A decision by Bankruptcy Judge Robert E. Littlefield, Jr., of Albany, N.Y., shows how “the Court has an independent duty to review the Disclosure Statement and Plan.” In his opinion on March 28, Judge Littlefield denied confirmation of a chapter 11 plan even though no party in interest had objected.A decision by Bankruptcy Judge Robert E. Littlefield, Jr., of Albany, N.Y., shows how “the Court has an independent duty to review the Disclosure Statement and Plan.” In his opinion on March 28, Judge Littlefield denied confirmation of a chapter 11 plan even though no party in interest had objected.

A lender with a checkered past, the debtor was a “classic” Ponzi scheme, according to the disclosure statement. First, there was an involuntary petition that was dismissed. A federal receivership ensued where the receiver filed a chapter 11 petition. It too was dismissed, on the court’s finding that the receiver did not have authority to file bankruptcy.

Meanwhile, the FBI searched the effects of the debtor’s principal, who soon filed a petition under Subchapter V of chapter 11. The principal has since been indicted and is incarcerated pending trial.

On motion by the U.S. Trustee, the court converted the principal’s case to chapter 7. The chapter 7 trustee filed a voluntary chapter 11 petition for the debtor. The debtor filed a liquidating chapter 11 plan and resolved several confirmation objections.

Court Supervision of Post-Confirmation Fees

Judge Littlefield said he did “not take issue” with the debtor’s contention that most of the confirmation requirements in Section 1129(a) had been met. Stating the court’s independent duty to review the plan, he analyzed several confirmation requirements, starting with Section 1129(a)(4).

The subsection provides:

Any payment made or to be made by the proponent [or] by the debtor . . . for services or for costs and expenses in or in connection with the case, or in connection with the plan and incident to the case, has been approved by, or is subject to the approval of, the court as reasonable.

Judge Littlefield cited a provision in “the Plan [that] provides for the reimbursement of costs and expenses for the Oversight Committee” created by the plan. He went on to say that the “reasonable expenses incurred by committee members may be paid by the Plan Administrator without Court approval.”

Another provision in the plan, Judge Littlefield said, provides that court approval is only required if the Oversight Committee objects to the fees and expenses of the Plan Administrator’s professionals.

“Taken together,” Judge Littlefield said, “the Plan and related documents remove the Court’s ability to review and approve expenses incurred by members of the Oversight Committee, professionals of the Oversight Committee and professionals of the Plan Administrator.” The result, he said, “is a cause for concern as it implicates significant conflicts of interest.”

Judge Littlefield explained that the “members of the Oversight Committee are to be paid by the very person they are charged with overseeing” and “may also be incentivized to approve each other’s professional fees.” He concluded that the plan “creates a risk of escalating fees outside of Court purview that would necessarily harm other creditors and the estate.”

Judge Littlefield held that “the Plan does not comply with § 1129(a)(4) and cannot be confirmed.” 

Conflicts on the Oversight Committee

Next, Judge Littlefield turned to Section 1129(a)(5), which he described as requiring the “plan proponent [to] identify those individuals who will effectuate the plan.” The subsection requires that “their appointment . . . be ‘consistent with the interests of creditors and equity security holders and with public policy.’”

Judge Littlefield said that a member of the Oversight Committee was one of the three creditors who filed the original involuntary petition that was dismissed, making that creditor subject to damages under Section 303(i). If it were on the Oversight Committee, he said that the creditor could “greatly influence” the decision by other committee members and the Plan Administrator about pursuing damages after confirmation.

In addition, the creditor had stated its intention to seek an allowance of an administrative claim for having made a substantial contribution to the case. As a result, Judge Littlefield saw “some discomfort” and ruled that “the Plan does not comply with § 1129(a)(4) and cannot be confirmed.”

Post-Confirmation Supervision

After confirmation, Judge Littlefield said that “the Plan Administrator and Oversight Committee seek the ability to carry out certain acts without the need for Court approval,” such as bringing and settling lawsuits. Consequently, he said that the court’s “day-to-day oversight would be largely curtailed.”

Conceding that “several cases” in the Southern District of New York had “ceded oversight to the parties,” Judge Littlefield found the cases to be “factually distinguishable” and lacked the “post-confirmation complexity of this case.”

In the debtor’s case, Judge Littlefield expected “a litany of litigation to accumulate significant assets for the estate.” The judge found himself “uncomfortable removing judicial checks and balances to the degree proposed in the Plan when the future of this case and the proceedings therein remains largely unknown.”

A Ponzi Scheme Finding

The debtor wanted Judge Littlefield to include a Ponzi scheme finding in the confirmation order, although the plan had no mention of such a finding. He admitted that “other courts have made a Ponzi scheme finding in their confirmation orders.”

The “Plan and Disclosure Statement,” Judge Littlefield said, “failed to provide proper notice to interested parties that such a finding would be sought in the confirmation order.” Consequently, “It would be inequitable for the Court to now make such a determination when said parties have not had a proper chance to voice any concerns they may have.”

Judge Littlefield saw “nothing preventing [the debtor] from seeking such a determination after confirmation.”

Judge Littlefield denied confirmation “so that a new disclosure statement and plan may be prepared, noticed and voted upon.”