[1]When we last reported on In re Loop 76,[2] the case was on appeal with the Ninth Circuit Bankruptcy Appellate Panel (BAP). In a lengthy decision that one could argue expanded the bankruptcy court’s ruling on classification, the BAP has since affirmed the bankruptcy court’s decision permitting separate classification of unsecured deficiency claims.[3] The Ninth Circuit Court of Appeals recently affirmed the BAP, but on a much narrower basis, holding that even if the appellant’s claim was classified with other unsecured claims, the debtor’s plan could nevertheless be confirmed because another impaired class had voted to accept the plan.[4] This article will briefly explore both decisions from the BAP and Ninth Circuit, and will offer some practice pointers for both debtors’ and creditors’ attorneys in chapter 11 cases.
The Bankruptcy Court Approves Plan Separately Classifying Unsecured Deficiency Claim
In In re Loop 76,[5] the U.S. Bankruptcy Court for the District of Arizona held that if a guaranty by a nondebtor provides the lienholder with an alternative source of repayment for a deficiency claim, then the deficiency claim is not necessarily “substantially similar” to other unsecured claims.[6] If the evidence presented at a confirmation hearing establishes that the guarantee was a significant factor in determining the creditor's vote (for example, by showing that the guarantee had value, i.e., the guarantors were solvent), 11 U.S.C. § 1122 requires the “guaranteed” deficiency claim be classified separately from nonguaranteed unsecured claims.[7] Issues of “gerrymandering” would not arise because § 1122 precludes placing dissimilar claims in the same class.[8]
BAP Affirms the Bankruptcy Court and Goes a Step Further
Wells Fargo Bank NA, whose unsecured, guaranteed deficiency claim was classified separately from unsecured trade-vendor claims, appealed the bankruptcy court’s decision.[9] Wells Fargo argued that (1) its unsecured deficiency claim could not permissibly be separately classified from other general unsecured claims; (2) the debtor’s loan and security agreement with Genesee Funding LLC was illegitimate and could not constitute an impaired, accepting class; and (3) the bankruptcy court erred in finding that the debtor’s plan was feasible.[10]
The BAP rejected all three of Wells Fargo’s arguments. While a full discussion of the BAP’s decision is beyond the scope of this article, there are a few notable points to be gleaned from it. First, in affirming the bankruptcy court’s ruling on classification, the BAP held that while § 1122(a) provides that dissimilar claims cannot be classified together, “[t]he Code does not expressly state whether a plan must classify similar claims together.”[11] Second, since the bankruptcy court has broad discretion in classifying claims, “its finding that a claim is or is not substantially similar to other claims constitutes a question of fact [that is] reviewable under the clearly erroneous standard.”[12] Third, if the bankruptcy court determines that claims are substantially similar, those claims may nevertheless be separately classified if the debtor can show a business or economic justification for doing so.[13]
Finally, the BAP rejected Wells Fargo’s argument that a third-party guarantor does not render its deficiency claim dissimilar to other unsecured claims.[14] Its argument was based on case law that was inconsistent with In re Johnston’s mandate on whether a claim that is substantially similar is not entirely dependent on how it relates to the debtor’s assets:
In re Johnston did adopt, however, Los Angeles Land’s[15] holding that the bankruptcy court has “broad latitude” in determining the similarity of claims, and that it need not follow some narrow definition. When the In re Johnston court considered third-party sources of recovery for Steelcase’s unsecured claim as a basis for dissimilarity, it was clearly looking beyond just Johnston’s assets.[16]
Given the BAP’s decision, it did not need to address (1) whether the debtor provided a business or economic justification for separately classifying similar claims; (2) whether the debtor separately classified similar claims in order to gerrymander an affirmative vote for its plan; or (3) if the guarantors of Wells Fargo’s debt were solvent.[17] In regards to the last issue, not only did the BAP question whether the guarantors’ financial condition was even a factor to consider, as collectability of the debt was never discussed in In re Johnston,[18] the court held that it could not consider that issue because Wells Fargo did not provide the BAP with the entire transcript reflecting the guarantors’ testimony regarding their solvency.[19]
Wells Fargo had objected to Genesee’s claim in bankruptcy court and contended that Genesee’s claim, secured by personal property purchased just before the bankruptcy, was not adequately documented and was manufactured in an effort to create an accepting, impaired class.[20] The BAP held that despite the actual agreement between Genesee and the debtor being infirm, the parties to the agreement acted in such a way as to conclusively show that they intended to form a binding agreement.[21] Addressing Wells Fargo’s argument that Genesee’s vote was cast in bad faith and should have been designated under 11 U.S.C. § 1126(e), the BAP held that by finding the parties’ dealings, while suspect, were not enough to invalidate the existence of the Genesee debt, the bankruptcy court essentially found that the Genesee claim was not manufactured. As such, the bankruptcy court did not need to address whether Genesee’s claim should have been designated. [22]
Finally, the BAP held that the bankruptcy court did not err in determining that the debtor’s plan was feasible. Not only did it fail to provide in its excerpts of the record the transcripts containing the debtor’s feasibility expert’s testimony and complete transcripts of the debtor’s principals’ testimony on feasibility, but Wells Fargo also failed to include the cross-examination of its own feasibility expert.[23] Since feasibility is a finding of fact, Wells Fargo had to demonstrate that the bankruptcy court’s findings of fact were clearly erroneous.[24] To show clear error, Wells Fargo had to show how the bankruptcy court’s findings were not supported by the record.[25] If Wells Fargo intended to reverse the bankruptcy court’s findings of fact, the entire record was required.[26] The court made the following statement:
By submitting virtually one side of the story, Wells Fargo has fallen short of meeting its burden. Therefore, we cannot confirm that the “record established” what Wells Fargo says it did (or did not). While perhaps the necessary transcripts are available on the bankruptcy court’s electronic docket, the Panel is not obligated to scour the record to try to make Wells Fargo’s case of clear error.[27]
Without the entire record, the BAP could only rely on what Wells Fargo provided, which supported the bankruptcy court’s finding on feasibility.
