Consensual Plans with Non-voting Classes When the Failure to Vote Means Acceptance

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Mar 2002

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When soliciting votes for a chapter 11 plan, plan proponents want as many acceptances
as possible. After all, more acceptances equate to more accepting classes. And the
acceptance of a plan by all classes of creditors allows for a consensual plan, as
opposed to a cramdown plan. While success is certainly obtainable with a cramdown
plan, a consensual plan is always preferable because the plan proponent avoids the
necessity of proving compliance with the Bankruptcy Code's cramdown provisions, as well
as avoiding an appeal and the accompanying costs and delays.

Plan proponents, however, cannot force claimants to vote to accept a plan, or even
to vote at all. The Bankruptcy Code, after all, imposes no punishment upon
non-voting claimants. Instead, a claimant may choose not to vote at all, thereby
allowing the chips to fall where they may. It is unlikely, however, that any
claimant that is truly interested in the bankruptcy case's outcome will not vote.

Based on such theory, arguments have successfully been made that the failure of
a class to vote equates to it "deemed acceptance." These arguments, and opinions
accepting them, are based on the concept of estoppel in that if a claimant is not
concerned enough to vote, it should not be heard to later complain. This concept is
not universally accepted, but can be a useful tool for practitioners when and where
it applies.

<h3>Voting Requirements in Chapter 11</h3>

Pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §1126(c)</a>, "a class of claims has accepted a plan
if such plan has been accepted by creditors...that hold at least two-thirds in
amount and more than one-half in number of the allowed claims of such class held by
creditors...that have accepted or rejected such plan. Thus, to determine whether a
class of creditors has accepted a plan, one must calculate the number of creditors
voting and the respective amount of the voting creditors' claim or interest, and
examine whether the number of creditors voting equates to 51 percent of the creditors
in that class voting, and whether the dollar amount of claims or interests voted
equates to more than 66 percent of the aggregate amount of claims of creditors that
voted. This calculation differs from the formula applied under the Bankruptcy Act,
whereby the total amount of creditors entitled to vote was calculated.

<blockquote><blockquote>
<hr>
<big><center>
While the Sweetwater doctrine may be
controversial, it can be a useful tool at
a confirmation hearing because it provides
for an efficient confirmation hearing
process.

</center></big>
<hr>
</blockquote></blockquote>

As a result, obtaining an accepting class is easier because non-voting creditors
are not counted in calculating class acceptance. The Bankruptcy Code, however, does
not address the result of a class in which no creditors voted. A non-voting class
is possible, particularly when a single creditor, typically a secured creditor, is
the only member of that class. Classes with one secured creditor are common because
of the differing treatment among secured creditors in most bankruptcy cases.

A single, secured creditor in a class may choose not to vote for a variety of
reasons, such as apathy and/or the desire to save any and all expense. Such
non-participation is rare because of the secured creditors' desire to protect its
rights. When a secured creditor that has participated in the bankruptcy case does not
vote, therefore, it is logical to assume that its failure to vote is not a rejection
of the plan. Indeed, an acceptance or rejection must be in writing, so the failure
to vote is not a rejection. Fed. R. Bankr. P. 3018(c). Certain courts
have adopted this logic and held that a non-voting single member of a class is deemed
to have accepted a plan. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Ruti-Sweetwater, 836 F.2d 1263 (10th
Cir. 1988)</a>.

<h3>Sweetwater and Its Progreny</h3>

In Sweetwater, judgment lien creditors were separately classified under the debtors'
plan of reorganization. Throughout the term of the bankruptcy proceeding, the judgment
creditors did not appear or otherwise participate. At the confirmation hearing, the
bankruptcy court accepted the debtors' assertion that the judgment creditors' failure
to object or vote on the plan, despite adequate notice, should be deemed an
acceptance of the debtors' plan, thereby allowing the debtors to avoid the cramdown
requirements set forth in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §1129(b)</a>.

