner's other creditors and its attorneys, participants in the settlement process would have to agree that 20% of any cash from insurance proceeds (the "Surcharge") would be paid into a plan payment fund.
The Bankruptcy Court for the Western District of Pennsylvania denied approval of the disclosure statement on the ground that the Plan was facially unconfirmable, as it was not proposed in good faith and was forbidden by law in contravention of section 1129(a)(3) of the Bankruptcy Code and was not feasible pursuant to section 1129(a)(11) of the Bankruptcy Code.3 Moreover, because Skinner was found to be unable to effectuate a confirmable plan within a reasonable period of time, the Bankruptcy Court converted the chapter 11 case to chapter 7 pursuant to section 1112(b) of the Bankruptcy Code.4 The District Court affirmed on appeal,5 and Skinner further appealed to the Third Circuit.
III. The Third Circuit's Decision
On appeal, the Third Circuit considered three issues:
1. whether the Bankruptcy Court erred in deeming the Plan unconfirmable without first holding a confirmation hearing;
2. whether the Bankruptcy Court erred in finding that the Plan was patently unconfirmable; and
3. whether the Bankruptcy Court abused its discretion in converting the chapter 11 case to chapter 7.
The Third Circuit affirmed the Bankruptcy Court's decision on all three issues.
A. Making a Confirmability Determination at the Disclosure Statement Stage
The Third Circuit affirmed that bankruptcy courts may address the issue of plan confirmation where it is obvious at the disclosure statement stage that a later confirmation hearing would be futile because the plan described by the disclosure statement is patently unconfirmable.6 The Third Circuit grounded this authority in the bankruptcy courts' equitable powers under section 105 of the Bankruptcy Code to control their own docket. The Third Circuit noted that "a court should not proceed with the time-consuming and expensive proposition of hearings on a disclosure statement and plan when the plan may not be confirmable because it does not comply with confirmation requirement."7
Further, the Third Circuit stated that a plan is patently unconfirmable where (1) confirmation defects cannot be cured by creditor voting or otherwise, and (2) those defects concern matters upon which all material facts are not in dispute or have been fully developed at the disclosure statement hearing.8
The Third Circuit cautioned though that bankruptcy courts must ensure that due process concerns are protected.9 The Third Circuit noted that Federal Rule of Bankruptcy Procedure 3020(b)(2) requires that the court shall rule on confirmation of the plan after notice and hearing, and that other courts of appeal have further recognized that a bankruptcy court must hold an evidentiary hearing on confirmation.10 Accordingly, to protect the plan proponent's due process rights, a bankruptcy court must make sure that plan proponents have sufficient notice that confirmability issues will be raised at a disclosure statement hearing.11 Nor should a court prematurely convert a disclosure statement hearing into a confirmation hearing.12
B. Confirmability of Skinner's Plan
On the second issue, the Third Circuit held that the Plan was patently unconfirmable as it was not feasible pursuant to section 1129(a)(11) of the Bankruptcy Code13 and was not proposed in good faith pursuant to section 1129(a)(3) of the Bankruptcy Code.14
As to feasibility, the Third Circuit held that the Plan was highly speculative because the Surcharge, which was the Plan's sole source of funding, depended on wholly speculative litigation proceeds and on the assumption that asbestos claimants would opt into the Plan's settlement process.15 The Third Circuit specifically noted that the asbestos litigation so far had been "overwhelmingly unsuccessful."16
The Third Circuit also held that the Plan was not proposed in good faith. Under the Plan, Skinner would be financially incentivized to sabotage its own defense (and cooperation with the insurers in connection therewith) because the only way that Skinner's creditors and attorneys could possibly be paid was if asbestos litigants win settlements against Skinner and pay the Surcharge to the plan payment fund.17 To make matters worse, the Plan's settlement process severely limited or eliminated the insurer's ability to take discovery, submit evidence, contest causation, or appeal a decision—all without setting up a properly funded section 524(g) trust and protective channeling injunction.18 Because there was no material dispute of fact with respect to any of the foregoing, and because neither the speculative nature of the Plan, nor the inherent conflict of interest could be cured by creditor voting or otherwise, the Third Circuit held that the Plan was patently unconfirmable.
