What Notice Is Effective In Bankruptcy? Indirect Notice May Not Be Adequate Notice

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1 FALL 2005 What Notice Is Effective In Bankruptcy? Indirect Notice May Not Be Adequate Notice Chapter 11 allows a debtor to reorganize and emerge from bankruptcy as a going concern. In order to emerge from bankruptcy, however, a debtor must propose and confirm a plan of reorganization that specifies how its pre-bankruptcy liabilities will be satisfied. Confirmation of a Chapter 11 plan binds the debtor and all creditors to the terms of the plan and, to the extent provided for in the plan, discharges claims against the debtor that arose prior to the confirmation date. A Chapter 11 debtor s discharge, in turn, is protected by both a statutory injunction and the terms of the order confirming the plan. These injunctions stay creditors from seeking to enforce their pre-bankruptcy claims following confirmation of the plan. Creditors who violate those injunctions risk being held in contempt of court and can be liable for monetary damages and other sanctions. The broad scope of such Chapter 11 relief, however, is subject to important constitutional limitations. Where a creditor s claim against the debtor is adversely affected by confirmation of the debtor s plan of reorganization, the plan is only binding on that creditor if the creditor received constitutionally-sufficient notice of the hearing to confirm the plan of reorganization and an opportunity to object to the plan. What constitutes constitutionally adequate notice of a Chapter 11 plan was the subject of a recent decision by the United States Bankruptcy Court for the District of Massachusetts in the Chapter 11 case of Arch Wireless. Nationwide s Pre-Bankruptcy Claim Against Arch Wireless Arch Wireless, the debtor, is a supplier of pagers and paging network time. Prior to the commencement of the Debtor s Chapter 11 case, Arch sold pagers and airtime to Nationwide Paging, Inc. which, in turn, resold the airtime and pagers to its customers. A dispute arose between Arch and Nationwide concerning Nationwide s payment obligations. Nationwide not only claimed that Arch overbilled it but that a large number of the pagers it had purchased from the Debtor were defective and that those defective pagers had cost Nationwide a substantial piece of business with its customers. 1 of 5

2 Notice Concerning the Confirmation Hearing Subsequently, Arch filed a petition for relief under Chapter 11 of the Bankruptcy Code. Notwithstanding Nationwide s complaint that a substantial number of the pagers it had purchased were defective, Arch failed to list Nationwide as creditor in its schedules and statements filed with the Bankruptcy Court and Nationwide did not receive formal notice of Arch s Chapter 11 filing. In addition, Arch failed to serve Nationwide with written notice of the deadline to file proofs of claim in the Chapter 11 case or the hearing to consider confirmation of its plan of reorganization. Arch did, however, publish a notice concerning the confirmation hearing in the Wall Street Journal and the Boston Globe. Ultimately, the Bankruptcy Court entered an order confirming Arch s plan of reorganization. The plan and confirmation order purported to discharge Arch from all claims, known or unknown, that arose prior to the date of the confirmation order and enjoined all persons or entities holding a claim against Arch from asserting claims against [Arch] following confirmation of the Plan. Arch Wireless s Post-Confirmation Litigation With Nationwide The billing issues between Arch and Nationwide were not resolved in Arch s Chapter 11 case. Shortly after entry of the confirmation order, Arch began terminating Nationwide s paging airtime services. Nationwide promptly filed suit in state court and obtained a temporary restraining order against Arch to prevent further disruption of hits paging services. In the state court action, Nationwide also sought a declaratory judgment regarding the amount, if any, it owed to Arch and damages arising from Arch s alleged overbilling, the defective pagers and Arch s failure to credit Nationwide for the defective pagers. Amazingly, the parties litigated for almost two years, before Arch notified Nationwide and the state court of the confirmation order. When Nationwide refused to dismiss its claims for damages or to continue to raise pre-confirmation events as a defense to Arch s counterclaims in the state court action, Arch filed a motion in the Bankruptcy Court seeking a declaration that Nationwide was in contempt of the order confirming Arch s plan of reorganization. In support of its contempt motion Arch alleged that although it failed to serve Nationwide with written notice of the deadline for filing proofs of claim in its Chapter 11 case, the hearing to consider confirmation of its plan or the confirmation order, Nationwide had actual knowledge that Arch had filed for Chapter 11 bankruptcy relief and, therefore, had a burden of further inquiry. In response, Nationwide simply contended that it was not bound by Arch s plan or the confirmation order because it did not receive adequate notice of the deadline for filing claims, the confirmation hearing or the confirmation order. The Bankruptcy Court s Ruling The Bankruptcy Court ruled that the plan and confirmation order were not binding on Nationwide and that Nationwide s pre-bankruptcy claims against Arch were not discharged. The court assumed for purposes of its decision that Nationwide knew that Arch had sought Chapter 11 relief but rejected Arch s claim that this knowledge charged Nationwide with a burden of further inquiry. Instead, the court reasoned that for a debtor s plan of 2 of 5

