Taking a Second Bite at the Apple:
What Debtors and Creditors’ Counsel Need
to Know About Serial Chapter 11 Filings
37th Annual Middle District Bankruptcy Seminar
Durham, NC
April 15th & 16th, 2016
Presented by:
Jennifer B. Lyday
Womble Carlyle Sandridge & Rice, LLP
Winston-Salem, NC
Mark S. Jones
The Finley Group
Charlotte, NC
Materials prepared by:
Francisco T. Morales
Womble Carlyle Sandridge & Rice, LLP
Raleigh, NC
Introduction
I.
Arguments for Dismissal of Serial Chapter 11 Filings
A. Improper Attempt to Modify a Substantially Consummated Plan
i. Corporate Cases
ii. Individual Cases
B. Subsequent Petition Filed in Bad Faith
C. Simultaneous Bankruptcy Proceedings
i. Corporate Cases
ii. Individual Cases
D. Automatic Stay Issues in Individual and Small Business Chapter 11 Cases
i. Small Business Cases
ii. Individual Cases
II.
Exceptions to Dismissal
A. Extraordinary and Unforeseen Changes in Circumstances
B. Orderly Liquidation
III.
Avoiding Serial Chapter 11 Filings
A. From a Creditor’s Perspective
B. From a Debtor’s Perspective
Conclusion
Introduction
The feasibility requirement contained in Section 1129(a)(11) of the Bankruptcy Code
requires that a bankruptcy court only confirm a Chapter 11 plan if confirmation “is not likely to
be followed by the liquidation, or the need for further financial reorganization, of the debtor or
any successor of the debtor under the plan, unless such liquidation or reorganization is proposed
in the plan.” 11 U.S.C. § 1129(a)(11) (emphasis added). Despite this requirement, there is
nothing in Chapter 11—or in any other chapter of the Bankruptcy Code—that expressly prohibits
a company or individual from commencing a subsequent Chapter 11 case, and a majority of
bankruptcy courts hold that there is no per se prohibition against serial Chapter 11 filings. In re
Jartran, Inc., 886 F.2d 859, 866-67 (7th Cir. 1988) (“[. . .] [I]t is equally clear that the provisions
of the Code permit the arrangement at issue here [a serial Chapter 11 filing.]”); In re Elmwood
Dev. Co., 964 F.2d 508, 511-12 (5th Cir. 1992) (“[T]he mere fact that a debtor has previously
petitioned for bankruptcy relief does not render a subsequent chapter 11 petition ‘per se’
invalid.”); In re Woods, Case No. 10-12397, 2011 WL 841270, at *3 (Bankr. D. Kan. Mar. 7,
2011) (“[. . .] [H]ad Congress intended to outlaw successive chapter 11 filings, it would have
included that prohibition in § 109 where it explicitly conditioned or prohibited successive
chapter 7 and chapter 13 filings.”). However, none of the above-referenced cases legitimize
serial Chapter 11 filings in the least, and serial filings will only survive in extraordinary and
limited circumstances.
This Article summarizes the existing case law on serial Chapter 11 filings—what are
commonly referred to as “Chapter 22” filings—and highlights issues that debtors and creditors’
counsel need to be aware of in both the corporate and individual Chapter 11 settings. Part I
describes the commonly recognized arguments for dismissal of Chapter 22 cases, which can be
summarized as follows: (i) the improper attempt to modify an already confirmed and
substantially consummated plan, (ii) the filing of a successive petition in “bad faith”, (iii) the
prohibition against having two simultaneous bankruptcy proceedings if no substantial
consummation has occurred or if no discharge has been granted, and (iv) the automatic stay
issues that may effectively prohibit a serial filing in individual and small business cases.
Part II describes certain recognized arguments against dismissal of Chapter 22 cases.
These arguments include (i) the existence of unforeseeable and extraordinary changes in
circumstances that have substantially impaired the debtor’s ability to perform under the
confirmed plan and created a genuine need to file a second case, and (ii) the fact that the second
filing is simply an attempt to proceed with an orderly liquidation of the debtor’s assets.
Finally, Part III provides several “takeaways” for debtors and creditors’ counsel on how
to avoid Chapter 22 filings.
I.
Arguments for Dismissal of Serial Chapter 11 Filings
A. Improper Attempt to Modify a Substantially Consummated Plan
i. Corporate Cases
Section 1141(a) provides that the terms of a confirmed plan are binding on the parties,
and courts have held that a confirmed plan of reorganization is a “new contract” between all such
parties. 11 U.S.C. § 1141(a); In re Dial Bus. Forms Inc., 341 F.3d 738, 744 (8th Cir. 2003).
Section 1127(b), in turn, prohibits a debtor from modifying a confirmed plan of reorganization
after substantial consummation of the plan.1 11 U.S.C. § 1127(b). Rather, the terms of an
already-confirmed and operable plan are binding on the parties and are generally given res
judicata effect. See, e.g., In re Adams, 218 B.R. 597, 600 (Bankr. D. Kan. 1998) (“The terms of
1
Substantial consummation includes, inter alia, “commencement of distribution under the plan.” 11 U.S.C. §
1101(2).
a confirmed plan usually represent the results of negotiations between the debtor and its
creditors, and the parties should be able to rely on the finality of those terms.”). “Taken together,
Sections 1141(a) and 1127(b) impose an important element of finality in chapter 11 proceedings,
allowing parties to rely on the provisions of a confirmed reorganization plan.” In re Caviata
Attached Homes LLC, 481 B.R. 34, 46 (B.A.P. 9th Cir. 2012) (citing In re Mableton-Booper
Assocs., 127 B.R. 941, 943 (Bankr. N.D. Ga. 1991)).
