The right of an impaired creditor to vote to accept or reject a plan of reorganization is one of the most "sacred entitlements that a creditor has in a chapter 11 case."1 The Bankruptcy Code, however, balances that vital right by granting a court with authority to strip that creditor of its vote (i.e., designate the vote) as a consequence of certain actions taken by, or behavior exhibited by, that creditor. Given the severe implications of such extraordinary relief, courts have almost universally recognized that depriving these creditors of the right to vote on a plan is a drastic remedy.
A recent ruling by the U.S. Bankruptcy Court for the District of Nevada in the Chapter 11 cases of Circus & Eldorado Joint Venture,2 is just the latest in a series of decisions in which a court found that, given the facts and circumstances it was confronted with, designation was nevertheless warranted.3 As the Circus & Eldorado decision illustrates, the key question for the court remains relatively simple: Are a creditor's actions sufficiently "ulterior" and/or inequitable enough to be deemed one of the so-called "badges of bad faith"?4
Courts have long sought to discourage "bad faith" behavior, and their ability to designate the vote of a creditor, which is now codified in Bankruptcy Code §1126(e), has a deep-rooted history in bankruptcy law. The relief was derived from §203 of Chapter X of the Bankruptcy Act of 1898 (as amended by the Chandler Act of 1938) and former Bankruptcy Rule 10-305.5 Both the Bankruptcy Act and the former Bankruptcy Rule empowered the court to direct a claim to be disqualified in connection with determining the requisite majority for acceptance of a plan, if the creditor's acceptance of (or failure to accept) a plan was not exercised in good faith.6 Similarly, §1126(e) allows a court, on request of a party in interest, to "designate any entity whose acceptance or rejection of such plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of [the Bankruptcy Code]."7 The Bankruptcy Code, however, is silent as to what constitutes "good faith" and, more importantly, what actions in connection with voting can a court conclude to have been made in bad faith.8
Typically, vote designation is aimed at preventing wrongful behavior by a creditor, such as the situation in which a creditor attempts to extract an undue or inequitable advantage for itself.9 The Supreme Court, in analyzing the history of Bankruptcy Act §203, determined that the provision was intended to apply to those creditors "whose selfish purpose was to obstruct a fair and feasible reorganization in the hope that someone would pay them more than the ratable equivalent of their proportionate part of the bankrupt assets."10 Likewise, the Second Circuit has noted that the relief afforded by §1126(e) is implicated when parties "venture beyond mere self-interested promotion of their claims."11
Accordingly, §1126(e) addresses two general types of bad faith cases: (1) instances where the creditor attempts to extract or extort a personal advantage or benefit unavailable to others in its class; and (2) instances where the creditor has an "ulterior motive" or otherwise attempts to secure some advantage that does not relate to its claim or protection of its self-interest as a creditor.12 In applying §1126(e), courts have therefore considered certain behavioral "badges of bad faith" to determine situations in which the motives of a creditor are unquestionably ulterior and almost certainly designed to result in an unfair benefit for such creditor.13 These situations arise where a creditor attempts to (a) block a plan in order to acquire, take over or otherwise assume control of the debtor for an inequitable strategic purpose, (b) put the debtor out of business, injure the debtor's business or otherwise gain a competitive advantage, (c) destroy the debtor out of pure malice, (d) prevent litigation against the creditor or (e) obtain benefits available under a private agreement between the creditor and a third party that depends on the debtor's failure to reorganize.14 In addition, one court found that the legislative history of §1126(e) indicates that a creditor who has a conflict of interest with the class in which it votes may be subject to vote designation.15
Importantly, however, the existence of an "ulterior motive" does not necessarily mean that a creditor's behavior will support a finding of bad faith. Instead, courts recognize that most creditors have interests beyond just their claim, and those other interests will invariably affect how they vote their claim.16 Likewise, a creditor's selfishness, without more, should not subject a creditor to vote designation because a creditor need not "approach reorganization plan votes with a high degree of altruism and with the desire to help the debtor and their fellow creditors."17 To find otherwise might result in situations in which few, if any, votes would be upheld by a court in the face of a designation challenge.
