It’s OK to Be Selfish: In re Monticello and Courts’ Continuing Deference to Creditors’ Interests

By: Corey Trail

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


            In In re Monticello Real Estate Investments, LLC, a bankruptcy court held that a creditor did not act in bad faith when it purchased unsecured debt from another creditor in order to have the votes necessary to veto a debtor’s reorganization plan.[1] In Monticello, the debtor was a realty investor that took out a $1.185 million loan to finance the purchase of an office center.[2]  After the debtor failed to satisfy the loan by its five year maturity date, the bank and the debtor entered into two loan modifications that extended the maturity date of the loan.[3] The debtor soon failed to adhere to the loan modifications and the bank began foreclosure proceedings.[4] In response, the debtor filed a chapter 11 bankruptcy petition and requested authority to use cash collateral.[5] The court granted the debtor’s request and instructed the parties to submit an agreed upon order authorizing the use of cash collateral that set forth a tentative agreement to restructure the bank’s debt.[6] As part of the agreement, the bank required the debtor to sign two promissory notes that it claimed contained “standard loan documents.”[7] However, the debtor rejected the standard loan forms and responded with a modified loan agreement, which the bank rejected.[8] The debtor filed the new agreement (“the Plan”) without the required new loan documents.[9] The court issued a second cash collateral order, which was again dependent on the execution of new loan documents.[10] Subsequently, the court scheduled a hearing to confirm the Plan.[11] Both the bank and a credit card company filed claims against the debtor.[12] In order to ensure that the debtor’s Plan was not able to acquire the requisite amount of votes, the bank purchased the claim from the credit card company to obtain enough votes to block the Plan’s confirmation.[13] The bank explained that had the Plan been confirmed, the FDIC would negatively rate the debt.[14] The debtor moved to have the bank’s ballots designated pursuant to 11 U.S.C. section 1126(e), stating that the bank’s desire to dictate the terms of the new loan documents, the cessation of negotiation on the new terms before the expiration deadline, and the purchasing of other claims exhibited a lack of good faith required by the statute.[15] The court however, disagreed, finding that because the execution of a new loan agreement on the bank’s terms was crucial to protecting the bank’s interests, the purchase of other claims to ensure that the Plan would not receive the necessary votes was not in bad faith.[16]

            Under the Bankruptcy Code, when a debtor’s reorganization plan is submitted to creditors, and the creditors cast votes in approval or disapproval that are not based in good faith, those votes can be disregarded (also known as designated) by the courts.[17] Section 1126(e), however, does not define a lack of good faith (or bad faith) and has left that task to the courts.[18] The court in In re Adelphia Communication Corp. noted that courts have found bad faith where: (1) the claimant used obstructive tactics and hold-up techniques to get better treatment for its claim in comparison to others in the same class, (2) the holder casts a vote with an ulterior purpose of securing an advantage it would otherwise not have, or (3) where the motivation behind the vote is not consistent with a creditor’s protection of its own self-interest.[19] The court in In re Federal Support Co. defined ulterior motives as “pure malice, strikes, blackmail and to destroy an enterprise in order to advance a competing business.”[20] The Adelphia court also noted that designation of a vote is a “drastic remedy,” and is therefore the exception, not the rule.[21]

         Indeed, in In re Federal Support Co., the court refused to find bad faith when a creditor that was a defendant in an antitrust claim voted against another company’s reorganization plan.[22] The court noted that the reorganization plan could be harmful to the creditor in an antitrust matter, and that the potential harm to the creditor alone was a valid reason for the vote to reject the plan.[23] In In re Figter Ltd., the court found no bad faith where a creditor purchased 21 unsecured claims to ensure that a reorganization plan failed.[24] While the reorganization plan seemed feasible, the Fourth Circuit noted that it “would not condemn mere enlightened self interest, even if it appears selfish to those who do not benefit from it.”[25] This selfishness is tolerated as long as “the interest being served is that of a creditor as creditor.”[26] On the other hand, in In re DBSD North America, Inc., the court invalidated the votes of a creditor that purchased claims in order to place itself in a position to acquire its competitor.[27] The court noted that despite the fact that internal memos confirmed the ulterior motive, such a motive could be inferred by the creditor buying the debt at par.[28] This was more, the court noted, “[that] most other creditors could only hope [for].”[29]

            Monticello demonstrates a court’s reluctance to designate a creditor’s vote for or against a reorganization plan. The Monticello court held that the bank’s desire to protect its balance sheet from a negative credit rating was a valid reason for the purchasing of other classes of debt to secure the votes needed to invalidate the Plan proposed by the debtor.[30] This was determined even though the court found that the debtor also had a good faith.[31] It can be inferred, therefore, that where there is good faith on both sides, a court will likely defer to the creditor’s good faith, so long as the creditor is not a latecomer to the reorganization proceeding.[32] If this is to change, it is clear that Congress will have to instruct the courts to give a more even-handed assessment of each side’s interest by an amendment of section 1126. Until then, little is likely to change.

