Ongoing Civil Litigation Does Not Defeat Chapter 11 Plan Feasibility

By: Kaitlin Fitzgibbon

St. John’s Law Student
American Bankruptcy Institute Law Review Staff
In In re RCS Capital Development,[1] the Bankruptcy Appellate Panel of the Ninth Circuit Court of Appeals affirmed the bankruptcy court’s finding that the debtor’s, RCS Capital Development (“RCS”), chapter 11 plan was feasible notwithstanding ongoing civil litigation between RCS and potential creditor ABC Learning (“ABC”).[2]  RCS filed its chapter 11 case, while it was simultaneously involved in two lawsuits[3] against ABC.  Ultimately, as a result of these actions, RCS had an enforceable claim against ABC for $57 million, and ABC had an enforceable claim against RCS for $41 million.[4]  In its proposed chapter 11 plan, RCS explained that it intended to use the $57 million as a setoff to pay ABC the full amount of its claim.[5]  However, the plan did not include a provision that accounted for the possibility that an appeal of the Nevada civil suit might result in ABC obtaining a judgment against RCS, thereby negating RCS’s right to setoff.[6]  Nevertheless, the BAP found that RCS’s plan was feasible, even though it did not factor in the possibility of an unfavorable appeal.
Section 1129 of the Bankruptcy Code requires that, among other things, the debtor’s plan of reorganization must be feasible in order to be confirmed.[7] In determining the feasibility of a plan, a court will consider whether the debtor has the means to execute the plan, and if, upon execution, whether the plan will allow the debtor to emerge from bankruptcy as a viable entity.[8]  Therefore, the court must consider whether a debtor is involved in any ongoing civil litigation when making these feasibility determinations.[9]  However, ongoing civil litigation is only one of many factors the court considers when determining whether a plan is feasible.[10] 
Just because there is pending civil litigation with a potential creditor, it does not necessarily follow that the plan is not feasible.  Therefore, the debtor does not have an obligation to include a provision in their plan for every possible outcome of a civil case.[11]  In examining how a civil case affects the feasibility of a debtor’s reorganization plan, a court will first consider the merits of both parties’ arguments in the lawsuit to determine what is likely to transpire, and then look to the effect that outcome will have on the debtor’s ability to execute its reorganization plan.[12]  The mere possibility of an unfavorable outcome in a civil case, which would negatively affect a debtor’s plan and may cause it to fail, is not enough to disprove feasibility, especially when the merits of an adverse party’s claim are weak.[13]  Although bankruptcy courts in the Ninth, Seventh and Third circuits have all embrace this approach, in practice they have more often than not found that ongoing litigation renders a chapter 11 plan not feasible because the outcome of such litigation is uncertain, which therefore, renders the success of the plan to not be reasonably likely.[14]
However, if the court determines that the potential creditor has a sufficiently small chance of succeeding on their claim, then the court will likely confirm the debtor’s plan, holding that it has met the Section 1129(a)(11) feasibility requirement even if the debtor has not included a provision in its plan for the possibility of the creditor’s success.  Using the rationale of the Bankruptcy Appellate Panel of the Ninth Circuit, whenever the court determines that there is a strong possibility that civil litigation will result in the debtor being required to pay a large sum to a creditor, the debtor will most likely be required to include a provision in its plan outlining how it will make that payment.  Ultimately, as a result of the Court’s decision, a debtor does not have to account for every possible outcome when drafting its chapter 11 plan of reorganization.  This has important ramifications for debtors who are parties in many ongoing civil lawsuits; since such debtors will not have to add provisions for every outcome their chapter 11 plans will be shorter and less complex.  As such, many debtors may be able to avoid unnecessarily burdening their respective estates with the extra costs associated with drafting plans of reorganization that account for every possible outcome of ongoing litigation.

[1] In re RCS Capital Dev., LLC, (In re RCSII) AZ-12-1626,2013 WL 3619172 (B.A.P. 9th Cir. July 16, 2013).
[2] See Id.,at *8.
[3] In re RCSCapitalDev.,LLC, (In re RCS I) AZ-12-1381, 2013 WL 3618550, at *2 (B.A.P. 9th Cir. July 16, 2013) (“On October 20, 2008, RCS sued ABC in the Arizona Superior Court for breach of contract.”); Id. *4 (“In March 2009, ABC filed the Nevada Action against ACCP, RCS, Krynski and CLA Partners, asserting a constructive trust claim over the properties ACCP purchased with ABC's funds along with other claims.”).
[4] Id., 2013 WL 3618550, at *1 (B.A.P. 9th Cir. July 16, 2013)(“RCS . . . [contends] that it [is] entitled to set off its claim against ABC for $57 million arising out of a liquidated judgment that it obtained in Arizona against ABC's [proof of claim] for $41 million that was based on the Nevada Action.”).
[5] In re RCS II, 2013 WL 3619172, at *2 (B.A.P. 9th Cir. July 16, 2013).
[6] Id.
[7] 11 U.S.C. § 1129(a)(11) (2010) (“Confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.”).
[8] See In re Union Fin. Servs. Grp., Inc., 303 B.R. 390, 427 (Bankr. E.D. Mo. 2003).
[9] See Harbin v. IndyMac Bank FSB (In re Harbin), 486 F.3d 510, 514 (9th Cir. 2007).
[10] In re Sagewood Manor Associates Ltd. P'ship, 223 B.R. 756, 763 (Bankr. D. Nev. 1998) quoting In re Lakeside Global II, Ltd., 116 B.R. 499, 506 (Bankr. S.D. Tex. 1989) (“The ‘traditional factors which have evolved to aid the bankruptcy court in a feasibility analysis include: (1) the adequacy of the capital structure; (2) the earning power of the business; (3) economic conditions; (4) the ability of management; (5) the probability of the continuation of the same management; and (6) any other related matter which determines the prospects of a sufficiently successful operation to enable performance of the provisions of the plan.’”).
[11]In re ELL 11, LLC., 2008 WL 916695, at *2 (Bankr. M.D. Ga. Apr. 2, 2008) (Deciding that a court must exercise discretion in evaluating the feasibility of Chapter 11 plan when ongoing litigation exists, but such claims will nor render plan automatically unfeasible).
[12] For example, in In re RCS Capital development, if ABC were to prevail on appeal of the Nevada’s court decision, RCS would be forced to liquidate further and financially restructure the corporation again, essentially causing the proposed Chapter 11 plan to fail.
[13] In re Seasons Partners, LLC, 439 B.R. 505, 515 (Bankr. D. Ariz. 2010) order confirmed, 4:09-BK-24017-JMM, 2010 WL 6556774 (Bankr. D. Ariz. Nov. 8, 2010). In In re RCS II, the court ultimately determined that there was no need for RCS to provide for a situation where they would not be able to offset their debt against the amount owed to them by ABC because the merits of ABC’s claim in the Nevada Action were so weak that there was only a small chance ABC would prevail on appeal.
[14] See American Capital Equipment, LLC v. Willard E. Bartel (In re Am. Capital Equip.), 688 F.3d 145, 156 (3d Cir. 2012); Accord In re DCNC N.C. I, LLC, 407 B.R. 651, 667 (Bankr.E.D.Pa.2009); In re Thompson, No. 92–7461, 1995 WL 358135, at *3–4 (Bankr.E.D.Pa.1995); In re Cherry, 84 B.R. 134, 139 (Bankr.N.D.Ill.1988); In re Rey, Nos. 04–B–35040, 04–B–22548, 06–B–4487, 2006 WL 2457435, at *7 (Bankr.N.D.Ill. Aug. 21, 2006).