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In re Novinda Corp.

United States Bankruptcy Appellate Panel of the Tenth Circuit

May 16, 2018

IN RE NOVINDA CORP., Debtor.
v.
NOVINDA CORP., Appellee. MINERALS TECHNOLOGIES, INC., COLLOID ENVIRONMENTAL TECHNOLOGIES COMPANY, LLC, and AMCOL INTERNATIONAL CORP., Appellants,

         Chapter 11

          Appeal from the United States Bankruptcy Court for the District of Colorado

          Aaron A. Boschee (Christopher Meyer of Squire Patton Boggs LLP, Cleveland, Ohio & Daniel Slifkin of Cravath, Swaine & Moore LLP, New York, New York, with him on the brief) of Squire Patton Boggs LLP, Denver, Colorado for Appellants.

          Joshua M. Hantman, (Samuel M. Kidder with him on the brief) of Brownstein Hyatt Farber Schreck, LLP, Denver, Colorado for Appellee.

          Before KARLIN, Chief Judge, NUGENT, and MOSIER, Bankruptcy Judges.

          OPINION

          MOSIER, BANKRUPTCY JUDGE.

         Appellants Minerals Technologies, Inc., Colloid Environmental Technologies Company, LLC, and AMCOL International Corp. were unsuccessful in their efforts to prevent confirmation of Novinda Corp.'s Chapter 11 plan of liquidation. They have appealed two Bankruptcy Court orders on plan confirmation: (1) the Order Overruling Objections to Confirmation, Finally Approving Disclosure Statement, and Denying Motion to Convert (Order Overruling Objections); and (2) the Order Confirming Second Amended Plan of Reorganization (Confirmation Order).[1] The Appellants contend that the Bankruptcy Court committed reversible error when it confirmed the Chapter 11 plan, which separately classified their claims, and that the Bankruptcy Court also erred when it found that the Chapter 11 plan is feasible. We find that the Bankruptcy Court did not commit any reversible error when it confirmed Novinda Corp.'s Chapter 11 plan and we therefore affirm.

         I. FACTUAL AND PROCEDURAL HISTORY

         Novinda Corp. (Debtor) was an advanced air quality technology company that developed and produced a product to remove mercury from coal ash waste generated by coal-fired power plants (Product).[2] The Debtor financed the development and production of the Product through venture capital funding, secured loans, and unsecured loans.[3] The Appellants were creditors of, and 18% equity holders in, the Debtor.[4] The Appellants claim that by January 2015 they had invested a total of $7.2 million in the Debtor.[5] As a condition of additional funding from the Appellants, Colloid became the exclusive manufacturer of the Product.[6] The Debtor paid Colloid one hundred percent of the actual manufacturing costs plus an agreed upon profit.[7] Colloid manufactured the Product and then invoiced the Debtor for its costs. In some instances, Colloid converted its receivables into promissory notes due to the Debtor's inability to pay.[8]

         The Debtor also received substantial equity from certain investment firms that help capitalize struggling businesses. These investment firms included Altira Technology Fund V, LP, NV Partners IV LP, and NV Partners IV-C, LP (Funds). As of the petition date, the Funds held $654, 986 in secured claims and $800, 342 in unsecured claims.

         The Debtor's contract with Colloid required the Debtor to pay any increase in manufacturing costs after Colloid provided a thirty-day notice and supporting documentation. On February 2, 2016, Colloid gave the Debtor notice of an immediate fifty percent increase in manufacturing costs and demanded advance payment before manufacturing any more of the Product.[9] The Debtor filed a Chapter 11 petition on April 1, 2016. The parties' characterizations of the relationship between the Debtor and the Appellants as well as the causes of the bankruptcy are dramatically different. The Debtor contends that Colloid failed to provide proper notice and documentation and that the manufacturing cost increase was fabricated in order to drive the Debtor out of business and usurp its business. The Debtor maintains it has claims against the Appellants for breach of contract, aiding and abetting a breach of fiduciary duty, and fraud.[10] The Appellants claim that the Debtor could not operate profitably in the face of a recent Supreme Court decision overturning EPA regulations on mercury pollution, and therefore the Debtor's failure was market-driven.[11]