[1] In re Monticello Realty Inv., 526 B.R. 902 (Bankr. M.D. Fla 2015).

[2] See Id. at 906.

[3] Id.

[4] See Id.

[5] See Id. at 906-07.

[6] See Id. at 907.

[7]See Id. at 908. The bank’s manager testified that the terms “[had] to be supported by loan documents which protected [the bank’s] collateral and provided customary rights and remedies.”

[8] Id.

[9] See Id.

[10] See Id. at 908.

[11] Id.

[12] See Id. The bank filed a secured claim in the amount of $850,054.38, while the credit card company filed a secured claim in the amount of $41,868.20.

[13] Id.

[14]See Id. The bank’s manager testified that the exclusions the debtor wanted to make in the new loan agreements would cause the FDIC to negatively rate the credit, due to the lack of cross default for the nonpayment of taxes, along with the debtor’s failure to pay taxes in the past. This would then have to be reported to shareholders.

[15] See Id. at 910.

[16] Id.

[17] See Figter Ltd. v. Teachers Insurance and Annuity Ass’n of America (In re Figter Ltd.), 118 F.3d 635, 638 (9th Cir. 1997) (“[T]he court may designate any entity whose acceptance or rejection of [a] plan was not in good faith, or was not solicited or procured in good faith or in accordance with the provisions of this title.” 11 U.S.C. § 1126(e)”).

[18] See In re DBSD North America, Inc., 421 B.R. 133, 137 (Bankr. S.D.N.Y. 2009) (explaining that the concept of good faith has been “left to caselaw”). See also In re Landing Assoc., Ltd, 157 B.R. 791, 802 (Bankr. W.D. Tex. 1993) (stating that the term “good faith” was left “intentionally undefined”).

[19] 47 B.R. 54, 60 (Bankr. S.D.N.Y. 2006).

[20] See Insinger Machine Co. v. Federal Support Co. (In re Federal Support Co.), 859 F.2d 17, 19 (4th Cir. 1988).

[21] See In re Adelphia, 47 B.R. at 60.

[22] 859, F.2d at 18.

[23]See Id. at 20.

[24] 118 F.3d at 637.

[25] See Id. at 639. See also In re Landing Assoc., Ltd, 157 B.R at 803 (“Mere selfishness does not rise to the level of bad faith.”)

[26]See In re DBSD North America, Inc. 421 B.R. at 139 (quoting Collier on Bankruptcy, 7 Collier on Bankruptcy ¶ 1126.06[2] (15th Ed. Rev. 2009).

[27] 421 B.R. 133, 141 (S.D.N.Y. 2009).

[28] See Id. at 112 n. 18.

[29]See Id. at 135. The court relied on the ruling in In re Allengheny Int’l, Inc., 118 B.R. 282 (Bankr. W.D. Pa. 1990). Bankruptcy court found fraud where the creditor purchased the claims in order to gain a favorable position where it could acquire its competitor.

[30]See In re Monticello, 526 B.R. at 910. The court once again refers to the bank manager’s testimony regarding the negative effect exclusion of the loan agreements would have on the bank’s balance sheets.

[31] See Id. at 914. During the time of negotiations with the bank, the debtor increased the occupancy from 56% to 83%. The court determined that the debtor had a good faith interest in continuing the operation of its business, and did not propose the plan for the ulterior motive of avoiding its tax liability – an accusation that the bank proffered against the debtor.

[32] For example, in In re Federal Support Co., 859 F.2d at 18, the creditor was a defendant in an antitrust suit and was facing heavy fines. The debtor proposed paying the proceeds for the reorganization by using fines it would get from the antitrust suit against the creditor. The Fourth Circuit concluded that an ulterior motive was unlikely because the debtor would have purportedly benefitted the same from a reorganization or liquidation if the antitrust claim was successful. Thus, the court concluded, there was no ulterior motive. The court further went on to say that in either case, “[i]t was for [creditor] to decide its own self interest.”