Substantive Consolidation Whether You Like It or Not?

The proposed plan restructured the lender’s loan to a term of 21 years that required certain monthly payments and called for a balloon principal payment at the end of the term. The plan included a due-on-sale clause that called for payment of the outstanding balance of the restructured loan if the underlying collateral were sold. The due-on-sale clause, however, would not apply if the collateral were sold between plan years 5 and 15. The objecting lender voted against the plan, including with respect to its claim as mezzanine lender. However, the Ninth Circuit decision pointedly notes, “The Lender never objected to or argued that the bankruptcy court was treating the cases as if substantive consolidation had occurred.”

The lender argued that the 10-year exception in the due-on-sale clause would allow the debtors to partially negate the benefit of the lender’s section 1111(b)(2) election. The lender also objected on the grounds that section 1129(a)(10) requires that at least one impaired class accept the plan and that this requirement must be applied on a “per debtor,” not “per plan,” basis. As the only class member for two of the five debtors, and having voted against the plan, the lender argued the plan did not satisfy section 1129(a)(10). The bankruptcy court rejected these challenges and approved the plan. The lender appealed.

Application of Section 1111(b)(2)

The three-judge panel of the Ninth Circuit first addressed the lenders’ claim that the limitation on the due-on-sale provision was improper in light of the lenders’ election under 11 U.S.C. § 1111(b)(2). After laying out the standards for statutory interpretation, the panel concluded that the lender’s argument that section 1111(b)(2) requires a due-on-sale clause was not supported by the text of the statute. The panel next considered 11 U.S.C. § 1123 and similarly found that nothing in that section requires that a due-on-sale clause be included in a plan whether a section 1111(b)(2) election has been made or not. While the court held that section 1111(b)(2) does not require a plan involving an electing creditor to contain a due-on-sale clause, it stated (in footnote 4):

This holding does not imply that “due-on-sale” protection is irrelevant to whether a plan is “fair and equitable” under section 1129(b). Although the Lender here waived any argument that the Plan was not “fair and equitable,” the availability of due-on-sale protection may inform whether a plan is confirmable in other reorganizations.

Application of Section 1129

With respect to the lender’s challenge to plan confirmation on the basis that the plan could not be confirmed over its vote against the plan as the only creditor class for the mezzanine loan debtors, the Ninth Circuit found, as a matter of first impression among the circuit courts, that section 1129(a)(10) applies on a “per plan” basis.

The panel said the plain language of section 1129(a)(10) supports the “per plan” approach, stating, “Under its plain language, once a single impaired class accepts a plan, section 1129(a)(10) is satisfied as to the entire plan.” The lender cited In re Tribune Co., 464 B.R. 126 (Bankr. D. Del. 2011), in support of its position. The panel dismissed the lender’s arguments based on Tribune with one of its pithier comments: “[T]he Lender’s argument is essentially a regurgitation of a summary of the Tribune decision unsupported by argument or other case law.” The lender also argued that while the plan stated it was a jointly administered plan, it was, in effect, a substantive consolidation. On this point, the court highlighted the fact that the lender never objected to the plan on this basis. The lender also argued the “per plan” approach would have adverse effects on mezzanine lenders, but the panel said these were policy concerns that should be left to Congress.

Circuit Judge Friedland filed a concurring opinion, stating that while she agreed with the panel’s holdings on section 1111(b)(2) and section 1129(a)(10),

I write separately, however, to acknowledge the argument advanced by JPMCC 2007-C1 Grasslawn Lodging, LLC (“Lender”) that it was unfairly deprived of the ability to object effectively to reorganization of the Mezzanine Debtors, despite being their only creditor. While Lender’s concern is not unfounded, I believe any unfairness resulted not from the interpretation of § 1129 that Lender challenged in this appeal, but instead from the fact that this particular reorganization treated the five Debtor entities as if they had been substantively consolidated—something Lender did not object to in the bankruptcy court.

Judge Friedland agreed with the lender that the plan provisions for distribution involved a degree of substantive consolidation and discussed the factors a bankruptcy court evaluates to determine whether substantive consolidation is appropriate. While sympathetic to the lender’s arguments, Judge Friedland was quite clear, as was the main opinion, that the lender should have raised the de facto substantive consolidation argument in the bankruptcy court and simply did not do so. Consequently, the argument was waived on appeal.

Conclusion

The Transwest opinion provides a cautionary tale for the trial attorney. Footnotes 2 and 4 of the decision clearly show that the court felt arguments that could have affected the court’s interpretation of section 1111(b)(2) were waived, as well as arguments pertinent to section 1129(a)(10). Indeed, the concurring opinion is a road map for counsel to follow when representing clients in jointly administered bankruptcies to argue and preserve issues of de facto substantive consolidation for appeal.

The opinion is the first circuit court opinion deciding whether section 1129(a)(10) applies on a “per plan” or “per debtor” basis. Counsel in jointly administered bankruptcies should keep not only In re Transwest in mind, as they evaluate whether and how to raise issues of de facto substantive consolidation, but also In re Tribune Co. “Per plan” or “per debtor” is by no means a closed issue after In re Transwest, and both opinions can be used to help shape arguments in similar cases in the future. The lesson of In re Transwest is not so much the interpretation of the two sections in the opinion; rather, the lesson is the court’s very clear statements that it could not consider all of the issues it felt it should consider because those issues had not been properly presented below and, as a result, could not be considered.

Andrew M. Toft is an attorney in Denver, Colorado.

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