Given this limitation on post-confirmation modification, the question becomes whether a
debtor can in effect modify such a confirmed plan by filing a new bankruptcy case. Courts agree
that the general rule is that a reorganized debtor may not file a new plan to effect a modification
of a substantially consummated plan. See Elmwood, 964 F.2d at 510-13 (dismissing second
Chapter 11 because its purpose was to modify a substantially consummated Chapter 11 plan); In
re Northampton Corp., 37 B.R. 110, 112-13 (Bankr. E.D. Pa. 1984) (same). Courts reason that if
the obligations of a prior Chapter 11 confirmed plan could be discharged in a Chapter 22, a
debtor could “continuously circumvent the provisions of a confirmed plan by filing chapter 11
petitions ad infinitum.” Id.
Therefore, when confronted with successive Chapter 11 petitions, bankruptcy courts will
inquire into the circumstances and nature of the new petition to assess whether it is, in actuality,
a ruse for simply modifying the earlier confirmed plan. Courts apply a variety of slightly
varying tests, but the basic and universally accepted threshold inquiry is whether the new petition
was filed after sufficiently compelling changes in circumstances that substantially impaired the
ability of the debtor to perform under the prior plan. In re Advantage Properties, Inc., Case No.
06-12363-11, 2007 WL 809510, at *4 (Bankr. D. Kan. Mar. 2007). “In order for a debtor to rely
on ‘changed circumstances,’ such circumstances must have been unknown at the time of
substantial consummation of the prior plan, and must have substantially affected the debtor’s
ability to perform that plan.” In re Savannah, Ltd., 162 B.R. 912, 915 (Bankr. S.D. Ga. 1993).
“Where, however, a debtor can anticipate the changed circumstances before confirmation of the
first plan and later files a second petition to relieve itself of its obligations under the prior plan,”
courts will construe such an effort as an impermissible attempt to modify a substantially
consummated plan and will dismiss the new filing. Id. at 915-16.
ii. Individual Cases
In the context of individual Chapter 11 cases, the analysis varies slightly. With the
passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
(“BAPCPA”), the Bankruptcy Code now differentiates between individual debtors and corporate
debtors in Chapter 11. Section 1127(e), which applies only if the debtor is an individual,
liberalized the plan modification rules contained in Section 1127. Section 1127(e) allows for
plan modifications after confirmation—but before completion of payments under the plan—
whether or not the plan has been substantially consummated. 11 U.S.C. § 1127(e) (“If the debtor
is an individual, the plan may be modified at any time after confirmation of the plan but before
completion of payments under the plan, whether or not the plan has been substantially
consummated [. . .].”) (emphasis added). “Stated differently, whereas a corporate Chapter 11
debtor whose confirmed plan is substantially consummated may not modify the plan, an
individual Chapter 11 debtor whose plan is substantially consummated may modify the plan.” In
re McMahan, 481 B.R. 901, 920 (Bankr. S.D. Tex. 2012).
This does not mean, however, that modification of an individual Chapter 11 is
accomplished through the filing a Chapter 22 petition. On the contrary, by amending Section
1127(e), BAPCPA put a mechanism in place for individual Chapter 11 debtors to modify their
confirmed plans—even if substantially consummated—without the necessity of having to file
another bankruptcy case.
This mechanism is evident under the plain language of Section
1127(f). Section 1127(f)(1) directs that “Sections 1121 through 1128 and the requirements of
section 1129 apply to any modification under [Section 1127(e)],” whereas Section 1127(f)(2)
states that “[t]he plan, as modified, shall become the plan only after there has been disclosure
under section 1125 as the court may direct, notice and a hearing, and such modification is
approved.” 11 U.S.C. § 1127(f).
At least one bankruptcy court has found that an individual debtor may not seek to modify
a prior confirmed Chapter 11 plan by filing an entirely new bankruptcy petition. In re McMahan,
481 B.R. at 921. The court in McMahan dismissed an individual’s Chapter 13 bankruptcy
petition that attempted to modify the terms of a prior confirmed Chapter 11 plan on the grounds
that it was an impermissible attempt to circumvent the prescribed modification procedures
outlined in § 1127(e) and (f). As the court in McMahan put it:
Such a procedure [a repeat filing] would be unnecessarily duplicative; it would
allow a debtor to essentially restructure the same liabilities that have already been
restructured in the Chapter 11 plan. Thus, while the Code permits modification of
an individual debtor’s confirmed Chapter 11 plan, this modification should be
obtained through the procedures afforded by the Code [within the prior Chapter
11 case].
Id.
In short, by explicitly setting forth a specific mechanism by which an individual Chapter
11 debtor can seek plan modification after substantial consummation, Congress implicitly
prohibited all other mechanisms—such as filing a serial bankruptcy case—for doing so. See
McMahan, 481 B.R. at 920-922.
B. Subsequent Petition Filed in Bad Faith
Section 1112(b) provides for conversion to Chapter 7 or dismissal of a Chapter 11 case
upon a showing of “cause.” 11 U.S.C. § 1112(b)(1). Section 1112(b)(4) contains an illustrative,
non-exclusive list of what constitutes “cause.” 11 U.S.C. § 1112(b)(4). It is well established,
however, that a Chapter 11 case may be dismissed for other, non-enumerated causes, including if
the petition was filed in bad faith. In re Kestell, 99 F.3d 146, 148 (4th Cir. 1996) (“[C]hapter 11
bankruptcy cases may be dismissed for lack of good faith, a requirement this Court has found to
be implicit in § 1112(b).”). “The good faith standard protects the integrity of the bankruptcy
courts and prohibits a debtor’s misuse of the process where the overriding motive is to delay
creditors without any possible benefit, or to achieve a reprehensible purpose throughout
manipulation of the bankruptcy laws.” Elmwood Dev. Co., 964 F.2d. at 510.
