Massachusetts Bankruptcy Court Adopts "Per Plan" Approach to Impaired Class Acceptance Requirement for Confirmation of Joint Chapter 11 Plan

If any class of creditors under a chapter 11 plan is "impaired," the Bankruptcy Code provides that the plan can be confirmed by the bankruptcy court only if at least one impaired class of non-insider creditors votes to accept the plan. This "impaired class acceptance" requirement—stated in section 1129(a)(10) of the Bankruptcy Code—is straightforward in cases involving a single debtor, or in cases where the bankruptcy estates of several debtors are "substantively consolidated" so that the assets and liabilities of each debtor are deemed to belong to a single consolidated entity.

However, the requirement is more difficult to apply in cases involving multiple affiliated debtors that propose a joint chapter 11 plan, but whose estates are not substantively consolidated, or are consolidated only for purposes of plan confirmation (sometimes referred to as "deemed substantive consolidation"). In such cases, the question is whether an impaired class of each debtor must accept the plan (the "per debtor" approach) or whether the acceptance of the joint plan by an impaired class of a single debtor, or fewer than all of the debtors, is sufficient (the "per plan" approach). This question is disputed among the courts. 

The U.S. Bankruptcy Court for the District of Massachusetts recently weighed in on this issue in In re NESV ICE, LLC, 2023 WL 2278603 (Bankr. D. Mass. Feb. 28, 2023). In a case where a chapter 11 plan provided that related debtors were deemed to be substantively consolidated, but would remain separate after confirmation of a joint chapter 11 plan, the court adopted the "per plan" approach. It also held that a junior secured creditor would not be deprived of its right to vote on the plan in accordance with a chapter 11 plan voting rights assignment in a prepetition subordination agreement.

"Per Debtor" Versus "Per Plan" Impaired Creditor Acceptance

Section 1129(a)(10) of the Bankruptcy Code provides that, if any creditor class is impaired under a chapter 11 plan, at least one impaired class must vote in favor of the plan, excluding any acceptance of the plan by an insider. This provision, which has been called the "statutory gatekeeper" to cramdown, must be satisfied for a chapter 11 plan to be confirmed either consensually or under the nonconsensual plan confirmation requirements set forth in section 1129(b). See In re 266 Washington Assocs., 141 B.R. 275, 287 (Bankr. E.D.N.Y.), aff'd, 147 B.R. 827 (E.D.N.Y. 1992). Thus, any chapter 11 plan, including a cramdown plan, cannot be confirmed in the absence of an accepting impaired class. 

Determining whether a plan satisfies section 1129(a)(10) is relatively easy in cases involving a single debtor and its classes of creditors (although even simple cases sometimes present the prospect of "artificial impairment" or "gerrymandering" to create an accepting impaired class). Making such a determination is more difficult, however, in complex chapter 11 cases, which commonly involve multiple debtors and joint chapter 11 plans.

In such cases, courts have been divided as to whether section 1129(a)(10) applies on a "per debtor" or "per plan" basis. If the requirement applies on a "per debtor" basis, at least one impaired class of creditors for each debtor would have to accept the plan for it to be confirmed. By contrast, the "per plan" approach requires only that at least one impaired class of creditors votes to accept the plan, irrespective of whether the creditors in the class hold claims against one, some, or all of the debtors

Another common aspect of chapter 11 cases involving multiple affiliated debtors is "substantive consolidation." Under this remedy, all assets and liabilities of multiple debtors are grouped together or consolidated to form a single estate to satisfy the claims of all creditors and interests of interest holders. Substantive consolidation is typically granted under circumstances where creditors dealt with affiliated debtors as a "single economic unit" or when the debtors' affairs "are so entangled that consolidation will benefit all creditors." In re Bonham, 229 F.3d 750 (9th Cir. 2000). When multiple debtors in a complex chapter 11 case have been substantively consolidated, the section 1129(a)(10) voting requirement is straightforward because the substantively consolidated entities are treated as a single debtor.

