Pac. W. Bank v. Fagerdala USA-Lompoc, Inc. (In re Fagerdala USA-Lompoc, Inc.), 891 F.3d 848 (9th Cir. 2018)

Pac. W. Bank v. Fagerdala USA-Lompoc, Inc. (In re Fagerdala USA-Lompoc, Inc.), 891 F.3d 848 (9th Cir. 2018)

Fagerdala USA – Lompoc, Inc. (“Fagerdala”) commenced a chapter 11 bankruptcy in the United States Bankruptcy Court for the Central District of California (the “Bankruptcy Court”).  Fagerdala’s principal asset was real property worth approximately $6 million.  Pacific Western Bank (“Pacific Western”) held a senior secured claim (in excess of $3.95 million) on Faegerdala’s real property. 

Fagerdala filed a plan of reorganization that placed Pacific Western’s claim in Class 1 and general unsecured claims in Class 4.  Both classes were deemed impaired; specifically, Pacific Western’s claim was impaired because the plan reduced the interest rate on the loan and modified other loan terms. 

Under section 1129(a)(10) of the Bankruptcy Code, a plan of reorganization that impairs a class of claims may be approved if at least one non-insider impaired class votes to accept the plan.  Class acceptance of a plan requires approval by (i) two-thirds by value and (ii) a majority in number of creditors of that class who vote on the plan.  Therefore, to block Fagerdala’s proposed plan, Pacific Western purchased more than half by number (but not all) of the claims in Class 4 (the “Purchased Claims”).

After Pacific Western voted to block the plan, Fagerdala moved to designate the Purchased Claims under Bankruptcy Code section 1126(e) (the “Designation Motion”), arguing that Pacific Western had not purchased the claims in good faith.  The Bankruptcy Court granted the Designation Motion, holding that (i) Pacific Western had an unfair advantage over unsecured creditors whose claims were not purchased and (ii) a creditor’s conduct in furtherance of its own interests should not be permitted to cause an unfair disadvantage to other creditors.  The district court affirmed. 

The Ninth Circuit reversed.  While offering to purchase all claims of a class indicated good faith, failure to offer to purchase all claims did not (by itself) constitute sufficient evidence of bad faith.  The Ninth Circuit criticized the Bankruptcy Court’s application of In re Figter, 118 F.3d 635, 639 (9th Cir. 1997), in which the Ninth Circuit held that the creditor, who purchased all claims of the class, had acted in good faith.  Analyzing Figter, the Ninth Circuit held that the Figter creditor’s offer to purchase all claims of the class was not the singular, dispositive factor in the court finding good faith; it was one of several factors.   Absent an ulterior motive (such as a non-preexisting creditor purchasing a claim to block an action against itself, a competitor purchasing claims to destroy the debtor’s business to further its own business or a debtor arranging for an insider to purchase claims), doing something allowed by the Bankruptcy Code and case law – purchasing a subset of claims to block a plan – did not indicate bad faith.

The Ninth Circuit further held that the Bankruptcy Court erred by examining only the effect of Pacific Western’s action, and not Pacific Western’s motivation, in determining that allowing Pacific Western to vote the Purchased Claims would give it an “unfair advantage” over other creditors.  Merely protecting a claim to its fullest extent is not evidence of bad faith.  Something more was required; namely, an ulterior motive unconnected to the creditor’s economic self-interest or an attempt to obtain something to which the creditor was not entitled.