Even if not prohibited per se, a Chapter 22 filing is scrutinized carefully to ensure it does
not constitute an abuse of the bankruptcy process or a “bad faith filing.” “Where a debtor
requests Chapter 11 relief for a second time, the good faith inquiry must focus on whether the
second petition was filed to contradict the initial bankruptcy proceedings.” Id. at 511. Simply
stated, courts will find bad faith when the successive Chapter 11 case was filed to avoid what the
reorganized debtor “now perceives to be a bad deal” under the consummated plan. In re Miller,
122 B.R. 360, 367 (Bankr. N.D. Iowa 1990). See Also In re Mableton-Booper Assocs., 127 B.R.
at 944 (finding that when a debtor files a second petition to relieve itself of its obligations under
the prior plan, bad faith may be inferred)
Under Fourth Circuit jurisprudence, when seeking dismissal of a Chapter 11 case for lack
of good faith, bankruptcy courts must apply the two-prong test articulated in Carolin Corp. v.
Miller, 886 F.2d 693 (4th Cir. 1989). Under Carolin, the movant for dismissal must show both i)
“the objective futility of any possible reorganization,” and ii) “the subjective bad faith of the
petitioner in invoking this form of bankruptcy protection.” Id. at 694. The objective futility
requirement is to “insure that there is embodied in the petition ‘some relation to the statutory
objective of resuscitating a financially troubled [debtor],’” and the court’s inquiry should focus
on whether there is any hope of rehabilitation. Id. at 701. The subjective bad faith requirement
ensures that the petitioner’s motivation is to “reorganize or rehabilitate” and not “to abuse the
reorganization process” in an attempt to cause hardship or delay to creditors. Id. at 702. While
the Carolin test is used predominantly for determining whether an initial Chapter 11 petition
should be dismissed for lack of good faith, courts have applied the same test in the Chapter 22
context. See, e.g., SUD Properties, Inc., 462 B.R. 547 (Bankr. E.D.N.C. 2011); Wharton v. IRS,
213 B.R. 464 (E.D.V.A. 1997).
In SUD Properties, the debtor, SUD, was engaged in the business of owning and
developing real estate. SUD Properties, Inc., 462 B.R. 548-549. In 2005, SUD purchased a tract
of land for which First Bank made two loans secured by a first and second deed of trust in the
land. Id. at 549. In 2006, SUD subdivided the tract into 88 lots and built the infrastructure to
support future residential development. Id. SUD sold 18 lots to homebuyers, but as the real
estate market declined, SUD was left with 70 unsold lots.
its loan obligations to First Bank.
Id. Subsequently, SUD defaulted on
Id. After First Bank initiated foreclosure proceedings, SUD
filed its first voluntary Chapter 11 petition.
Id. As part of the first plan of reorganization, SUD
was to sell the remaining 70 lots by January 31, 2014. Id. SUD failed to sell the lots pursuant to
the first plan, and the first bankruptcy case was therefore dismissed. Id. First Bank initiated a
second foreclosure proceeding, but on the eve of the sale, SUD filed a second voluntary Chapter
11 petition. Id. In the second plan of reorganization, SUD proposed to convey one-half of the
vacant lots to First Bank in full satisfaction of the bank’s claim, appraising each of these lots at
approximately $43,000 for a total of $1.5 million. (As of the petition date, First Bank’s claim
was approximately $1.3 million). Id. at 556.
First Bank moved to dismiss SUD”s Chapter 22 filing as has having been filed in bad
faith. Id. at 550-51. First Bank contended that SUD’s second reorganization was objectively
futile because SUD was unable to propose a confirmable plan or make interest payments on its
obligations to First Bank. Id. First Bank also contended that the case was filed with subjective
bad faith for the improper purpose of delaying First Bank’s previously authorized foreclosure on
the lots. Id. at 552. Central to First Bank’s subjective bad faith argument was language in
SUD’s prior confirmed Chapter 11 plan that stated: “No future bankruptcy filing by any party
shall stay a foreclosure proceeding brought by First Bank against the [real property collateral]
related to the First Bank’s indebtedness.” Id. First Bank argued that the aforementioned clause
provided First Bank with in rem relief and the ability to foreclose on its real property, which the
Chapter 22 filing had now stayed. Id. SUD argued that its proposed plan was feasible because
of changed circumstances evidenced by a recent appraisal of the property that established SUD
had no less than a 67% equity cushion. Id. at 551. Moreover, SUD argued that the Chapter 22
petition was not filed with subjective bad faith as it was not filed to stay the right of First Bank to
foreclose on its notes secured by the real property collateral. Id. at 554. According to SUD, the
case was file to provide an alternative way to pay the claims of First Bank and all other noninsider creditors in full, a result that could not be achieved through foreclosure.
Id. at 551.
With regard to objective futility, the court noted that at the motion to dismiss stage, “[t]he
inquiry should focus on ‘assessing whether there is no going concern to preserve. . .and. . . no
hope of rehabilitation, except according to the debtor’s terminal euphoria.’” Id. at 551-52.
Finding that courts across the county have acknowledged that creditors can receive the
“indubitable equivalent” of their claim when the debtor surrenders real property in satisfaction of
the creditor’s claim—even in the case where the debtor surrenders a portion of the collateral in
full satisfaction of the claim—the court concluded that it could not be said that SUD did not have
a reasonable prospect of rehabilitation. Id. at 555. Accordingly, the Court found that First Bank
failed to carry its burden of proof with respect to whether SUD’s reorganization efforts were
objectively futile. Id. at 556.
