An Unrung Bell Revocation of an Order Confirming a Reorganization Plan

The reality of most bankruptcy cases is that there
is loss of trust. Pre-petition, the debtor agreed to perform certain
obligations, but for whatever reason was unable to do so. The
sentiment of mistrust in a chapter 11 case should be alleviated with
the presence of a court overseeing the debtor's case, the debtor having
to obtain the court's approval to perform various functions, the
independent U.S. Trustee monitoring events, and perhaps the
appointment of committees assuring that their constituency's interests
are adequately represented. An additional measure of comfort is
Bankruptcy Code §1144, which provides that courts have the power
to revoke the confirmation order as well as the debtor's discharge
should the court determine that the order confirming a plan was obtained
through fraud.² While this statutory gloss can provide some
comfort to creditors and other parties in interest by knowing that if
the debtor plays fast and loose with the court, it could potentially
lose the relief that was the purpose behind filing a voluntary
petition, recent decisions from the U.S. Bankruptcy Court for the
Southern District of New York illustrate that depending on the
complexity of the confirmed plan, this relief may be illusory
regardless of the commission of fraud by the debtors-in-possession
(DIPs). </p><p>Section 1144 provides: </p><blockquote> <p>On request of a
party in interest at any time before 180 days after the date of the
entry of the order of confirmation, and after notice and a hearing,
the court may revoke such order if and only if such order was procured
by fraud. An order under this section revoking an order of
confirmation shall— </p> <blockquote> <p>(1) contain such
provisions as are necessary to protect any entity acquiring rights
in good-faith reliance on the order of confirmation; and <br> (2)
revoke the discharge of the debtor. </p>

</blockquote></blockquote><p>In <i>Trico Marine Services Inc. et
al.</i>, the debtors filed voluntary petitions on Dec. 21,
2004.³ On the petition date, the debtors owed approximately
$400 million to creditors, including $275 million to holders of senior
notes. Under a pre-packaged plan, the debtors proposed to exchange the
notes for 100 percent of common stock in the reorganized debtors. The
proposed plan also cancelled the common stock issued by the debtors,
but the debtors and the noteholders agreed that holders of this common
stock would receive warrants exercisable for up to 10 percent of the
reorganized debtors' common stock. </p><p>The case moved quickly to
confirmation. The court entered the order confirming the plan on Jan.
21, 2005. The effective date of the plan was March 15, 2005, at which
time the reorganized debtor distributed 10 million shares of its new
common stock to the noteholders and 998,868 new warrants to the holders
of the "old" common stock in the debtors. Thereafter, the
reorganized debtors publicly offered for sale an additional 4 million
shares of common stock. </p><p>The plaintiffs, owners of in excess of 44,000
shares of Trico common stock,⁴ filed their lawsuit seeking
to revoke the order confirming the plan. The plaintiffs alleged that
the confirmation order was procured by fraud as a result of the
debtors' chief financial officer's testimony at the confirmation
hearing. The CFO testified that the debtors' fourth quarter 2004
revenue was "not materially" higher than what was depicted
in the disclosure statement; however, the plaintiffs maintained that
the fourth quarter revenue exceeded the projected revenue listed in
the disclosure statement by 35 percent. The impact of this alleged fraud
was said to mislead the court into confirming a reorganization plan as
fair and equitable, when in fact the available cash flow of the debtor
at the time of confirmation was more than sufficient to service its
debt and therefore produce value for the "old equity."
Instead, old equity in the aggregate was left with nothing more than
warrants to purchase 10 percent of the reorganized common stock, or as
specifically alleged in the complaint, "relegation of pre-hearing
equityholders to post-confirmation warrant-holders."⁵
</p><p>Addressing these allegations, the bankruptcy court considered two
approaches. The first was §1144, which provides a court with the
discretion to revoke a confirmation order if the order was obtained by
fraud. Even if the court determined that the order was obtained by
fraud, it had to "consider all of the circumstances and determine
'whether revocation of the confirmation can or would lead to an
outcome that is more equitable than leaving the order
intact.'"⁶ Indeed, §1144 provides that an order
revoking a confirmation order must, in part, "contain such
provisions as are necessary to protect any entity acquiring rights in
good-faith reliance on the order of confirmation." </p><p>The court
also considered whether the doctrine of equitable mootness applied.
The reorganized debtors argued that it could and relied on it to assert
that the court should dismiss the complaint. The court noted that this
doctrine is typically asserted in the context of an appeal of a
confirmed plan when, although relief could be fashioned, the
implementation of it would be inequitable. Nonetheless, the court
acknowledged that some courts used the doctrine when addressing an
§1144 complaint. </p><p>Without deciding whether equitable mootness
applied, the court ruled that it could not revoke the plan under
either §1144 or equitable mootness. Because the confirmed plan
involved the distribution of new common stock to the noteholders as
well as warrants to the DIP's existing shareholders, "it would be
exceedingly difficult to unwind and impossible to protect innocent
third parties" should the court revoke the confirmation
order.⁷ The court noted that the new common stock traded
based on a substantially de-leveraged company, one that improved its
ratio of liabilities to equity from 8-to-1 pre-confirmation to 2-to-1
post-confirmation. Revoking confirmation would alter these financial
assumptions and potentially leave the common stock valueless. In
addition, purchasers of the reorganized debtors' common stock could
unknowingly become creditors rather than equity-holders because the
reorganized debtors issued common stock in place of notes. Anticipating
the upheaval that would be caused by revoking the confirmation order,
the court noted that the more practical remedy would be to leave the
confirmation order intact and allow the plaintiffs to seek damages
through a different cause of action. The court granted the reorganized
debtors' motion for summary judgment and provided the plaintiff with
30 days to file an amended complaint. </p><p>The plaintiffs filed a motion
to supplement the record, which the court treated as a motion for
reargument.⁸ The court granted the motion, but it adhered
to its original decision. It explained that relief under §1144
required a revocation of the discharge, protection of those who acquired
rights in good-faith reliance on the confirmation order and the
reinstatement of the <i>status quo ante</i>. "[U]nless [the
court] can fashion an order that would revoke the debtor's discharge,
restore the status quo existing before confirmation and protect those
who relied in good faith on confirmation," the court could not
revoke the confirmation order.⁹ Examining the <i>status quo
ante</i> prong, the court noted that in some instances, this step can
be accomplished easily. For example, if the plan simply provided for a
money distribution to creditors, the reinstated DIP could sue to
recover these distributions. That said, the court noted that things
are trickier with complex plans. If stock is issued under a plan,
restoration of the status quo ante would require debts to be
reinstated and stock to be cancelled. Moreover, innocent purchasers of
this stock would have to be protected as well.

