In Re Original IFPC Shareholders, Inc.
MEMORANDUM OPINION
The procedural history of this matter is relatively straightforward. The debtor-in-possession, Original IFPC Shareholders, Inc. (“IFPC”), incorporated under Illinois law in 1995 for the sole purpose of prosecuting a trade-secret-misappropriation claim against AT & T Wireless Devices, Inc. (“AT & T”) and Hughes Network Systems, Inc. in the Circuit Court of Du-Page County, Illinois (Case No. 93 CH 1065). The decade-old claim became one of two bankruptcy-estate assets after IFPC filed a Chapter 11 bankruptcy case on April 7, 2004. By that time two state court judgments had been entered in favor of the defendants. The first judgment resulting from a bench trial was reversed on appeal after the Appellate Court of Illinois found that the plaintiff had a right to trial by jury. The second trial was by jury; it produced the same result after a six-week trial in 2003, a verdict in favor of the defendants.
By means of its July 6, 2004 Chapter 11 Plan of Reorganization, IFPC intends to use the second estate asset, a bank account worth approximately $17,000, and expected post-petition investments of approximately $1,750,000 (given priority repayment status under the plan) to finance both an appeal seeking a third trial and the third trial, should the second adverse verdict get reversed on appeal. The proceeds from an IFPC triumph in a third trial would fund 100% payment of all allowed prepetition and postpetition claims plus interest under the proposed plan, with equity security holders retaining their ownership interests in the debtor corporation.
IFPC totaled the nonpriority unsecured claims in this case at $14,828,444, an amount which can be broken down into three groups: 1) a group of investors holding a “Promissory Note and Equity
The U.S. Trustee filed a “Motion to Convert or Dismiss Case” pursuant to 11 U.S.C. § 1112(b), arguing that IFPC did not file this Chapter 11 case in good faith, that it has no real need for business-reorganization bankruptcy relief, that its plan is both unconfirmable and unfeasible, and that the true creditor body (as opposed to shareholders) will not be well served by сontinued prosecution of the trade-secret-misappropriation claim in state court.
Discussion and Analysis
A. Continuing Loss and Inability to Rehabilitate under § 1112(b)(1)
As the first basis for dismissal or conversion to Chapter 7, the U.S. Trustee relies on § 1112(b)(1), which provides in pertinent part as follows:
(b) Except as provided in subsection (c) of this section, on request of a party in interest or the United States trustee ..., and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors and the estate, for cause, including—
(1) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation....
11 U.S.C. § 1112(b). Each of the two elements in subsection (1) must be present for this ground to apply. 7 Lawrence P. King et al., Collier On Bankruptcy ¶ 1112.04[5][a], at 1112-30 (15th ed. rev. 2004)
In this case, the debtor IFPC has continued to incur post-petition quarterly U.S. Trustee fees and administrative costs, primarily for legal representation in this bankruptcy ease, and will continue to incur costs of up to $1,750,000 for legal representation in the state court litigation (assuming it wins the first of at least two rounds) if IFPC concurrently remains in Chapter 11. It is undisputed that IFPC sells no goods or services to produce a cash flow to raise . this amount; IFPC would be required to gather post-petition investors to either lend this amount and/or buy additional stock. The U.S. Trustee, furthermore, has established the “continuing loss” element of § 1112(b)(1): IFPC has an ongoing negative cash flow resulting in a net decrease in value and no definite source of income.
See In re Citi-Toledo Partners,
The second “standard under section 1112(b)(1) is not the technical one of whether the debtor can confirm a plan, but, rather, whether the debtor’s business prospects justify continuance of the reorganization effort.” 7 King et al.,
supra,
¶ 1112.04[5][a][ii], at 1112-33. In a traditional Chapter 11 case, the second element, whether the debtor has a “reason
The Court concludes thаt cause for conversion or dismissal has been established under § 1112(b)(1).
B. Inability to Effectuate a Plan under § 1112(b)(2)
The U.S. Trustee similarly requests conversion or dismissal due to the debtor-in-possession’s “inability to effectuate a plan.” 11 U.S.C. § 1112(b)(2). Other courts have focused on two different types of issues in applying this standard: the existence of a viable business enterprise as well as the more technical Chapter 11 plan-confirmation standards. See 7 King et al., supra, ¶ 1112.04[5][b], at 1112— 34 to -39.