With regard to subjective bad faith, the court found that the language in SUD’s prior
confirmed Chapter 11 plan only stated “that a foreclosure proceeding will not stayed by any
future bankruptcy filings,” but did not “prohibit the Debtor from filing a [successive] petition or
plan of reorganization.” Id. at 554. In fact, the court noted that the language “no future
bankruptcy filing” in fact anticipated the possibility of a second bankruptcy filing.
Id.
Moreover, the court noted that Section 349(a) of the Bankruptcy Code provides that dismissal of
a case will not prejudice a debtor with regard to the filing of a subsequent petition.
Id.
Therefore, the Court did not find that SUD had filed its Chapter 22 petition with subjective bad
faith. Id. Cf. Wharton v. IRS, 213 B.R. at 466-67 (dismissing a “Chapter 33” petition filed for
the sole reason to delay collection of tax debt owed to the IRS that had been rendered nondischargeable in previous Chapter 11 and Chapter 22 cases).
C. Simultaneous Bankruptcy Proceedings
i. Corporate Cases
As is the case with successive filings, the Bankruptcy Code does not explicitly prohibit
simultaneous bankruptcy cases. See In re Cowan, 235 B.R. 912, 915-16 (Bankr. W.D. Mo.
1999) (“There is no statutory prohibition against having two bankruptcy cases at the same
time.”); In re Kosenka, 104 B.R. 40, 42 (Bankr. N.D. Ind. 1989) (stating that Section 109 of the
Bankruptcy Code does not contain a prohibition against two simultaneous Title 11 cases).
Despite the lack of statutory or rule guidance, however, in the corporate Chapter 11 context,
courts have held that a simultaneous bankruptcy petition may not proceed if the prior confirmed
plan has not been consummated, no final decree has been entered, and the case has remained
open. See, e.g., In re Delaware Valley Broadcasters LP, 166 B.R. 36, 38-39 (Bankr. D. Del.
1994) (holding that debtor was unable to file a new Chapter 11 petition when, almost
immediately after confirmation of its plan, debtor defaulted under the terms of the plan, was
never able to fund the plan, and had a complete inability to consummate the plan); Prudential
Ins. Co. of America v. Colony Square Co., 40 B.R. 603, 605-06 (Bankr. N.D. Ga. 1984)
(dismissing Chapter 11 petition that was filed six years after a confirmed, but not substantially
consummated Chapter 12 plan).
ii. Individual Cases
In contrast, in the individual Chapter 11 context, it is the discharge that serves as the
dividing line on whether to allow a simultaneous case to proceed, and courts generally agree that
a debtor may not file a second bankruptcy case before entry of the discharge order in the first
case.2 See, e.g., In re Turner, 207 B.R. 373, 378 (2d Cir. 1997) (“[T]here is universal agreement
among [courts] that where a debtor files for [bankruptcy relief] and then files [a second petition]
before receiving a discharge in the original case, that [second case] is a nullity.”); In re Hodurski,
156 B.R. 353 (Bankr. D. Mass. 1993) (prohibiting second filing before entry of discharge in the
first case); Kosenka, 104 B.R. at 46–47 (citing cases that emphasize the importance of the
2
Unlike individual Chapter 11 cases, where the debtor does not receive a discharge of debts until payments under
the plan are fully completed, the effect of plan confirmation in corporate Chapter 11 cases is to grant a discharge of
debts unless otherwise provided for under the plan. 11 U.S.C. § 1141(d)(1). Therefore, in the corporate context,
there is no issue of a debtor maintaining two simultaneous cases in which no discharge has been granted.
discharge in the first case); In re Cowen, 29 B.R. 888, 894–95 (Bankr. S.D. Ohio 1983)
(dismissing second case because, inter alia, it was filed before entry of the discharge in the first
case). Because under Section 1141(d)(5) an individual Chapter 11 debtor does not obtain a
discharge until all plan payments have been completed (or the court grants the debtor a hardship
discharge), courts have dismissed subsequent bankruptcy filings in individual cases where the
debtors had not received a discharge in the prior Chapter 11 case. See, e.g., McMahan, 481 B.R.
at 913-14 (finding that because the debtor had not received his discharge in a prior pending
Chapter 11 case, the debtor was barred from prosecuting a subsequent Chapter 13 case).
D. Automatic Stay Issues in Individual and Small Business Chapter 11 Cases
i. Individual Cases
BAPCPA changes to 11 U.S.C. § 362 provide an additional way by which creditors can
effectively prevent the serial filing of individual and small business Chapter 11 petitions.
For individual debtors in cases under Chapters 7, 11, or 13, Section 362(c)(3) limits the
applicability of the automatic stay to thirty (30) days after the petition date if the debtor had a
pending case within the one-year preceding the petition date, but such case was dismissed.3 11
U.S.C. § 362(c)(3)(A). A debtor may obtain a continuation of the automatic stay if a debtor
“demonstrates that the filing of the later case is in good faith as to the creditors to be stayed.” 11
U.S.C. § 362(c)(3)(B). However, such relief will only be granted upon a motion by the debtor,
which must be heard before the expiration of the thirty (30) day period. Id.
Similarly, Section 362(c)(4) provides that if an individual debtor has had two or more
cases pending within the one-year preceding the petition date that were dismissed, the debtor
3
Note that Section 362(c)(3)(A) terminates the automatic stay with respect to certain actions taken with respect to
the debtor but not with respect to property of the estate. Therefore, a majority of bankruptcy courts have held that
foreclosure proceedings continue to be stayed. See, e.g., In re Brandon, 349 B.R. 130, 132 (Bankr. M.D.N.C. 2006).
does not obtain the protection of the automatic stay upon the filing of the subsequent petition.4
11 U.S.C. § 362(c)(4)(A)(i). If the debtor wants the stay to be placed into effect, the debtor must
file a motion within thirty (30) days of the filing of the subsequent case requesting the court to
impose the automatic stay and must demonstrate “that the filing of the later case is in good faith
as to the creditors to be stayed.” 11 U.S.C. § 362(c)(4)(B).
