Bankruptcy Court Permits Pre-Petition Payment in Full In Order To Moot Sole Plan Objection And Permit Confirmation Of Chapter 11 Plan

In a recent decision, the U.S. Bankruptcy Court for the Eastern District of Michigan held that a chapter 11 debtor may pay an unsecured claim in full prior to confirmation in order to moot the creditor’s objection to the debtor’s plan of reorganization and allow confirmation of the plan.

In In re RnD Engineering LLC,[1] there were two chapter 11 debtors: Richalin Digue, an individual, and RnD Engineering, LLC, a limited liability company controlled by Digue. Digue had been employed for many years by Nagel Precision, Inc., the major creditor in the case, before leaving to form his own firm. Afterwards, Nagel filed suit in state court for misappropriation of trade secrets and related torts. The debtors filed chapter 11 cases on the eve of trial in the state court action, and the state court claims were refiled in an adversary proceeding commenced in the bankruptcy court by Nagel.[2]

The bankruptcy court found in favor of Nagel, finding the debtors liable for interference with business relationships, breach of fiduciary duty and unjust enrichment.[3] The court awarded an allowed claim of $564,503.16 in damages against both debtors, and found that the claim was nondischargeable in Digue’s chapter 11 case. The court, however, denied the request for injunctive relief on Nagel’s trade secret claim.[4] The judgment in the adversary case was not appealed.[5]

Shortly afterward, the debtors filed a plan of reorganization that proposed to pay all allowed claims in full within one year from the effective date. Nagel objected to confirmation on the basis that the plan was not feasible and that it was inequitable to leave existing management in charge of RnD when the court had found that Digue had caused RnD to engage in fraudulent and dishonest conduct that severely damaged Nagel.[6]

Rather than continue litigating with Nagel, the debtors embarked upon a creative strategy to moot its objections. The debtors filed a motion requesting that the court authorize them to pay the creditor’s claim in full, with interest, prior to confirmation, thereby terminating the creditor’s status as a party in interest and rendering its objections to confirmation moot.

The court granted the motion.

First, the court held that it had the authority to grant the motion under §§ 105, 363 and 1107 of the Bankruptcy Code.[7] The court noted that the parties did not seriously dispute its power to authorize such a payment under § 105 and noted that courts have authorized such payments under § 105 to critical vendors.[8] It also found that § 363 gave it authority to authorize the proposed use of estate funds.[9]

Second, the court considered whether the creditor would have the right to refuse the payment. Neither of the parties had located any authority on point, and the court was unable to locate any on its own. Nonetheless, the court held that the creditor had no right to refuse the payment.[10]

The court turned to the central question presented by the motion: whether or not it should exercise its discretion to authorize payment of the claim in order to eliminate the contentious and determined opposition to confirmation of a single creditor. Nagel argued that full payment of the claim would trample on its due process rights and violate the public interest. Essentially, Nagel wanted to continue to be able to argue that the debtors should be put out of business through denial of confirmation of their chapter 11 plans even after its claim had been fully satisfied and it was no longer a creditor.[11]

The court noted that the right to appear and be heard in a chapter 11 case is governed by § 1109 of the Code, which says that a “party in interest, including the debtor, the trustee, a creditors’ committee, an equity security-holders committee, a creditor, an equity security-holder, or any indenture trustee, may raise and may appear and be heard on any issue in a case under this chapter.”[12] Since the payment would terminate Nagel’s status as a creditor, the court considered whether Nagel had any other basis to continue to be a party in interest.

Although the court recognized that § 1109 does not provide the exclusive list of who may be a party in interest, it held that Nagel was unable to demonstrate any pecuniary interest or other relationship to the debtors that would allow it to continue to be a party in interest after its claim was paid in full.[13] The court held that once Nagel’s claim was paid in full, its only relationship to the debtors was that of a competitor to the debtors in business, and that being a competitor in the same industry as a debtor does not make one a party in interest with standing to object to confirmation of a chapter 11 plan or prosecute a motion to appoint a chapter 11 trustee.[14] The court distinguished cases holding that a creditor whose claim is unimpaired because it will be paid in full on the effective date has standing to object to confirmation because in that situation the plan must first be confirmed before the claim is unimpaired.[15]

Finally, noting that it had denied injunctive relief, the court held that Nagel would not have standing to object to confirmation after payment based on its belief that Digue was a “bad guy” who should be put out of business for the public good.[16] Although it recognized the importance of the integrity of the bankruptcy process, it rejected Nagel’s “self-appointment as the guardian of the public interest” because it would contravene the statutory limits upon standing established by Congress.[17]

RnD thus provides an opening for creative debtors’ counsel in chapter 11 cases, but it is likely to be a limited one. For one thing, the circumstances were fairly unusual – there was a single creditor intent on litigating the debtors into oblivion, and the debtors were proposing full payment to all creditors. Nagel simply paid it a little earlier than other unsecured creditors. It would be quite another thing if the debtors were proposing to pay Nagel in full while not paying other unsecured creditors. It is, however, a demonstration of how creative lawyering can help resolve an otherwise intractable situation.