Denial Of Chapter 11 Plan Confirmation Unwarranted Even If Plan Support Agreements Violated Disclosure Requirements

• Published date: 30 September 2022
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Financial Restructuring
• Law Firm: Jones Day
• Author: Nick Buchta, T. Daniel Reynolds and Mark Douglas

A bedrock principle underlying chapter 11 of the Bankruptcy Code is that creditors, shareholders, and other stakeholders should be provided with adequate information to make an informed decision to either accept or reject a chapter 11 plan. For this reason, the Bankruptcy Code provides that any "solicitation" of votes for or against a plan must be preceded or accompanied by stakeholders' receipt of a "disclosure statement" approved by the bankruptcy court that explains adequately the background of the case as well as the key provisions of the chapter 11 plan. The solicitation of votes of stakeholders outside of this process is deemed improper, and those votes accordingly may be disallowed.

However, to promote communication and negotiation among the debtor and other stakeholders throughout the course of a chapter 11 case, courts generally construe the term "solicitation"'and the remedies for improper solicitation'narrowly. The United States Bankruptcy Court for the Southern District of New York recently addressed this issue in In re LATAM Airlines Grp. S.A., 2022 WL 2206829 (Bankr. S.D.N.Y. June 18, 2022) (unpublished opinion), as amended, 2022 WL 2541298 (Bankr. S.D.N.Y. July 7, 2022), stay pending appeal denied, No. 20-11254 (JLG) (Bankr. S.D.N.Y. July 7, 2022), certification denied, No. 20-11254 (JLG) (Bankr. S.D.N.Y. July 26, 2022), aff'd, 2022 WL 3910718 (S.D.N.Y. Aug. 31, 2022). In an unpublished opinion, the court overruled an objection to confirmation of a chapter 11 plan based on the debtors' alleged violation of the plan solicitation requirements by entering into agreements with certain creditors, prior to the court's approval of a disclosure statement, that obligated those creditors to vote in favor of a plan in exchange for allowance of their claims. According to the court, even if those plan support agreements were improper (and the court did not reach that question), the only remedy for the violation was disallowance of the creditors' votes, which would not change the outcome of the voting process.

Solicitation and Disqualification of Votes on a Chapter 11 Plan

Section 1125(b) of the Bankruptcy Code provides that votes in favor of a chapter 11 plan can be solicited postpetition only after the creditor or shareholder receives a court-approved disclosure document containing "adequate information," a concept defined in section 1125(a). The provision is "designed to 'discourage the undesirable practice of soliciting acceptance or rejection at a time when creditors and stockholders were too ill-informed to act capably in their own interests.'" In re Heritage Org., LLC, 376 B.R. 783, 794 (Bankr. N.D. Tex. 2007) (quoting In re Clamp-All Corp., 233 B.R. 198, 208 (Bankr. D. Mass. 1999)).

In cases where section 1125(b) has been violated, section 1126(e) provides a remedy:

On request of a party in interest, and after notice and a hearing, the court may designate any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.

11 U.S.C. ' 1126(e) (emphasis added). "Designation" of an entity under section 1126(e) means that it is disqualified from voting or its vote is disallowed. See Collier on Bankruptcy ' 1126.06 (16th ed. 2022). Votes cast by any creditor or interest holder designated under the provision are not counted for the purpose of determining whether the plan has been accepted by a class of creditors or interest holders under sections 1126(c) and 1126(d). See In re DBSD N. Am., Inc., 634 F.3d 79, 106 (2d Cir. 2011).

Designation of a vote under section 1126(e) "is a drastic remedy, and, as a result, designation of votes is the exception, not the rule. The party seeking to have a ballot disallowed has a heavy burden of proof." In re Adelphia Commc'ns Corp., 359 B.R. 54, 61 (Bankr. S.D.N.Y. 2006)).

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