Bankruptcy Judge John T. Dorsey of Delaware had confirmed a corporate debtor’s chapter 11 plan. He didn’t permit the debtor to file another chapter 11 case in California for a second restructuring of the secured debt that had been restructured in the first reorganization in Delaware.

Employing Bankruptcy Rule 1014(b) and Section 1127(b) in his January 30 opinion, Judge Dorsey transferred the case to Delaware and dismissed the new California petition as a bad faith filing. The petition in California had been filed three years after the Delaware plan had become effective.

We invite our readers to compare the case before Judge Dorsey with Johnson & Johnson’s newest shot at resolving talc liability with a third chapter 11 petition in Houston, following the dismissals of two chapter 11 filings in New Jersey. In making the comparison, note that J&J created a new, Texas-based debtor called Red River Talc LLC in place of LTL Management LLC, the subsidiary that the Third Circuit dismissed for having no “financial distress.” Are the distinctions significant? Does it matter that one case was confirmed and the other dismissed?

The Second Chapter 11 Filing Three Years Later

A corporate debtor had filed a chapter 11 petition in Delaware encumbered with debt in the original principal amount of about $173.5 million secured by substantially all of the assets. The debtor owned a luxury hotel in California that fell on hard times during the pandemic.

In late 2021, Judge Dorsey confirmed a chapter 11 plan giving the lender a restructured secured loan in the principal amount of some $185 million. The good times didn’t last long, though, because planned renovations of the hotel ran over budget, and business didn’t improve as expected following the pandemic.

The lender had allowed the debtor to sell part of the project and put the remainder on the market. When a buyer didn’t appear, the lender started foreclosure. The lender gave the debtor another chance by agreeing to take a haircut for being taken out. When a new lender didn’t appear, the debtor filed a new chapter 11 case in California one day before the scheduled foreclosure sale.

The lender filed a motion in Judge Dorsey’s court to transfer venue to Delaware and dismiss the new petition. Note: The original chapter 11 case in Delaware had not been closed.

Two Bites at the Apple Prohibited

The lender’s motion to transfer venue was governed by Bankruptcy Rule 1014(b), which provides:

If petitions commencing cases under the Code . . . are filed in different districts by, regarding, or against (1) the same debtor . . . on motion filed in the district in which the petition filed first is pending . . ., the court may determine, in the interest of justice or for the convenience of the parties, the district or districts in which the case or cases should proceed.

The lender’s motion to dismiss was governed by Section 1112(b), under which “cause” for dismissal is shown if the petition was not filed in good faith.

The lender contended that the new petition was filed in bad faith because “the debtors’ sole purpose in filing the new case was to evade the consequences of their defaults under the chapter 11 plan previously confirmed by this Court.” In that vein, Judge Dorsey said,

Courts have held that chapter 11 filings made for the purpose of modifying a previously confirmed and substantially consummated plan in violation of Section 1127(b) of the Code are made in bad faith and must be dismissed under Section 1112(b) of the Code.

In pertinent part, Section 1127(b) provides that a “reorganized debtor may modify [a confirmed] plan at any time after confirmation of such plan and before substantial consummation of such plan . . . .”

The debtor contended that Rule 1014(b) did not apply because the first case was “substantially complete” and the debt restructured in the prior case was new debt to be handled in a new chapter 11 case. Judge Dorsey disagreed, saying, “It is clear from the record in this case that the [debt restructured in the first case] arose out of the First Bankruptcy Case and is therefore governed by the [Delaware] Plan.” He added that the debt restructured in Delaware was “not new debt that came into existence independent of the First Bankruptcy Case, but rather was a product of the bankruptcy process.”

Having found the ability to transfer venue, Judge Dorsey held that the new petition, filed “for the purpose of restructuring the [debt restructured in the first case], would have the effect of modifying the substantially consummated Plan, contrary to the provisions of Section 1127(b) of the Code.”

Judge Dorsey then turned to the question of whether there were “changed circumstances” justifying a new filing. He said that the “plain text” of Section 1127(b) does not allow any exception to the requirement that a modification must occur before “substantial consummation.” Quoting a 1998 decision by Bankruptcy Judge Conrad B. Duberstein, he said that the section provides “finality” with respect to confirmation orders for both the debtor and creditors.

To protect finality, Judge Dorsey said that “Debtors must show extraordinary, unforeseeable changed circumstances to avoid dismissal under Section 1112(b) of a second chapter 11 case that would result in a de facto modification of a previous plan.” [Emphasis added.]

Judge Dorsey went on to find that the debtor’s financial problems occurring after confirmation in the first case “were foreseeable, and none rise to the level of extraordinary.” He distinguished authorities proffered by the debtor to justify a new filing.

In one case, the debt to be affected was new debt unrelated to the first bankruptcy. In the second case, the plan had not been substantially consummated, and the court in the third case found that changed circumstances were “entirely unforeseeable.”

Judge Dorsey granted the motion to transfer venue and dismissed the petition in the second case that had been filed in California.