In multiple-debtor chapter 11 cases, the bankruptcy judges in the District of Delaware and the Middle District of Florida have adopted the "per debtor" approach when applying section 1129(a)(10). See In re Tribune Co., 464 B.R. 126, 182–83 (Bankr. D. Del. 2011), on reconsideration in part, 464 B.R. 208 (Bankr. D. Del. 2011), aff'd, 587 B.R. 606 (D. Del. 2018), aff'd, 972 F.3d 228 (3d Cir. 2020); In re Consol. Land Holdings, LLC, 2021 WL 3701799, *6 (Bankr. M.D. Fla. 2021); In re JER/Jameson Mezz Borrower II, LLC, 461 B.R. 293, 303 (Bankr. D. Del. 2011). In these cases, the courts reasoned that if the debtors' estates have not been substantively consolidated, the joint plan is effectively a separate plan for each debtor.

The U.S. Court of Appeals for the Third Circuit affirmed a Delaware bankruptcy court's adoption of this approach in Tribune. In Tribune, the bankruptcy court reasoned that, in multiple-debtor cases, the reference to "plan" in section 1129(a)(10) was an inadequate basis to "conclude that only one debtor—or any number fewer than all debtors—must satisfy [the] standard" under the provision because rules of construction under section 102(7) of the Bankruptcy Code state that "the singular includes the plural." See Tribune, 464 B.R. at 182. The court concluded that "plan" should be construed to consist of "plans" in conjunction with other subsections of section 1129 where the term "plan" is also used in the singular, but is understood to apply to all debtors in a multiple-debtor case. Id. at 183 (citing 11 U.S.C. § 1129(a)(1) (compliance with applicable provisions of the Bankruptcy Code); 11 U.S.C. § 1129(a)(3) (good faith requirement)). In addition, the bankruptcy court noted that the "best interest of creditors" test in section 1129(a)(7), which applies to every impaired class of creditors for each joint debtor, is compatible with the "per debtor" approach. Id.

The Tribune bankruptcy court also emphasized that "[i]n the absence of substantive consolidation, entity separateness is fundamental." Id. at 182 (citation omitted). The court acknowledged that large multiple-debtor cases are commonly jointly administered for convenience and that joint plans may be proposed for convenience because the plans propose a single distribution. Even so, the court explained, in cases involving nonconsensual chapter 11 plans, "convenience alone is not sufficient reason to disturb the rights of impaired classes of creditors of a debtor not meeting confirmation standards." Id. at 183.

By contrast, the U.S. Court of Appeals for the Ninth Circuit and a handful of bankruptcy courts have embraced the opposite view, ruling that the plain meaning of section 1129(a)(10) requires a "per plan" approach. See Grasslawn Lodging, LLC v. Transwest Resort Properties Inc. (In re Transwest Resort Properties, Inc.), 881 F.3d 724, 730 (9th Cir. 2018); In re Pacific Links U.S. Holdings, Inc., 2022 Bankr. LEXIS 5380, *19 (Bankr. D. Haw. May 13, 2022); In re Station Casinos, Inc., 2010 Bankr. LEXIS 5380, **82-83 (Bankr. D. Nev. Aug. 27, 2010); JPMorgan Chase Bank, N.A. v. Charter Commc'ns Operating, LLC (In re Charter Commc'ns), 419 B.R. 221, 266 (Bankr. S.D.N.Y. 2009); In re Enron Corp., 2004 Bankr. LEXIS 2549, **235-36 (Bankr. S.D.N.Y. July 15, 2004). 

In Transwest, the Ninth Circuit ruled, as a matter of first impression among the circuits courts of appeals, that section 1129(a)(10) applies on a "per plan" basis.

The Ninth Circuit examined the plain language of section 1129(a)(10) to determine whether the provision should apply on a "per plan" basis. The court reasoned that the provision "makes no distinction concerning or reference to the creditors of different debtors under 'the plan,' nor does it distinguish between single-debtor and multi-debtor plans." Transwest, 881 F.3d at 729. Rather, the court concluded, the section 1129(a)(10) cramdown threshold for a joint plan is satisfied where "a single impaired class accepts a plan." Id.

