The U.S. Court of Appeals for the Fifth Circuit recently ruled that a secured creditor that received notice of a debtor's Chapter 11 bankruptcy, but was not otherwise involved in the bankruptcy, did not "participate" in the reorganization and its lien accordingly survived confirmation of the debtor's reorganization plan.
A copy of the opinion is available at: http://www.ca5.uscourts.gov/opinions/pub/12/12-60648-CV0.wpd.pdf.
A lender ("Lender") extended a loan to a business ('Debtor") that was secured against Debtor's office building. After Lender perfected its security interest in the building, three other entities perfected security interests in the same building.
Debtor later filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, acknowledging the other security interests, but listing Lender's lien as "disputed." Lender received several notices of Debtor's bankruptcy, but never filed a proof-of-claim in the bankruptcy proceedings or otherwise involved itself in the reorganization. Debtor's eventual reorganization plan provided no recovery for Lender.
The Bankruptcy Court confirmed the plan. Lender subsequently moved for a declaratory judgment that its lien had survived plan confirmation, or for an order amending the confirmation plan to provide for Lender's lien. Denying Lender's motion, the Bankruptcy Court ruled that the plan's confirmation voided Lender's lien. See 11 U.S.C. § 1141(c).
Lender appealed. The district court reversed, ruling that mere notice to Lender did not constitute "participation" in the reorganization so as to void its lien. Debtor appealed. The Fifth Circuit affirmed.
As you may recall, the Bankruptcy Code provides that "after confirmation of a plan, the property dealt with by the plan is free and clear of all claims and interests of creditors, equity security holders, and of general partners in the debtor." 11 U.S.C. § 1141(c).
Noting the so-called default rule that a secured creditor may ignore the bankruptcy proceeding and look to the lien for satisfaction of the debt as long as the lien is not invalidated through some other provision of the Bankruptcy Code, the Fifth Circuit pointed out its holding that section 1141(c) only voids liens held by a lien holder who actually participates in the bankruptcy reorganization. See Elixir Indus., Inc v. City Bank & Trust Co. (In re Ahern Enters, Inc.), 507 F.3d 817, 822 (5th Cir. 2007)("In re Ahern Enterprises") (requiring four conditions to void a lien under Section 1141(c): (1) plan confirmation; (2) the property subject to the lien must be dealt with by the plan; (3) the lien holder must participate in the reorganization; and (4) the plan must not preserve the lien).
The Fifth Circuit observed that "participation" connoted activity, not mere nonfeasance, and that other federal appellate courts have similarly required more than notice to have "participated" for purposes of section 1141(c). See, e.g., In re Penrod, 50 F.3d 459, 461 (7th Cir. 1995); FDIC v. Union Entities (In re Be-Mac Transp. Co.), 83 F.3d 1020, 1023 (8th Cir. 1996).
The Court thus concluded that mere receipt of notice of a bankruptcy filing was not "participation" in the reorganization so as to void a lien under Section 1141(c). In so doing, the Fifth Circuit pointed out that Lender never filed a proof of claim in this case, concluding that In re Ahern Enterprises required affirmative conduct on the part of a secured creditor in the reorganization, such as filing a proof of claim, or serving on a creditors' committee. In the Court's view, mere passive receipt of notice was insufficient to void a lien under section 1141(c).
Accordingly, because Lender never "participated" in Debtor's bankruptcy reorganization, the Fifth Circuit affirmed the district court's ruling.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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Chicago, Illinois 60602
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