Third Circuit Finds Settlement Agreement to be Plan Modification

In SCH Corp. et al. v. CFI Class Action Claimants (In re SCH Corp.), the Third Circuit Court of Appeals held that a settlement agreement that constituted a plan modification request must be examined under 11 U.S.C. §1127 as opposed to Federal Rule of Bankruptcy Procedure 9019.

Factual Background

Prior to their January 2009 petition date, SCH Corp. and its debtor-affiliates (the Debtors) were engaged in the debt collection business. Before the Debtors sought bankruptcy protection, they were defendants in a number of class action lawsuits alleging violations of the Fair Debt Collections Practices Act pending in a variety of jurisdictions. The plaintiffs in these class action suits (the CFI Claimants) constituted the largest group of general unsecured creditors in the Debtors’ bankruptcy proceedings.

Post-petition, the Debtors’ assets were sold to Levine Leichtman Capital Partners III, L.P. (LLCP), over the objection of the CFI Claimants, and eventually transferred to NCG, a subsidiary of LLCP. After the first plan received objections, LLCP proposed an amended plan that was supported by the CFI Claimants where LLCP served as the plan proponent and sponsor and NCG functioned as the plan funder. The confirmed plan provided for NCG to make annual payments of $200,000 for five years with the first payment due in April 2010 and the final payment due in April 2014. The confirmed plan further provided that NCG could offset its annual payments for unpaid professional fees and losses incurred by LLCP and NCG in defending against future consumer lawsuits.

The plan went effective and NCG began making the required payments, however, NCG asserted offset rights and, therefore, very little of the funds were distributed to general unsecured creditors. NCG also asserted offset rights regarding litigation expenses that were eventually reimbursed by insurance. As a result of NCG’s post-confirmation actions, the CFI Claimants moved to dismiss the Debtors’ bankruptcy proceedings for bad faith and, alternatively, sought to enforce the confirmed plan.

The Responsible Officer, the disbursing and litigation agent appointed by the plan, reached an agreement with NCG to resolve the funding dispute that provided for, among other things, NCG to make three additional annual payments in 2015, 2016 and 2017 and sought the Bankruptcy Court’s approval of the settlement pursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure. The CFI Claimants objected to the purported settlement and argued that it amounted to a post-confirmation request to modify the plan that should be governed by 11 U.S.C. §1127(b) and moved to dismiss the bankruptcy proceeding.

After an evidentiary hearing, the Bankruptcy Court approved the settlement agreement under Rule 9019 and denied the CFI Claimants’ motion to dismiss. The Bankruptcy Court granted the motion after examining the settlement under Rule 9019. The CFI Claimants appealed the Bankruptcy Court’s ruling, on both the 9019 motion and the settlement agreement, to the District Court. The District Court eventually dismissed the appeal and affirmed the Bankruptcy Court’s order, finding that the Bankruptcy Court properly applied the Rule 9019 standard. In affirming the Bankruptcy Court’s ruling, the District Court dismissed the CFI Claimants Section 1127 argument because the CFI Claimants had allegedly offered little support in favor of that argument.

Analysis

The Third Circuit began its analysis with a review of the plain language contained in Section 1127. Section 1127(b) provides that “[t]he proponent of a plan or the reorganized debtor may modify such plan at any time after confirmation of such plan…if…the court, after notice and a hearing, confirms such plan as modified, under Section 1129 of this title.” 11 U.S.C. §1127(b). The Court noted that the bankruptcy code does not define “modification” and courts that have examined the issue of whether a change amounts to a modification “distinguish between the courts’ inability to modify a plan and their ability to clarify a plan where it is silent or ambiguous; and/or interpret plan provisions to further equitable concerns.” The Court went on to find that the Bankruptcy Court abused its discretion in failing to consider whether the settlement was a modification of the plan under Section 1127(b). The Responsible Officer had argued that because the settlement agreement did not change the economic relationship with NCG, the settlement agreement did not modify the plan. The Third Circuit rejected that argument because the settlement agreement involved an extension of the plan funding period, from five years to eight years and held that the settlement agreement amounted to a modification. Due to the plan provision that permitted LLCP and NCG to offset its plan payment obligations with litigation costs, the extension of the plan funding period had the practical effect of preventing the CFI Claimants from bringing more class actions for an additional three years. In support of its conclusion, the Third Circuit relied upon case law out of the Fifth Circuit and a series of district courts that had found similar agreements to be plan modifications. The Court did note in dictum, and the CFI Claimants agreed, that if the settlement agreement only provided for a compromise in the payments within the five year period, then the settlement would not have amounted to a plan modification.

The case was remanded back to the Bankruptcy Court to evaluate the settlement agreement under Section 1127.