Summer Never Sleeps for Bankruptcy Opinions in the Third Circuit

September 28, 2012

Plan Confirmation
In In re American Capital Equipment, LLC, 688 F.2d 145 (3d Cir. 2012), the Third Circuit ruled that a bankruptcy court may determine that a Chapter 11 plan is unconfirmable at the disclosure statement stage.  The ruling occurred after a five year span in which the debtor proposed five plans.   At issue was the source of funding for the plan, consisting exclusively of a surcharge to asbestos claimants that was derived from “wholly speculative litigation proceeds.”  The bankruptcy court determined that the plan would not be feasible when its success piggy-backed on the proceeds of uncertain litigation outcomes and that this defect could not be cured by the creditor voting process.  The Third Circuit agreed and found it permissible for the bankruptcy court to exercise its power to determine its own docket and prevent a long, drawn out confirmation process, by ruling that a bankruptcy plan is patently unconfirmable during a disclosure statement hearing when (a) there are no disputes of material fact; and (b) defects in the plan cannot be cured by creditor voting.

In most bankruptcy cases, confirmation hearings occur after the court conducts a hearing to approve a disclosure statement and it is circulated along with the plan to creditors who then vote on the plan. This ruling supports authority that permits bankruptcy courts to refuse to even go forward with the confirmation process, which can be lengthy and expensive, when the court faces a patently unconfirmable plan at the hearing on approval of the disclosure statement.

Equitable Mootness
In another decision arising out of the case of In re Philadelphia Newspapers, LLC, 690 F.3d 161 (3d Cir. 2012), the Third Circuit determined that an appeal cannot be dismissed as equitably moot based solely on the criteria that a Chapter 11 plan has been substantially consummated.  Equitable mootness is a doctrine applied by courts to dismiss an appeal as moot, even though equitable relief could be granted, if granting that relief would be inequitable.  In the bankruptcy context, the doctrine is usually used to avoid the potential of overturning a confirmed plan after a debtor goes through the process of negotiating, constructing and obtaining court approval of a plan.  The decision resulted from an appeal of the denial of an administrative claim relating to post-petition defamation claims.

The Third Circuit panel reiterated that a court must consider the five factors set forth in In re Continental Airlines, 91 F.3d 553, 560 (3d Cir. 1996) in determining equitable mootness and stressed that the analysis must focus on whether allowing the appeal to go forward would undermine the plan, even if the plan has already been “substantially consummated.”  Further, Judge Ambrose admonished that the multi-factor test must be administered narrowly, noting that the doctrine had become “far too expansive” in its application by lower courts.  He determined that the doctrine should be applied in a cautious manner and limited in scope so as not to “unscramble complex bankruptcy reorganizations” in situations where the party taking the appeal, “should have acted before the plan became extremely difficult to retract.”  The Judge found that an appeal on an administrative expense claim amounting to 1.7% of the purchase price of a sale under the plan was not worth the risk unraveling the plan or the sale itself.  Thus, parties should be aware that application of the equitable mootness doctrine in future cases may be narrower than past precedent might suggest.

The bankruptcy court of the Eastern District of Pennsylvania recently ruled that sanctions were warranted against Sovereign Bank for its failure to produce requested documents in an adversary proceeding.  In In re 400 Walnut Street Associates, LLP, 475 B.R. 217 (Bankr. E.D. Pa. 2012), the debtors asserted that pre-petition, they had reached an agreement with Sovereign on a forbearance agreement that was to be drafted by the bank.  It was represented to the Debtors that this was in progress.  Prior to completing this process, the Bank sold its paper to a third party who then sought to enforce the terms of the note against the debtors even though it was in forbearance causing the debtors’ to file for bankruptcy protection.

The Debtors commenced an adversary proceeding seeking to prevent enforcement of the note and served a subpoena duces tecum on Sovereign seeking production of all documents in connection with the forbearance agreement.  Initially, Sovereign produced a set of documents that did not support the Debtors’ position on the existence of the forbearance agreement resulting in dismissal of  six of seven counts raised in the adversary complaint, upon a motion to dismiss made by Sovereign.  The Debtors subpoenaed Sovereign for more information relating to the remaining count and was eventually forced to file a motion to compel compliance with the subpoena due to Sovereign’s reluctance to produce requested documents. Sovereign then produced documents that were responsive to the first subpoena and would have greatly aided the Debtors in opposing Sovereign’s motion to dismiss.  It was alleged by Sovereign, among other things, that the documents were privileged, yet no privilege log was submitted as required under the Federal Rules of Civil Procedure (“FRCP”).  During an investigation and review of the documents by the court to help determine the privilege issue, Sovereign’s Senior Counsel submitted an affidavit that it was not the bank’s practice to produce privilege logs or indexes for the documents it produces under subpoena requests, despite being required to under the FRCP.  The court found that even a cursory review of the documents that Sovereign initially withheld, showed that they were “directly relevant, proverbial smoking gun type documents.”

The bankruptcy court, noting that it had rarely seen a more egregious abuse of the FRCP discovery rules, held Sovereign in contempt of the FRCP and imposed monetary and non-monetary sanctions against Sovereign. In doing so, the Court considered the prejudice which occurred due to Sovereign’s misconduct, the need to deter the bank from continued violations of the FRCP, its “sarcastic and dismissive written submissions” and the bank’s indifference to the FRCP.  The non-monetary sanction was a waiver of attorney client privilege with respect to all of the documents.  A hearing was set for determination of the monetary sanctions.

To avoid this type of result, when faced with a subpoena, parties must be aware of their obligations under the FRCP and to avoid practices that permit “institutional misconduct” in handling discovery requests.