1. Feasibility Issues
As to the first type of issue, it overlaps with the plan-confirmation requirement of § 1129(a)(ll), which mandates that “[c]on-firmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.” 11 U.S.C. § 1129(a)(ll). On either account, it is significant that the debtor has no marketable goods or services аnd no other types of income-producing investments that would sustain payments to pre-petition and post-petition creditors if any
To prevail, the U.S. Trustee must meet his burden of proof by a pre
2. Plan-Confirmation Obstacles
The second type of issues under § 1112(b)(2) is the kind relating to Chapter 11 plan-confirmation standards that could not reasonably be satisfied by the debtor-in-possession’s proposed reorganization plan.
See Matter of Woodbrook Associates,
For instance, under the plan, “Class 4-Priority Claims of Post-Petition Investors” consists of those who will be funding the aforementioned $1,750,000 ($250,000 plus $1,500,000) and will be repaid 100% plus interest before Class 5, consisting of general unsecured pre-petition creditors, will be paid.
7
Class 6 and Class 7 consist of two other types of pre-petition general unsecured creditors, including certain promissory note holders and AT & T’s and Hughes’ contingent and unliquidated claims for prevailing-defendant court costs. Most critically, the plan goes on to provide that after the Class 5 creditors are paid in full — but not after the Classes 6 and 7 creditors are paid in full — the Class 4 claimants will receive an additional 2000% payment on their claims, for a total payment of 2100%. Although the plan is not clear in this respect, the extra 2000% payment either trumps Class 6’s and Class 7’s right to full payment, or it dilutes the pool of money that (the debtor-in-possession assumes) will be available to pay the unsecured creditors of Class 6 and Class 7. This arrangement is problematic for either of two reasons. According to § 1129(a)(7), each Chapter 11 plan claimant under Class 6 and Class 7 is entitled at least to an amount, in present value terms, that is equal to what it would receive had IFPC been liquidated under Chapter 7. Because the fate of the debtor’s primary asset, the cause of action, is highly speculative, this
Further, if any one of Classes 5, 6, and 7 votes to reject the plan, § 1129(a)(8) will not be satisfied, and § 1129(b)(1) will be brought into play before the Court may confirm the plan. The latter provision prevents unfair discrimination between classes of unsecured claimants, especially where the disparity between the recovery percentages of those classes is large.
See, e.g., In re Aztec Co.,
Another significant obstacle to plan confirmation is section “XIII. Dischargе,” which provides as follows:
Upon satisfaction of the allowed claims in this case, the Debtor, along with any and all co-debtors of the Debtor, shall be discharged of any and all obligations owed any such claimant, creditor, or other party in interest, providing any such claimant, creditor, or other party in interest votes affirmatively on the Plan, irrespective of whether any such claimant, creditor, or party in interest filed a proof of claim. Upon confirmation of the Debtor’s Plan in this case, with said affirmative vote of those voting on the plan, any such claimant, creditor, or other party in interest shall be stayed from proceeding against any and all co-debtors of the Debtor, irrespective of whether any such claimant, creditor, or party in interest filed a proof of claim.
(IFPC Plan of Reorg. at 8.) This provision is difficult to reconcile with the Bankruptcy Code in a couple of respects and additionally creates an ambiguity with regard to those voting to reject the plan. The first sentence could be read to imply that the extremely broad discharge injunction will not issue with respect to rejecting
To be sure, the Seventh Circuit has distinguished third-party releases in Chapter 11 plans from the limitations on the discharge injunction in § 524(e), refusing to adopt a
per se
rule against the former.
See Matter of Specialty Equipment Companies,
(1) There is an identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate; (2) The non-debtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor; (4) The impacted class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; (6) The plan provides an opportunity for those claimants who choose not to settle to recover in full....
In re Dow Corning Corp.,
Even under the unsettled, more permissive views of third-party Chapter 11 plan injunctions, the plan injunction here does not pass muster. The second sеntence of section XIII is so broad as to enjoin all nonconsenting creditors from seeking outside monetary relief against “any and all co-debtors of the Debtor,” who remain unidentified. Thus, the third-party injunction is nonconsensual as to AT & T, Hughes, and any other creditor voting against the plan. Further, under the
Dow Coming
and
Master Mortgage
criteria, the plan injunction against nondebtors could not be approved inasmuch as no disclosed information would permit a favorable finding on any of the first three required elements.
Cf. Matter of Woodbrook Associates,
The discharge of nondebtors is just the first of two infirmities in paragraph XIII of the plan. Regarding the other infirmity, the Bankruptcy Code provides as follows:
The confirmation of a plan does not discharge a debtor if—
(A) the plan provides for the liquidation of all or substantially all of the property of the estate;
(B) the debtor does not engage in business after consummation of the plan; and
(C) the debtor would be denied a discharge under section 727(a) of this title if the case were a case under chapter 7 of this title.
