To Confirm Or Not To Confirm? Third Circuit Rules That Bankruptcy Court May Determine At Disclosure Statement Stage That A Chapter 11 Plan Is Patently Unconfirmable

1. 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.

2. 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.

3. 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...