The Ninth Circuit panel rejected the lender's argument that the "per plan" approach had the effect of substantively consolidating the debtors and therefore would wreak havoc on mezzanine lenders who rely on debtors' separate existences for purposes of preserving their collateral. According to the court, "[S]uch hypothetical concerns are policy considerations best left for Congress to resolve." Id. at 730.

In a concurring opinion, Circuit Judge Friedland wrote that because the chapter 11 plan effectively merged the debtors without any assessment of whether substantive consolidation was appropriate, the lender's argument that it was unfairly deprived of the ability to object effectively to confirmation had some foundation. Even so, he noted, the lender failed to raise that objection in the bankruptcy court, choosing instead to rely on its objections under section 1129(a)(10). Id. at 731-33.

Assignment of Voting Rights in Intercreditor and Subordination Agreements

Generally, holders of allowed claims and interests have the right to vote to accept or reject a chapter 11 plan. See 11 U.S.C. § 1126(a). Claimants or interest holders whose claims or interests are not "impaired" under the plan (as defined in 11 U.S.C. § 1124), however, are deemed conclusively to accept the plan, and stakeholders who would receive nothing under the plan are deemed to reject it. See 11 U.S.C. §§ 1126(f) and (g). In addition, any holder of a claim or interest to which an objection has been filed does not have the right to vote the portion of the claim or interest objected to, unless the holder obtains an order temporarily allowing the claim or interest for voting purposes pending resolution of the merits of the objection. Unliquidated or contingent claims may be estimated for purposes of voting on a plan. See 11 U.S.C. § 502(c).

Subordination agreements among creditors specifying in advance how their competing claims against the borrower will be dealt with in terms of priority, receipt of payment, recourse to assets, and other related rights commonly include provisions that restrict or transfer the junior creditors' right to vote on a chapter 11 plan. Such assignments of plan voting rights are often included to maximize senior creditors' control over the plan process and enhance their ability to obtain confirmation of a plan they support.

A subordination agreement providing for subordination of debt or security generally is enforceable in a bankruptcy case pursuant to section 510(a) of the Bankruptcy Code, which provides that a subordination agreement is enforceable in a bankruptcy case "to the same extent that such agreement is enforceable under applicable nonbankruptcy law." 

Courts disagree over whether an assignment of plan voting rights in a subordination agreement is enforceable. Some courts have concluded that they are not. See, e.g., In re Fencepost Productions Inc., 629 B.R. 289, 295 (Bankr. D. Kan. 2021) (a provision in a pre-bankruptcy subordination agreement under which a subordinated creditor assigned to a senior creditor its right to vote on any chapter 11 plan proposed for the borrower was not enforceable because it conflicted with section 1126(a)); In re SW Bos. Hotel Venture, LLC, 460 B.R. 38, 52 (Bankr. D. Mass. 2011) (ruling that an assignment of plan voting rights was not enforceable and stating that "[a]lthough 11 U.S.C. § 510[(a)] provides for the enforceability of subordination agreements, such agreements cannot nullify provisions of the Bankruptcy Code [such as section 1126(a)]"), aff'd in part, rev'd in part, 479 B.R. 210 (B.A.P. 1st Cir. 2012), vacated on other grounds, 748 F. 3d 393 (1st Cir. 2014); In re Croatan Surf Club, LLC, 2011 WL 5909199, *2 (Bankr. E.D.N.C. Oct. 25, 2011) ("EFP is the holder of its claim, and therefore EFP is entitled to vote its claim. There is no reason to deviate from the plain language of § 1126(a)."); In re 203 N. LaSalle St. P'ship, 246 B.R. 325, 331 (Bankr. N.D. Ill. 2000) ("Subordination … affects the order of priority of payment of claims in bankruptcy, but not the transfer of voting rights."); In re Hart Ski Mfg. Co., 5 B.R. 734, 736 (Bankr. D. Minn. 1980) (noting that the right to participate in voting on a chapter 11 plan and "other rights related to contract priority of distribution pursuant to Section 510(a) cannot be affected by the actions of the parties prior to the commencement of a bankruptcy case when such rights did not even exist.").

