Insider's Purchase of Impaired Claims to Secure Plan Votes Constituted Improper "Gerrymandering," Rendering Plan Unconfirmable
In re Machne Menachem, Inc., 233 Fed. Appx. 119 (3d. Cir. Apr. 19, 2007) (Circuit Judge Julio M. Fuentes)
An insider of debtor Machne Menachem, Inc. purchased the claims of four unsecured creditors to alter the composition of the class of non-insider unsecured claimants. When the debtor’s plan or reorganization was then approved by voters and confirmed by the United States Bankruptcy Court for the Middle District of Pennsylvania, a former director of the debtor, who also was the proponent of a competing plan, appealed the confirmation order to the district court, arguing that the plan violated the good faith requirement of the plan confirmation provisions of the Bankruptcy Code. The district court reversed the bankruptcy court, and the Third Circuit affirmed the reversal, finding that the debtor impermissibly gerrymandered the classes to secure the necessary votes in favor of the plan.
The debtor, Machne Menachem, Inc., was a not-for-profit company that operated a summer camp for boys in Pennsylvania. During a battle for control of the debtor among its board of directors, the company filed a bankruptcy petition in the United States Bankruptcy Court for the Middle District of Pennsylvania. There were two competing plans of reorganization; one was filed by the debtor, and the second by a former director, Yaakov Spritzer. The court confirmed the debtor’s plan.
Spritzer argued that the plan could not be confirmed, contending that it was not a plan proposed in good faith. In support of this argument, Spritzer pointed to the purchase of the claims of four unsecured creditors by Levi Heber, the son of one of the debtor’s remaining directors. These claims were then reclassified from the Class 4 (non-insider unsecured claims) to Class 5 (insider unsecured claims). Because the plan required the consent of one impaired class, under 11 U.S.C. § 1129(a)(10), and Class 4 approved the plan by a three vote margin, Spritzer contended that the claims purchase by Heber was intended to rig the plan confirmation vote.
The district court vacated the confirmation order, ruling that the debtor gerrymandered Class 4 to secure confirmation. The debtor then appealed that ruling.
The Third Circuit Court of Appeals affirmed the district court decision, finding the purchase of claims by an insider of the debtor rendered the plan unconfirmable. Such a course of action amounted to vote manipulation by gerrymandering, undermining the requirements of consent by unimpaired classes.
The Third Circuit also affirmed the district court’s finding that the plan violated the requirements that each claim or interest of a particular class receive equitable treatment under the plan. Although all Class 4 claimants were to be paid in full under the plan, two claims out of the four purchased outside the plan were not paid in full.
Thus, the Third Circuit found that the purchase of claims outside the plan violated the confirmation requirements of the Bankruptcy Code.