Subsequently, the judgment creditors appeared and attacked certain provisions of the
debtors' confirmed plan, which affected their liens. The bankruptcy court rejected all
such arguments and held that the judgment creditors were bound by the debtors' confirmed
plan. Upon the judgment creditors' appeal of the order confirming the debtors' plan,
the district court affirmed the bankruptcy court.

The district court reasoned that under the Bankruptcy Act, non-voting creditors
in a class were deemed to reject the plan, as a debtor had to carry class by
counting the total members of a class, as opposed to just the voting members. Under
the Bankruptcy Code, however, non-voting members were not deemed to have rejected
the plan. Therefore, a court could deem a class as having accepted the plan, even
though the single creditor in that class did not vote.

The Tenth Circuit affirmed and held that "to hold otherwise would be to endorse
the proposition that a creditor may sit idly by, not participate in any manner in
the formulation and adoption of a plan [of] reorganization, and thereafter, subsequent
to the adoption of the plan, raise a challenge to the plan for the first time."
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Ruti-Sweetwater Inc., 836 F.2d 1263, 1266 (10th Cir.
1988)</a>. Since adopting the judgment creditors' argument would relieve creditors from
taking an active role in protecting their claims, the Tenth Circuit held that the
judgment creditors' inaction constituted an acceptance of the debtors' plan for purposes
of §1129(b). But, see <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re M. Long Arabians, 103 B.R. 211,
215 (Bankr. 9th Cir. BAP 1989)</a> (where the court held that there can
be no deemed acceptance where a creditor objected to the plan, regardless of voting).

The Tenth Circuit's holding has been adopted by other courts, which have likewise
held that a non-objecting, non-voting secured creditor that is the single member of
a class is deemed to have accepted the plan for purposes of §1129(b). See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
re Campbell, 89 B.R. 187 (N.D. Fla. 1988)</a>.

The Tenth Circuit, however, could have reached its result without finding a
deemed acceptance for §1129(b) purposes. After all, it can be argued that a
creditor that does not object consents by acquiescence and waives the objection. Thus,
any following appeal is subject to dismissal because of the failure to timely raise
the issue during the bankruptcy case. Indeed, many courts have found that failing
to participate and vote does not equate to a deemed acceptance of a plan.

<h3>Rejection of the Sweetwater Doctrine</h3>

While most circuit appeals courts have not ruled on the Sweetwater doctrine, other
courts have rejected the theory. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Townco Realty Inc., 81 B.R.
707 (Bankr. S.D. Fla. 1987)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Friese, 103 B.R. 90
(Bankr. S.D.N.Y. 1989)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Adkisson Village Apartments of Bradley
Co. Ltd., 133 B.R. 923 (Bankr. S.D. Ohio 1991)</a>. The only
reason to avoid §1129's cramdown requirements is if they cannot be met. If such
requirements cannot be met, then the purpose of §1129 and of calculating
acceptance by affirmative votes is fulfilled.

Many of the cases rejecting Sweetwater, however, actually distinguish themselves based
on the facts of the case, i.e., the class that is allegedly deemed to accept,
affirmatively and timely objected to the plan. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. Long Arabians, 103 B.R.
at 215</a>. In fact, there has yet to be an appeals court to reject Sweetwater.
The lack of such a case is not surprising, however, because the Sweetwater doctrine
applies when creditors have not participated. Most creditors that acquiesce during the
bankruptcy case do not actively participate after confirmation. Thus, few cases or
controversies arise, lending credibility to Sweetwater through the lack of controverting
precedent.

<h3>Conclusion</h3>

While the Sweetwater doctrine may be controversial, it can be a useful tool at a
confirmation hearing because it provides for an efficient confirmation hearing process.
Further, circumstances could arise whereby no impaired classes have accepted a plan,
and the deemed acceptance is necessary for the plan to comply with
§1129(a)(10). While such an application would extend the Sweetwater doctrine,
it is surely possible. The question would then arise as to who had standing to appeal
the issue—objecting creditors, or the non-voting, non-participating creditors.

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Friday, March 1, 2002 - 12:00

Bankruptcy Rule

2002