Two Subchapter V Plan Confirmation Standards: (i) Chapter 7 Liquidation, & (ii) Unfair Discrimination (In re Lapeer Aviation)

By: Donald L Swanson

Every now and then we get an example of how a process should work.

That’s exactly what we have, regarding confirmation of a contested Subchapter V plan, in the case of In re Lapeer Aviation, Inc., Case No. 21-31500 in the Eastern Michigan Bankruptcy Court.

In an opinion issued October 12, 2022, (Doc. 264), the Lapeer Court declares that, (i) most of the plan confirmation standards are satisfied, but (ii) the plan is deficient under two confirmation standards and, therefore, cannot be confirmed.

What follows is a summary of the Court’s analysis of the two confirmation deficiencies and of how the parties then work together to get the two deficiencies resolved.

Facts

Debtor gets its revenue from operating an airport, from running a flight school at the airport, and from selling, installing and servicing electronic equipment for airplanes.

Debtor files its voluntary Chapter 11 petition and its Subchapter V Plan of Reorganization. The Plan provides for distribution of the following funds to creditors:

• all of Debtor’s net disposable income for five years; and
• the proceeds, if any, of certain litigation claims.

Various creditors object to confirmation of the Plan.

In evaluating the Plan, the Court declares [fn. 1] that, while most of the confirmation standards are met, deficiencies under these two separate standards require denial of confirmation:

• Chapter 7 liquidation; and
• Unfair discrimination.

Chapter 7 liquidation standard

The “best-interests-of-creditors” standard—in § 1129(a)(7)—requires that an impaired class receive under the plan at least what that class would receive in a chapter 7 liquidation.[Fn. 1]

Regarding this standard, Debtor’s President testifies that five claims/lawsuits against third parties should produce combined recoveries of $2 million for the bankruptcy estate.

In an attempt to satisfy the Chapter 7 liquidation standard, the Plan provides these three points:

• Should Debtors elect to pursue these Causes of Action after confirmation, the Debtors have devoted the net proceeds towards the payment of up to 100% of Allowed Unsecured Claims;
• It is assumed that a Chapter 7 trustee is very likely to abandon these Causes of Action as a result of the time-consuming litigation which would be required to recover and the uncertainty associated with collection; and
• Accordingly, the Debtors have assumed that these Causes of Action are more valuable to Beneficiaries if administered under this Plan as compared to a liquidation.

The Court rules, regarding the Chapter 7 standard, like this:

• Given the $2 million value testimony, the Court must assume that a Chapter 7 trustee would pursue and liquidate the claims—accordingly, the “best-interests-of-creditors test” requires that the claims be pursued; but
• The Plan provides no assurance that Debtors will pursue the claims—in order for the Plan to be confirmed, it must:
  • provide for pursuit of the claims by Debtor and also grant derivative standing to other interested parties to pursue such claims, if Debtor fails to adequately do so; and
  • require Debtor or other interested parties to seek Court approval, if they wish to settle or abandon the claims.

Unfair discrimination standard

“Unfair discrimination” is a standard for non-consensual confirmation of a Subchapter V plan—under § 1191(b).[Fn. 2]

The term “unfair discrimination” is not defined in the Bankruptcy Code. However, the purpose of the requirement is to ensure that the value a dissenting class receives will equal the value given to other similarly situated classes.

–Sixth Circuit test

One test, followed by courts in the Sixth Circuit, creates a rebuttable presumption that a plan unfairly discriminates when there is:

• a dissenting class;
• another class of the same priority; and
• a difference in the plan’s treatment of the two classes that results in either:
  • a materially lower percentage recovery for the dissenting class (measured in terms of the net present value of all payments); or
  • regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution.

–Ruling and rationale

The two classes at issue are Class VI and Class VIII, each of which is comprised of one equity security holder:

• Class VI is comprised of the ownership interest of Gene Kopczyk; and
• Class VIII is comprised of the ownership interest of Carl Jennings.

Despite both classes being comprised of equity security holders:

• The Class VI claim holder, Kopczyk, retains his ownership interest; but
• The Class VIII claim holder, Jennings, is required to relinquish his ownership interest in exchange for a cash payment of $15,000.

The only difference between these two classes is that Class VI’s Kopczyk has management and control rights over Debtor, while Class VIII’s Jennings does not.

The Plan’s differing treatment of the two ownership classes has the potential, in light of Plan projections, to result in a materially lower percentage recovery for Jennings—the elimination of his ownership interest for a $15,000 payment would deprive Jennings of any recovery from the lawsuits.

The discriminatory treatment afforded to Jennings is, therefore, unfair.

–Debtor’s arguments are rejected by the Court

Debtor argues that the unfair discrimination issue is not properly before the Court because Jennings did not raise the issue.

• The Court responds—while it is true that no one raised this argument, the Court is still bound by Subchapter V’s plan confirmation statute and cannot confirm a plan which unfairly discriminates between similarly situated classes.

Debtor also argues that the Bankruptcy Code permits discrimination: it only prohibits unfair discrimination, and the discrimination here is fair because of, (i) the difference in management and control of Debtor (Kopczyk has it, and Jennings doesn’t), and (ii) Jennings’s efforts to undermine Debtor’s reorganization efforts, oppose Debtor’s discharge, and cancel Debtor’s contracts.  

• The Court responds—this argument is not compelling because:
  • Asserting colorable legal positions is seldom, if ever, grounds for discriminating between similar classes;
  • If Jennings interferes in the operations or management of Debtor, there are Code-based remedies available; and
  • Accordingly, the proposed discriminatory Plan treatment is not fair.

Stipulated Confirmation Order

In response to the Court’s ruling on confirmation, Debtor files its Third Amended Plan (Doc. 267).  The amended plan contains the following provision:

• “4.6.1  Treatment of Class VI Claims.  Gene Kopczyk and Carl Jennings shall retain their Claims of Interest in the Debtor.”

Additionally, the disputing parties get together and agree upon a stipulated confirmation Order (Doc. 272).  The stipulated Order includes the following provisions:

• “Debtors shall obtain permission of the bankruptcy court before any of the causes of action listed in the amended exhibit A to the Third Amended Plan are settled or abandoned”; and
• “the request for confirmation of the Third Amended Plan is GRANTED.  The Thrid Amended Plan is hereby CONFIRMED pursuant to 11 U.S.C. § 1191(b).”

Conclusion

The In re Lapeer Aviation, Inc., case is an example of how the Subchapter V confirmation process should work:

• The Court requires satisfaction of all confirmation standards for a Subchapter V plan; and
• The parties work together to achieve a resolution of their disputes.

Kudos to all involved in the case!

———————

Footnote 1.  11 U.S.C. § 1129(a)(7) provides the following plan confirmation standard (emphasis added):

“(7) With respect to each impaired class of claims or interests—(A) each holder of a claim or interest of such class—(i) has accepted the plan; or (ii) will receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date.”

Footnote 2.  11 U.S.C. § 1191(b) provides the following plan confirmation standard (emphasis added):

“(b) . . . the court, on request of the debtor, shall confirm the plan notwithstanding the requirements of such paragraphs if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.