Ninth Circuit Narrowly Affirms the BAP
On June 10, 2014, the Ninth Circuit Court of Appeals affirmed the BAP,[28] holding that Wells Fargo’s appeal was not equitably moot and that the bankruptcy court did not err in finding that Genesee’s claim was valid and voted in good faith. The debtor sought to dismiss Wells Fargo’s appeal as equitably moot because its plan had been substantially consummated.[29] The debtor argued that unwinding the plan years after it was confirmed would unfairly prejudice claimholders who had been paid under the plan.[30] Since Wells Fargo stated it would not ask third-party claimholders to disgorge payments that they had received and avowed that it would refund all payments that it had received under the plan, the Ninth Circuit was satisfied that no third parties would be unfairly affected if it were to rule in Wells Fargo’s favor and that the bankruptcy court could fashion an appropriate remedy.[31]
With respect to Genesee’s claim, the Ninth Circuit largely adopted the BAP’s ruling on the issue: Although the terms of the agreement between the debtor and Genesee were imprecise, the parties’ actions indicated assent to be bound. Moreover, like the BAP, the Ninth Circuit held that by finding that the debtor’s plan was proposed in good faith, the plan complied with title 11 and that the Genesee class voted to accept the plan, the bankruptcy court implicitly found that Genesee voted in good faith to accept the plan and as such, that its vote should not have been designated.[32]
Addressing Wells Fargo’s argument that the debtor impermissibly gerrymandered by classifying its unsecured deficiency claim separate from other unsecured claims, the court of appeals held that “[r]esolution of this issue … would not change the result in this case.”[33] The existence of the Genesee class essentially mooted Wells Fargo’s classification argument: “Here, the Genesee class, which was impaired, voted to accept the plan. Even if Wells Fargo’s unsecured claim were to be classified with the other unsecured claims (and that class were to reject the plan), Genesee’s vote in favor of the plan would still allow the plan to be confirmed.”[34]
Takeaways from In re Loop 76
Importance of Multiple Classes of Impaired, Consenting Claimants
The significance of more than one impaired and consenting class cannot be overstressed. Not only does the existence of more than one impaired and consenting class reduce the objecting creditor’s incentive to attack creditors or votes in a single class — as the objecting creditor must torpedo more than one impaired and consenting class to avoid “cramdown” under 11 U.S.C. § 1129(a)(10) — but the existence of multiple impaired and consenting classes protects against the potentiality that the claim that comprises the impaired and consenting class is acquired by the objecting creditor. For example, in In re Loop 76, in an effort to defeat confirmation, Wells Fargo acquired multiple claims that comprised impaired and consenting classes, including a separately classified and secured tax claim.
Classification Depends Heavily on the Facts
As the BAP made clear, whether one creditor’s unsecured claim should be separately classified from other unsecured claims greatly depends on whether there are “certain characteristics or ‘special circumstances’” that render that particular creditor’s claim dissimilar.[35] For example, in In re Loop 76, the BAP held that Wells Fargo was
an undersecured creditor who has a third-party source of recovery, whom it has already sued. Even if Loop 76 makes the 10% payment on the claim, Wells Fargo can still proceed to collect its entire debt from the guarantors. This is clearly a “special circumstance” that does not apply to any other unsecured claimants and accords Wells Fargo a different status.[36]
Accordingly, to support separately classifying seemingly similar unsecured claims, debtors’ attorneys are wise to present evidence to differentiate a debtor’s classification scheme. For example, is the creditor’s claim guaranteed? Are the guarantors solvent? Is the creditor pursuing or likely to pursue the guarantors? Is the litigation against the guarantors contentious? Is it likely that the creditor will prevail against the guarantors? If the creditor does prevail against the guarantors, will the creditor be paid more than other unsecured creditors or in full? Explore factual distinctions among claims and whether they are truly “similar.”[37]
Moreover, different creditors may have different motivations. As the bankruptcy court noted in In re Loop 76, “[c]reditors may favor a plan because it provides future jobs in the community, because they may be able to do business with the reorganized debtor, or because the reorganized debtor will provide a useful product or service to the community.”[38] Other creditors, such as those holding unsecured deficiency claims, might be motivated by ensuring that a plan that unfavorably treats their secured claim is not confirmed.