Courts must therefore differentiate between situations where a creditor's actions do not rise to the level of bad faith behavior that Congress empowered courts to prevent, and those situationsfor example, purchasing a blocking position in a voting class with an improper motive or through impermissible meanswhere a creditor crosses the line and demonstrates the behavior that necessitates vote designation.
'Allegheny' and 'DBSD'
For example, in In re Allegheny Int'l, an investor purchased certain subordinated debentures of the debtor immediately prior to filing a plan of reorganization that would have given it control of the debtor.18 Thereafter, in order to defeat the debtor's competing plan, the investor strategically purchased a blocking position in the two highest impaired classes (thereby ensuring that the debtor could not confirm its plan of reorganization). In granting the debtor's motion to designate and disqualify the votes of the investor, the Allegheny court imputed bad faith to the investor's intent by finding, among other things, that the investor had filed its plan of reorganization at the eleventh hour, purchased significant claims only after the voting period on the debtor's own plan began, purchased a clear blocking position, paid prices close to par for the claims and purchased almost exactly the amount required to block the debtor's plan.19
Equally disconcerting to the Allegheny court was the fact that the investor was able to defeat any plan of reorganization and thereby obstruct a "fair and feasible reorganization."20 The investor was clearly interested in taking over and controlling the debtor, and the Allegheny court was convinced that the investor had "engaged in a pervasive pattern of bad faith designed to control the debtor and manipulate the bankruptcy process."21 The Allegheny court also determined that the investor's actions were a clear violation of the purposes of Chapter 11 that provided the court "with ample grounds to impose restraints and sanctions."22 Nevertheless, subsequent to the Allegheny decision, courts were generally not inclined to designate the votes of a creditor who had obtained a blocking position, absent a greater showing of a bad faith motive.23
However, the Second Circuit in DBSD brought the Allegheny decision back into the spotlight when it affirmed the decision of the bankruptcy court to designate the votes of DISH Network Corporation after the bankruptcy court (in relying on the Allegheny and Waco decisions) determined that DISH, an indirect competitor of the debtors and a part-owner of a direct competitor of the debtors, acted in bad faith. Specifically, the bad faith imputed to DISH, who was not a pre-existing creditor of the debtors, revolved around its purchase of an entire class of claims after the debtors had proposed their plan. The Second Circuit agreed with the bankruptcy court's factual finding that rather than maximizing its recovery on the debt, DISH's ulterior motive was evinced by its position as a competitor to the debtors, its willingness to overpay for the claims it bought,24 its attempt to propose its own competing plan and (especially) by its internal communications that showed a desire to "obtain a blocking position" and "control the bankruptcy process for this potentially strategic asset."25
Interestingly, the Second Circuit emphasized that its opinion imposed "no categorical prohibition on purchasing claims with acquisitive or other strategic intentions."26 Moreover, the court also noted that it was not addressing the situation where a pre-existing creditor votes with strategic intentions.27
'Circus & Eldorado'
If one thing is clear from the decisions related to vote designation, it is that the concept of bad faith is a fluid one that requires an examination of the totality of the circumstances, and not just a single set of factors.28 This is further illustrated by the very recent Circus & Eldorado cases. There, the U.S. Bankruptcy Court for the District of Nevada designated the plan votes of a noteholder of the debtors, and imposed sanctions against it, after finding that the noteholder acted in bad faith when it improperly attempted to induce other creditors to vote against the debtors' plan by filing a motion to terminate exclusivity. The motion described the purported failings of the debtors' plan of reorganization and described, in detail, the noteholder's alternative plan structure.29 The court had not previously been presented with this information and the noteholder did not obtain approval to disseminate the information.
Most troubling to the court was that the creditor filed its motion seeking to terminate exclusivity during the debtors' exclusive solicitation period and while the debtors were in the process of soliciting votes on their approved disclosure statement and plan.30 Additionally, and as further evidence of the noteholder's bad faith, the court was equally troubled and perplexed by the failure to set or notice a hearing date for the court to hear the exclusivity motion.31 Accordingly, the court concluded that while the noteholder was perfectly entitled to act in its own self-interest and to try maximize the return on its claim, the noteholder's true purpose was to acquire operating ownership of the debtors.32 The court's analysis of the creditor's conduct, therefore, falls squarely within the "badges of bad faith" that justify vote designation.