3 reorganization to be binding, the Due Process Clause of the Fifth Amendment of the United States Constitution requires that known creditors, like Nationwide, receive actual notice of the hearing to consider confirmation of the plan and that requirement could not be satisfied by publishing a notice of the hearing in a regional or national newspaper. Lessons The Arch Wireless case illustrates an important principle but involves unusual facts. In this case, Arch did not provide a known creditor with notice of either the deadline for filing claims or the hearing to consider confirmation of its plan of reorganization. In the vast majority of cases, however, debtors do provide their creditors with actual notice of those events and those creditors are bound by the bankruptcy court s order discharging claims and the burden is on those creditors to participate in the debtor s bankruptcy case if they object to the treatment of their claims under the debtor s plan of reorganization. Unfortunately, it is not uncommon for bankruptcy notices to be sent to and received by non-legal personnel who often fail to timely intervene in the debtor s bankruptcy case. The consequences of not participating in the bankruptcy case can be severe. For example, a creditor who fails to respond to a debtor s objection to its claim most likely will lose the right to receive its rightful dividend from the debtor s bankruptcy estate. To avoid that result, creditors should establish procedures for promptly reviewing notices received from debtors in bankruptcy and responding when necessary to protect their rights. Absent such procedures, creditors who receive notice of litigation to confirm a plan of reorganization but nonetheless fail participate in that litigation will be bound by the terms of plans of reorganization confirmed in bankruptcy. NEWS AND NOTES Congratulations to Richard Pedone Turnaround Management Association (TMA), the only international non-profit association dedicated to corporate renewal and turnaround management, honored outstanding corporate renewal accomplishments with the 2005 Best Turnaround and the 2005 Transaction of the Year awards at their Annual Conference held in Chicago on October Congratulations to Rick Pedone and Craig Tractenberg who were recognized for their work with the Ground Round Cooperative. The Transaction of the Year award for Small Company Transaction (Revenue of $50 million USD) went to Richard C. Pedone of Nixon Peabody LLP, Boston, for Independent Owners Cooperative, LLC, Freeport, Maine. Attorney News Mark Berman Mark Berman, Boston office, authored the Buying and Selling a Distressed Business chapter in the MCLE publication called Buying and Selling a Privately Owned Business in Massachusetts. 3 of 5

4 Amanda Darwin and Mark Berman Amanda Darwin, Boston office, and Mark Berman, Boston office, co-authored an article on Second Lien Financing and the Intercreditor Agreement that was published in the September 26, 2005 issue of Credit Investment News. Victor Milione and Mark Berman Victor Milione, Boston office, and Mark Berman, Boston office, were listed in the recent publication of Boston Magazine s Super Lawyers for their practice in bankruptcy law. 4 of 5

5 Bankruptcy Group Please feel free to call or your usual contact or any member in our Bankruptcy Group listed below. ATTORNEY NAME PHONE Daniel Sklar dsklar (603) Mark Berman mberman (617) Renee Bergmann rbergmann (215) Richard Bernard rbernard (516) (212) Robert Christmas rchristmas (212) Amanda Darwin adarwin (617) (212) Dennis J. Drebsky ddrebsky (212) Joseph Gitto jgitto (516) Howard Gorney hgorney (617) Lee Harrington lharrington (617) Gregory Mascitti gmascitti (585) Victor Milione vmilione (617) James Monroe jmonroe (415) Frank Morrissey fmorrissey (617) Richard Pedone rpedone (617) John Snellings jsnellings (617) Douglas Spelfogel dspelfogel (516) Peter Tamposi ptamposi (603) William Thomas wthomas (585) Craig Tractenberg ctractenberg (215) of 5 Albany, NY Omni Plaza 30 South Pearl Street Albany, NY Boston, MA 100 Summer Street Boston, MA Buffalo, NY 40 Fountain Plaza, Suite 500 Buffalo, NY Garden City, NY 990 Stewart Avenue Garden City, NY Hartford, CT CityPlace 185 Asylum Street Hartford, CT Los Angeles 555 West Fifth Street, 46 th Floor Los Angeles, CT McLean, VA 2010 Corporate Ridge, Suite 700 McLean, VA New York, NY 437 Madison Avenue New York, NY Orange County, CA 2040 Main Street, Suite 850 Irvine, CA Palm Beach Gardens, FL 4400 PGA Boulevard, Suite 900 Palm Beach Gardens, FL Philadelphia, PA 1818 Market Street Philadelphia, PA Providence, RI One Citizens Plaza Providence, RI Rochester, NY Clinton Square Post Office Box Rochester, NY San Francisco, CA Two Embarcadero Center San Francisco, CA Washington, DC 401 9th Street, N.W., Suite 900 Washington, DC