Western Real Estate Equities, L.l.c. v. Village at Camp Bowie I, L.p.: Bypassing Congressional Intent to Enable Manipulation of the Chapter Eleven Bankruptcy Process

• Publication year: 2022

47 Creighton L. Rev. 123. WESTERN REAL ESTATE EQUITIES, L.L.C. V. VILLAGE AT CAMP BOWIE I, L.P.: BYPASSING CONGRESSIONAL INTENT TO ENABLE MANIPULATION OF THE CHAPTER ELEVEN BANKRUPTCY PROCESS

WESTERN REAL ESTATE EQUITIES, L.L.C. V. VILLAGE AT CAMP BOWIE I, L.P. : BYPASSING CONGRESSIONAL INTENT TO ENABLE MANIPULATION OF THE CHAPTER ELEVEN BANKRUPTCY PROCESS

Hannah K. Fischer

I. INTRODUCTION ................................... 124

II. FACTS & HOLDING ................................ 126

III. BACKGROUND .................................... 129

A. THE STATUTES ESTABLISHING CHAPTER ELEVEN PLAN CONFIRMATION ............................. 129

B. COURTS RECOGNIZE THE PURPOSE OF THE REORGANIZATION REQUIREMENTS IS TO PROVIDE SUPPORT OF THE PLAN BY CREDITORS ............. 131

1. Connecticut Bankruptcy Court Finds Purpose is to Prove Support by Creditors..... 131

2. The United States District Court for the Western District of Wisconsin Reviews Legislative History ........................... 132

C. THE FIRST CIRCUIT DECLARED THAT INTENTIONAL MANIPULATION OF THE VOTING PROCESS IS CONSIDERED ARTIFICIAL IMPAIRMENT .. 133

D. THE EIGHTH CIRCUIT DETERMINED IMPAIRMENT MUST BE ECONOMICALLY DRIVEN ................. 134

E. VARIOUS COURTS IDENTIFY THE ISSUE OF GOOD FAITH ........................................... 136

1. The Ninth Circuit Suggests Artificial Impairment is Indicative of Bad Faith ........ 136

2. The Fifth Circuit Recognizes Lack of Good Faith ........................................ 137

IV. ANALYSIS ......................................... 138

A. THE FIFTH CIRCUIT ERRED IN ALLOWING AN ARTIFICIALLY IMPAIRED CLASS OF CLAIMS TO QUALIFY AS A VOTING CLASS IN A REORGANIZATION PLAN ........................... 140

B. THE FIFTH CIRCUIT ERRED IN DETERMINING THAT AN ARTIFICIAL CLASS OF CREDITORS DID NOT VIOLATE THE GOOD FAITH REQUIREMENT ..... 143

V. CONCLUSION ..................................... 146

I. INTRODUCTION

The United States Bankruptcy Code (hereinafter sometimes re-ferred to as "the Code") reorganization process promotes two goals: the equitable distribution among creditors and giving debtors a new start.(fn1) The United States Court of Appeals for the Eighth Circuit fur-thers each of these goals by disallowing creditors to manipulate the reorganization process through artificial impairment of claims.(fn2) In contrast, a recent ruling by the United States Court of Appeals for the Fifth Circuit ignores congressional intent by merely requiring literal compliance standard.(fn3) The Fifth Circuit ruling not only creates confu-sion for courts that have not yet addressed the issue, but also opens the door to allow creditors to manipulate their claims, as a method to ensure bankruptcy courts will accept their reorganization plans.(fn4)

Chapter Eleven of the Code governs reorganizations (i.e. an indi-vidual or business debtor wants to reorganize their debts to make them more manageable and avoid insolvency).(fn5) A reorganization plan includes four distinct steps: (1) the debtor must propose a plan, (2) the debtor must file statements which provide information about the debtor and the plan, (3) the plan must be submitted to impaired clas-ses of creditors or claim, who in turn must approve it by a two-thirds vote, and (4) the court must confirm the plan at a confirmation hear-ing.(fn6) A court will only confirm the plan if it determines that the plan balances the interests of both the debtor and the creditors.(fn7) The clas-ses of claims or classes of creditors must be comprised of similarly sit-uated claims.(fn8) If, under the third step, no class of creditors accepts the plan, the plan can still be confirmed via a so-called cramdown pro-cess.(fn9) The cramdown forces the plan upon dissenting creditors as long as it does not unfairly discriminate against the creditors.(fn10)

