Affirming the bankruptcy court below in a case of first impression, in In re Caviata Attached Homes, LLC, 481 B.R. 34 (B.A.P. 9th Cir. 2012), a Ninth Circuit bankruptcy appellate panel held that a relapse into economic recession following a chapter 11 debtor's emergence from bankruptcy was not an "extraordinary circumstance" that would justify the filing of a new chapter 11 case for the purpose of modifying the debtor's previously confirmed plan of reorganization.
Modification of a Confirmed Chapter 11 Plan
Section 1141(a) of the Bankruptcy Code provides that the terms
of a confirmed chapter 11 plan are binding on all parties. Section
1127(b) provides that a confirmed chapter 11 plan may be modified
only before the plan has been substantially consummated. Under
section 1101(2), "substantial consummation" occurs when:
(i) substantially all of the property to be transferred under the
plan has been transferred; (ii) the debtor or its successor has
assumed the business or management of substantially all of the
property dealt with by the plan; and (iii) distributions under the
plan have commenced. Taken together, sections 1127(b) and 1141(a)
impose an important element of finality in chapter 11 cases that
allows stakeholders to rely on the provisions of a confirmed
chapter 11 plan.
Although section 1127(b) prohibits modification of a substantially
consummated plan, some courts have ruled that "serial"
(successive) chapter 11 filings are not per se impermissible and
that a second plan may modify the first plan if there has been an
unforeseeable or unanticipated change in circumstances. See Elmwood
Dev. Co. v. Gen. Electric Pension Trust (In re Elmwood Dev. Co.),
964 F.2d 508 (5th Cir. 1992); In re 1633 Broadway Mars Rest. Corp.,
388 B.R. 490 (Bankr. S.D.N.Y. 2008). However, as noted by the court
in In re Adams, 218 B.R. 597 (Bankr. D. Kan. 1998), "[e]ven
extraordinary and unforeseeable changes will not support a new
Chapter 11, if these changes do not substantially impair the
debtor's performance under the confirmed plan." Examples
of unforeseen changed circumstances justifying a second chapter 11
filing and modification of a previous plan have included
federal-law changes affecting tenancy of an apartment building,
termination of service by major airlines that had provided vital
customers for an airport hotel, crops or livestock lost due to
weather or natural disaster, and substantial adverse judgments. The
bankruptcy appellate panel considered this question in Caviata
Attached Homes.
Caviata Attached Homes
In 2005, Caviata Attached Homes, LLC ("Caviata")
obtained a $40.7 million recourse loan from California National
Bank ("CNB") to develop a 184-apartment housing complex.
In exchange, Caviata executed a promissory note and deed of trust,
which assigned Caviata's right, title, and interest in the
apartment complex to CNB. Caviata soon defaulted on the loan. In
response, the parties entered into a series of forbearance
agreements. Caviata, however, defaulted yet again. This time, CNB
sued in state court to foreclose. CNB subsequently sold the loan to
U.S. Bank, N.A. ("U.S. Bank").
In 2009, before the scheduled foreclosure trial, Caviata filed for
chapter 11 protection in Nevada. The company filed a chapter 11
plan proposing to make payments on U.S. Bank's $27.5 million
secured claim at a reduced rate of interest for three years, by the
end of which Caviata would either sell the apartment complex or
refinance the loan.
In its approved disclosure statement, Caviata expressly warned of
the risks posed by a continued downturn in the economy on the value
of the property and on Caviata's ability either to refinance
the U.S. Bank loan or to realize sufficient value from a sale in
three years to pay the secured claim of U.S. Bank in full.
U.S. Bank objected to confirmation, arguing that the plan was not
feasible, because of, among other things, the declining value of
the apartment complex and continued uncertainty in the real estate
market. The bankruptcy court overruled U.S. Bank's objections
and confirmed the plan. In so ruling, the court agreed with
Caviata's witnesses that the apartment complex could be sold
for at least $34 million within three years, "when the cycle
of downturn would improve."
Caviata filed a second chapter 11 petition in Nevada 15 months
later, in August 2011. Although it had not yet defaulted under its
confirmed chapter 11 plan, Caviata contended that it would soon be
unable to perform, due to an "unexpected" relapse into
recession, particularly in the real estate market. At the time of
Caviata's second chapter 11 filing, the value of the apartment
complex was appraised at $21 million to $23 million.
U.S. Bank sought dismissal of the second chapter 11 case, arguing
that the filing was a bad-faith attempt to circumvent the
prohibition in section 1127 against modifications to a
substantially consummated plan. Caviata countered that section
1127's prohibition does not apply where "extraordinary
circumstances" substantially impair a debtor's ability to
perform under its confirmed plan.
The bankruptcy court dismissed the case for "cause"
under section 1112(b) of the Bankruptcy Code. The court ruled that,
although Caviata did not act in bad faith by filing a second
chapter 11 case, section 1127 barred the modifications that Caviata
sought to make to its confirmed plan. According to the court,
"[T]he fact that the economy changes doesn't relieve
people from their contractual obligations." It added that
"in 2010 there were certainly inklings that the economy was
very bad" and that "just being wrong that the economy is
worse than [Caviata] thought it was going to be is [not] a basis
for filing a new plan." Caviata appealed the dismissal
order.
The Bankruptcy Appellate Panel's Decision
The bankruptcy appellate panel affirmed, holding that changed market conditions cannot justify a second chapter 11 filing unless the changes were both unforeseeable and fundamental to the market itself. In Caviata's case, the court explained, the risk that the real estate and lending markets would not improve as expected was specifically identified by both Caviata in its disclosure statement and U.S. Bank in its objection to confirmation. It could not be said, therefore, that those conditions were unforeseeable. According to the appellate panel, Caviata did nothing wrong by using its "best guess" for an economic recovery when formulating its chapter 11 plan. Guessing wrong, however, was not an excuse to undo the plan once it was confirmed.
Outlook
From a creditor's perspective, Caviata Attached Homes
underscores the importance of testing a plan proponent's
assumptions in a proposed chapter 11 plan with a view toward
blocking confirmation if the plan is unfeasible for whatever
reason. Building a strong evidentiary record in connection with
plan confirmation can forestall subsequent assertion in a serial
chapter 11 filing that an eventuality was unanticipated or
unforeseeable.
As in other contexts (e.g., orders approving asset sales), the
finality of an order confirming a chapter 11 plan is an important
part of U.S. bankruptcy jurisprudence. Caviata Attached Homes
indicates that such finality is not easily skirted (regardless of
how the subsequent challenge is formally framed), and stakeholders
seldom receive another bite at the apple absent compliance with the
Bankruptcy Code's strict requirements or, in some cases, a
showing of extraordinary circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.