11 U.S.C. § 1141(d)(3);
see also Great American Pyramid,
IFPC’s plan violates § 1141(d) of the Bankruptcy Code by granting the debtor-in-рossession a discharge to which it is not entitled and, therefore, is facially uncon-firmable. See 11 U.S.C. § 1129(a)(l)-(2). All that remains to be done, regardless of the Code chapter, is to prosecute a third trial (if and when the same is awarded and the necessary funds materialize) and then close shop and distribute the cash proceeds (if any) of the suit. Such an operation is a liquidation; it does not entail “engagfing] in business after consummation of the plan.” § 1141(d)(3). This determination is a federal statutory question; whether the activity is legal under Illinois corporate law is irrelevant.
On one last minor matter, the Court does not agree with AT & T that IFPC’s plan violates the “absolute priority rule” by allowing all shareholders to retain their equity interests. The feasibility and likelihood of IFPC’s future payment of AT
&
T’s contingent debt has been rightly called in doubt, but such considerations are sepa
IFPC did not defend against the U.S. Trustee’s motion and AT
&
T Wireless’s support thereof by offering any amendments to the filed Chapter 11 plan; the Court has no other plans to consider in this case. Also, “[a] Chapter 11 case can be dismissed at any time. Creditors need not wait until a debtor proposes a plan or until the debtor’s exclusive right to file a plan has expired.... The very purpose of § 1112(b) is tо cut short this plan and confirmation process where it is pointless.”
Matter of Woodbrook Associates,
3. Conclusion
As an alternative to its ruling under § 1112(b)(1), the Court finds that the U.S. Trustee has established grounds for dismissal or conversion under § 1112(b)(2), as the debtor-in-possession is unable to effectuate its Chapter 11 plan.
C. Unenumerated Grounds Establishing “Cause” for Conversion or Dismissal, Including Lack of Good Faith in Filing a Chapter 11 Case
The U.S. Trustee argued in his reply brief and at the hearing on the motion that the circumstances of the present case demonstrate that the debtor has not met the good-faith filing requirement, because IFPC has no legitimate need for reorganization under Chapter 11, only a need to prevent itself from being sued for collection of prior litigation expenses.
While § 1112(b) permits involuntary dismissal or conversion for a non-exhaustive list of ten grounds, its general authority to dismiss “for cause” has engenderеd the development of common-law grounds for dismissal. Accordingly, federal courts have created a good-faith filing requirement for debtors opposing dismissal or conversion under § 1112(b).
See In re Marsch,
Courts generally consider the totality of circumstances surrounding a variety of objective and subjective indicators.
See, e.g., In re Stump,
Several, but not all, of the following conditions usually exist. The debtor has one asset, such as a tract of undeveloped or developed real property. The secured creditors’ liens encumber this tract. There are generally no employees except for the principals, little or no cash flow, and no available sources of income to sustain a plan of reorganization or to make adequate protection payments pursuant to 11 U.S.C. §§ 361, 362(d)(1), 363(e), or 364(d)(1). Typically, there are only a few, if any, unsecured creditors whose claims are relatively small.... Alternatively, the debtor and one creditor may have proceeded to a stand-still in state court litigation, and the debtor has lost or has been required to post a bond which it cannot afford. Bankruptcy offers the only possibility of fоrestalling loss of the property....
Resort to the protection of the bankruptcy laws is not proper under these circumstances because there is no going concern to preserve, there are no employees to protect, and there is no hope of rehabilitation, except according to the debtor’s “terminal euphoria.” The Sixth Circuit in [In re] Winshall Settlor’s Trust, 758 F.2d [1136] at 1137 [(6th Cir.1985)], aptly noted that [t]he purpose of Chapter 11 reorganization is to assist financially distressed business enterprises by providing them with breathing space in which to return to a viable state. See In re Dolton Lodge TrustNo. 35188, 22 B.R. 918 , 922 (Bankr.N.D.Ill.1982). “[I]f there is not a potentially viable business in place worthy of protection and rehabilitation, the Chapter 11 effort has lost its raison d’etre. ...” In re Ironsides, Inc.,34 B.R. 337 , 339 (Bankr.W.D.Ky.1983).
Matter of Little Creek Development Co.,
(1) the debtor has only one asset;
(2) the debtor has an ongoing business to reorganize;
(3) there are any unsecured creditors;
(4) the debtor has any cash flow or sources of income to sustain a plan of reorganization or to make adequate protection payments; and
(5) the case is essentially a two party dispute capable of prompt adjudication in state court.
