Section 1126 of the Bankruptcy Code and the Dangers of Sleeping on Your Rights as a Creditor

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A seat at the table: this is what you likely want when your financial interests are drawn into a bankruptcy court proceeding.  You’ll seek to be heard and do what you can to maximize your recovery. This is especially true if you’re a creditor in a chapter 11 case.  Yet a recent decision shows what can happen if you do the opposite and choose to “sit one out” rather than have a say in the outcome of a chapter 11 case. In re Fred Bressler, No. 20-31023, 21 WL 126184 (Bankr. S.D. Tex. Jan. 13, 2021).

Debtor Fred Jay Bressler, M.D. filed for bankruptcy under chapter 11, subchapter V of title 11 of the Bankruptcy Code. Two mortgage companies held more than $800,000 in secured claims, and 33 creditors had unsecured claims totaling about $1.1 million. One of the secured claims was held by Harris County, Texas, for approximately $14,000 in unpaid property taxes on Dr. Bressler’s personal residence.

About seven months later, Dr. Bressler filed a disclosure statement and a plan of reorganization. The plan proposed to pay unsecured creditors $300,000 over five years and to make regular mortgage payments to the secured creditors.  The plan classified the Harris County claim as an impaired secured claim that would be paid in full in five years, contingent on the County's agreement.  Harris County voted to accept the plan.  Just seven unsecured creditors voted on the plan, all in favor.  But those claims totaled just $75,000.

The Bankruptcy Court approved the disclosure statement and scheduled a confirmation hearing. At that hearing, Bankruptcy Judge Eduardo Rodriguez questioned if Dr. Bressler had obtained the required votes to confirm the plan. For a class to accept a plan, Bankruptcy Code section 1126(c) requires the affirmative vote of two-thirds in amount and one-half in number.  The seven of 33 unsecured creditors that voted on Dr. Bressler’s plan held less than 10% of the unsecured claims.   Bankruptcy Judge Rodriguez required Dr. Bressler to file an amended plan and scheduled a second hearing.  At the second hearing, Judge Rodriguez again questioned whether Dr. Bressler had the votes needed to confirm the amended plan and asked the parties to brief the matter.

In his decision, Judge Rodriguez addressed the treatment of claims from creditors who fail to vote.  Importantly, Judge Rodriguez observed that  the “failure to cast a written vote constitutes neither acceptance nor rejection of the plan... Those ‘nonvotes’ do not satisfy the language of § 1126(c) and thus, do not count toward the numerosity requirements.” In re Fred Bressler at *3.

The practical implications of this ruling are stark:

Claims that have not voted or that have been objected to by a party-in-interest and are not temporarily allowed by the Court for purposes of voting pursuant to Rule 3018(a), are not considered. Therefore, if only one member of a class, in compliance with Rule 3018(c), votes in favor of the plan and all others fail to vote, the voting member binds the entire class and that class will be deemed to have accepted the plan (emphasis added). Id.

Accordingly, In re Fred Bressler demonstrates the pitfalls for creditors who don’t participate in a chapter 11 case.  If creditors remain passive like the 26 creditors in this case that, in the aggregate, held more than 90% of Dr. Bressler’s unsecured debt while only receiving about a 25% aggregate recovery, they risk having a result determined by other creditors who might have divergent and potentially opposite end-goals. This is could lead to a plan of reorganization that leaves the sleepy creditors with an inadequate recovery.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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