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When a Reorganized Debtor is Unable to Fulfill its Chapter 11 Plan Commitments

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For a business to bring itself through a bankruptcy and end up as a reorganized debtor with a confirmed plan of reorganization is a great achievement. Confirmation can only be accomplished with foresight, planning, and of course, a team of professionals to help guide the way. In obtaining the creditor buy-in necessary to confirm a chapter 11 plan, the business debtor must understand and explain the issues that caused it to require bankruptcy protection and be able to explain why those issues will no longer plague the reorganized company. It must provide an analysis of projected cash-flows and convince creditors that the obligations promised in the plan of reorganization can be met. The creditor body must be convinced that they are better off with a reorganized debtor than they would be if the business was forced into liquidation. The debtor will also have to demonstrate that confirmation of a chapter 11 plan of reorganization is not likely to be followed by the liquidation, or the need for further financial reorganization (unless such liquidation or reorganization is proposed in the plan).

Modification to a Confirmed Chapter 11 Plan

Despite the best of forecasts, unforeseen events do occur. Perhaps key personnel leave the company, or new competition enters the market. Perhaps the need for the business’s product disappears (remember Polaroid cameras). Or, as too often the case, it may be that the debtor promised more than it could deliver and the obligations agreed to in the plan of reorganization can simply not be met.

What then? If a reorganized debtor wants to modify its confirmed Chapter 11 Plan, the timing of such an effort is critical. Section 1127(b) of the Bankruptcy Code provides the exclusive means by which to modify a plan:

“The proponent of a plan or the reorganized debtor may modify such plan at any time after confirmation of such plan and before substantial consummation of such plan..”

The term ‘substantial consummation’ which appears in Section 1127(b) is defined in Section 1101(2) of the Bankruptcy Code.

‘substantial consummation’ means—

(A) transfer of all or substantially all of the property proposed by the plan to be transferred;

(B) assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan; and

(C) commencement of distribution under the plan.

When examining section 1101(2) in conjunction with section 1127(b) the requirements for post-confirmation modification is limited to specific circumstances. To modify a plan after confirmation (1) transfer of all or substantially all of the property proposed by the plan must not have taken place; (2) the debtor or his successor must not have assumed the business or management of all or substantially all of the property dealt with by the plan; and (3) distribution according to the plan must not have begun

In the event of a post-confirmation modification, the court must conduct a hearing and confirm the modified plan. 11 U.S.C. § 1129. However, pursuant to Sections 1127(c)39 and 1127(d), the proponent of the modified plan does not have to re-petition the acceptance of creditors. Prior acceptances are binding unless the person accepting decides to reject (rejections are treated similarly.

When is a Plan of Reorganization Substantially Consummated?

Distributions to be made under the plan to creditors over a period of time are not the focus of determining if a plan has been substantially consummated. Instead, Section 1101(2)(A) focuses on transfers under the plan proposed to take place on or near the effective date of the plan confirmation.

Consider the case of In re Dunavant & Son Dairy, 75 Bankr. 328 (M.D. Tenn. 1987). There the debtor operated a dairy farm in Tennessee. The original plan provided for the sale of essential all the debtors assets another dairy farmer Simmental Breeding Corporation (“SBC”). Id. at 328. A proposed buyer, SBC, would pay cash and assume and agree to pay certain debts, the plan proponents anticipated that the sale would enable the reorganized debtor to add milking cows to the debtor’s herd, thereby increasing revenues of the reorganized debtor. The increased herd and revenues were a critical factor in the plan’s success. Id. at 330. The bankruptcy court confirmed the modified plan. On appeal concerning the confirmation of the modified plan a secured creditor argued, inter alia, that the debtor's modified plan was in violation of Section 1127(b) because: (1) the originally confirmed plan had already been substantially consummated. Id at 331.

The district court upheld the bankruptcy court’s findings that ‘ because there had not been a transfer of all or substantially all of the property to SBC as provided by the plan, there had been no substantial consummation . . .’ within the meaning of Section 1101(2)(A). Id. at 332. After confirmation of the original plan, the debtor had taken steps toward consummation of the plan. Id. However, the deeds and bills of sale for the property sought to be conveyed had never been delivered to SBC. Id. Thus, the requirement of Section 1101(2)(A) was not met. Id. at 333.

The court continued its analysis by holding that circumstances warranted modification pursuant to Section 1127(b). Id. SBC's ability to add milking cows to the debtor's herd was key to the debtor's ability to rehabilitate, for it was the primary means by which the debtor sought to increase revenues. Id. However, because an appeal of the confirmation order remained pending, SBC failed to add the milking cows to the herd. Id. This resulted in a loss of revenues so great that implementation of the original plan was no longer feasible. Id. at 334. The court found that this fact alone would warrant modification of the original plan. Id.

The Door to the Courthouse is Closed and Locked

So what does a re-organized debtor do if the plan has already been substantially consummated but it the business is not viable? Where a reorganization plan has already been confirmed and substantially consummated, but the debtor is unable to continue in business under the plan, the bankruptcy court, in the interest of fairness and equitable treatment for all creditors, has the discretion to permit liquidation under Chapter 11 rather than to require conversion of the case to Chapter 7. In re Jartran, Inc., 71 B.R. 938 (Bankr. N.D. Ill. 1987), decision aff'd, 87 B.R. 525 (N.D. Ill. 1988), judgment aff'd, 886 F.2d 859 (7th Cir. 1989).

