The secondary bankruptcy claims market has become big business over the past several years, resulting in a proliferation of court rulings that underscore risks and “regulation” around claims-trading, especially when claims are purchased for strategic objectives and not anticipated cash recovery. Commentators have reviewed the decisions of In re KB Toys Inc.,[1] Dish Network Corp. v. DBSD N. Am. Inc. (In re DBSD N. Am. Inc.)[2] and In re Fisker Automotive Holdings Inc.[3] extensively.[4] KB Toys cautions that a claim buyer holds a claim with all the disabilities that would have burdened the original claimant, DBSD highlights the limits of claim acquisition as a tactical strategy for taking control through the plan-confirmation process, and Fisker demonstrates the willingness of courts to look to underlying facts as the basis to limit permissible parameters of a credit bid under 11 U.S.C. § 363(k). Two decisions entered just this summer, CWCapital Asset Management LLC v. Burcam Capital II LLC[5] and In re LightSquared Inc.,[6] may refine the scrutiny of plan ballots cast by claim purchasers when a debtor arguably manipulates claim classification under its plan or otherwise seeks designation under 11 U.S.C. § 1126(e).
Burcam
In Burcam, the U.S. District Court for the Eastern District of North Carolina reversed and remanded a plan-confirmation order, holding that it was “clearly erroneous” to find that there was a legitimate business purpose for separate classification of unsecured claims purchased by the sole secured creditor in a chapter 11 plan when such classification was an obvious attempt at gerrymandering the votes.[7] CWCapital was the sole secured creditor of the debtor, Burcam Capital II LLC, a commercial real estate developer. The debtor’s original plan proposed to pay creditors in full and provided for two classes of unsecured creditors, a standard class for general unsecured claims and a convenience class. CWCapital filed a motion to dismiss the case, arguing that the plan was unconfirmable, but while the motion was pending, voting proceeded.[8] Seeking to block confirmation, CWCapital purchased 16 trade creditors’ unsecured claims (approximately 68 percent of the unsecured debt), and cast its votes as both secured and unsecured creditors to reject the plan.[9] After receiving the ballots, but before the confirmation hearing, the debtor filed a modified plan, providing for a third class of unsecured creditors that was comprised solely of the unsecured claims purchased by CWCapital, with the treatment that was different from the treatment proposed for the other classes of unsecured claims.[10] CWCapital objected to both plans and at the confirmation hearing, renewed its argument that the case be dismissed. Denying CWCapital’s motion and confirming the second proposed plan, the bankruptcy court agreed with the debtor’s argument that a third class was necessary in order to pay trade creditors quicker than claims that were owned by CWCapital in order to maintain business goodwill.[11]
On appeal, the district court noted that while Fourth Circuit precedent would permit a debtor some flexibility in placing similar claims in separate classes, a showing that the proposed classification was “undertaken for reasons [that were] independent of the debtor’s motivation to secure the vote of an impaired, assenting class” was required.[12] The district court was unimpressed by the debtor’s contention that preserving goodwill with its trade creditors justified receiving their payment on a faster track than that proposed for the unsecured debt held by CWCapital, particularly when at confirmation the debtor held ample cash to have paid all of the unsecured debt immediately.[13]
The court expressed equal skepticism about the timing of the filing of the second plan, noting that no separate classification was sought until after the debtor learned the results of CWCapital’s vote on the original plan.[14] Burcam also failed to persuade the district court that unsecured claims held by CWCapital were different from the claims of trade creditors explicitly because CWCapital was not a trade creditor.[15] As noted by the district court, “[t]he general rule is that the identity of the holder does not render the claims themselves dissimilar.”[16] Considering whether the underlying legal nature of the CWCapital unsecured claims might distinguish it from the trade creditors’ unsecured claims, thereby supporting separate classification, the district court concluded that it would not. The court ruled that at the time CWCaptial purchased the claims, the legal nature of the claims were precisely the same: general unsecured debt that was owed to trade creditors.[17]
