Although he held that consumer protections in Section 363(o) do not apply to asset sales in chapter 11 plans, Bankruptcy Judge James L. Garrity, Jr. of Manhattan ruled that a plan cannot cut off a homeowner’s defenses and rights of recoupment against someone who purchases his or her mortgage.
In a 134-page opinion with the most exhaustive case law analysis you may ever read, Judge Garrity nonetheless held that the Ditech chapter 11 plan failed the so-called best interests test because it did not provide consumers with a recovery equal to what they would realize in chapter 7, where Section 363(o) would apply and where their claims would survive against a purchaser.
The August 28 opinion revolved around Section 363, where subsection (f) allows the sale of estate property “free and clear of any interest in such property,” so long as one of five conditions is met.
“Notwithstanding subsection (f),” subsection 363(o) says that someone who purchases “any interest in a [specified type of] consumer credit transaction . . . or consumer credit contract . . . shall remain subject to all claims and defenses that are related to such consumer credit transaction or consumer credit contract, to the same extent as such person would be subject to such claims and defenses of the consumer had such interest been purchased at a sale not under this section.”
Ditech’s (Attempted) Second Reorganization
Ditech is a servicer and originator of home mortgage loans and a servicer of reverse mortgages. In early 2018, Ditech confirmed and consummated a prepackaged chapter 11 plan that extinguished more than $800 million in debt for borrowed money but did not impair unsecured creditors, including homeowners who might have claims regarding their mortgages.
Once again lacking liquidity, the company and affiliates filed another chapter 11 petition in February 2019 accompanied by a restructuring support agreement with some but not all creditor groups.
In May, the U.S. Trustee appointed an additional official committee to represent consumer creditors, principally meaning homeowners with mortgages that Ditech originated or serviced.
The consumers’ committee came into being after the official unsecured creditors’ committee agreed on a global settlement that did not preserve consumers’ claims and defenses regarding their mortgages. Consumers had not participated in negotiations leading up to the global settlement that formed the foundation for the revised chapter 11 plan.
The revised plan called for selling the assets to two purchasers who were selected after an exhaustive auction process. The buyers are among the country’s largest mortgage servicers.
Briefly stated, the agreements with the buyers required Ditech to sell the assets in a chapter 11 plan free and clear of consumers’ claims, including those covered by Section 363(o). The buyers’ obligations were conditioned upon sales free and clear, but one of the buyers agreed to a price reduction if the sale did not strip off homeowners’ claims.
According to Judge Garrity, consumers’ claims covered a “wide range of alleged misconduct” by Ditech relating to the “ownership, origination, and/or servicing of mortgages, including, among other things, overstating and failing to correct borrower accounts, improperly servicing borrower accounts . . . , demanding payments barred by confirmed plans or the discharge injunction . . . , improperly foreclosing on borrowers’ properties, and violation of state and federal consumer protection and debt collection laws . . . .”
Although the plan would have barred homeowners from suing the purchasers, it provided $5 million to cover consumers’ claims. In a chapter 7 liquidation, Ditech contended that consumers would recover nothing. Ditech therefore believed that Judge Garrity could cram down the plan on consumers under Section 1129(b).
The official consumers’ committee opposed confirmation, raising multiple objections. The U.S. Trustee also objected.
After Ditech brought the plan to court for confirmation, Judge Garrity found only two flaws, but they were enough to deny confirmation.
Act I: Section 363(o) Doesn’t Apply to Chapter 11 Plans
The consumers’ committee contended that the preservation of consumers’ claims in Section 363(o) applies to chapter 11 plans, thus barring confirmation.
Judge Garrity disagreed. His meticulous analysis of the inapplicability of Section 363 to chapter 11 cases merits reading in full text.
Judge Garrity extensively analyzed legislative history and found that “Congress intended to limit Section 363(o)’s effect to pre-plan sales, not chapter 11 reorganizations, including those effectuated through plan sales.” He therefore decided that “plan sales can be free and clear of claims without invoking Section 363(f)” and that “complying with Section 363(f) is not necessary to confirm a plan that provides for a sale free and clear of claims upon confirmation” under Section 1123(a)(5)(D).
Judge Garrity thus concluded that the plan was not required to comply with Section 363(o), but that wasn’t the end of the story.
Caution: Don’t forget about Section 363(o). It will return in the third act to drive a stake through the heart of the plan.