Other courts have enforced such assignments of voting rights. See, e.g., In re Coastal Broad. Sys., Inc., 2013 WL 3285936, at *5–6 (D.N.J. June 28, 2013), aff'd, 570 Fed. App'x 188 (3d Cir. 2014); In re Avondale Gateway Ctr. Entitlement, LLC, 2011 WL 1376997, *4 (D. Ariz. Apr. 12, 2011); In re Erickson Ret. Cmtys., LLC, 425 B.R. 309, 316 (Bankr. N.D. Tex. 2010); In re Aerosol Packaging, LLC, 362 B.R. 43, 47 (Bankr. N.D. Ga. 2006).

NESV Ice

Attleboro, Massachusetts, ice rink operator NESV Ice, LLC (d/b/a New England Sports Village) and affiliates created to operate other sports-related venues (collectively, the "debtors") filed for chapter 11 protection on August 26, 2021, in the District of Massachusetts.

In 2016, HarborOne Bank ("HarborOne") provided approximately $11.5 million in construction and term loan financing to certain of the debtors secured by liens on substantially all of their assets. In 2019, Ashcroft Sullivan Sports Village Lender, LLC ("Ashcroft") loaned approximately $8 million to the debtors' (non-debtor) parent company, Ajax 5Cap NESV, LLC ("Ajax"), to be used in part to finance the debtors' construction projects. The loan was secured by junior liens on substantially all of the assets of all of the debtors except NESV Land East, LLC ("Land East").

In connection with the financing, Ashcroft and HarborOne entered into a subordination agreement providing in relevant part that Ashcroft authorized HarborOne:

[T]o take such action as may be reasonably necessary or appropriate to effect the subordination provisions and other rights and/or remedies granted to [HarborOne] in the Agreement (including, without limitation, in the case of [HarborOne], to file a proof of claim and to vote upon matters with respect to which [Ashcroft] may be able to vote in connection with any bankruptcy proceedings related to any of the Borrowers or Ajax).

In December 2020, HarborOne assigned its loans and the related subordination agreement to SHS ACK, LLC ("SHS"). 

The debtors, whose chapter 11 cases were jointly administered, and certain other plan proponents, including Ashcroft, proposed a joint plan of reorganization. The plan would restructure the SHS debt and resolve disputed contractor claims, including claims asserted by general contractor Construction Source Management, LLC ("CSM" and, together with SHS, the "objecting creditors") arising from the construction of the debtors' sports facilities beginning in 2016. The plan included a compromise and settlement of Ashcroft's junior secured claims against all debtors except for Land East, by which settlement Ashcroft's claims would be subordinated and converted to equity in the reorganized debtors.

The proposed plan included a "deemed substantive consolidation" provision stating that "the Reorganized Debtors shall continue to maintain their separate corporate existences for all purposes other than the payment of Claims as expressly provided for in the Plan." It further provided that the assets and liabilities of each debtor would be "merged" with the assets and liabilities of the other debtors "for the purposes of implementing the Plan and satisfying Allowed Claims as provided for in the Plan." 

In advance of the plan confirmation hearing, the objecting creditors argued that the proposed joint chapter 11 plan could not be confirmed because: (i) it did not comply with section 1129(a)(10), as Land East had no impaired accepting class of creditors, even though Ashcroft held impaired secured claims against the remaining debtors and had voted to accept the plan; (ii) the requirements for substantive consolidation of the debtors had not been met; and (iii) SHS was entitled to vote Ashcroft's claim in accordance with the terms of the subordination agreement.

