Solicitation of Plan Rejections without Court Approval Throwing Mud at the Proponents Plan

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Sep 2004

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Prior to soliciting
acceptances of a proposed reorganization plan, a plan proponent must clear
certain hurdles. Indeed, the Bankruptcy Code prohibits solicitation prior
to approval of a disclosure statement to insure that holders of claims and
interests receive "adequate information." See 11 U.S.C. §1125. Upon
approval of a disclosure statement, the Bankruptcy Code authorizes the
solicitation of acceptances, as well as rejections.

Though authorizing the solicitation of rejections
after approval of a proponent's disclosure statement, §1125
does not address the procedure for obtaining authority to seek rejections,
nor how a party may solicit rejections. Section 1125's silence on
this issue has led to differing authority among courts as to what, if any,
authority is necessary prior to a plan opponent soliciting rejections from
holders of claims and interests, and how a party may seek rejections.

<h4>Section 1125 and the Authority Necessary to Solicit Votes</h4>

Pursuant to 11 U.S.C. §1125, "[a]n
acceptance or rejection of a plan may not be solicited after the
commencement of the case under this title...unless, at the time of or
before such solicitation, there is transmitted to such holder the plan or a
summary of the plan, and a written disclosure statement approved, after
notice and a hearing, by the court as containing adequate
information." Noticeably, §1125 does not limit the ability to
solicit acceptances or rejections to plan proponents.

Nor does §1125 require approval of a plan
opponent's solicitation materials prior to dissemination, only the
approval of a disclosure statement. Due to §1125's express
provisions, therefore, certain courts have held that any party, whether
aligned with the plan proponent or not, may solicit acceptances or
rejections after the court approves a plan proponent's disclosure
statement. See Century Glove Inc. v. First
American Bank of New York, 860 F.2d 94 (3d
Cir. 1988).

In Century Glove, the debtor filed a reorganization plan, obtained court
approval of its disclosure statement and solicited votes in support
thereof. 860 F.2d at 95. Counsel for one creditor then presented a letter
to several key creditors asking them to vote against the proposed plan and
to comment on an alternative plan drafted by the creditor, a copy of which
was included with the letter. Id. At no time did counsel solicit other creditors to vote on
its alternative plan, which was clearly marked "draft." Id. at 102.

While the bankruptcy court held that the creditor had
violated 11 U.S.C. §1125(b) by "providing additional materials
such as the copies of its draft plan...," both the district court and
the Third Circuit disagreed. Id. at 96. In fact, the Third Circuit determined that
§1125 "never limits the facts which a creditor may receive, but
only the time when
a creditor may be solicited." Id. at 100 (emphasis in original). After all, "Congress
was concerned not that creditors' votes were based on misinformation,
but that they were based on no information at all." Id.

The Third Circuit, therefore, determined that
§1125(b) "does not on its face empower the bankruptcy court to
require that all communications between creditors be approved by the
court." Id.; cf. In re Apex Oil Co., 111 B.R. 245, 249 (E.D. Mo. 1990) (stating that parties
should proceed with caution when soliciting rejections with additional
information). In fact, the Third Circuit stated that while a debtor
"temporarily has the exclusive right to file a plan," the debtor does not have the right "to
have its plan considered exclusively." Id. at 102 (emphasis in original). Accordingly, "a party
does not solicit acceptances when it presents a draft plan for the
consideration of another creditor, but does not request that
creditor's vote." Id. at 102; cf. In re Temple
Retirement Community Inc., 80 B.R. 367
(Bankr. W.D. Tex. 1987) (holding that correspondence stating another plan
had been drafted if the debtor's plan was rejected violated
§1125(b)).

In so doing, the Third Circuit interpreted
"solicitation" narrowly so as to not inhibit creditor
negotiations. See Id. at 101. Therefore, while a soliciting party may not suggest an
alternative unapproved plan, it may react to and present contrary views
regarding the plan reflected in the approved disclosure statement. In re Clamp-All Corp., 233
B.R. 198 (Bankr. D. Mass. 1999).

<h4>The Propriety of Disseminating Additional Information in Soliciting Votes</h4>

Though a plan opponent may seek rejections, without
additional court authority the propriety of disseminating additional
information remains questionable, particularly if such additional
information is misleading or inaccurate. See
Apex Oil, 111 B.R. at 249. After all, most
would argue that inaccurate information is inadequate information, which
should prevent the dissemination thereof.

Century Glove, although briefly addressing the issue, expressed little
concern that such information might include misrepresentations. In fact,
the Third Circuit held that "[o]nce adequate information has been
provided to a creditor, §1125(b) does not limit communications between
creditors. It is not an antifraud device." Id. at 101 (emphasis added).

