A secured creditor (MTGLQ) challenged the votes of another creditor that purchased claims on the grounds that either (1) the creditor should be treated as an insider or (2) it cast its votes in bad faith. The votes were important because the debtor wanted to count them in meeting a requirement under the Bankruptcy Code that its plan of reorganization be accepted by at least one impaired class without counting votes of insiders.
MTGLQ itself attempted to buy the claims of a creditor (Bresco) that had installed a wireless internet system and security cameras at the debtor’s apartment complex. It got as far as sending a check to Bresco for full payment of its claim. However, Bresco’s principal became uncomfortable with what he perceived to be inconsistencies in MTGLQ’s offer. So he voided and returned the check, stating that he wasn’t interested in selling. MTGLQ then filed an adversary proceeding to contest the validity and priority of the Bresco claims. Another company, The Security Network (TSN), subsequently contacted Bresco and acquired the claims.
Key facts include the following:
- The owner of TSN (Mr. Alexander) said that he bought the claims in the hope that TSN would obtain future work from the debtor.
- Mr. Alexander was familiar with the equipment that secured the Bresco claims and had inspected it prior to payment for the claims.
- He was aware of the MTGLQ litigation challenging the purchased claims.
- He also considered members of the debtor to be friends – having known one member (Mr. Chester) since childhood and a second member (Mr. Armstrong) since high school.
- Mr. Chester personally offered to reimburse any attorney fees incurred by TSN in the bankruptcy case.
- TSN was not required to vote the claims in any particular manner.
As summarized by the court: “In constructing and obtaining acceptance of a plan, debtors can negotiate, compromise and pursue settlement offers. Debtors, however, cannot solicit votes, either formally or informally, prior to the publication of a disclosure statement and plan. … Further, debtors cannot ask creditors to vote in favor of a plan.”
MTGLQ made several arguments based on the relationship between Mr. Alexander (TSN principal) and Mr. Chester and Mr. Armstrong (debtor principals):
- One theory was that the debtor controlled TSN as a result of the friendship among the principals, so that TSN should be considered an insider of the debtor. (In that case, TSN’s vote would not count in meeting the requirement for an impaired accepting class.)
- Alternatively, under Section 1126(e) of the Bankruptcy Code, a court may designate “any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the requirements of [the Bankruptcy Code].”
In reviewing the evidence, the court concluded there was no credible evidence that Mr. Alexander was coerced into purchasing the claims or promised that TSN would receive more than it was entitled to under the plan, and the promise to pay legal fees was an obligation of Mr. Chester personally, as opposed to the debtor.
Instead, the court found that Mr. Alexander based his decision to acquire the claims on the desire to position TSN for future work and his knowledge of the equipment that secured the claim. The court further found that the parties did not discuss how the claim should be voted and a favorable vote was not required to obtain future work.
Parties should be aware that a debtor cannot strike a side deal or promise individual creditors more than is provided in the plan in order to achieve confirmation. They should also keep in mind that challenges to the propriety of a vote can sometimes be difficult to defend since they involve a determination of motivation.
Vicki R. Harding, Esq.