Acquire Claims Before They Are Voted On
Wells Fargo acquired a number of claims in an attempt to prevent the debtor from confirming its plan using the “cramdown” option of § 1129(a)(10). While not mentioned in the reported decisions in this case, Wells Fargo acquired two claims that had already voted to accept the debtor’s plan, and the bankruptcy court refused to allow Wells Fargo to recast the votes. Creditors who acquire claims for the purpose of preventing confirmation are wise to remember the legal adage, “caveat emptor.”
Preserve Arguments for Appeal
Finally, the BAP refused to review certain issues that were raised by Wells Fargo on appeal because Wells Fargo failed to provide a complete record of the bankruptcy court proceedings. In its apparent fervor to tell its side of the story, Wells Fargo did not provide the entire transcript of the guarantors’ testimony on their solvency to the BAP[39] and failed to provide complete transcripts of the testimony regarding feasibility.[40] To reverse a trial court on issues of fact, an appellant must show that the trial court’s findings were clearly erroneous.[41] To show clear error, the appellant must show how the trial court’s findings were not supported by the record.[42] Without a complete record, a trial court’s findings cannot be reversed.[43] Accordingly, ensuring that the entire record is provided and not just snippets supporting the positions one is advocating for will safeguard against the appellate court glossing over, or even ignoring, critical issues raised on appeal.
[1] The authors represented the debtor in In re Loop 76 LLC in bankruptcy court.
[2] Dale C. Schian and Trent S. Trueblood, “Bankruptcy Court for the District of Arizona Holds Separate Classification of Undersecured Creditor’s Deficiency May Be Required by § 1122(a),” ABI Real Estate Committee Newsletter (February 2011), available at www.abiworld.org/committees/newsletters/realestate/vol8num1/required.ht… (last visited Sept. 10, 2014).
[3] In re Loop 76 LLC, 465 B.R. 525 (B.A.P. 9th Cir. 2012), aff'd, 12-60021, 2014 WL 2580684 (9th Cir. June 10, 2014).
[4] In re Loop 76 LLC, 12-60021, 2014 WL 2580684 (9th Cir. June 10, 2014).
[5] In re Loop 76 LLC, 442 B.R. 713 (Bankr. D. Ariz. 2010).
[6] Id. at 714.
[7] Id.
[8] Id., n.5.
[9] In re Loop 76 LLC, 465 B.R. 525.
[10] Id. at 535.
[11] Id. at 536 (emphasis added).
[12] Id. (citing Steelcase Inc. v. Johnston (In re Johnston), 21 F.3d 323, 327 (9th Cir. 1994)).
[13] Id. (citing Barakat v. Life Ins. Co. of Va. (In re Barakat), 99 F.3d 1520, 1526 (9th Cir. 1996)).
[14] Id. at 540.
[15] In re Los Angeles Land & Invs. Ltd., 282 F. Supp. 448 (D. Haw. 1968), aff’d, 447 F.2d 1366 (9th Cir. 1971).
[16] In re Loop 76 LLC, 465 B.R. at 540 (citing In re Johnston, 21 F.3d at 327).
[17] Id. at 541, n.11.
[18] Id.
[19] Id.
[20] Id. at 530.
[21] Id. at 542-43.
[22] Id. at 544.
[23] Id.
[24] Id. at 545.
[25] Id.
[26] Id.
[27] Id. (citing In re Kritt, 190 B.R. 386-87 (B.A.P. 9th Cir. 1995)).
[28] In re Loop 76 LLC, 2014 WL 2580684, at *1-2.
[29] Id. at *1.
[30] Id.
[31] Id. (citations omitted).
[32] Id. at *2.
[33] Id.
[34] Id.
[35] In re Loop 76 LLC, 465 B.R. at 541.
[36] Id. (citations omitted).
[37] See, e.g., In re Red Mountain Machinery Co., 448 B.R. 1, 6-8 (Bankr. D. Ariz. 2011) (approving classification scheme where secured lender’s deficiency claim was classified separately from other general, unsecured claims because, among other things, lender could, unlike other general, unsecured claimants, look to debtor’s principals for repayment, and whose claims were subject to pending equitable subordination proceeding).
[38] In re Loop 76 LLC, 442 B.R. at 722-23.
[39] In re Loop 76 LLC, 465 B.R. at 541, n.11.
[40] Id. at 544.
[41] Id. at 545 (citing Gionis v. Wayne (In re Gionis), 170 B.R. 675, 681 (B.A.P. 9th Cir. 1994)); Rule 8009(b); B.A.P. 9th Cir. Rule 8006-1.
[42] Id.
[43] Id. (citing In re Kritt, 190 B.R. at 387 (quoting Burkhart v. Fed. Dep. Ins. Corp. (In re Burkhart), 84 B.R. 658, 661 (B.A.P. 9th Cir. 1988))); FRAP 10(b)(2) (“If the appellant intends to urge on appeal that a finding or conclusion is unsupported by the evidence or is contrary to the evidence, the appellant must include in the record a transcript of all evidence relevant to that finding or conclusion.”)).