         Not long after it filed bankruptcy, the Debtor auctioned substantially all of its assets, including intellectual property, leases, equipment, and accounts receivable. The only bidder was the Funds, and the assets were assigned to a new entity named Novinda Holdings, Inc.[12] After the sale, the only other material asset of the estate was the potential litigation against the Appellants (Litigation Claims).[13] Without any realistic prospect for rehabilitation, the Debtor filed a liquidating plan.[14] The Appellants objected to confirmation of the plan and filed a motion to convert the case to one under Chapter 7 (Motion to Convert).[15] The Debtor then amended the proposed plan twice (Amended Plan).[16]

         The Amended Plan contained twelve different classes of claims, which are summarized as follows:

Class 1: Class 1 consisted of the priority claims of eight former employees pursuant to § 507(a)(4) for accrued vacation leave. Class 1 claimants would be paid in full through 4 quarterly payments. This class was deemed "impaired" because claimants would not receive interest on the deferred payment of their claims.
Class 2: Class 2 consisted of secured creditors, who would receive the value of the property securing their claim, with any deficiency treated in Class 3.
Class 3: Class 3 consisted of unsecured trade claims (other than the Appellants) and the Funds' unsecured claims. The claims would be paid a pro rata distribution along with the Class 4 claims of the Appellants from any remaining funds left in the estate after payment of Classes 1 and 2 and satisfaction of estate expenses. The Funds' unsecured claims in this class were subordinated to the other Class 3 claims. Once all non-Funds unsecured trade claims were paid in full, the Funds would receive pro rata distributions along with Class 4 claims.
Class 4: Class 4 contained the Appellants' unsecured claims, which were to be paid a pro rata distribution as determined by the aggregate amount of Classes 3 and 4, but would not benefit from the Funds' voluntary subordination to the other claims in Class 3.
Class 5: Class 5 was the administrative convenience class and consisted of unsecured claims of $1000 or less, which would be paid at 70% shortly after the effective date of the Amended Plan. Any Class 3 or 4 claims could have elected to reduce their claim to $1000 and receive treatment pursuant to Class 5.
Classes 6 - 12: The remaining classes consisted of equity holders, which would be paid at different rates per share from any remaining funds available after payment of Classes 3 through 5.[17] The Amended Plan provided for the appointment of an administrator (Plan Administrator) to make distributions and investigate and pursue the Litigation Claims.[18]The Amended Plan further provided that the Funds would contribute $400, 000 to the estate, which would be used for distributions under the Amended Plan. Up to $25, 000 of the $400, 000 could also be used to finance investigation of the Litigation Claims.[19]Essentially, Classes 3 and 4 were not guaranteed any distribution and would only recover meaningfully if the Plan Administrator prevailed on the Litigation Claims.

         The Appellants objected to confirmation, arguing that (1) the Plan Administrator was biased in favor of the Funds; (2) the Plan was not feasible as creditor recovery was based on the outcome of speculative litigation; (3) Classes 3, 4, and 5 were unfairly discriminatory and were improperly classified for purposes of gerrymandering; and (4) the Amended Plan was not proposed in good faith.[20] The Bankruptcy Court overruled the Appellants' objections to the Amended Plan, denied the Motion to Convert in the Order Overruling Objections, [21] and confirmed the Amended Plan in the Confirmation Order.[22]

         The Appellants timely appealed both the Order Overruling Objections and the Confirmation Order, which were joined for purposes of briefing and argument.[23] The Appellants sought a stay pending appeal in the Bankruptcy Court, which the Bankruptcy Court denied.[24] The Appellants also filed a motion for a stay pending appeal before the Bankruptcy Appellate Panel and that motion was denied.[25]

         II. JURISDICTION AND STANDARD OF REVIEW

         This Court has jurisdiction to hear appeals of final orders.[26] An order overruling objections to confirmation and confirming a Chapter 11 plan is a final order for purposes of 28 U.S.C. § 158(a).[27] This appeal raises four issues: (1) claims classification; (2) good faith; (3) feasibility: and (4) unfair discrimination.