The practical effect of Sections 362(c)(3) and (c)(4) is to prevent individuals from filing
serial bankruptcy petitions by providing for limited or no automatic stay protection upon the
filing of a successive bankruptcy petition.
ii. Small Business Cases
Although the stay limitations on individual serial filers are not insurmountable, that is not
the case for small business serial filers. Section 362(n)(1) effectively prevents the serial filing of
bankruptcy petitions by preventing the automatic stay from going into effect in any case where
the debtor:
1) Has a small business case pending at the time the [subsequent] petition is filed;
2) Was a debtor in a small business case that was dismissed for any reason by an order
that became final in the two-year period ending on the date of the order for relief
entered with respect to the [subsequent] petition;
3) Was a debtor in a small business case where a plan was confirmed within two years
from the date of the order for relief entered with respect to the [subsequent] petition;
or
4) Is an entity that has acquired substantially all of the assets or business of a small
business debtor, unless such entity establishes by a preponderance of the evidence
4
Unlike Section 362(c)(3), Section 362(c)(4) does not contain the limiting language “with respect to the debtor.”
Courts have thus found that for cases that fall under Section 362(c)(4), Congress removed the applicability of the
automatic stay in its entirety. In re Brandon, 349 B.R. at 132.
that such an entity acquired substantially all of the assets or business of such small
business debtor in good faith and not for the purpose of evading the application of
Section 362(n)(1).
11 U.S.C. § 362(n)(1).
Section 362(n)(2), in turn, provides a small reprieve to the drastic consequences of
Section 362(n)(1) by providing exceptions if the subsequent case is “an involuntary case
involving no collusion by the debtor with creditors” or if “the debtor proves by a preponderance
of the evidence that the filing of the petition resulted from circumstances beyond the control of
the debtor not foreseeable at the time the case then pending was filed,” and if the debtor
demonstrates that “it is more likely than not that the court will confirm a feasible plan, but not a
liquidating plan, within a reasonable period of time.” 11 U.S.C. §§ 362(n)(2)(A) and (B).
Confusion has arisen as to the meaning of the phrase “circumstances beyond the control
of the debtor not foreseeable at the time the case then pending was filed” in Section
362(n)(2)(B)(i). Debtors would certainly argue that “at the time the case then pending was filed”
means “at the time the prior Chapter 11 case was filed,” and that there is no need for the prior
case to still be pending before the court for the Section 362(n)(2) exception to apply. However,
that is not how the statutory language has been interpreted. In Palmer v. Bank of the West, 438
B.R. 167, 169 (Bankr. E.D. Wis. 2010), one of the few reported decisions discussing Section
362(n) in detail, the court concluded that “the plain language of [the] provision does not support
[the debtor’s] proposed interpretation.” Instead, “the case then pending” refers to the prior
Chapter 11 case that is still pending at the time the second petition is filed, making the exception
applicable only in situations where two cases are concurrently pending before the court. Id. In
other words, for the exception of Section 362(n)(2) to apply, the debtor must have a small
business case pending at the time the subsequent petition is filed, and the exception will not
apply when the first case has already been dismissed by the time the debtor files the second case.
Id. In support of its conclusion, the Palmer court read the provisions in Section 362(n)(1)
together with Section 362(n)(2), noting that Section 362(n)(1) prevents the automatic stay from
going into effect in four separate situations, one of which “refers to the situation where the
debtor ‘is a debtor in a small business case pending at the time the petition was filed.’” Id.
(emphasis original). The court concluded that “§ 362(n)(2)(B)(i)’s reference to a petition that is
filed because of circumstances ‘not foreseeable at the time the case then pending was filed’
appears to refer to a petition that is currently pending under § 362(n)(1)(A).” Id. The court
concluded that “Congress could have been more precise in its drafting, but the foregoing
construction conforms with the plain language of the statute.” Id.
Because the situation of two cases pending at once is highly unlikely (especially
considering the prohibition against having two simultaneous cases pending before the court, as
discussed in Section I(C) supra), the practical effect of Section 362(n) is to prevent a small
business debtor from filing a Chapter 22 petition by providing for no automatic stay protection
upon the filing of the second small business debtor case.
II.
Exceptions to Dismissal
A. Extraordinary and Unforeseen Changes in Circumstances
As previously noted, a majority of bankruptcy courts agree that there is no per se
prohibition against serial Chapter 11 filings. However, survival of a subsequent petition appears
to be the exception rather than the rule. In re Caviata Attached Homes LLC, 481 B.R at 47. For
a Chapter 22 filing to survive, the subsequent petition must not be filed in bad faith and must not
constitute an attempt to modify an earlier confirmed and substantially consummated plan of
reorganization. Therefore, when confronted with a Chapter 22 filing, bankruptcy courts will
inquire into the circumstances and nature of the new petition to assess whether it is, in actuality,
a ruse for simply modifying the earlier confirmed plan.
The basic and universally accepted threshold inquiry is whether the new petition was
filed as a result of unforeseeable and extraordinary changes in circumstances that “substantially
impair[ed] the debtor’s performance under the confirmed plan.” In re Bouy, Hall & Howard and
Assocs., 208 B.R. 737, 745 (Bankr. S.D. Ga. 2004). In addition, courts look at a variety of
circumstantial factors to assess whether the successive petition is an attempt to modify an earlier
plan. Common factors include (i) the length of time between the cases, (ii) the foreseeability and
substantiality of the events that gave rise to the second filing, (iii) whether the new plan
contemplates liquidation or reorganization, (iv) the degree to which creditors consent to the filing
of the second reorganization, and (iv) whether an objecting creditor’s rights have been altered.