There is No Per Se Prohibition of Successive Bankruptcy Filings

If the reorganized debtor seeks to liquidate, its subsequent Chapter 11 case will normally not be dismissed (the “Jartran Principle”), although it may be subject to conversion to Chapter 7. The only two courts of appeals to examine this question hold that serial chapter 11 filings are not per se impermissible. In Fruehauf Corp. v. Jartran (In re Jartran), the Seventh Circuit observed that, there is no prohibition of serial good faith Chapter 11 filings in the Code—indeed, there is not even a time limit on successive filings parallel to that imposed on individuals or family farmers. 11 U.S.C. § 109(g). As the district court noted, Congress could easily have included repeat corporate debtors in that section. In re Jartran, Inc., 886 F.2d at 870. According to the Jartran court, Congress's failure to do so “‘indicates that corporate debtors are exempt from even the minimal constraints on serial filing imposed on other kinds of debtors.’” Id. As a result, corporate debtors are exempt from even the minimal constraints on serial filings imposed on other kinds of debtors. Id.

Serial Chapter 11 Cases are Permissible if Filed in Good Faith

The debtor, Jartran, filed its first Chapter 11 petition in December, 1981. A plan of reorganization was confirmed in September, 1984, and distributions as provided by the plan commenced shortly thereafter. In March, 1986, the debtor filed a second Chapter 11 petition and proposed a liquidating plan that would alter the terms of the plan confirmed in the first Chapter 11.

The court rejected a creditor's contention that the second petition unlawfully sought to modify the first plan after it had been substantially consummated. It did not propose to alter or amend any of its existing obligations with any creditor, but rather to liquidate its assets. The second filing was, according to the court, merely a “‘good faith admission that Jartran was unable to continue operating as a going concern’” and not an impermissible modification. In re Jartran, Inc., 886 F.2d at 868 (quoting bankruptcy court decision).

The creditor alternatively sought to dismiss the second Chapter 11 by arguing the appropriate remedy, upon failure of the plan, was conversion to Chapter 7 pursuant to § 1112(b). The Seventh Circuit also rejected this argument, holding that § 1112(b) did not require conversion upon default under a confirmed plan. In re Jartran, Inc., 886 F.2d at 868. By its own terms, § 1112(b) only authorizes a court to enter an order of conversion if it finds that conversion is in the interests of the creditors and the estate. The court determined that the best interests of the creditors and the estate would be served by liquidation under the new Chapter 11 rather than by conversion to Chapter 7.

Jantran I operated a nationwide trust and trailer rental business through independent agents. In re Jartran, Inc., 71 B.R. at 939. It commenced a chapter 11 proceeding and eventually confirmed a plan of reorganization. The objectives of Jantran I was to reorganize and continue operations. See Id. Leases where modified to that goal. Id at 940. Upon confirmation of it plan Jantran was discharged from its pre-petition debtor, revested with its assets and continued its operations as a reorganized debtor. Id. at 942.

Jantran II had a different goal. Id. No successor to the nationwide truck and trailer rental business would emerge through the plan. Id. The result of a confirmation of would not be a discharge of Jartran II from its pre-petition debts. Id. Under § 1141(d)(3)(A) confirmation of a plan that provides for liquidating all, or substantially all, of an estate's property does not discharge the debtor of its pre-petition debts. Id.

The lower court in Jartran found that the debtor was not trying to circumvent the binding terms of a confirmed plan, but was attempting an orderly liquidation after having failed to successfully reorganize under the terms of its prior Chapter 11 plan. The second filing was a “good faith admission” that the reorganized Debtor was not able to operate as a going concern. Id. The court of appeals allowed the second filing because it seemed to be the cleanest liquidation alternative, and there was nothing in the statute that prohibited the filing except some floating good faith standard that had clearly not been violated in Jartran.

In subsequent reorganization cases, the standard to show good faith is very high. If a subsequent plan is filed for the purpose of reorganization courts focus on the foreseeability and substantiality of events which ultimately caused the subsequent filing. See e.g. Lincoln Nat'l Life Ins. Co. v. Bouy, Hall & Howard & Assocs. (In re Bouy, Hall & Howard & Assocs.), 208 B.R. 737 (Bankr. S.D. Ga. 1995); In re Adams, 218 B.R. 597 (Bankr. D. Kan. 1998). However, the mere fact that a debtor has previously petitioned for bankruptcy relief does not render a subsequent Chapter 11 petition ‘per se’ invalid. See In re Elmwood Dev. Co., 964 F.2d 508, 511 (5th Cir.1992) (finding that the Code itself contains no absolute bar against filing a second Chapter 11 petition).

In conclusion, case law supports both the principle that serial chapter 11 filings are not per se impermissible, and that a second plan may modify the first plan where there are extraordinary circumstances that are unforeseeable are present. The courts will look for a demonstration the subsequent filing is commenced in good faith. The good faith determination depends largely upon the bankruptcy court's on-the-spot evaluation of the debtor's financial condition, motives, and the local financial realities. A collation of factors, rather than any single datum, controls the resolution of this issue.

The law firm of Scura, Wigfield, Heyer, Stevens & Cammarota, focuses its bankruptcy practice on representing small businesses in complicated chapter 11 proceedings. Free bankruptcy consultations are available.

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David L. Stevens

I have a passion for what I do. There are few things I enjoy more than helping good people and viable businesses find solutions to overwhelming debt.

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