Act II: Setoff and Recoupment
Next, Judge Garrity dealt with setoff and recoupment, which, generally speaking, are not affected in bankruptcy by virtue of Section 533 and common law. With regard to setoff, the debtors tweaked the plan to the satisfaction of the consumers’ committee. Recoupment was another issue.
Judge Garrity held that the plan must not disturb consumers’ “defenses or rights of recoupment under applicable non-bankruptcy law.” He added a proviso, however. He said that defenses and rights of recoupment “do not require the Buyers . . . to pay money damages, refund amounts paid by, or pay monies (except escrow advances) on behalf of or for the account of, the Borrower.”
Again, Judge Garrity’s detailed examination of case law is worthy of analysis in full text.
Act III: Plan Flunks Best Interests Test
Judge Garrity found that the plan was filed in good faith, but it failed the best interests test under Section 1129(a)(7). The section requires a plan to give each creditor “not less” than what the creditor “would so receive or retain if the debtor were liquidated under chapter 7 . . . .”
The debtors argued that consumers would receive nothing on their claims in a chapter 7 liquidation. They contended that Section 363(o) was irrelevant, because best interests only measures claims recoverable from the debtor, not from third-party purchasers. Judge Garrity disagreed.
Indisputably, Judge Garrity said, Section 363(o) would apply were the debtors liquidated in chapter 7, “notwithstanding that the Court has determined that Sections 363(f) and (o) are not applicable” to a sale under a chapter 11 plan.
In chapter 7, Judge Garrity said, consumers “would retain their claims and defenses pursuant to Section 363(o).” The debtors’ liquidation analysis of consumers’ recoveries in chapter 7 “did not account for these Consumer Claims, but should have,” he said.
“As such,” Judge Garrity said, the debtors “have failed to satisfy the ‘best interests’ test of Section 1129(a)(7)” because the plan did not assure consumers of a recovery commensurate with claims that would be preserved in chapter 7 under Section 363(o).
Act IV: Settlement Disapproved
At the confirmation hearing, the debtors were also seeking approval of the global settlement that underlay the plan and would have given $5 million to a trust for consumer creditors.
The debtor contended that $5 million was a reasonable settlement because the consumers’ claims were speculative at best. Judge Garrity declined to approve the settlement because the debtors’ valuation did not “attempt to place a value on those claims.”
Valuation
Is Judge Garrity’s decision just about valuation? Would he have confirmed the plan had the debtors produced competent evidence to show that $5 million was more than the consumers’ collective claims, thus giving the plan a passing grade under the best interests test?
A more thorough liquidation analysis may not have been enough. Judge Garrity also ruled that the plan could not cut off defenses and rights of recoupment. Will the buyers be willing to go forward in the face of recoupment?
Appeal
Judge Garrity’s ruling would have given rise to an intriguing appeal were it not for Bullard v. Blue Hills Bank, 135 S. Ct. 1686, 191 L. Ed. 2d 621 (2015), which held that denial of confirmation of a chapter 13 plan is not a final, appealable order. Presumably, the same principle will prevent Ditech from appealing denial of confirmation in chapter 11.
Perhaps Judge Garrity would authorize an interlocutory appeal, but is the ice cube melting too quickly?
The consumers are not out of the woods. Bullard permits Ditech to confirm an amended plan that preserves consumers’ claims and then ask the appellate court to reinstate the plan that Judge Garrity nixed on August 28. Respectfully, the Ditech case shows that Bullard is an uncomfortable fit in a complex chapter 11 case.
Although he held that consumer protections in Section 363(o) do not apply to asset sales in chapter 11 plans, Bankruptcy Judge James L. Garrity, Jr. of Manhattan ruled that a plan cannot cut off a homeowner’s defenses and rights of recoupment against someone who purchases his or her mortgage.
In a 134-page opinion with the most exhaustive case law analysis you may ever read, Judge Garrity nonetheless held that the Ditech chapter 11 plan failed the so-called best interests test because it did not provide consumers with a recovery equal to what they would realize in chapter 7, where Section 363(o) would apply and where their claims would survive against a purchaser.
The August 28 opinion revolved around Section 363, where subsection (f) allows the sale of estate property “free and clear of any interest in such property,” so long as one of five conditions is met.
“Notwithstanding subsection (f),” subsection 363(o) says that someone who purchases “any interest in a [specified type of] consumer credit transaction . . . or consumer credit contract . . . shall remain subject to all claims and defenses that are related to such consumer credit transaction or consumer credit contract, to the same extent as such person would be subject to such claims and defenses of the consumer had such interest been purchased at a sale not under this section.”