Id. at 743-44.
Since the key issue is whether a successive petition follows on the heels of an
unforeseeable and extraordinary change in circumstances, below is a list of cases where courts
have addressed the issue of change in circumstances.
These cases reveal that only truly
extraordinary and substantial events will qualify as a sufficient change in circumstances.
Moreover, the debtor must affirmatively show that the change in circumstances substantially
impaired its ability to perform under the confirmed plan. In other words, the mere fact of a
change in circumstances is insufficient, unless the debtor can explain how that change in
circumstances actually affected its ability to operate under the confirmed plan.
Change in Circumstances in Selected Cases
Insufficient Change in Circumstance Cases
In re Caviata Attached
Decreased income, increased expenses, and the state of the U.S.
Homes LLC, 481 B.R. 34
economy in 2010 with regard to real estate markets were not
(B.A.P. 9th Cir. 2012)
unforeseen circumstances or extraordinary changes in market
conditions warranting a second Chapter 11 filing, especially when
the prior Chapter 11 plan was confirmed merely 15 months prior
to the subsequent filing.
In re Woods, Case No. 1012397, 2011 WL 841270
(Bankr. D. Kan. 2011).
The 2008 credit crisis was not a sufficient change in
circumstances when the debtor failed to present evidence
connecting that event to its inability to attract financing from local
banks.
In re Skeen, Goldman LLP,
Case No. 07-10535-JS, 2007
WL 4556683 (Bankr. D.
Md. 2007).
In re Advantage Properties,
Case No. 06-12363-11,
2007 WL 809510 (Bankr.
D. Kan. 2007).
Identification of a new legal argument as to why the prior
confirmed plan violated state ethics laws was an insufficient
change in circumstances.
In re Motel Properties, Inc.,
314 B.R. 889 (Bankr. S.D.
Ga. 2004).
The September 11, 2001 attacks, the Iraq War, and market
declines during the early 2000s were not sufficient changes in
circumstances to warrant a new Chapter 11 filing, when the
debtor failed to present evidence showing any correlation between
those events and its declining revenues.
In re Northtown Realty Co.,
LP, 215 B.R. 906 (Bankr.
E.D.N.Y. 1998).
A decline in the retail industry which resulted in the debtor
having fewer tenants in its retail complex was not a sufficient
change in circumstances.
In re Roxy Real Estate Co.,
Inc., 170 B.R. 571 (Bankr.
E.D. Penn. 1993).
The default of the debtor’s tenant was not a sufficient change in
circumstances since such defaults are generally foreseeable in the
regular course of business for retail landlords.
In re Mableton-Booper
Assocs., 127 B.R. 941
(Bankr. N.D. Ga. 1991).
A property manager’s drug problem and mismanagement, a loss
of tenants, building repairs, debts coming due, and changing
market conditions were all insufficient changes in circumstances
because they were all foreseeable at the time the confirmed plan
A fire in the debtor’s rental space, logistical issues with tenant
rental payment collection, and a new manager of the debtor’s
operations were insufficient changes in circumstances. The
property fire and the tenant payment confusion both occurred
after the debtor defaulted under the confirmed plan, and the new
manager came on the scene too late in the process to justify a new
plan.
was created. The debtor knew of the property manager’s drug
and behavioral problems, and facility deterioration was entirely
foreseeable. Likewise, the debt obligations were certainly
foreseeable and had matured according to schedule. Finally,
changed market conditions are generally insufficient.
In re Elmwood Co., 964
F.2d 508 (5th Cir. 1992).
The addition of new tenants, a new settlement agreement with a
different creditor, a prospective buyer, pending litigation, and the
nationwide credit crunch of the early 1990s were all insufficient
changes in circumstances because they were each foreseeable at
the time the confirmed settlement was negotiated. In fact, some
of the “changed circumstances,” such as the litigation and the
opportunity to sell, were already occurring at the time of
settlement.
Sufficient Change in Circumstance Cases
In re SUD Properties, 462
An appraisal of the debtor’s sole asset (real property) was a
B.R. 547 (Bankr. E.D.N.C.
sufficient change in circumstances to warrant a new plan of
2011).
repayment when the appraisal revealed that the debtor’s property
provided a “67% equity cushion” and could afford the debtor the
opportunity to make repayment to the creditor in the form of a
dirt-for-debt plan.
In re 1633 Broadway Mars
Restaurant Corp., 380 B.R.
490 (Bankr S.D.N.Y. 2008).
The change in circumstances prong was satisfied when the
debtor’s prior good relations with the landlord soured, the
landlord’s multiple notices of default made it impractical for the
debtor to attract domestic financing, and the debtor’s investors
had a good faith reason to be concerned.
In re Tillotson, Case No. 01- For the purposes of analysis, the court assumed (and likely
10134, 2001 WL 1095084
agreed) that livestock illness, freak weather occurrences, and
(Bankr. W.D.N.Y. 2001)
market-related changes were sufficient changes in circumstances.
However, the successive filing was dismissed because, even with
these changed circumstances, the new filing was made in bad
faith.
In re Adams, 218 B.R. 597
(Bankr. D. Kan. 1998).
A fire that destroyed 3,000 acres of pastureland and killed a large
portion of the debtor’s cattle herd was a sufficient change in
circumstances.
In re Bouy, Hall & Howard
and Assocs., 208 B.R. 737,
745 (Bankr. S.D. Ga. 1995).
Closure and relocation of a nearby airport terminal and the
elimination of two airline routes to the area were sufficient
changes in circumstances for a debtor whose hotel business
depended on local air traffic for customers.
In re Roth, Case No. 9340460, 1994 WL 234532
(Bankr. D.S.D. 1994).