In re St. Paul Self Storage Ltd. Partnership,
While IFPC is correct that a dеbt- or is eligible for Chapter 11 relief even though it does not maintain an ongoing business,
12
the Supreme Court’s acknowl
The Supreme Court also recognized that under various circumstances the “estate will be worth more if reorganized under Chapter 11 than if liquidated under Chapter 7.”
Toibb,
IFPC is more optimistic about its prospect for “rehabilitation,” maintaining that new investors have committed $250,000 to permit pursuit of the second appeal in state court. However, the “rehabilitation” label could be loosely attached to virtually any type of activity in a bankruptcy case, even though the absence of any true business activity would not warrant a traditional reorganization analysis of preserving going-concern value to benefit creditors and еmployees in the long run.
Cf. Integrated Telecom Express,
Liquidation under the present circumstances is nothing more than what would have occurred outside bankruptcy: litigating a cause of action through to judgment and, if any proceeds exist at the end of the day, distributing the proceeds according to nonbankruptcy law. As this Court recognized in the Chapter 7 context of
In re American Telecom Corp.,
Although its practical import is unclear, IFPC’s best argument is that a few of the litigation-consultant creditors will sue, execute, and have a sheriffs sale of the primary asset to satisfy their debts, leaving the other creditors no assets from which to collect and no
pro rata
share of the asset that did exist (whatever it is worth). The Court acknowledges in this case-and has acknowledged the same in the Chapter 7 context,
see American Telecom,
As an alternative to its rulings under § 1112(b)(1) and (b)(2), the Court finds that “cause” for conversion or dismissal has been established in that this Chapter 11 case was filed in bad faith, as an understanding of that term has developed under the Bankruptcy Code.
D. Choosing Betweеn Conversion and Dismissal of Chapter 11 Cases Under § 1112(b)
Once “cause” is established under § 1112(b), the choice between dismissal and conversion to Chapter 7 is based on the best interests of creditors and of the estate.
See Quarles v. U.S. Trustee,
The Court has considered conversion to Chapter 7 but has concluded that at the present time, a Chapter 7 case would not serve any substantial purpose. One of
As for the other asset, the trade-secret claim, it is technically property of the еstate available for the benefit of creditors in a Chapter 7 forum,
see
11 U.S.C. § 541, and the preexisting trial and appellate attorneys could be retained by the estate under § 327(e) for the limited, special purpose of prosecuting the claim in state court. Although the estate may abandon to the debtor burdensome assets of inconsequential value in the bankruptcy scenario,
see
11 U.S.C. §§ 554(a)-(c)
&
§ 362(c)(1);
Great American Pyramid,
Finally, one other problem identified above must be considered here: namely, that all creditors may be worse off if a few creditors begin suing and executing on the bank account and/or the trade-secret cause of action, leaving other creditors no possibility of recovery. At least right now, the Court is not aware that this dilemma exists, and it is unlikely to exist as most of those creditors are case professionals who have an interest in maintaining the status quo. Should this true bankruptcy concern come to pass, though, IFPC may still choose to file a voluntary Chapter 7 case in spite of the Court’s dismissal of its Chapter 11 case; alternatively, affected creditors may initiate an involuntary Chapter 7 case to protect their interests. In these scenarios, even if the trustee abandons the cause of action, he could still be persuaded by concerned creditors to delay dismissing or closing the bankruptcy case until the state court litigation is finally resolved, thereby preserving the automatic stay to protect the creditor body from the acts of individual creditors who might sue IFPC to the detriment of all creditors.
See
11 U.S.C. § 362(c)(2)
&
(a)(l)-(2) (defining the temporal scope of that portion of the automatic stay protecting the debtor personally rather than the estate property);
cf.
§ 362(c)(1) & (a)(3)-(4) (temporal scope of the automatic stay protecting estate property). Similarly, if IFPC’s primary asset ever produces any proceeds, but such proceeds are inadequate to pay all debts in full, a voluntary or involuntary Chapter 7
Conclusion
For the foregoing reasons, the U.S. Trustee’s motion to dismiss this Chapter 11 case is granted. This opinion constitutes findings of fact and conclusions of law under Bankruptcy Rule 7052. A separate order consistent with the opinion will be entered in compliance with Bankruptcy Rule 9021.
Notes
. Approximately 87 persons invested around $14,000,000.
. Approximately 18 creditors hold around $750,000 in litigation-related claims.
