Overview of Section 109(c)(5). By its terms, section 109(c)(5) can be satisfied by the debtor four different ways. In re Valley Health Sys., 383 B.R. 156, 162–63 (Bankr. C.D. Cal. 2008) (section 109(c)(5) provides four distinct options because it is written in the disjunctive). First, the debtor may “obtain the agreement of creditors holding a majority in amount of the claims in each class” the debtor “intends to impair under a [Chapter 9] plan . . . .” 11 U.S.C. § 109(c)(5)(A). Second, the debtor may show that it “has negotiated in good faith with creditors” but failed to obtain an agreement on the terms of a plan. Id. § 109(c)(5)(B). Third, the debtor may show that it “is unable to negotiate with creditors because such negotiation is impracticable.” Id. § 109(c)(5)(C). Finally, the debtor may show that it “reasonably believes that a creditor may attempt to obtain a [preferential] transfer.” Id. § 109(c)(5)(D).
Legislative history. Section 109(c)(5) is the product of a Congressional compromise. Under the former Bankruptcy Act, the debtor was required to file its Chapter 9 petition with a reorganization plan preapproved by 51 percent of creditors. See In re Cottonwood Water & Sanitation Dist., Douglas Cnty., Colo., 138 B.R. 973, 975–76 (Bankr. D. Colo. 1992). The preapproval requirement could not be met by large cities, and in the wake of the financial crisis of the mid-1970s, Congress sought to eliminate it. Id. at 977–78. Fearing easy access to Chapter 9, the municipal bond community resisted, forcing Congress to compromise. 2 Collier on Bankruptcy ¶ 109.04[e] (Henry J. Sommer & Alan N. Resnick eds. 16th ed. 2011). In 1976, Congress passed an amendment retaining the preapproval provision, but it added the impracticability condition and others as alternatives. Id. These alternatives have been largely retained in section 109(c)(5).
Section 109(c)(5)(A): The Plan Acceptance Condition. A vestige of the Bankruptcy Act, the plan acceptance condition of section 109(c)(5)(A) is a difficult condition to satisfy. Prepetition, the debtor must have a Chapter 9 plan proposal accepted by a majority in amount of claims in each class the debtor intends to impair under a plan. 11 U.S.C. § 109(c)(5)(A). Case law under this condition is scant as few debtors have been able to garner such a consensus amongst their typically diverse and acrimonious body of creditors.
Section 109(c)(5)(B): The Good Faith Negotiation Condition. While section 109(c)(5)(A) assumes successful prepetition negotiations, section 109(c)(5)(B) does not. Instead, the debtor must show that it “has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class” the debtor “intends to impair under a plan.” 11 U.S.C. § 109(c)(5)(B).
Courts interpret section 109(c)(5)(B)’s reference to a “plan” to require the debtor to make an initial showing that prepetition negotiations with creditors revolved around a specific Chapter 9 plan proposal. See, e.g., Sullivan Cnty., 165 B.R. at 78. Although courts have stopped short of requiring a formal plan, the necessary substance of the plan proposal remains unclear. See, e.g., Vallejo, 408 B.R. at 297 (“[S]ome outline or a term sheet of a plan which designates classes of creditors and their treatment is necessary.”); Sullivan Cnty., 165 B.R. at 78 (“[S]ome sort of comprehensive plan is required . . . .”).
As a practical matter, formulating a detailed plan proposal should help the debtor identify the universe of creditors with whom it must negotiate. For example, if the debtor contemplates paying a class of creditors in full, that class is not “impaired” under the plan and negotiation with the class is unnecessary. See In re Town of Westlake, Tex., 211 B.R. 860, 867–68 (Bankr. N.D. Tex. 1997).
Apart from establishing the existence of a plan proposal, the debtor must also demonstrate that it negotiated in “good faith.” The good faith inquiry is a particularly intricate analysis because courts recognize that negotiation is a two-way street requiring “some very minimal burden of reciprocity be placed on parties with whom a debtor must negotiate.” Westamerica Bank v. Mendocino Coast Recreation and Park Dist. (In re Mendocino Coast Recreation & Park Dist.), No. 12–CV–02591–JST, 2013 WL 5423788, at *7 (N.D. Cal. Sept. 27, 2013). Accordingly, courts generally review the timeline of the negotiations and focus on (1) the degree of the disclosure about the proposed bankruptcy plan; (2) the time creditors were given to respond; and (3) the responses of the creditors. See id.
