A recent Chapter 11 reorganization case gives creditors more incentive to raise plan confirmation-related objections at the disclosure statement hearing before the plan is presented for confirmation. The authority is particularly useful if the creditor’s intention is to obtain relief from the stay to foreclose on the basis that a plan is not feasible or to defeat an effort to “cram-down” a restructured debt.  In July, the Third Circuit Court of Appeals upheld the conversion of a Chapter 11 case to a Chapter 7 at the disclosure statement stage where a creditor demonstrated that the debtors’ plan of reorganization was patently unconfirmable.  See In re Am. Capital Equip., LLC, 2012 U.S. App. LEXIS 15333 (3d Cir. 2012).    

In the In re Am. Capital Equip. case, the debtors proposed a plan to pay creditors’ claims from a surcharge the debtors would receive from recoveries on asbestos litigation claims against the debtors.  Since the debtors’ insurance policies obligated them to cooperate with their insurers in defending against those same asbestos claims, an inherent conflict existed:  the defendant debtors would only receive plan funding to the extent they lost or settled the cases brought by asbestos claimants.  The insurers therefore argued that if the plan were confirmed, the debtors would be motivated to weaken their defenses against asbestos-related claims just to receive funding.   

The appellate court found that the debtors’ proposed plan was patently unconfirmable because it failed to satisfy the feasibility and good faith confirmation requirements under 11 U.S.C. § 1129.  The plan relied on speculative future litigation and created an inherent conflict of interest.  Because the plan was patently unconfirmable and the debtor conceded it had no alternative plan, the court also approved the conversion of the case to Chapter 7 without proceeding to a formal confirmation hearing. 

This decision affords creditors more leverage earlier in a Chapter 11 case because they can now seek to curtail the time-consuming and expensive hearings on plan confirmation if they can demonstrate at the disclosure statement stage that a debtor’s plan is patently unconfirmable.  Should you have any questions and need assistance in evaluating a proposed plan of reorganization, please feel free to contact us.