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Fifth Circuit Protects Secured Creditor

By: Gregory G. Hesse and Charlotte Ritz

In a recently reported Chapter 11 bankruptcy case, a properly noticed secured lender placed its collateral at risk by failing to ensure that the debtor’s reorganization plan specifically preserved its lien. Acceptance Loan Co. v. S. White Transp., Inc. (In re: S. White Transp. Inc.).  After the bankruptcy court confirmed the plan, the lender argued that its lien survived despite not being retained by the plan. The U.S. Court of Appeals for the Fifth Circuit agreed, and held that confirmation of such a plan cannot extinguish a lien unless, among other things, the lender has done “more” in the bankruptcy case than merely receive notice.

As a result of this decision, a lender may believe its lien will remain intact so long as it remains fairly inactive in the bankruptcy case or ignores the case altogether. However, such actions would not be prudent because it is not yet known what level or type of involvement would be sufficient or whether the “more-than-notice” rule will be adopted by other courts. Accordingly, secured lenders should object to the confirmation of a plan that fails to preserve the lien. It is a simple objection and avoids the possibility, however slight, that the lien will be extinguished.

The Decision

In the case of debtor S. White Transportation, secured creditor Acceptance Loan Co. received notice of the bankruptcy, the debtor’s reorganization plan and the plan confirmation hearing. Even though the plan did not specifically preserve the creditor’s lien, the creditor failed to vote against the plan or object to confirmation, and the plan was confirmed.

After confirmation, the creditor asked the bankruptcy court to declare that its lien had survived the confirmation or, in the alternative, to amend the plan to preserve the lien. Citing 11 U.S.C. §1141(c), the court denied the creditor’s requests. Section §1141(c) provides that, “except as otherwise provided in the plan or in the order confirming the plan,” property dealt with by a confirmed Chapter 11 reorganization plan is “free and clear of all claims and interests.” The Fifth Circuit previously had held that §1141(c) voids liens only if, among other things, the secured creditor had “participated” in the reorganization. Elixir Indus., Inc. v. City Bank & Trust Co. (In re Ahern Enters. Inc.) The bankruptcy court found that the notice provided to the creditor throughout the case was sufficient to constitute “participation” within the meaning of the Fifth Circuit’s Ahern test.

The district court reversed on the basis that “[s]omething more” than notice is necessary for lien avoidance. The Fifth Circuit affirmed that ruling, noting that the word participation “connotes activity, and not mere nonfeasance,” that the Seventh and Eighth circuits had “required more than notice” in similar scenarios, and that it had been unable to locate any decisions extinguishing the lien of a creditor who had no involvement with the bankruptcy case other than receiving notice.

Observations

It is not clear how much, or what type of, participation would be sufficient to extinguish a lien through plan confirmation. The Seventh Circuit has held that filing a proof of claim constitutes sufficient participation. Query whether filing a notice of appearance or attending a meeting of creditors would be adequate. Until there is additional guidance regarding the required level of participation, the most prudent course is to object to a reorganization plan that does not specifically retain the lien and appeal any order confirming such a plan. This course of action prevents confusion regarding the existence of the lien and eliminates the need to litigate over the participation requirement after the fact.

Also of note, the U.S. Supreme Court has repeatedly emphasized that the plain meaning of a statute should control its interpretation. See, e.g., United States v. Ron Pair Enters., 489 U.S. 235, 241 (1989). Under the plain meaning of §1141(c), the secured lender’s active participation in the case is not required. Of course, a lienholder has rights under the Due Process Clause of the Fifth Amendment of the U.S. Constitution, and therefore is entitled to notice of the plan, as well as an opportunity to object to its confirmation. Accordingly, there is a significant risk that, unlike the Fifth Circuit, another circuit court or the Supreme Court would conclude that constitutionally sufficient notice is enough to extinguish the lien.

Gregory G. Hesse is a partner in the bankruptcy and reorganization practice group at Hunton & Williams, LLP in Dallas. Contact him at ghesse(at)hunton.com. Charlotte Ritz is an associate general counsel with Fannie Mae.

Copyright (c) January 2014 by BankNews Media


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