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The Chapter 11 Disclosure Statement: A Case Study
Section 1125 (a)(1) of the Bankruptcy Code requires that a debtor’s proposed plan of reorganization be accompanied by a disclosure statement that must contain “adequate information” about the debtor’s financial and business affairs to allow creditors and parties in interest to fairly and effectively evaluate the plan. Specifically, the debtor must disclose information about the history of their financial and business affairs, income and expenses, and the value of their assets, among other things. Bankruptcy courts have an independent duty to review the adequacy of such statements and confirm that the mandatory provisions of § 1129(a) of the Bankruptcy Code are met by the proposed plan they accompany. A Bankruptcy court will not approve a disclosure statement if it contains disclaimers, caveats, or inaccuracies or when it describes a fatally-flawed plan incapable of confirmation by the court.
Last Summer, Judge Robert A. Gordon of the United States Bankruptcy Court for the District of Maryland addressed disclosure statements and their adequacy in the matter of Roberts Plumbing and Heating, LLC, et al., Debtors, 2011 WL 2972092 (July 20, 2011) (“Roberts Plumbing”). Judge Gordon found that the disclosure statements at issue fell well below the required minimum standard and included “outlandish provisions without rational basis;” nonetheless, he allowed the debtors to amend the statements and provided guidance as to the requisite criteria for approval of their plan.
In Roberts Plumbing, Roberts Plumbing filed a plan of reorganization and disclosure statement and co-debtors D&M Realty and Monica Harenberg also filed a disclosure statement (Roberts Plumbing, D&M Realty, and Harenberg will be collectively referred to as “Debtors” and the two disclosures statements as “Disclosure Statements”). The Disclosure Statements contained provisions requiring that the Debtors’ principals’ personal liability be released in exchange for their financial contributions to a new entity owned by them. The financial contributions would be used to fund the proposed plan of reorganization.
At a hearing to determine the adequacy of the Disclosure Statements, the Court found that Roberts’ counsel had attempted to “filibuster” his client’s inadequate disclosure statement into adequacy, a task he was incapable of doing because of the grossly inadequate nature of the statement. The Debtors subsequently filed amended Disclosure Statements, which according to the Court drew only narrow, technical objections. The Court found, however, that one secured creditor in particular filed a “limited, yet important, substantive” objection to the amended Disclosure Statements. Specifically, the objection at issue asserted that the third-party releases of personal liability and injunctions to protect the same contained in the proposed plan of reorganization violated 11 U.S.C. § 524(e). Ultimately, the Court agreed with that objection.
In addressing whether the plan at issue violated § 524(e), the Court evaluated two “complex” cases: Menard-Sanford v. Mobey (In re A.H. Robins, Inc.), 880 F.2d 694 (4th Cir. 1989) and In re Continental Airlines, Inc., 203 F.3d 203 (3d Cir. 2000). The Court noted that while A.H. Robins constitutes the Fourth Circuit’s only published guidance as to whether a Chapter 11 plan can legally discharge, enjoin or release the liability of non-debtor third-parties, given the extreme factual differences between it and the instant case, the Court could drew little guidance therefrom.
Instead, the Court focused on Continental Airlines, which according to the Court “provides a good framework for guiding the evaluation of the release, discharge or enjoinment of third-party liability.” According to the Continental Airlines court, such extraordinary relief could only be supported by findings that determine whether the releases are fair and supported by consideration, whether the success of the reorganization is dependent upon the releases, and whether the releases are a “key element” of the plan.
Applying Continental Airlines, the Court found that the record to date provided no factual basis for finding that the release of third-party liability was either warranted or desirable and that Roberts offered no legal rationale to explain why the discharge of third-party liability should be permitted over the plain meaning of § 524(e). Put simply, the Court held as no factual or legal basis existed for the contemplated releases and as the proposal at issue appeared to be grounded in bad faith, the plan provisions that barred debt collection from non-debtor third-parties violated § 524(e), making the plan unconfirmable. The Court found that it could not approve the Disclosures Statements for the same reason.
The Court also found that the Disclosure Statements provided inadequate information regarding the Debtors’ relationship; their pre-petition history and finances; their performance during bankruptcy; their assets and liabilities; their liquidation analysis; and the feasibility/implementation of their plan. The Court noted that Ms. Harenberg’s exemptions and notes regarding certain schedules were also inadequate because they contained “a cavalcade of disclaimers and renouncements” that effectively rendered them meaningless. Drawing particular ire from the Court was the plan’s attempt to “cherry pick” good assets and scrub the Debtors clean of personal liability so they could continue the same business as if they’d never filed for bankruptcy, which the Court characterized as “a particularly repugnant version of bad faith.”
While the Court was (obviously) highly critical of the plan and Disclosure Statements, it did not limit its analysis to a mere critique of their problems; instead, the Court provided guidance as to what information the plan should contain going forward. Specifically, the Court stated that the plan should contain the following information:
The case is instructive, not only to Chapter 11 practitioners, but also to creditors’ counsel to demonstrate the minimum requirements and what should be avoided when arguing for approval of a disclosure statement.