</p><blockquote><blockquote>
<hr>
<big><i><center>
Parties in interest must understand that even if fraud is subsequently
discovered, §1144 may not serve as a means for relief if
unscrambling the egg...isn't possible.
</center></i></big>
<hr>
</blockquote></blockquote>

<p> Given the facts in this case, the court reiterated that it could not
revoke the confirmation order. The court reasoned that any relief it
constructed could not restore the status quo as of the confirmation
order because the court could not cancel any stock sold through the
reorganized debtors' secondary offering. The court also reiterated its
concern for protecting shareholders who purchased the stock based on
the financial status achieved by emerging from bankruptcy. That said,
the plaintiffs suggested that the shareholders could return to
noteholder status and obtain reinstated net operating losses (NOLs)
with a present value in excess of $90 million, which could be used to
offset past or future income and reduce income tax liability. The
court did not accept this argument, finding that the NOLs were
irretrievably lost under the tax laws and that rescission of the
transaction would not undo the tax effect of the initial transaction.
</p><p>Thus, the court concluded that even if the plaintiffs proved fraud,
it was unable to fashion a remedy that would satisfy the requirements
of §1144. It dismissed the complaint and provided the plaintiffs
with 30 days to amend their complaint and seek other appropriate
relief. </p><p>While these cases involved an attack to confirmation by
former equity, as opposed to unsecured creditors, the critical point
is that even though the Code provision emphasizes that a confirmation
order can be revoked "if and only if such order was procured by
fraud," the court's first step will likely be an examination into
what was accomplished in the reorganization plan. Although courts will
not countenance fraud, little will be accomplished under §1144 in
proving that the debtor was a bad actor if the plan involved an
intricate reorganization that would be cumbersome—if even
possible—to unwind. Creditors and parties in interest should be
mindful of this when faced with a complicated plan, particularly when
involving payment via the distribution of equity. Parties in interest
must understand that even if fraud is subsequently discovered,
§1144 may not serve as a means for relief if unscrambling the egg
(<i>i.e.</i>, returning parties who relied on the confirmation order in
the position they were in prior to the order's entry) isn't possible.
If there is any question, committee counsel or other counsel involved
in the confirmation process would do well to press for specifics from
those testifying as to the financial condition of the debtor at the
time of confirmation. </p><h3>Footnotes</h3><p> 1 Douglas E. Wedge, an
associate in Moore &amp; Van Allen PLLC's Charleston, S.C., office,
made significant contributions to the research and writing of this
column, which the author gratefully acknowledges. </p><p>2 Further
references to the Bankruptcy Code shall be by section number only. </p><p>3

<i>Salsberg v. Trico Marine Services Inc.</i> (<i>In re Trico Marine
Services Inc.</i>), 337 B.R. 811 (Bankr. S.D.N.Y. 2006). </p><p> 4
<i>See</i> Complaint of Steven Salsberg and Gloria Salsberg, Bankr.
S.D.N.Y. Case No. 04-17985(SMB), Adv. Pro. No. 05-2313. </p><p>5
<i>Id</i>. </p><p>6 337 B.R. at 814. </p><p>7 <i>Id</i>. at 815. </p><p> 8

<i>Salsberg v. Trico Marine Services Inc.</i> (<i>In re Trico Marine
Services Inc.</i>), 2006 Bankr. Lexis 724, Case No. 04-17985 (SMB),
Adv. Pro. No. 05-2313 (Bankr. S.D.N.Y. May 5, 2006). </p><p>9 <i>Id</i>.
at *5. </p>