If the ruling on the field stands, consumer credit contracts are ineligible for sale free and clear of consumer claims and defenses through a chapter 11 plan. Hon. James L. Garrity, Jr. in the Southern District of New York recently ruled that while § 363(o) does not apply directly to sales through chapter 11 plans, § 1129(a) nevertheless precludes an attempt to strip a consumer’s defenses and rights of recoupment against a buyer who purchases the consumer’s mortgage debt under a plan.
The Playbook: § 363 vs. § 1123
The Bankruptcy Code provides for a sale of assets during a bankruptcy case in two ways: (1) by motion under § 363; or (2) through a chapter 11 plan pursuant to §§ 1123 and 1129.
Section 363 of the Bankruptcy Code governs the use, sale or lease of property in a bankruptcy case under any chapter. It specifically includes a mechanism for selling property of the estate free and clear of other interests if one of five enumerated conditions are met. Through the BAPCPA amendments of 2005, Congress limited such “free and clear” sales under § 363(f) by adding § 363(o), which provides that a debtor’s interest in a consumer credit contract sold under § 363(f) remains subject to all of the consumer’s claims and defenses to the same extent as if it had been purchased at a sale that was not held pursuant to § 363.
Section 1123 of the Bankruptcy Code governs the contents of a chapter 11 plan and applies only in chapter 11 cases. It requires that the plan provide adequate means for its implementation, which may include the sale of all or any part of the estate free of any lien, and allows the plan to provide for a sale of all or substantially all of the property of the estate.
Completion of a pass under § 1123 requires confirmation of a chapter 11 plan. Under § 1129, confirmation shall occur only if several conditions are met, including (1) the plan and its proponent comply with applicable provisions of the Bankruptcy Code (§ 1129(a)(1)-(2)), (2) the plan has been proposed in good faith (§ 1129(a)(3)), and (3) each holder of a claim or interest in an impaired class has accepted the plan or will receive under the plan no less than such holder would receive under a chapter 7 liquidation of the debtor (§ 1129(a)(7)).
In re DITech Holding Corporation, No. 19-10412 (Bankr. S.D.N.Y.)
In In re Ditech Holding Corporation, the debtors were a parent holding company and 13 direct or indirect subsidiaries and trust companies who collectively operated as an independent servicer and/or originator of mortgage loans. They proposed a chapter 11 plan under § 1123 through which approximately 1 million consumer credit contracts would be sold free and clear of claims and defenses of the consumers to those contracts, despite thousands of pending proceedings asserting such claims and/or defenses. The debtors asserted that their “pass” could be completed because § 363 does not apply to a sale of assets through a chapter 11 plan.
The consumer creditors’ committee, the U.S. Trustee and various other parties in interest threw a challenge flag, arguing that the debtors could not sell the consumer credit contracts as proposed under the plan without violating § 1129(a). Specifically, they argued that § 1129(a)(1)-(2) required compliance with § 363, the plan was not proposed in good faith, and the plan did not pass the “best interests” test in § 1129(a)(7) because the consumer creditors’ claims and defenses would survive in a chapter 7 liquidation, where any sale would be conducted under § 363.
The bankruptcy court agreed with the debtors that compliance with § 363 was not necessary to confirm a chapter 11 plan that provides for a sale of assets free and clear of claims upon confirmation. Nevertheless, the court called multiple fouls on the play and denied confirmation, holding that:
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the debtors failed to satisfy § 1129(a)(1)-(3) to the extent the plan purported to limit the consumer creditors’ ability to assert rights of recoupment against the buyers of the debtors’ assets. Since such state common law consumer defenses may not be extinguished in bankruptcy, they should be left undisturbed; and
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the debtors failed to satisfy the “best interest” test in § 1129(a)(7) with respect to the consumer creditors to the extent that they would receive or retain more if the debtors were liquidated under chapter 7. Rejecting the debtors’ arguments that such a ruling effectively “bootstraps” § 363(o) into § 1129(a), the court noted that there was no dispute that if the debtors were liquidated under chapter 7, § 363(f) and (o) would apply to a sale of the Consumer Creditor Agreements. As a result, the court reasoned that it must apply those provisions in determining whether the debtors met their burden under § 1129(a)(7), notwithstanding that the Court determined that § 363(f) and (o) were not directly applicable to the proposed plan, because “nothing in the Code says otherwise.”
Though not ultimately dispositive in this case, the court also ruled that § 363 is not an “applicable provision” in every chapter 11 case or in the instant case, for purposes of § 1129(a)(1)-(2).
Judge Garrity’s thorough analysis of the types and conditions of asset sales in chapter 11 cases is worthy of further review for chapter 11 practitioners. The specific rulings in this case could have significant implications for chapter 11 debtors, who may find it more difficult to complete passes and find eligible receivers under chapter 11 plans.