The Bankruptcy Court's Ruling

As an initial matter, the bankruptcy court issued a "tentative ruling" on whether acceptance of a plan by an impaired class under section 1129(a)(10) should be considered on a "per debtor" or "per plan" basis.

U.S. Bankruptcy Judge Christopher J. Panos noted the split of authority among the courts regarding this issue and acknowledged that there is no controlling precedent in the First Circuit. He explained that if the plan proponents could demonstrate that substantive consolidation of the debtors was appropriate, the joint plan would pass muster under either view of the requirements of section 1129(a)(10). If not, Judge Panos concluded, the court would apply the "per plan" approach: 

While I have carefully considered the reasoning of the Tribune line of cases, I interpret § 1129(a)(10) to permit confirmation of a joint plan of reorganization where at least one class of impaired creditors of one debtor has accepted the plan under certain discrete circumstances where limited consolidation is proposed as a good faith means of implementing the plan…. I am cognizant that applying the "per plan" approach may allow for greater attempts at chicanery by plan proponents, but creditors are protected by judicial scrutiny of the business reasons for proposing a joint plan, the relationship of the debtors, and the importance of "entity separateness," the benefit to creditors of each estate, and whether any objecting party is prejudiced by the proposed limited consolidation other than a claim of prejudice because one or more of the debtors failed to obtain acceptance from a class of impaired creditors. In this case, it appears unlikely that it would be found that SHS or CSM are materially prejudiced by limited consolidation and application of the "per plan" rule as it relates to Land East.

NESV Ice, 2023 WL 2278603, at *19 (emphasis added).

Next, Judge Panos rejected the objecting creditors' argument that SHS was entitled to vote Ashcroft's claims under the parties' subordination agreement. He explained that, because the plan provided that Ashcroft would receive no distribution other than equity in exchange for its junior secured claim before payment in full of SHS's claims, it appeared, without deciding whether the distribution of equity interests might be subject to the provisions of the subordination agreement, that permitting SHS to vote Ashcroft's claim was not "reasonably necessary or appropriate" to effectuate the provisions of the subordination agreement.

In addition, Judge Panos determined that he need not enforce the intercreditor voting agreement included in the subordination agreement. He wrote that "provisions in such an agreement cannot invalidate applicable provisions of the Bankruptcy Code [i.e., section 1126(a)], and I would likely find the voting provision to be unenforceable" in accordance with the rulings in SW Boston, LaSalle, and other similar decisions. Id. 

Outlook

Although the bankruptcy court's rulings in NESV Ice were "tentative" and intended to provide guidance regarding the parties' preparation for the confirmation hearing on the debtors' joint chapter 11 plan, the decision is instructive for two reasons. First, the bankruptcy court adopted the "per plan" approach to section 1129(a)(10) even though the debtors' estates were deemed to be substantively consolidated only for purposes of plan confirmation. This approach gives debtors in multidebtor chapter 11 cases an easier road to cramdown confirmation of a joint chapter 11 plan, regardless of whether the debtors actually have been substantively consolidated. Although this is welcome news for debtors, it reignites the debate on the issue and creates additional uncertainty for debtors and creditors in jurisdictions where the courts have not addressed it.

Second, the bankruptcy court in NESV Ice signaled that it would not enforce a senior secured creditor's right to vote the claim of a junior creditor in accordance with the terms of a prepetition subordination agreement. In so ruling, the bankruptcy court joined with many other courts in concluding that a prepetition voting rights assignment cannot skirt the chapter 11 plan enfranchisement mandate in section 1126(a). 

Section 1129(a)(10) has long been a source of confusion and disagreement among bankruptcy courts presiding over multidebtor chapter 11 cases. So much so that the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 recommended that the requirement for an accepting impaired class be eliminated. See ABI Commission to Study the Reform of Chapter 11: 2012-2014 Final Report and Recommendations, 23 Am. Bankr. Inst. L. Rev. 1, 280-84 (2015). Nearly 10 years after the commission's final report, however, Congress has not been inclined to act on this recommendation.

Read the full Business Restructuring Review.