Another way to circumvent the interests of the creditors is for the debtor to artificially impair one of the classes of creditors to ensure that they will approve the plan.(fn11) An intentional and minimal manip-ulation of the claim, known as artificial impairment, creates problems regarding whether the debtor has satisfied section 1129(a)(10) of Chapter Eleven of the Bankruptcy Code, which requires that one im-paired class of creditors accept the plan.(fn12) Artificial impairment also creates problems regarding the good faith requirement under section 1129(a)(3), which requires that there is a reasonable likelihood the plan will achieve the goals of the Bankruptcy Code.(fn13)

In Western Real Estate Equities, L.L.C. v. Village at Camp Bowie I, L.P.,(fn14) the United States Court of Appeals for the Fifth Circuit held that an artificially impaired class of claims in a Chapter Eleven reor-ganization plan violates neither section 1129(a)(10) nor section 1129(a)(3), the good faith requirement.(fn15) The debtor objected to the plan claiming it violated section 1129(a)(10) by artificially creating a class of creditors to achieve a vote.(fn16) The debtor also claimed that the creation of an artificial class of creditors violated the good faith re-quirement found in section 1129(a)(3).(fn17)

On appeal, the Fifth Circuit discussed the jurisdictional divide as to whether an artificially impaired class of creditors can satisfy the requirement of section 1129(a)(10).(fn18) Whereas the United States Court of Appeals for the Eighth Circuit has held that such claims can-not satisfy the requirement, the United States Court of Appeals for the Ninth Circuit determined that it does not matter how the class of claims became impaired.(fn19) The Fifth Circuit rejected the view of the Eighth Circuit and joined the Ninth Circuit in stating that the Bankruptcy Code does not require that the classes became impaired eco-nomically or by manipulation by the debtor.(fn20) The court further stated that such a group created merely to satisfy a vote did not vio-late the good faith requirement because the plan was proposed hon-estly and legally, under the totality of the circumstances.(fn21)

This Note will first review the facts and holding of In re Village at Camp Bowie.(fn22) Next, this Note will discuss the basic principles and requirements of Chapter Eleven reorganizations under the Bank-ruptcy Code as shown by the statutory language and case law inter-pretations.(fn23) Finally, this Note will then argue the following: (A) the Fifth Circuit failed to correctly apply the provisions of the Bankruptcy Code when it interpreted the Code to allow an artificially impaired class of creditors to satisfy section 1129(a)(10), which requires accept-ance by at least one impaired creditor; and (B) the Fifth Circuit erred in determining that an artificial class of creditors did not violate the good faith requirement.(fn24) This Note will conclude by noting that the Fifth Circuit ignored the purpose of a reorganization plan under Chapter Eleven of the Bankruptcy Code.(fn25)

II. FACTS & HOLDING

In Western Real Estate Equities, L.L.C. v. Village at Camp Bowie I, L.P.,(fn26) a real estate limited liability company and developer of land ("the Village") filed a petition for reorganization under Chapter Eleven of the Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas.(fn27) Prior to filing the petition, the Village had taken out multiple short-term promissory notes, which eventually came to be owned by Western Real Estate Equities ("Western").(fn28) In its reorganization petition, the Village declared debt of $32,112,711 to Western and $59,398 to unsecured trade creditors who had provided services towards the development of the land.(fn29) Western filed a mo-tion to halt the Chapter Eleven petition arguing that the Village had insufficient equity in its land for the reorganization.(fn30) The bank-ruptcy court concluded that the Village had thirty four million dollars of real estate equity, which was enough for the plan as it exceeded the total claims of its creditors.(fn31) The bankruptcy court did not lift the stay on the foreclosure proceedings.(fn32)

In November of 2010, the Village filed its plan for Chapter Eleven reorganization and the bankruptcy court put the plan to a vote by the classes of creditors.(fn33) Under section 1129(a)(10) of the Bankruptcy Code, the confirmation of a reorganization plan requires the accept-ance of at least one class of impaired claims.(fn34) A class of claims is considered impaired under the plan if the plan alters the rights to the claim or interest of the holder.(fn35) The proposed plan designated two voting groups as the impaired classes of claims: Western's secured claim and the unsecured claims of the trade creditors.(fn36) The trade creditors, as a whole, voted to approve the plan, whereas Western voted against it.(fn37) Because the Bankruptcy Code requires the ap-proval of only one class of creditors, the bankruptcy court confirmed the plan, despite Western's objections.(fn38)

Western alleged that the Village created an artificially impaired unsecured class of creditors merely to obtain the approving vote, which violated two sections of the Bankruptcy Code.(fn39) Section 1129(a)(10) requires approval of one class of creditors that is impaired under the plan.(fn40) The good faith requirement, section 1129(a)(3), pro-vides that all plan proposals be in good faith and not forbidden by law.(fn41) Western objected to the plan, arguing that not only was the group of trade...