Article courtesy of David P. Simonds and Edward J. McNeilly (both of Hogan Lovells US LLP)
In re Claar Cellars LLC, 623 B.R. 578 (Bankr. E.D. Wash. 2021)
In In re Claar Cellars LLC, 623 B.R. 578 (Bankr. E.D. Wash. 2021), the United States Bankruptcy Court for the Eastern District of Washington (the “Bankruptcy Court”) denied confirmation of the debtors’ chapter 11 plan of reorganization and approved confirmation of the competing chapter 11 plan filed by the debtors’ principal secured lender. While the Bankruptcy Court found that the debtors had proposed their plan in good faith, it rested on unrealistic assumptions about future business performance, and thus did not show that there were adequate means to implement the plan or that the plan was feasible.
From the 1980s onwards, Robert and Crista Whitelatch had been growing grapes in Washington State. In the 1990s, the Whitelatch family expanded operations by producing and selling finished wine under the Claar Cellars label. The Whitelatch family enterprise comprised the following components:
- Debtor Claar Cellars LLC (“Claar”) owned a winemaking facility that processed, stored and finished wine and sold it to buyers in both bulk and by bottle.
- Debtor RC Farms LLC (“RC” and, together with Claar, the “Debtors”) owned several parcels of real property, most of it vineyards, but the remainder being used for various other purposes. After harvest, RC transferred its grapes to Claar. Historically, Claar paid for the grapes in amounts sufficient to satisfy the expenses RC incurred from its agricultural operations.
- Non-Debtor Whitelatch Living Trust (the “Trust”), which Mr. and Mrs. Whitelatch formed for estate planning purposes, owned various pieces of property, including a parcel of real property containing vineyards farmed by RC as well as a structure that serves as both a residence and a shop.
Starting in 2016, the Debtors began to finance operations with money borrowed from HomeStreet Bank (“HomeStreet”). Claar borrowed under a secured line of credit and an equipment loan, both of which are guaranteed by RC, the Trust, and Mr. and Mrs. Whitelatch and their two sons individually. RC borrowed under a term loan; this indebtedness is secured by mortgages on some (but not all) of RC’s and the Trust’s real property and is guaranteed by Claar and the nondebtor individuals guaranteeing the Claar obligations.
Revenue declines between 2016 and 2019 led to breaches of the financial covenants in the HomeStreet loans. The business relationship deteriorated further as Claar failed to repay the line of credit upon maturity on September 1, 2019, and the debtors ceased making their respective contractual payments on the equipment and term loans. HomeStreet accelerated all indebtedness, and sued the obligors in state court for repayment and sought appointment of a custodial receiver. In December 2019, the state court appointed a custodial receiver over the Debtors’ property and certain property of the Trust. In January 2020, the Debtors filed for bankruptcy. While the filing of the bankruptcy petition invoked the automatic stay with respect to the Debtors, the state court receivership order became operative against the non-debtors. After the Debtors’ plan exclusivity lapsed, HomeStreet filed a competing plan.
The Competing Plans
The Debtors’ plan proposed to merge Claar and RC into a single reorganized debtor, revoke the Trust and contribute the real property farmed by RC to the reorganized debtor, and permit the reorganized debtor to continue to operate through December 2025. The plan promised to pay all creditors in full with interest over this roughly five-year period. The plan also proposes to reamortize the HomeStreet debt over twenty-five years with annual payments in the reamortized amounts due in each of the first four years and the remaining amount due in a “balloon” payment in 2025. General unsecured creditors would receive five equal annual payments during the same period. The source of the promised payments was uncertain, with the plan reserving optionality to fund the creditors’ payments from operations, sales or refinancing.
The gist of HomeStreet’s plan was that a plan agent would assume control of the Debtors’ operations and assets. Under the continued supervision of the Bankruptcy Court, the plan agent would evaluate matters and then proceed to monetize the debtors’ assets for distribution in accordance with the Bankruptcy Code’s priorities. The process was intended to maximize value for all stakeholders, including the Whitelatch family as residual claimants. The HomeStreet plan proposed to work in tandem with the pending receivership proceeding.
