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Section 363(o) Implications: Bankruptcy Court Denies Debtor’s Request to Disband Consumer Creditors’ Committee

On May 17, 2019, the Bankruptcy Court for the Southern District of New York announced that the Official Committee of Consumer Creditors (the “Consumer Committee”) appointed in the In re Ditech Holding Corp. bankruptcy case would not be disbanded.  Ditech, supported by the ad hoc group of term loan lenders (the “Ad Hoc Group”), had filed a motion requesting that the Consumer Committee be disbanded or alternatively have a limited scope and budget.  After receiving objections from the U.S. Trustee (the “UST”), Consumer Committee, and various consumer borrower groups, the Court refused to disband or otherwise limit the Consumer Committee.  The Court found that consumers constitute the majority of Ditech’s unsecured creditors and that the Official Committee of Unsecured Creditors (“UCC”) could not adequately protect consumer borrower issues arising under section 363(o) of the Bankruptcy Code.

Request and Appointment of the Consumer Committee

On April 19, 2019, the Bluhm Legal Clinic at Northwestern Pritzker School of Law (the “Clinic”) filed a letter in Ditech requesting the appointment of a consumer creditor committee on behalf of three consumer borrowers who had each entered into a reverse mortgage arrangement with an affiliate of Ditech.  The reverse mortgage allowed the consumers to borrow against the equity in their home.  The Clinic asserted that the Ditech loans were “predatory and exploitative [in] nature,” were conducted “fraudulently,” and led to the consumers receiving “no proceeds or benefits.”  Four days after the Clinic’s letter was filed, a law firm (the “Firm”) joined the Clinic’s request, asserting that the Firm represented hundreds of similarly situated consumer borrowers and that the Firm was “concerned that the Debtor’s reorganization will rely on the continued abuse of existing consumers and create new victims.”  On March 2, 2019, the UST appointed the five member Consumer Committee to represent all consumer creditors.

Challenge Against Appointment of the Consumer Committee

On May 8, 2019, Ditech filed a motion seeking to disband or, alternatively, limit the Consumer Committee’s scope and cap the Consumer Committee’s fees and expenses at $250,000.  Ditech argued that the appointment of the Consumer Committee would (a) cause “unnecessary complexity and delay [to] these chapter 11 cases,” (b) lead to “unnecessary incremental costs on the estates,” (c) cast “a shadow on the bidding and sale process,” and (d) lead to an increased risk that the entire reorganization could be jeopardized.  Ditech further asserted that the consumer creditors were already adequately represented by the UCC, which owes a fiduciary duty to all general unsecured creditors.  Alternatively, by limiting its scope and budget, Ditech argued that the Consumer Committee would only pursue “those legitimate goals for which the interests of the consumer creditors truly diverge from those of the other unsecured creditors” and would “prevent duplicative and unnecessary costs.”  That same evening, the Ad Hoc Group filed a statement in support of Ditech’s motion.

Pleadings in Support of Appointment of the Consumer Committee

On May 13, 2019, the UST, Consumer Committee, Clinic, and Firm all filed oppositions to Ditech’s motion, arguing that the Consumer Committee was necessary in order to protect consumer borrowers with respect to section 363(o) of the Bankruptcy Code.  Section 363(o) provides that if an entity purchases any interest in a consumer credit transaction, such as Ditech’s home loan portfolio, through a 363(b) asset sale, then the purchaser remains subject to all claims that are related to such consumer credit transaction to the same extent as if the purchase had occurred outside of bankruptcy.  However, Ditech’s proposed plan of reorganization provides that in the event of an asset sale under section 363(b), section 363(o) would not apply and the sale would be free and clear of consumer claims.  The parties argued that in light of the plan’s proposed stripping of the section 363(o) protections, the Consumer Committee was necessary in order to protect the “approximately 1.5 million” individual consumer borrowers with residential mortgage loans or reverse mortgage loans originated or serviced by Ditech.

Court Holds that Appointment of the Consumer Committee is Appropriate

After a hearing on May 14, 2019, on May 17, 2019, the Court denied Ditech’s motion to disband or alternatively limit the scope and budget of the Consumer Committee.  The Court found that the UST did not “reflexively” appoint the Consumer Committee but took other steps to address the consumer borrowers’ concerns first, including supporting a general claims bar date extension, adding two consumers as members of the UCC, raising issues with Ditech regarding the proposed plan’s waiver of section 363(o), and consulting the UCC before appointing the Consumer Committee.  The Court also held that Ditech did not present evidence that the UST acted improperly and that Ditech was always aware that a separate consumer borrower committee could be appointed.

Key Takeaways

As made clear by the Ditech holding, counsel for an official committee of unsecured creditors must be cognizant of the general interests of the unsecured creditors when negotiating a plan of reorganization.  In some instances, the unsecured creditors’ committee must recognize that the sole objective may not be to merely maximize the economic recovery for unsecured creditors, but to also protect certain unsecured creditors’ legal rights.  This is what did not occur in Ditech – the UCC agreed with Ditech’s plan even though the plan would prejudice the rights of a significant subset of the unsecured creditor class.  The UCC’s lapse in considering the interests of these unsecured creditors led to the appointment of the Consumer Committee on the eve of a confirmation hearing, thereby increasing administrative costs and likely causing a delay in confirmation.  The UST has the power to appoint special-interest committees at any time during the case to the extent it believes certain groups of creditors are not being adequately represented.  By proactively analyzing how a material group of the unsecured creditor class could be negatively impacted by a settlement or plan, and by ensuring that the rights of those creditors are protected in the settlement or plan, practitioners can facilitate a successful reorganization or sale and preserve estate resources by avoiding future committee appointment standoffs.

© Copyright 2019 Squire Patton Boggs (US) LLP

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About this Author

Kyle F. Arendsen Bankruptcy lawyer Squire PB
Associate

Kyle Arendsen is a member of the firm’s Restructuring & Insolvency Practice Group and is involved in all aspects of corporate restructuring, bankruptcy and insolvency proceedings. Kyle has extensive experience representing debtors and creditors throughout the restructuring process. His restructuring matters encompass a wide variety of industries, including oil and natural gas, gaming, retail and banking.

Prior to joining Squire Patton Boggs, Kyle worked for an international law firm and focused his practice on representing debtors to successfully prepare for...

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