C. Conversion to Chapter 7
Finally, the Third Circuit affirmed the Bankruptcy Court decision to convert the cases to chapter 7 pursuant to section 1112(b) of the Bankruptcy Code. Specifically, the Third Circuit held that the Bankruptcy Court did not abuse its discretion in finding that Skinner's inability to propose a confirmable plan and to do so within a reasonable period of time constituted cause to convert the cases to chapter 7.19 While the Bankruptcy Court failed to explicitly address whether conversion or dismissal was in the best interest of creditors and the estate, as required by section 1112(b), the Third Circuit was satisfied that under the Bankruptcy Court's reasoning neither creditors nor the estate could conceivably benefit if a chapter 11 plan could never be effectuated.20 Therefore, based on the futility of the pursuit of a chapter 11 plan, the Third Circuit held that the Bankruptcy Court did not abuse its discretion by converting the cases to chapter 7.
IV. Conclusion
Given that bankruptcy courts already have widely recognized that they may consider plan confirmability at the disclosure statement stage, the decision in American Capital Equipment should perhaps not come as a surprise. Nevertheless, this decision is noteworthy for at least three reasons. First, it represents the first time that a circuit court has directly confirmed the propriety of the widespread use of this authority, and by basing this authority on section 105(a) of the Bankruptcy Code the Third Circuit placed this practice on solid ground. Second, the Third Circuit also has provided important guidance to lower courts within its circuit as to the circumstances under which a court may deny approval of a disclosure statement on the ground that the plan is patently unconfirmable. Specifically, such denial is appropriate where (1) confirmation defects cannot be cured by creditor voting or otherwise, and (2) those defects concern matters upon which all material facts are not in dispute or have been fully developed at the disclosure statement hearing. Finally, the Third Circuit also has issued an important warning: confirmability issues may only be considered at the disclosure statement hearing if the plan proponent has been provided with sufficient notice that such issues will be raised at this stage.
Footnotes
1 2012 WL 3024202 (3d Cir. July 25, 2012).
2 The Plan did not utilize a section 524(g) trust or channeling injunction.
3 In re Am. Capital Equip., Inc., 405 B.R. 415, 423-24 (Bankr. W.D. Pa. 2009)
4 Id. at 426-27.
5 Skinner Engine Co. v. Allianz Global Risk U.S. Ins. Co., 2010 WL 1337222 (W.D. Pa. March 29, 2010).
6 Skinner Engine Co. v. Allianz Global Risk U.S. Ins. Co., 2010 WL 1337222 (W.D. Pa. March 29, 2010).
7 Id. at *6 (quoting In re Kehn Ranch, Inc., 41 B.R. 832, 832-33 (Bankr. S.D. 1984)) (internal quotations omitted).
8 Id. at *7.
9 Id. at *7 n. 6.
10 Id. at *5-*6.
11 Id. at *7 n. 6.
12 Id. The case before the Third Circuit did not raise such due process concerns because the Bankruptcy Court's scheduling order had given sufficient notice to Skinner that confirmability issues would likely be considered at the disclosure statement hearing. Id. at *7 n.6.
13 A plan is feasible, if confirmation thereof is not likely to be followed by liquidation, or the need for further financial reorganization, unless such liquidation or reorganization is proposed in the plan. See 11 U.S.C. §1129(a)(11).
14 Am. Capital Equip., LLC, 2012 WL 3024202, at *7-*12. The Third Circuit did not address whether the Plan was also unconfirmable on the ground that it was forbidden by law.
15 Id. at *8.
16 Id.
17 Id. at *10-*11.
18 Id. at *11-*12.
19 Id. at *14.
20 Id. at *15.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.