LightSquared
In LightSquared, SP Special Opportunities LLC (SPSO), an entity that was wholly owned by the chairman and controlling shareholder of a competitor of the debtors, purchased all pre-petition secured debt.[18] Under the debtors’ plan, the SPSO claim was separately classified, whereby it would receive a note, while the non-SPSO pre-petition secured debt would be paid in cash equal to their secured claims.[19] The U.S. Bankruptcy Court for the Southern District of New York found that the separate classification of the SPSO claim was proper because it was a competitor with significant non-creditor interests.[20] However, the court held that the SPSO class’s vote could not be designated under 11 U.S.C. § 1126(e) as it was cast in “bad faith.”[21] The court acknowledged that votes cast by competitors should be viewed with scrutiny, but found that SPSO did not buy the “claims with the intent of voting against any plan that did not give it a strategic interest in the reorganized company.”[22] In this vein, the court declined to review the acts of the secured creditor outside of the voting process, holding that an § 1126(e) designation should only take into consideration the voting conduct of the creditor.[23] In its analysis, the court relied on two distinguishing factors from DBSD: (1) SPSO purchased the debt below par and acquired all of the debt prior to the filing of the plan; and (2) there were valid reasons for SPSO’s rejection of the plan outside of its position as a competitor — namely that the plan deprived SPSO of its first lien security interest and gave consideration that was virtually indistinguishable from equity interest. [24]
Conclusion
DBSD’s lessons are observed as heralding a critical fact-based inquiry into the motives of a claim buyer behind its votes on a debtor’s plan, with the Second Circuit also emphasizing that its decision should not be read as a categorical prohibition on ulterior motives or self-interest, as “[m]erely purchasing claims in bankruptcy ‘for the purpose of securing the approval or rejection of a plan does not of itself amount to bad faith.’”[25] If the holdings of CWCapital and LightSquared signify a trend, courts are honing their fact analyses in these disputes, scrutinizing motives of the debtor and claims buyer alike, with the timing and economics of the claim acquisition at the fore.
[1] 736 F.3d 247 (3d Cir. 2013) (“KB Toys”), but compare Enron Corp. v. Springfield Assocs. LLC (In re Enron Corp.), 379 B.R. 425 (S.D.N.Y. 2007).
[2] 634 F. 3d 79 (2d Cir. 2010) (“DBSD”).
[3] 510 B.R. 55 (Bankr. D. Del. 2014) (“Fisker”).
[4] See, e.g., Walter Benzija, “Cloudy with a Chance of Disallowance: Does § 502(d) Inhere to the Claim or Claimant?,” XXXIII Am. Bankr. Inst. J. 2, 14-15,82 (February 2014); Elliot Ross, “DBSD and Vacant Class Problem: Confirmation without Representation,” XXXI Am. Bankr. Inst. J. 5, 60-61, 98-99 (June 2012); and Oscar N. Pinkas and Joseph G. Selby, “Is Fisker Automotive Holdings a New Limit on Credit-Bidding?,” XXXIII Am. Bankr. Inst. J. 4, 14, 84-86 (April 2014). All articles are available at journal.abi.org (log-in required).
[5] 2014 U.S. Dist. LEXIS 87900, 5:13-CV-278-F; 5:13-CV-279-F (E.D.N.C. June 24, 2014) (“Burcam”).
[6] 513 B.R. 56 (Bankr. S.D.N.Y. 2014) (“LightSquared”).
[7] 2014 U.S. Dist. LEXIS 87900, at 18-19.
[8] Id. at 4.
[9] Id.
[10] Id. at 5.
[11] Id. at 6.
[12] Id. at 9.
[13] Id. at 18.
[14] Id. at 15.
[15] Id. at 21-23.
[16] Id. at 23.
[17] Id. at 26.
[18] 513 B.R. at 61, 84.
[19] Id. at 64-65.
[20] Id. at 85-88.
[21] Id. at 92.
[22] Id. at 89, 91, citing DBSB, 634 F.3d at 104.
[23] Id. at 92.
[24] Id. at 90-92.
[25] 634 F. 3d at 102 (citing In re P-R Holding Corp., 147 B.R. 895, 897 (2nd Cir. 1945)).