Other courts have held that solicitations similar to Century Glove violate
§1125. See, e.g., In re Aspen Limousine
Service Inc., 198 B.R. 341, 347 (D. Colo.
1996). In Aspen Limousine, a plan opponent sent a six-page letter to all creditors apprising
them of its alternate plan and urging them to reject the proposed plan. The
letter further stated that creditors that already voted could change their
votes and use the enclosed ballot. Though somewhat factually similar to the
Century Glove fact
pattern, the plan opponent in Aspen Limousine was far more aggressive in its solicitation, to which
the court took exception.

The court distinguished Century
Glove because (a) Century Glove did not involve
a small business debtor under §§1121(e) and 1125(f); (b) the plan
opponent admittedly was not seeking comments on its plan, but was actually
soliciting votes; and (c) the plan opponent sent its plan to all creditors,
instead of those merely requesting information about the alternate plan. See Id. at 348. In fact, the
court found that the plan opponent's solicitations were a
"deliberate and unabashed attempt to circumvent the confirmation and
solicitation procedures." See Id. at 348-49.

Similarly, sending a draft competing plan could
violate §1125(b) if that draft competing plan contained
"falsehoods or mischaracterizations" or otherwise distorted the
voting process. See In re Gulph Woods Corp., 83 B.R. 339, 342-43 (Bankr. E.D. Pa. 1988). In Gulph Woods, a plan opponent
disseminated pre-marked ballots that requested return service to the plan
opponent instead of the plan proponent, which the court held distorted the
voting process because it was bound to cause confusion among creditors. See Id. at 343.

The cases reflect circumstances where plan opponents
sent solicitation materials without seeking prior approval. Often the
damage caused by the additional solicitation materials will not be known
until late in the balloting process. Nonetheless, plan proponents are not
without countermeasures.

<h4>Remedies for Scorned Plan Proponents</h4>

In finding violations of §1125(b), courts might
sanction the offending creditor. See, e.g.,
Aspen Limousine, 198 B.R. at 350-51.
Sanctioning the offending creditor may not remedy the damage caused by such
solicitations. The Bankruptcy Code, however, contains its own remedy for
bad-faith solicitations. See 11 U.S.C. §1126(e).

Section 1126(e) authorizes a bankruptcy court to
disqualify votes, whether acceptances or rejections, if such votes were
solicited or procured in bad faith. In one of the few cases addressing this
point, the bankruptcy court in In re Walnut
Equipment Leasing Co. cited to §1126(e)
and stated, with little or no additional analysis, that correspondence sent
urging support of a plan "sufficiently tainted the vote...to justify
ignoring that class's acceptance of the plan...." Case No.
97-19699DWS, 1999 WL 1068448, at *4 (Bankr. E.D. Pa. 1999). The Walnut Equipment opinion,
however, does not include much analysis or factual discussion. While the
court found bad faith, it did not discuss what act, in particular,
constituted bad faith.

Another court has held that an unsecured
creditors' committee did not act in bad faith, and therefore did not
implicate §1126(e), when it sent a letter of "recommendation to
its constituents" about a proposed plan. See
In re Cajun Electric Power Cooperative Inc.,
230 B.R. 715, 743 (Bankr. M.D. La. 1999). In Cajun
Electric, however, the court expressly noted
that no allegations of "factual inaccuracy or omission" were
asserted with regard to the letter. Id. In doing so, the court implied that the existence of
factual inaccuracies or omissions would support a bad-faith finding
resulting in the disallowance of votes. See
Id.; 11 U.S.C. §1126(e).

Therefore, while little case law exists, based on the
holdings of Walnut Equipment and Cajun Electric, one can conclude that dissemination of correspondence sent
in bad faith that sufficiently taints the voting process supports the
disallowance of votes under §1126(e) and that factual inaccuracies and
omissions are factors to consider when determining bad faith.

<h4>Conclusion</h4>

Though Century Glove is considered the pinnacle case, the guidance given in Apex Oil appears to succinctly
state the rule: Prior court approval is not necessary only if (a) the
information provided is truthful and absent of any false or misleading
statements or legal or factual mischaracterizations; (b) the information is
presented in good faith; and (c) the soliciting party does not propose or
suggest an alternative plan that has yet to gain court approval or
otherwise failed to travel through the appropriate legal channels, as
dictated by the Code. See Apex Oil, 111 B.R. at 249.

While §§105(a) and 1126(e) provide certain
remedies, other countermeasures are available. For example, a creditor that
supports a proposed plan could send additional information that criticizes
the plan opponent's correspondence and explains the inaccuracies
therein. Again, such counter-measures should not include a solicitation for
votes accepting the plan and should narrowly focus on attacking the
rejection solicitation materials.

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Wednesday, September 1, 2004 - 12:00

Bankruptcy Rule

2004