“It’s all about the Benjamins” – Sean “Puff Daddy” Combs
Can a creditor continue to pursue litigation against a debtor and contest confirmation of a Chapter 11 plan after the debtor satisfies the creditor’s asserted claim in full? A recent bankruptcy court decision held that a creditor cannot refuse to accept full payment of its claim in order to continue litigating in the hope of forcing a debtor out of business. In doing so, the United States Bankruptcy Court for the Eastern District of Michigan held that payment of a claim in full – which is not the creditor’s decision to accept or reject – has the effect of taking away the creditor’s status as a “party in interest with the right to be heard” under Section 1109(b) of the Bankruptcy Code. In its capacity as a mere “business competitor,” such party cannot continue to litigate in the bankruptcy court or oppose confirmation of a Chapter 11 plan.
The relevant facts in In re RnD Engineering, LLC follow. Richilan Digue worked at Nagel Precision for many years. After Digue left Nagel, Digue formed RnD Engineering to compete directly with Nagel. Nagel sued Digue and RnD in state court, alleging that they had intentionally interfered with Nagel’s business. Before that action was resolved, RnD and Digue filed for Chapter 11 bankruptcy.
Nagel brought an adversary proceeding in the bankruptcy case alleging the same claims, seeking both damages and injunctive relief. The Court noted that the primary motivation for Nagel’s adversary proceeding was not simply to obtain monetary relief, but rather to “put [Digue] out of business so that he doesn’t do something bad in the future.” After trial, the Court awarded Nagel an allowed claim of $564,503.16, but denied Nagel’s request for injunctive relief on the basis that Nagel failed to prove that RnD and Digue misappropriated any of Nagel’s trade secrets.
RnD and Digue then proposed a Chapter 11 plan that would provide for payment in full of Nagel’s claim on the effective date of the plan, thus leaving Nagel unimpaired. Nagel, as the sole objector to the plan, argued that (i) the plan was not feasible because the Debtors did not have the cash to pay Nagel in full on the effective date; (ii) parties in interest would not benefit from the continuation of RnD’s existing management because the Court has already found that Digue’s prepetition conduct was “dishonest and fraudulent;” and (iii) the plan did not satisfy the cramdown provisions of Section 1129(b) of the Bankruptcy Code.
To minimize the dispute between the parties, the Court required the Debtors to place sufficient funds on deposit to ensure payment in full of Nagel’s claim on the effective date. Because the Debtors did not have that cash on hand at the confirmation hearing, the Court adjourned the confirmation hearing for nearly three months, until the date that the Debtors would have sufficient funds to pay Nagel in full. The Court also asked the parties to submit briefs regarding whether Nagel would have standing to assert objections to the plan if Nagel were “unimpaired” under Section 1124 of the Bankruptcy Code — by virtue of being paid in full. Concurrently, the parties continued to litigate with the Debtors filing a motion for authority to pay Nagel’s claim in full immediately — prior to plan confirmation. Nagel opposed confirmation and sought appointment of a Chapter 11 trustee, arguing that it had a right to refuse payment based on the source of the funds and the fact that it would preclude further litigation on principle. As Nagel asserted, this was “not just about the money[,]” but about the wrong that RnD and Digue had done in the industry and in the community, and the continued risks posed by RnD’s ongoing business, as managed by Digue.
The Bankruptcy Court — noting that this appeared to be a case of first impression — granted the Debtors’ motion, permitting the Debtors to pay Nagel’s claim in full, thus eliminating Nagel’s involvement in the case and making him “unimpaired” and unable to contest confirmation of the Debtors’ plan.
After concluding that immediate payment of Nagel’s claim was warranted and appropriate as a use of property outside the ordinary course of business pursuant to Section 363 of the Bankruptcy Code, the Court concluded that such payment would not impermissibly deprive Nagel of its due process rights or otherwise violate public policy. The Court observed that Section 1109(b) provides an exhaustive list of parties with a right to appear, but “does not list a competitor of a debtor as a party-in-interest,” because having a financial interest in the industry of the debtor is not the same as having a financial interest in the Debtors’ Chapter 11 cases, and that because Nagel would no longer be a creditor — but simply a business competitor — it would not be a party in interest with the right to be heard under Section 1109(b).
The Court also noted that, contrary to Nagel’s assertions, the “integrity of the bankruptcy process” did not support Nagel’s continued litigation, out of a desire to force the Debtors out of business in light of their allegedly dishonest and fraudulent conduct against Nagel. The Court observed that “Nagel’s self-appointment as the guardian of the public interest finds no support in the law.” Because the purposes of Chapter 11 had been served, the Court would not “permit Nagel to use these [c]hapter 11 cases to indulge its desire to put the Debtors out of business, no matter how understandable Nagel’s anger at the Debtors’ pre-petition misconduct.” Consequently, because the Debtors were entitled to pay Nagel’s claims in full immediately, Nagel had no right to be heard in the Chapter 11 cases.
Importantly, the Court noted that despite this outcome with respect to Nagel, the integrity of the bankruptcy process was imperative, and that it fully intended to exercise its “independent duty under § 1129(a) of the Bankruptcy Code to consider whether all of the elements necessary for confirmation of the plan are present at the confirmation hearing.”
The RnD decision provides that a creditor has no legal right to refuse payment in full of its allowed claim, to the extent that such payment causes the creditor to no longer be a “party in interest” pursuant to Section 1109 of the Bankruptcy Code. Thus, creative debtors may be able to overcome creditors’ objections — or other relief being sought in the Chapter 11 case — by paying such creditor in full, immediately. Other courts may follow suit and summarily reject arguments that the erstwhile creditor is attempting to promote the public interest or otherwise achieve goals that are not contemplated by the Bankruptcy Code. On the other hand, creditors wishing to continue their involvement in the case should consider asserting contingent claims or otherwise ensuring that they continue to be parties in interest – for example, contract counterparties or holders of other interests in the case — to minimize the likelihood of being taken out of the case by virtue of a forced settlement —albeit in full.