Fifth Circuit Rules Secured Creditors Who Snooze Do Not Lose

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On August 5, 2013, the Fifth Circuit Court of Appeals ruled in Acceptance Loan Co., Inc. v. S. White Trans., Inc. (In re S. White Transp.) that a creditor's lien remained intact notwithstanding that the confirmed plan of reorganization provided for its extinguishment and notwithstanding that the secured creditor received proper notice throughout the bankruptcy case.1
The Fifth Circuit held in White Transportation that section 1141(c) of the Bankruptcy Code, which provides that "... property dealt with by the plan is free and clear of all claims and interests," only applies if the creditor actively "participates" in the bankruptcy case. This is one of a very few instances in which a creditor sleeping on his rights in a chapter 11 case may actually fare better than one who does not.
The Fifth Circuit relied on the test announced in its prior decision in Elixir Indus. Inc. v. City Bank & Trust Co. (In re Ahern Enters. Inc.),2  although the creditor's lien in Ahern was found extinguished by the confirmed plan. In Ahern, the Fifth Circuit held:
Four conditions must ... be met for a lien to be voided under section 1141(c): (1) the plan must be confirmed; (2) the property that is subject to the lien must be dealt with by the plan; (3) the lien holder must participate in the reorganization; and (4) the plan must not preserve the lien.3
The Fifth Circuit noted that the requirement of creditor participation is a "judicial gloss" on section 1141(c), and explained that the requirement "... insures that the secured creditor has notice of the plan and the potential effect on the creditor's lien." 4   However, the requirement of creditor participation as set forth in Ahern (and followed in White Transportation) does not distinguish between creditors who intentionally, perhaps for strategic reasons, choose not to participate in a chapter 11 case and those who do not participate because they do not appreciate the potential significance of the effect of confirmation of a plan. The Fifth Circuit cited no textual support for its interpretation of section 1141(c)5 and cited only two court of appeals cases from other circuits. 6
The debtor and the secured creditor in White Transportation had been engaged in years of state court litigation before the bankruptcy filing. Only two weeks after the plan was confirmed, the secured creditor in White Transportation filed a declaratory judgment action challenging the lien extinguishment. This certainly gives the appearance that the secured creditor was well aware of the potential effect of the plan and made the strategic decision to sit quietly by, biding its time until the plan was confirmed. The secured creditor may have believed that it was more advantageous to derail a confirmed plan than to challenge confirmation at the outset. On the other hand, did the debtor truly believe that the secured creditor had given up after years of presumably contentious litigation or was the debtor hoping to slide something by the secured creditor? There was the potential for gamesmanship by both parties. The decision in White Transportation appears to come down on the side of secured creditors.
The significance of the decision is uncertain.  It certainly gives hope to a secured creditor who after receiving proper notice wakes up and finds that a plan has been confirmed purporting to alter its lien rights. It is unlikely, however, that the decision will lead to widespread recommendations to secured creditors by their lawyers to sit out during a chapter 11 case. The risk of nonparticipation is just too great absent more case law in this area.
12013 U.S. App. LEXIS 16181 (5th Cir. Aug. 5, 2013).
2507 F.3d 817, 822 (5th Cir. 2007).
3Id. at 822 (emphasis added). 
4Id. at 823 (citations omitted) (emphasis added).
5Cf. Stern v. Marshall, 564 U.S. __, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011) (Scalia,J., concurring) ("... [T]he more fundamental flaw in the many tests suggested by our jurisprudence is that they have nothing to do with the text." (in context of bankruptcy court jurisdiction))
6However, the creditor's lien was found to survive plan confirmation in only one of the two cases. F.D.I.C. v. Union Entities (In re Be-Mac Transp. Co.), 83 F.2d 1020, 1023 (8th Cir. 1996)(FDIC's lien found to survive confirmed plan purporting to extinguish it when FDIC was not allowed to vote or participate in plan process due to disallowance of claim); In re Penrod, 50 F.3d 459, 461 (7th Cir. 1995)(creditor's lien found extinguished by confirmed plan).