Two recent cases highlight reluctance by bankruptcy courts to designate claims of creditors who are on friendly terms with Chapter 11 debtors.
Bankruptcy Court in Southern District of Ohio Declines to Designate Claims of Friendly Creditor
In a case in the Southern District of Ohio a debtor’s insiders encouraged a friendly creditor to purchase claims by promising to reimburse the creditor for any legal fees it incurred in the Chapter 11 case. Had the creditor or its principal’s relationship with the debtor been the motivating factor for the transaction, rather than the independent exercise of business judgment, the court could have disregarded the creditor’s vote for the plan as votes cast by insiders. One of the secured creditors argued that the friendly creditor and its principal acted as proxies of the debtor in casting votes in favor of confirmation and sought to designate the creditor’s claims on these grounds. The court found that the creditor’s principal based his decision to purchase the claims on the prospect of obtaining future work from the debtor along with his inspection of the collateral that secured the claims. Further, the creditor was not required to vote the claims in favor of the plan. On that basis, the court concluded that neither the friendly creditor nor its principal qualified as non-statutory insiders of the debtor.
Bankruptcy Court in District of Delaware Finds Designation Was Not Warranted
In a case in the District of Delaware a debtor executed a postpetition, pre-disclosure statement restructuring support agreement (RSA) with some of its creditors. Designation of the votes of these creditors would have resulted in the Debtor lacking sufficient votes to confirm its plan. The debtor and the RSA parties urged the court to follow In re Century Glove(C.A. 3rd Cir) to construe solicitation narrowly and deny designation of their votes. The court cited to the Third Circuit and a decision from a bankruptcy court in Texas to narrowly construe “solicitation,” noting the RSA support parties were all sophisticated financial players represented by able and experienced professionals. The court held that designation of votes was not warranted where the creditors were acting at all times to maximize their own recoveries and to advance the debtor’s reorganization process to facilitate a prompt and substantial return on their respective claims.
The Second Circuit on Designation
The Second Circuit captured the standard used when a party seeks to disallow creditors to vote on a plan when Judge Gerber said “[a] right to vote on a plan is a fundamental right of creditors under Chapter 11. Designation of a creditor’s vote is a drastic remedy, and, as a result, designation of votes is the exception, not the rule. The party seeking to have a vote disallowed has a heavy burden of proof.” Where creditors act with the apparent goal of furthering their own self-interest and maximizing their recoveries, courts will be extremely reluctant to disenfranchise creditors from their statutory rights.