If the debtor presents a sufficiently detailed plan proposal and gives creditors a reasonable time to respond, then the burden shifts to creditors to make counter-proposals. See Detroit, 504 B.R. at 176. For any class that then responds with an immutable position, the debtor is deemed to have satisfied the good faith requirement with respect to that class. See In re City of Stockton, Cal., 493 B.R. 772, 792–93 (Bankr. E.D. Cal. 2013). The good faith inquiry’s focus on the prepetition behavior of the debtor and its creditors makes satisfying section 109(c)(5)(B) difficult to predict.
Section 109(c)(5)(C): The Impracticability Condition. The impracticability condition of section 109(c)(5)(C) is probably the easiest condition to satisfy, given its broad interpretation by courts. Congress did not define “impracticable.” Consequently, courts look to the plain meaning of the term. “‘Impracticable’ means ‘not practicable; incapable of being performed or accomplished by the means employed or at command; infeasible.’” Valley Health Sys., 383 B.R. at 163. Likewise, “impracticability” means “[a] fact or circumstance that excuses a party from performing an act . . . because (though possible) it would cause extreme and unreasonable difficulty.” In re New York City Off-Track Betting Corp., 427 B.R. 256, 277 (Bankr. S.D.N.Y. 2010) (internal citations omitted). In applying these broad definitions, courts have concluded that the impracticability determination is “a fact-sensitive inquiry that ‘depends upon the circumstances of the case.’” Id. (quoting Vallejo, 408 B.R. at 298).
The debtor can satisfy the impracticability condition based on the “sheer number” of its creditors. See, e.g., In re Pierce Cnty. Hous. Auth., 414 B.R. 702, 713–14 (Bankr. W.D. Wash. 2009) (over 7,000 creditors and interested parties); Stockton, 493 B.R. at 794 (2,400 retirees and “no natural representative capable of bargaining on their behalf.”). But see Ellicott Sch. Bldg. Auth., 150 B.R. at 266 (no allegations of impracticable negotiations and debtor held public meetings to which all bondholders were invited). These cases illustrate that the impracticability condition should be easier to meet for larger municipalities who tend to have more creditors.
However, the debtor can also demonstrate impracticability in situations other than those necessarily encountered by large municipalities. For example, the debtor can show impracticability by the “need to file a petition quickly to preserve [its] assets.” Vallejo, 408 B.R. at 298; see In re Boise Cnty., 465 B.R. 156, 169 (Bankr. D. Idaho 2011) (county anticipated imminent execution on cash accounts); In re Cnty. of Orange, 183 B.R. 594, 607–08 (Bankr. C.D. Cal. 1995) (lenders demanded additional collateral and threatened to liquidate portfolio). The debtor also can show impracticability when there is a “need to act quickly to protect the public from harm,” City of San Bernardino, Cal., 499 B.R. 776, 786 (Bankr. C.D. Cal. 2013), or a breakdown in negotiations with a large creditor. See Off-Track Betting Corp., 427 B.R. at 278; In re Villages at Castle Rock Metro. Dist. No. 4, 145 B.R. 76, 85 (Bankr. D. Colo. 1990). None of the above examples are exhaustive and often the debtor’s situation is a blend of them.
Section 109(c)(5)(D): The Preference Condition. The final alternative is the preference condition of section 109(c)(5)(D). This provision requires the debtor to show it “reasonably believes that a creditor may attempt to obtain a [preferential] transfer” under section 547. 11 U.S.C. § 109(c)(5)(D). Section 547 avoids certain kinds of prepetition transfers of the debtor’s property interests to creditors. See id.§ 547(b). Although the case law is sparse, an attempt to execute a judgment on the debtor’s property may constitute—or help to effectuate—a “transfer” of the debtor’s property that satisfies the preference condition. See Boise Cnty., 465 B.R. at 170 (finding creditor’s attempt to execute on debtor’s accounts satisfied § 109(c)(5)(D)).