The debtors’ poor health problems that necessitated the sale of
half their milk herd constituted a sufficient change in
circumstances.
In re Casa Loma Assocs.,
Case No. 90-04886, 1991
WL 4082 (Bankr. N.D. Ga.
1991).
An unanticipated change in federal law prohibiting "adults only"
apartment complexes, which severely affected debtor's tenancy
rates; tenants who vandalized the premises, thereby increasing
operating expenses; and discovery of fire damage and structural
defects in an apartment building, which were unknown at the time
of plan confirmation, were changed circumstances warranting the
second chapter 11 filing.
These “changes in circumstances” cases reveal that courts will generally look for an
event that affected the debtor uniquely, was unanticipated at the time of the confirmed plan, and
that had a clear impact (negative or positive) on the debtor’s ability to either attract new funding
or to continue operating at historical revenue levels. Notably, courts tend to look for each of
these factors, and will not recognize a change in circumstances as sufficient if a single factor is
missing.
For instance, in Mableton-Booper Associates, the court refused to recognize the
mismanagement and drug problems of a senior employee as a sufficient change in circumstances
because the company’s general partner and guarantor knew about this individual’s behavioral
problems when the confirmed plan was created. In re Mableton-Booper Assocs, 127 B.R. at
943–44.
Therefore, even though the employee’s behavior was unique to the debtor and
negatively impacted the debtor’s ability to operate, it was not a sufficient change in
circumstances because it was foreseeable. Id.
In cases of economic change, courts have generally held that changed market conditions
alone are insufficient to warrant a second Chapter 11 filing. Such market fluctuations should be
part of the risk calculation for a debtor in possession. However, “where a debtor experiences a
‘fundamental change in its market’ and not the typical fluctuations of supply and demand, if
unforeseeable, the change may represent sufficiently changed circumstances to warrant a second
filing.” In re Bouy, Hall & Howard and Assocs., 208 B.R at 745.
B. Orderly Liquidation
Another recognized exception to the prohibition against Chapter 22 filings are instances
where a debtor has failed to reorganize under a confirmed Chapter 11 plan and is simply
attempting to proceed with an orderly liquidation and wind up of its affairs in a manner most
advantageous to its creditors. This exception was first recognized by the Seventh Circuit in the
case of In re Jartran, 886 F.2d at 866-70.
The debtor, Jartran, had filed its original Chapter 11 petition in December 1981. Id. at
861. A plan of reorganization was confirmed in September 1984, and distributions as provided
by the plan commenced shortly thereafter. Id. Less than a year and a half later, in March 1986,
the debtor filed a second Chapter 11 petition and proposed to file a liquidating plan that would
supersede the terms of the prior confirmed plan. Id. A creditor sought to dismiss the debtor’s
Chapter 22 filing contending that the second petition unlawfully sought to modify the first plan
after it had been substantially consummated. Id. at 868.
The court rejected the creditor’s
argument finding that the debtor did not propose to alter or amend any of its existing obligations
with any creditor, but rather to liquidate its assets. Id. The second filing was, according to the
court, merely a “good faith admission that Jartran was unable to continue operating as a going
concern” and not an impermissible modification. Id.
The creditor alternatively sought to dismiss the Chapter 22 filing arguing that the
appropriate remedy, upon failure of the plan, was conversion to Chapter 7 pursuant to Section
1112(b), rather than a new liquidating Chapter 11. Id. at 867. The court also rejected this
argument, holding that Section 1112(b) did not require a court to convert a case upon default
under a confirmed plan. Id. By its own terms, Section 1112(b) only authorizes a court to enter
an order of conversion if it finds that conversion is in the interests of the creditors and the estate.
Id. The court determined that the best interest of the creditors and the estate would be best
served by liquidation under the new Chapter 11 rather than by conversion to Chapter 7, as
conversion would have triggered an array of administrative problems. Id. Six years had lapsed
since the original filing, and a year and a half had passed since the plan had been confirmed.
According to Section 348, any conversion would relate back to the date of the filing. Thus it
would have become unclear which of Jartran’s assets would be included in the estate. Id.
Moreover, conversion to a Chapter 7 would have raised questions as to which pre-conversion
claims would be entitled to administrative expense priority. Id. In dictum, the bankruptcy court
concluded that neither Section 549 nor Section 348(d) was designed or intended to apply to an
entity such as Jartran that had operated under a confirmed, non-amendable plan of
reorganization. Id. The court allowed the filing of the case because it seemed to be the cleanest
liquidation alternative, and there was nothing in the statute that prohibited that filing except the
good faith standard that had clearly not been violated in the case. Id.
III.
Avoiding Serial Chapter 11 Filings
A. From a Creditor’s Perspective
Creditors who find themselves in repeat Chapter 11 filings with the same debtor are
immensely frustrated, and the question arises about the possibility of dismissing the second case.
However, creditors should also focus on pursuing strategies ex ante that will limit a debtor’s
ability to make a serial filing in the first place. One such strategy is the inclusion of contractual
provisions in the first Chapter 11 plan or in the confirmation order that precludes the debtor from
making future filings or attempting to alter its plan of repayment to the creditor.
For example, in Roxy Real Estate Company, the parties entered into a settlement
agreement that included such a provision. In re Roxy Real Estate Co., Inc., 170 B.R. at 572.
The provision was approved by the court and incorporated in the confirmed plan and stated:
The Debtor shall not modify, attempt to modify or cause to be modified the terms
of this Agreement or any Order approving the Agreement or the agreements or
documents referenced herein, whether through the proposal or promulgation of a
Plan or Reorganization, or by requesting, moving for or acquiescing in the entry
of any stipulation or order in this or any successor bankruptcy proceeding.