         A. Claim Classification and Designation

         There is no clear Tenth Circuit authority on the appropriate standard of review for claims classification. Other circuits appear to have reached divergent conclusions on this point.[28] The determination of the factors that justify separate classification of claims is a question of law reviewed de novo, but whether the requisite factors have been established is a question of fact reviewed for clear error.[29]

         B. Good Faith

         Whether a plan has been proposed in good faith under § 1129(a)(3) is a factual finding that this Court reviews for clear error.[30]

         C. Feasibility

         "Whether a plan is feasible is a question of fact, subject to the clearly erroneous standard on appeal from an order confirming the plan."[31]

         D. Unfair Discrimination

         The Bankruptcy Court's factual findings on the issue of unfair discrimination are reviewed for clear error, but if those "factual findings are premised on improper legal standards or on proper ones improperly applied, they are not entitled to the protection of the clearly erroneous standard, but are subject to de novo review."[32]

          III. PRELIMINARY MATTERS

         A. Equitable Mootness

         The Debtor has not filed a separate motion to dismiss the appeal, but in its brief, the Debtor argues this appeal is equitably moot and should be dismissed.[33] Although the Tenth Circuit has articulated a standard for application of the equitable mootness doctrine, [34] none of the Debtor's arguments are particularly compelling. More importantly, the Debtor has failed to properly place the issue before this Court. There is no motion to dismiss this appeal on equitable mootness grounds, and we will not address the issue further.

         B. Attempts to Supplement to the Record on Appeal

         The Appellants filed a supplemental appendix which contains, in part, a Motion for Stay Pending Appeal Pursuant to Bankruptcy Rule 8007 and a Post Confirmation Quarterly Report, which are not properly part of the record on appeal.[35] The Debtor has not requested that these documents be stricken from the record.

         After this appeal was fully briefed and taken under submission after oral argument, the Appellants filed a Motion to Supplement the Appendix (Motion), [36] requesting that the Court include in the record on appeal the Debtor's January 30, 2018 Post Confirmation Quarterly Report. The Debtor subsequently filed its objection to the Motion, [37] which requested that the Court deny the Motion or, if the Court granted the Motion, allow the Debtor to also supplement the record with an affidavit from the Plan Administrator. None of the documents in the supplemental appendixes existed at the time the Bankruptcy Court entered the Confirmation Order, which is on appeal, and therefore those documents could not have been considered by the Bankruptcy Court in issuing that decision. BAP Local Rule 8018-1(g) provides that "[o]nly documents properly before the bankruptcy court may be included in the appendix and considered by this Court."[38] The Tenth Circuit has made it clear that appellate courts should not review documents that were not before the trial court when the rulings at issue were made.[39] Accordingly, it is improper for this Court to review the documents supplementing the appendixes on appeal and the requests to supplement the appendix will be denied.

         IV. DISCUSSION

         The Appellants assert that the Bankruptcy Court committed a number of errors when it confirmed the Amended Plan in the hope that this Court will find at least one of those asserted errors necessitates a reversal of the Bankruptcy Court's order. The Appellants assert that the Bankruptcy Court erred by permitting the separate classification of their claims, and argue that their treatment under the Amended Plan constitutes unfair discrimination prohibited by § 1129(b)(1).[40] They also contend that the Bankruptcy Court erred in finding the Amended Plan was feasible.

