New York Court Allows Reorganized Debtor to Prosecute Action Not Identified in its Disclosure Statement

May 2013Lending & Restructuring Alert

A New York state court recently denied a motion to dismiss an action brought by a reorganized debtor against the former chair of the official committee of unsecured creditors in the debtor's chapter 11 case.1 The decision is noteworthy for its holding that the reorganized debtor had standing to commence an action against the former committee member even though the claim was not expressly listed as an asset of the estate in the debtor's chapter 11 disclosure statement.

Background

The Glazier Group, Inc. ("GGI") provided management services to several of its restaurant affiliates (collectively, the "Affiliates"). Prior to GGI's chapter 11 filing, disputes arose between GGI, the Affiliates and Premium Supply Co., Inc. ("Premium Supply") as to monies owed for the restaurant supply products provided by Premium Supply to the Affiliates. These disputes were resolved by an agreement (the "Settlement Agreement"), whereby Premium Supply agreed that GGI would not be liable for the debts owed by the Affiliates, and that the Affiliates would remain liable for their respective portions of the indebtedness owed to Premium Supply.

Litigation in the Bankruptcy Court

Thereafter, GGI filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"). None of the Affiliates filed for bankruptcy. Despite the language of the Settlement Agreement negating GGI's liability to Premium Supply, Premium Supply filed a proof of claim against GGI in the Bankruptcy Court asserting an unsecured claim exceeding $237,000. As alleged by GGI, Premium Supply then successfully campaigned for the formation of an official committee of unsecured creditors (the "Committee"), and Premium Supply was selected to act as chair of the Committee.

GGI filed an objection with the Bankruptcy Court seeking to expunge Premium Supply's proof of claim. The Bankruptcy Court sustained the objection and expunged Premium Supply's proof of claim based, in part, on the terms of the Settlement Agreement. Accordingly, Premium Supply was removed from the Committee.

Next, GGI filed a plan of reorganization (the "Plan") that provided for an infusion of outside capital to pay all secured and priority claims in full and a 20% distribution to GGI's unsecured creditors. Importantly, the liquidation analysis attached to GGI's disclosure statement filed in support of the Plan (the "Disclosure Statement") demonstrated that a liquidation of GGI's estate would provide only a partial payoff of GGI's secured indebtedness and no distribution to GGI's unsecured creditors. The Bankruptcy Court approved GGI's Disclosure Statement, and confirmed GGI's Plan, which became effective on January 13, 2012.

The State Court Lawsuit

After the Plan was confirmed, GGI commenced an action against Premium Supply in the Supreme Court of the State of New York, County of New York (the "State Court") asserting that Premium Supply breached the Settlement Agreement by asserting a frivolous claim against GGI in its chapter 11 case, which required GGI to incur a substantial amount of legal fees to expunge the claim and other costs.

The Court Denies Premium Supply's Motion to Dismiss

Premium Supply moved to dismiss GGI's claims, principally on the grounds that GGI did not have legal standing to bring the action because GGI did not disclose its claims against Premium Supply in the Disclosure Statement that GGI provided to its creditors.

Premium Supply's motion to dismiss relied upon the general proposition that undisclosed claims of a debtor do not revert to a reorganized debtor after plan confirmation.2 The State Court rejected Premium Supply's argument. First, the State Court highlighted the fact that the release and exculpation provisions contained in the order confirming GGI's Plan specifically excluded Premium Supply, which indicated to all parties, at a minimum, that the Debtor would likely sue Premium Supply after plan confirmation. The State Court also noted that the Plan confirmation order specifically stated that "[p]ursuant to Section 1141(b) of the Bankruptcy Code, on the Effective Date, title to all properties and assets of the Debtor and its Estate shall vest in the Reorganized Debtor free and clear of all liens, claims and encumbrances…" The State Court found that these facts supported a finding that GGI's claims against Premium Supply were disclosed to its creditors, and revested back to GGI upon confirmation of the Plan.

Interestingly, the State Court also indicated that its decision would not change even if it found that GGI's claims against Premium Supply had not been disclosed to GGI's creditors. The State Court found persuasive the argument of GGI's counsel that the disclosure of a $300,000 claim that GGI could assert would not have materially affected the vote of any of GGI's unsecured creditors, who comprised the only class of creditors entitled to vote on the Plan. The liquidation analysis attached to the Disclosure Statement demonstrated that a liquidation of GGI's assets (excluding the claim against Premium Supply) would have resulted in a 14% distribution to GGI's secured lender, and no distribution to GGI's unsecured creditors. If GGI's $300,000 claim against Premium Supply were included as an asset of the GGI estate, a liquidation of GGI's assets would have resulted in an 18% distribution to GGI's secured lender, and still no distribution to GGI's unsecured creditors. In contrast, GGI's Plan provided for the secured lender to be paid in full and a 20% distribution to GGI's unsecured creditors. Based on these facts, the State Court found that the disclosure of GGI's claim against Premium Supply would not have materially affected the vote of GGI's unsecured creditors in favor of the Plan, and GGI's failure to explicitly disclose its claim against Premium Supply did not prevent the claim from revesting in the reorganized GGI.

Observations

This case highlights the important protections reorganized debtors receive under the Bankruptcy Code with respect to the preservation and revesting of causes of action that accrue during the pendency of a chapter 11 case. The State Court recognized that express disclosure of GGI's claim against Premium Supply would not have made a material difference in the vote confirming GGI's Plan, and refused to countenance Premium Supply's argument that non-disclosure was automatic grounds to strip the reorganized GGI of standing to bring its claim.

This case also draws an important distinction from those cases holding that a chapter 11 debtor's failure to disclose potential causes of action against the debtor's creditors in its disclosure statement precludes the debtor from litigating those claims post-confirmation.3 Those cases recognize that a creditor may vote differently on a debtor's plan if the creditor is aware that it could face potential litigation from the debtor after confirmation. In this case, however, the Bankruptcy Court specifically ruled that Premium Supply was not a creditor of GGI, and thus Premium Supply was not entitled to vote on GGI's Plan. As such, the State Court found that the express disclosure of a potential claim against a non-creditor would not have affected the vote of GGI's creditors with respect to the Plan.

Finally, the State Court recognized that "[i]t is neither reasonable nor practical to expect a debtor to identify in its plan of reorganization or disclosure schedules every outstanding claim it intends to pursue with a degree of specificity that [defendants] would require."4 In other words, defendants in lawsuits filed by reorganized debtors cannot assume that a debtor's failure to list in its disclosure statement each lawsuit it may bring post-confirmation will bar the reorganized debtor from prosecuting those claims after it emerges from bankruptcy.


Copyright © 2013 Herrick, Feinstein LLP. Lending & Restructuring Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.



1The Glazier Group, Inc. v. Premium Supply Co., Inc., Index No. 650259-2012 (N.Y. Sup. Ct., April 19, 2013).

2See Rosenshein v. Kleban, 918 F. Supp. 98, 103 (S.D.N.Y 1996).

3See, e.g., Kelley v. S. Bay Bank (In re Kelley), 199 B.R. 698, 703-04 (9th Cir. B.A.P. 1996); Mickey's Enters., Inc. v. Saturday Sales, Inc., 165 B.R. 188 (W.D. Tex. 1994).

4The Glazier Group, Inc. at 14, citing In re I. Appel Corp., 300 B.R. 564, 569 (S.D.N.Y. 2003), aff'd 104 Fed. Appx. 199 (2d Cir. 2004).