(Emphasis added).
In Roxy, the debtor defaulted under this agreement, and the creditor proceeded to
foreclose on its real property collateral. Id. at 572–73. Immediately prior to the foreclosure sale,
however, the debtor filed a second Chapter 11 petition. Id. In granting the creditor’s motion to
dismiss the second case, the court noted that “the stipulation[s and terms in the prior agreement]
expressly stated that [they] would survive succeeding bankruptcy filings.
Courts have
repeatedly found second bankruptcy filings to be in bad faith when they represent attempts to
rescind agreements made in the earlier bankruptcy filing.”
Id. at 577 (emphasis added).
Therefore, a provision of this type may provide an additional way for a creditor to argue for the
existence of bad faith in any serial filing by the debtor.
Similarly, in Elmwood Development Company, the court refused to allow the debtor to
renege on an earlier settlement agreement with a creditor. In re Elmwood Dev. Co., 964 F.2d at
513. The settlement, which was approved by the bankruptcy court, provided that the creditor
was to have immediate authority to proceed with foreclosure and was intended to be, as stated in
the agreement, “bankruptcy proof.” Id. at 510. Accordingly, the court held that a second
bankruptcy petition attempting to amend this plan was filed in bad faith. Id. Likewise, in
Weiszhaar Farms, Inc. v. Livestock State Bank, 113 B.R. 1017, 1021 (D.S.D. 1990), the court
found compelling the fact that the debtor was attempting to use a successive filing to “avoid
triggering the valid, judicially enforceable ‘drop-dead’ clause contained in the stipulation entered
into between the parties.” The court therefore dismissed the successive filing as having been
made in bad faith. Id. at 1023.
Accordingly, creditors should insist on the inclusion of a provision stating that the
agreement for repayment between the debtor and the creditor shall survive in perpetuity,
including in the event of a successive bankruptcy proceeding.
Although these types of
provisions may not be absolutely bulletproof—especially in a situation where a debtor can carry
its burden of proof that a subsequent case was filed in good faith and that the debtor faced an
unforeseeable and extraordinary change in circumstances that substantially impaired its ability to
perform under the confirmed plan—they will at least provide a creditor with another tool at its
disposal to argue for dismissal of a new Chapter 11 case.
B. From a Debtor’s Perspective
While Chapter 22 filings do not appear to be occurring in unusually large numbers or
proportions, the troubling fact remains that failure to reorganize does occur despite the feasibility
requirement under Section 1129(a)(11). With this in mind, what can debtors and their counsel
do to avoid the Chapter 22 scenario?
In an article published in the September, 2013 edition of the ABI Journal, turnaround
consultants Gina Gutzeit and John Yozzo analyzed the Chapter 22 filings of 19 large companies
(assets or liabilities greater than $50 million at initial filing) that originally filed for Chapter 11
during the Great Recession (2008-2009) but that failed again from 2010 onward. See Gina
Gutzeit and John Yozzo, What’s New With Chapter 22?, XXXII ABI Journal 8, 36-37, 74-76
September, 2013 (available at http://www.abi.org/abi-journal/whats-new-with-chapter-22).
Gutzeit and Yozzo found that “contrary to the broad perception that Chapter 22 filers often fail to
de-lever enough when they emerge from Chapter 11, these debtors mostly achieved very
significant levels of debt reduction in their initial reorganization; often, two-thirds of pre-petition
debt or more was eliminated.” Id. Gutzeit and Yozzo concluded that a common theme that
pervaded Chapter 22 filings were the financial projections underlying the debtors’ initial Chapter
11 plans, “forecasts that ultimately proved to be errant.” Id. Gutzeit and Yozzo noted that the
debtors often included “modest” low or no growth sale and operating margins in their disclosure
statement projections, when, in fact, severe business contraction was happening at the time. Id.
Gutzeit and Yozzo point out that such errant projections may have to do with both inherent
forecasting biases of the debtors and the severity and lingering duration of the Great Recession,
but for industries affected by severely disruptive change, the authors were struck by the inability
of some debtors to gauge the reorganization and profitability potential of their businesses. Id.
This was especially true for debtors involved in industries undergoing “paradigm-changing
events,” such as newspapers and yellow pages directories. As Gutzeit and Yozzo put it, “[i]t is
also likely that debtors are more predisposed than other constituents to the notion that tomorrow
will be a better day.” Id. In order to prevent quick re-failures, debtors must pay careful attention
to financial projections and their ability to meet such projections.
Conclusion
Creditors have a variety of tools at their disposal that can be used to preclude a debtor’s
ability to proceed with a Chapter 22 filing. Either through a motion to dismiss after a subsequent
Chapter 11 petition has been filed or through ex ante contractual provisions, creditors should be
able to effectively protect themselves against attempts by a debtor to avoid the obligations under
a confirmed and substantially consummated prior plan of reorganization.
In the case of
individual and small business Chapter 11 debtors, changes to Sections 362 and 1127 by
BAPCPA have made it particularly difficult—if not effectively impossible—for these debtors to
proceed with a Chapter 22 filing. Notwithstanding the foregoing, courts will allow Chapter 22
cases where the debtor is proceeding with an orderly liquidation that is in the best interests of
creditors. Courts will also allow Chapter 22 cases when the debtor can show that the subsequent
case was filed in good faith, and the debtor faced an unforeseeable and extraordinary change in
circumstances that substantially impaired its ability to perform under the prior confirmed plan.
Debtors face a difficult burden of proof to qualify for such exception, and only truly
extraordinary and unforeseen circumstances will qualify. The failure of the economy to live up
to the debtor’s expectation—especially in today’s market—will likely not be considered
extraordinary and sufficiently unforeseeable to shield a debtor’s Chapter 22 from dismissal.