          A. Classification of Claims - § 1122(a)

         The Appellants maintain that "[t]he Bankruptcy Court erred in holding that a chapter 11 liquidating plan that separately classifies one unsecured trade creditor from all others in order to facilitate an intra-class gift that excludes that unsecured trade creditor does not unfairly discriminate."[41] In so arguing, the Appellants conflate claims classification issues with unfair discrimination issues and mistakenly characterize the separate classification of their claims as unfair discrimination under § 1129(b). The Appellants mistakenly argue that before a court approves a classification scheme it must consider whether the classification complies with § 1129(b). But § 1129(b) does not address classification of claims; it focuses instead on whether a plan unfairly discriminates and is fair and equitable with respect to each "class of claims."[42] By contrast, claim classification is addressed in § 1122. In other words, § 1122 deals with the creation of classes of claims, while § 1129(b) deals with the treatment of those classes. While § 1123(a)(4) requires each creditor in a class to receive the same treatment-unless a creditor agrees to less favorable treatment-there is no requirement that creditors in different classes receive the same treatment.

         In reviewing classification schemes, bankruptcy judges are given limited guidance from the Bankruptcy Code itself. Section 1122(a) provides that "a plan may place a claim or an interest in a particular class only if such claim or interest is substantially similar to the other claims or interests of such class."[43] As a result, a plan proponent cannot place dissimilar claims together in the same class, such as secured claims with unsecured claims, or priority unsecured claims with non-priority unsecured claims. But § 1122(a) does not require the converse-that similar claims be placed in the same class.[44] Accordingly, courts generally permit separate classification of similar claims, subject to certain caveats, the most prominent of which is the axiom that separate classification may not be used to gerrymander the vote on plan confirmation. Bankruptcy courts have consistently adhered to this "one clear rule, "[45] i.e., debtors may not separately classify claims under § 1122 for the purposes of obtaining an impaired consenting class under § 1129(a)(10).[46] Some courts have reasoned that once a plan proponent has shown that substantially similar claims were not separately classified to gerrymander a consenting class of impaired claims, the court need not make any further inquiry into whether the separate classification of similar claims violates § 1122(a) and the remaining confirmation issues should be addressed under § 1129. [47] But most courts impose the additional requirement that there be a reasonable basis or legitimate business or economic justification for the separate classification of similar claims.[48] There is no controlling Tenth Circuit law on this issue, but that is not critical to our decision because the Debtor has shown a reasonable basis to separately classify the Appellants' claims.

         1. The Debtor Has Shown That Unsecured Claims Were Not Separately Classified to Gerrymander an Impaired Consenting Class

         The Appellants contend that the Debtor gerrymandered voting on the Amended Plan by separately classifying their claims. They object to both the establishment of an administrative convenience class in Class 5 and the separate classification of their claims in Class 4. They further contend that the creditors in Classes 3, 4, and 5 should all be placed into the same class and that they have been separated only to manipulate voting results. The Bankruptcy Court was not persuaded by this argument. It instead correctly concluded that the Debtor did not have to separately classify the claims in Classes 3, 4, and 5 in order to satisfy § 1129(a)(10) because the Debtor was reasonably certain it could fulfill this requirement through an affirmative vote of Class 1.

         The separate classification of the priority wage claims in Class 1 was completely appropriate-even necessary-because the wage claims were not substantially similar to other claims. Since Class 1's claims, consisting of employee priority claims pursuant to § 507(a)(4), should not be classified with general unsecured claims, the Appellants cannot seriously contend that Class 1 was created to gerrymander voting on the plan. The Bankruptcy Court found that Class 1 served as the impaired consenting class for purposes of § 1129(a)(10).[49] It also determined the employees in the class were not insiders.[50] Evidence in the record supports this finding.[51] In fact, the Appellants even stipulated that the Debtor's evidence met § 1129(a)(10)'s burden to obtain the accepting vote of at least one impaired class.[52] Once a plan has been accepted by an impaired class of claims that was not created for gerrymandering purposes, any claims of gerrymandered voting have little relevance under § 1129(a)(10).

         2. The Administrative Convenience Claims Are Properly ...


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