. "In the argument that followed the hearing in this case, counsel for N.R. suggested that this apparent shortfall would be made up from the proceeds of N.R.’s state court action against the title company, but no evidence was presented [by the debtor-in-possession] to allow for any valuation of that lawsuit.”
In re N.R. Guaranteed Retirement,
. "However honest in its efforts the debtor may be, and however sincere its motives, the District Court is not bound to clog its docket with visionary or impracticable schemes for resuscitation.”
Tennessee Pub. Co. v. American Nat. Bank, 299
U.S. 18, 22,
. A reorganization plan under chapter 11 must be more than a nebulous speculative venture and must have a realistic chance of success which would lead to rehabilitation, and if outside financing is needed, it must be clearly in sight.
In re K.C. Marsh Co., Inc., 12 B.R.
401 (Bankr.D.Mass.1981). The Bankruptcy Code does not guarantee successful reorganization, nor does it provide a framework within which the debtor may indefinitely opei'ate; rather, it only provides a breathing period for the debtor to seek to reorganize.
In re Jones,
In re Great American Pyramid Joint Venture,
.As the court in Imperial Heights Apartments so aptly stated:
At best, the estate consists only of an alleged cause of action for a lawsuit claiming a tenuous equity in an apartment complex. There is not even an insinuation that capital is available to fund a viable plan of reorganization, nor even to bear typical administrative expenses. Such absence of an economic entity reflects both upon "the reasonable likelihood of rehabilitation” and the "inability to effectuate a plan.”
Matter of Imperial Heights Apartments, Ltd.,
. In different contexts, this Chapter 11 case has presented confusing questions of what is debt and what is equity. Here, Chapter 11 plan Class 4 appears to provide treatment for some sort of administrative claims entitled to priority payments under the plan, meaning that the class claimants do or will presumably hold some sort of postpetition, pre-con-firmation debt instrument. However, the aforementioned July 21, 2004 chart lists the individuals contributing the $250,000 for the appeal costs as the "New Capitol [sic] List,” implying that these investors are purchasing stock in the debtor-in-possession rather than loaning money.
Corporate debtors can issue new securities upon confirmation of a Chapter 11 plan, 11 U.S.C. §§ 1123(a)(5)(J) & 1129(a)(4), but that type of new interest is completely different from a priority administrative expense claim in a bankruptcy case — a claim that could never accrue after Chapter 11 plan confirmation, see 11 U.S.C. §§ 503(b), 364(a)-(c), 507(a)(1), & 1129(a)(9)(A).
. There is no question that as far as true administrative claims are concerned, 100% of the claim amount would have priority over the claims, of general unsecured pre-petition creditors. See 11 U.S.C. §§ 503(b), 507(a)(1), 1129(a)(7)(A) & (a)(9)(A). Here, we are dealing with 2100% of the claim amount.
. If, outside of bankruptcy, Class 4 would actually be considered to cоnsist of shareholders under Illinois corporate law, then the right to such a dividend would, of course, come behind the creditors’ claims of Classes 5, 6, and 7, and the payment scheme under this Chapter 11 plan would be even more unfairly discriminatory than just described.
. "The Court cautions the Gentle Reader that a permanent injunction is a rare thing, indeed, and only upon a showing of exceptional circumstances in which the factors outlined above are present will this Court even entertain the possibility of a permanent injunction."
In re Master Mortg. Inv. Fund,
. The inquiry is important as a result of the very different legal rights that creditors and equity security holders have under the Code.
See
11 U.S.C. § 101(10), (16), & (17); § 726(a)(2) & (6); § 1129(a)(7)(A). While a bankruptcy trustee owes a fiduciary duty both to creditors and shareholders, the duty to creditors takes precedence over the duty to shareholders as a result of creditors' legаlly superior interests under federal bankruptcy law.
See Commodity Futures Trading Com’n v. Weintraub,
. Whether an entity such as IFPC is a lawful corporation existing in good standing under the State of Illinois (as stressed by IFPC) is a separate legal question from whether its reor-ganizational objectives are entitled to continuing protection under Chapter 11. Whether pursuit of a cause of action is a legitimate activity in and of itself is beside the main point of the federal law embodied in § 1112.
. During a later post-trial stage of the game, a Chapter 7 case or a nonbankruptcy workout/settlement could ration out the funds if the proceeds of the lawsuit were insufficient to satisfy the aggregate amount of claims.
. "The fact that these insiders were willing to purchase the assets outside of bankruptcy undercuts any argument that the protections of the Code affected the purchase price.”
Integrated Telecom Express,