District Court Holds Section 105 can be Used to Avoid Default Provisions Under Confirmed Chapter 11 Plan
In In re Texas Comptroller of Public Accounts v. Patrick Taylor Adams, et al., Civ. A. No. 3:18-CV-727-L (N.D. Tex. May 31, 2020) [Dkt. No. 8], the District Court for the Northern District of Texas recently affirmed a bankruptcy court’s order reinstating the automatic stay against a creditor post-confirmation and preventing such creditor from exercising its plan remedies against the debtors upon plan defaults. In doing so, the Court implicitly rejected the argument that the res judicata effect of a confirmed plan stripped the bankruptcy court of authority to grant post-confirmation relief under section 105 of the Bankruptcy Code in contravention of specific plan terms. Equity seemed to be the underlying principle under this Memorandum Opinion.
In December 2015, two Debtors sought chapter 11 relief after losing significant amounts of money on a new business venture involving a restaurant. Approximately a year later, the Debtors confirmed their joint chapter 11 plan (“Plan“), which required, among other things, that the Debtors make monthly payments to a specific creditor, the Texas Comptroller of Public Accounts (the “Creditor“), in respect of its claim.
The Plan also included a default provision in the event the Debtors missed a payment to the Creditor. The provision generally entitled the Debtors to cure up to 2 missed payments, but on the third missed payment the Creditor could enforce its entire claim against the Debtors and exercise all rights and remedies against them under applicable nonbankruptcy law (the “Drop Dead Clause“).
As the story goes, the Debtors tripped the Drop Dead Clause by missing more than 2 payments, thereby entitling the Creditor to seize the Debtors’ primary assets in a separate furniture business, which was profitable and which the Debtors had owned and operated for 32 years.
When the Creditor threatened to exercise its plan remedies, the Debtors filed a motion with the bankruptcy court, requesting that the automatic stay be reinstated as to the Creditor, on grounds that the Debtors could now bring all past-due payments current and the Creditors’ exercise of remedies (as to the Debtors’ furniture business) jeopardized the entire Plan, as it would cutoff the Debtors’ revenue stream and thus eliminate payments to several parties, including the Creditor, other creditors and the Debtors’ landlord and employees.
The bankruptcy court granted the Debtors’ motion, based section 105(a) of the Code, which provides that a “court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].” 11 U.S.C. § 105(a). Notably, the bankruptcy court also made findings that the Debtors were entitled to injunctive relief on their request.
On appeal, the Creditor argued that the bankruptcy court erred because (a) the confirmation order was res judicata on the issue of the Creditor’s default remedies and (b) equity could not be used to undermine the res judicata effect of the confirmation order.
The District Court ultimately disagreed with the Creditor and affirmed the bankruptcy court’s ruling.
According to the District Court, at the heart of the dispute was whether the bankruptcy court lacked authority under section 105(a) to enter an order reinstating the automatic stay as to the Creditor, thus precluding remedies under the confirmed Plan.
Continuance or reinstatement of an automatic stay “is within the bankruptcy court’s authority under 11 U.S.C. § 105(a).” See In re Martin Exploration Co., 731 F.2d 1210 (5th Cir. 1984) (affirming bankruptcy court’s continuation of automatic stay under section 105(a), which “amounted to the issuance of a new stay”). The continuation or reinstatement of the automatic stay under section 105 is a form of injunctive relief, so the four requirements for injunctive relief must be satisfied. Prudential Ins. Co. of Am. v. Ryan Place Joint Venture, 93 B.R. 471, 474 & n.9 (N.D. Tex. 1988) (citing Sunbelt Savings Assoc. of Tex. v. Truman, 95 B.R. 55, 57 (N.D. Tex. 1988)) (other citations omitted).
The District Court held that since the bankruptcy court made findings as to each requirement for injunctive relief, that court had proper authority to reinstate the automatic stay under section 105 of the Code. While the Creditor argued that the Debtors never specifically asked for injunctive relief (and only requested reinstatement of the automatic stay), the District Court found that a request for reinstatement of the automatic stay was all that was necessary to invoke the bankruptcy court’s authority under section 105(a), which, significantly, provides that a court may act sua sponte.
Interesting, the Memorandum Opinion does not include a discussion about the res judicata effect of a confirmed plan and whether section 105(a) can be used to avoid such binding effect. But, maybe the District Court felt that the Bankruptcy Court had inherent authority to revisit its own orders?
Nor does the Opinion discuss how the bankruptcy court’s ruling essentially modified the terms of the Plan after it was substantially consummated, seemingly in contravention of section 1127(b) of the Code. What the Opinion suggests is that there is now a new method that can be used to avoid section 1141 of the Code–which enforces plan terms–when enforcement of such terms would cause a greater harm to all creditors.
Takeaway-the underlying ruling of the bankruptcy court seemed to be driven by equitable considerations, i.e., if the bankruptcy court did not intervene the Creditor’s actions would have jeopardized the entire reorganization. The District Court’s ruling seems to suggest that the bankruptcy court has discretion to make such calls.
But, while equity surely prevailed in this case, it is questionable whether the law did. Because the District Court’s Opinion does not address a couple of arguments made by the Creditor and significant Supreme Court precedent, like Law v. Siegel, –U.S.–, 134 S. Ct. 1188 (2014) (which curbs the use of section 105 to contravene other Bankruptcy Code provisions), it is uncertain whether the Adams case was intended to provide sound guidance to future litigants in similar shoes. The Opinion, itself, in no way encourages debtors to avoid plan terms–nor, in the humble opinion of the author, would it be advisable to counsel debtors that such approach is generally acceptable.