Litigation Claimants Get A Second Chance In Bankruptcy Appeal

On June 17, 2014, a three-judge panel of the Third Circuit Court of Appeals1 vacated a District Court's dismissal order and resuscitated a bankruptcy appeal brought by a group of litigation creditors seeking recourse against the debtors post-confirmation.2 The Third Circuit opinion is an important reminder to both debtors and creditors that the doctrine of "equitable mootness" has limits and that confirmation of a plan does not preclude review of post-confirmation actions inconsistent with obligations in the plan.

The debtors, SCH Corp., American Corrective Counseling Services, and ACCS Corp., which had been engaged in the debt collection business, filed for Chapter 11 bankruptcy in the District of Delaware in January 2009. The largest group of unsecured creditors were plaintiffs in pending class actions brought under the Fair Debt Collection Practices Act and similar statutes against the Debtors in California, Florida and Indiana (the "CFI Claimants").3

The bankruptcy plan of liquidation, confirmed with support by the CFI Claimants, allowed for a sale of the Debtors' businesses to a subsidiary of their largest creditor, National Corrective Group ("NCG"). The CFI Claimants rejected an initial plan containing third-party releases preventing them from pursuing NCG post-bankruptcy in exchange for total consideration of approximately $2.5 million.4 The amended plan removed those third-party releases and provided for payments by NCG of $200,000 a year for five years (a total of $1 million). The plan allowed NCG to offset payments of certain litigation costs up to $200,000 per year.5

Post-confirmation, virtually no distributions were made to unsecured creditors (including the CFI Claimants) even though $200,000 had been distributed under the plan, as NCG asserted set-off rights following litigation initiated by the CFI Claimants' counsel post-bankruptcy against NCG.6 NCG also filed disqualification motions against counsel for the CFI claimants for representing CFI Claimants and the plaintiffs in the new California litigation against NCG.7 These disqualification motions were successful.

Subsequently, the CFI Claimants sought a range of relief in bankruptcy court, moving for a dismissal of the debtors' bankruptcy cases, enforcement of the terms of the amended plan, and sanctions against NCG, and asserting, inter alia, that the person appointed as disbursing agent and litigation designee, Carl Singley, "acted in bad faith by transferring the...