Notice, Notice, Notice: When Is a Plan of Reorganization Not Binding?

In re Puchi Properties Inc., 601 B.R. 677 (Bankr. D. Ariz. 2019) –

A chapter 11 trustee filed a motion with the bankruptcy court seeking to enforce a confirmation order and to compel a tenant to comply with terms of the plan of reorganization. The bankruptcy court addressed both jurisdiction and confirmation issues.

About three months prior to the bankruptcy the tenant entered into a lease with the debtor and a third party as 50-50 co-landlords. The lease provided for rent of $8,000 per month for the first five years of the term with one half of each rent payment to be made directly to each co-landlord. The debtor included the lease in its bankruptcy schedules, although neither the tenant nor its counsel was added to the debtor’s master mailing list.

Relevant events include the following:

  • May 28, 2014: About two months after the February 2014 bankruptcy filing the tenant sent a letter to the debtor’s principal attempting to terminate the lease.
  • July 8, 2014: The trustee notified the tenant’s counsel that he was formulating a plan of reorganization and needed copies of the lease.
  • July 14, 2014: Debtor’s counsel informed the trustee that it did not believe the property was an asset of the bankruptcy estate and that the debtor may have materially breached the lease so that it was no longer effective.
  • July 29, 2014: The trustee filed a stipulated motion authorizing the tenant to pay certain amounts it had withheld pursuant to writs of garnishment against the debtor and to pay future rent directly to the trustee. After notice and a hearing, the court approved the stipulation. Although a party to the stipulation, the tenant was not given notice of the hearing and its counsel did not appear.
  • July 30, 2014: The trustee responded to the tenant’s counsel that he was trying to determine ownership of the leased property and planned to bring a fraudulent transfer lawsuit to bring the debtor’s 50% ownership interest back into the bankruptcy estate if necessary. The trustee further asserted that there had not been any breach of the lease.
  • May 11, 2015: A plan of reorganization was filed by the trustee that (1) no unexpired leases were rejected; (2) if a party to a lease being assumed under the plan objected, it was required to file a written statement by the deadline for confirmation objections; and (3) parties failing to submit a timely statement were deemed to have waived objection to the proposed lease assumption.
  • November 4, 2015: The court held a confirmation hearing, at which time all objections were resolved and the court determined the plan was confirmable.
  • March 11, 2016: The court entered a confirmation order. The order confirmed the plan with a couple of modifications, including one that vested one-half of the fee title to the property in the reorganized debtor effective nunc pro tunc as of April 14, 2013.
  • March 28, 2016: The plan became effective, and scheduled leases were assumed.
  • November 27, 2017: The tenant sued the debtor in state court regarding the rights, obligations and liabilities of the parties under the lease.
  • January 12, 2018: The trustee filed a motion in bankruptcy court asking the court to enforce the confirmation order and compel the tenant to comply with the terms of the plan.

The trustee conceded that he did not serve the tenant with the plan solicitation package, formal notice of the confirmation hearing or the deadline for plan confirmation objections. Surprise, surprise – the tenant did not file an objection to the proposed lease assumption. There was also no evidence that the tenant was served with written notice of the confirmation order.

The bankruptcy court first addressed whether it had jurisdiction. Post-confirmation jurisdiction is fairly limited. Under applicable precedent the test was whether there was “‘a close nexus to the bankruptcy plan or proceeding sufficient to uphold bankruptcy court jurisdiction.’ … ‘[M]atters affecting ‘the interpretation, implementation, consummation, execution, or administration of [a] confirmed plan will typically have the requisite close nexus.””

Within these limits, a plan provision for retention of jurisdiction is generally given effect. Given that this case involved determining whether the tenant was bound by the plan and the confirmation order, the court had no difficulty concluding that it had jurisdiction.

On the merits, the tenant argued that it could not be bound by the plan because it was not given notice. The plan trustee countered that the tenant’s actual notice of the bankruptcy case together with its participation in negotiations satisfied due process so that it should be bound. The tenant further argued that the lease was not validly assumed since it was not given notice of the proposed assumption.

The court characterized the threshold issue as whether the debtor validly assumed the lease under the plan. An unexpired lease may be assumed pursuant to section 365 of the Bankruptcy Code by motion or through a plan of reorganization. In either case, adequate notice is key:

  • The court commented that FRBP 6006 only addresses motions, but concluded that the responsibilities of the debtor cannot be “radically diminished” if assumption is through a plan. So, the notice requirements for an assumption motion were instructive.
  • The tenant was also entitled to the notice that a plan proponent is required to give to affected parties, such as notice of the deadline for filing acceptances and rejections of the plan, as well as notice of entry of the confirmation order required under bankruptcy rules.
  • The ultimate test is due process, which requires that “notice [be] reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.”

While actual notice may be relevant, the court held that general knowledge of the bankruptcy case was not sufficient. Affected parties do not have a duty to investigate and debtors should not be rewarded for negligently failing to provide proper notice.

In this case the trustee failed to serve the tenant with the disclosure statement, plan, notice of confirmation hearing or the confirmation order. Although the tenant had general knowledge of the bankruptcy case, it did not actively participate in the case, and in fact, believed the property was not an asset of the estate. Thus, without notice the tenant would not know that the plan retroactively vested title and provided for assumption of the lease.

Accordingly, the court held that (1) since the tenant was not given adequate notice, it was not bound by the confirmation order, and (2) given that the trustee did not validly assume the lease through the plan, the lease was deemed rejected.

Lawyers tend to assume without question that a confirmation order is binding and that the terms of a plan are enforceable. It can be very frustrating if a title company expresses reservations when it is asked to jump on this bandwagon. However, as this case illustrates, those reservations may not be entirely baseless.

Vicki R Harding, Esq.

P.S.: This is my 500th blog post. Hard to believe!

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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