Section 1126 of the Bankruptcy Code and the dangers of sleeping on your rights as a creditor | Patterson Belknap Webb & Tyler LLP

A seat at the table is probably what you want when your financial interests are embroiled in bankruptcy proceedings. You will seek to be heard and do what you can to maximize your recovery. This is especially true if you are a creditor in a Chapter 11 case. Yet a recent decision shows what can happen if you do the opposite and choose to “do nothing” rather than have a say in the matter. outcome of a Chapter 11 case. In re Fred BresslerNo. 20-31023, 21 WL 126184 (Bankr. SD Tex. January 13, 2021).

Debtor Fred Jay Bressler, MD filed for bankruptcy under Chapter 11, Subchapter V of Title 11 of the Bankruptcy Code. Two mortgage companies had more than $800,000 in secured debt and 33 creditors had unsecured debt 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 reorganization plan. The plan proposed to pay unsecured creditors $300,000 over five years and to make regular mortgage payments to secured creditors. The plan classified Harris County’s claim as an impaired secured claim that would be paid in full in five years, subject to the county’s agreement. Harris County voted to accept the plan. Only seven unsecured creditors voted on the plan, all in favor. But those claims only totaled $75,000.

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

In his ruling, Judge Rodriguez addressed the handling of claims by non-voting creditors. Importantly, Judge Rodriguez observed that “failure to vote in writing does not constitute either acceptance or rejection of the plan…These ‘non-votes’ do not satisfy the language of §1126(c) and therefore, does not count towards the number requirements. In re Fred Bressler at 3.

The practical implications of this decision are striking:

Claims which have not been voted on or which have been disputed by an interested party and which are not temporarily authorized by the Court for the purpose of a vote in accordance with Rule 3018(a), are not taken into account. Therefore, if there is only one member of a class, according to Rule 3018(c)votes in favor of the plan and all others do not vote, the voting member binds the entire class and that class will be deemed to have accepted the plan (emphasis added). Identifier.

Consequently, In re Fred Bressler demonstrates the pitfalls for creditors who do not participate in a Chapter 11 case. If creditors remain passive like the 26 creditors in this case who, in total, held more than 90% of Dr. receiving only about 25% aggregate recovery, they risk having an outcome determined by other creditors who may have divergent and potentially conflicting end goals. This could lead to a reorganization plan that leaves creditors asleep with insufficient collection.