The Bankruptcy Court’s Decision
The Bankruptcy Court sustained HomeStreet’s objection to the Debtors’ plan. While the plan was proposed in “good faith” (thus satisfying section 1129(a)(3) of the Bankruptcy Code), the Debtors’ plan failed to satisfy the requirements of section 1123(a) of the Bankruptcy Code.
First, the Debtors’ plan did not satisfy section 1123(a)(5), which requires that a plan “provide adequate means for the plan’s implementation.” This required that the plan specify sufficient means to allow all terms, including whatever creditors payments are proposed in the plan, to be completed. While the plan stated that creditors would receive payments via funds from operations, asset sales or future refinancing, it failed to explain when and which option would be chosen, and how that option would be executed. The lack of detail and lack of firm processes that could constitute adequate means for the plan’s implementation rendered it unconfirmable.
Second, the indeterminacy of the plan also fell afoul of section 1123(a)(3) of the Bankruptcy Code, which requires that the plan must “specify the treatment of any class of claims or interests that is impaired under the plan.” The lack of details explaining how, among other things, HomeStreet’s loan would be repaid within five years created a level of uncertainty that was inconsistent with either section 1123(a)(3) and (5).
Moreover, the Debtors’ plan included prohibited content. Bankruptcy Code section 524(e) provides that, subject to a narrow exception, “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” The Debtors’ plan violated this provision in two ways. First, it impermissibly restructured the terms upon which the non-debtor Trust and Whitelach family members were liable to HomeStreet, by extending the terms of their guarantees, when such guarantees could be fully called under non-bankruptcy law following acceleration of the principal debt in 2019. Second, the Debtors’ plan impermissibly shielded the property of the non-debtor Trust from HomeStreet, as the effect of transferring certain property from the Trust to the reorganized debtors would be to shield such property from HomeStreet’s rights in the state court action, thus extending bankruptcy rights to a non-debtor.
Next, the Debtors’ plan did not satisfy the “feasibility test” of Bankruptcy Code section 1129(a)(11), which requires that plan confirmation be “not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.” The Debtors’ plan relied on future sales of property and/or future refinancings, none of which had been shown to be likely to occur or feasible. The Debtors’ business had performed poorly prior to the onset of the COVID-19 pandemic. The success of the plan required a return, by 2025, to revenues last achieved by the Debtors in 2013 and 2014. The plan was based on projections that were unduly realistic and overoptimistic. It was unlikely the Debtors would be able to consummate a successful refinancing or achieve an adequate sale. Thus, the Debtors’ plan was not feasible.
Finally, the Debtors’ plan, which proposed to transfer property of the Trust that was subject to the pending state court receivership, violated Bankruptcy Code section 1129(a)(16), which provides that transfers of property under a plan “be made in accordance with any applicable provisions of nonbankruptcy law that govern the transfer of property by a corporation or trust that is not a moneyed, business, or commercial corporation or trust.” The proposed transfer violated applicable Washington State law.
In contrast, the Bankruptcy Court found that the HomeStreet plan satisfied all of the requirements of the Bankruptcy Code, including the cramdown provisions of Bankruptcy Code section 1129(b), by offering sufficient protection to the Whitelatch family’s residual equity interests as to provide for “fair and equitable” treatment as required by section 1129(b).
This case serves as a salutary reminder that a bankruptcy plan must show, not tell. While the Debtors’ plan, on its face, promised to repay both the secured lender and all unsecured creditors in full, failure to show (i) specifically how the proposed sales or refinancing would be implemented or (ii) that the plan was built on realistic, stress-tested, and market-tested assumptions doomed the Debtors’ plan to failure. Moreover, bankruptcy courts ordinarily will not allow a bankruptcy plan to restructure obligations of non-debtors to the detriment of vested rights of creditors.