In re Brotby

• Decision Date: 07 November 2003
• Docket Number: BAP No. CC-03-1081-PaPMa.,Bankruptcy No. LA-01-41339 ES.
• Citation: 303 B.R. 177
• Parties: In re William Krag BROTBY, Debtor. Computer Task Group, Inc., Appellant, v. William Krag Brotby, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

303 B.R. 177

In re William Krag BROTBY, Debtor Computer Task Group, Inc., Appellant, v. William Krag Brotby, Appellee.

BAP No. CC-03-1081-PaPMa.

Bankruptcy No. LA-01-41339 ES.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted on July 24, 2003.

Filed November 7, 2003.

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Randy P. Orlick, Cox, Castle & Nicholson, LLP, Los Angeles, CA, for Computer Task Group, Inc.

N. Jane DuBovy, Law Offices of N. Jane DuBovy, Pacific Palisades, CA, for William Krag Brotby.

Before PAPPAS,¹ PERRIS and MARLAR, Bankruptcy Judges.

OPINION

PAPPAS, Bankruptcy Judge.

Debtor William Krag Brotby's Third Amended Chapter 11 Plan (hereinafter "Plan") was confirmed by the bankruptcy court. A creditor, Computer Task Group, Inc. (hereinafter "CTG"), argues that the bankruptcy court committed several errors in deciding to confirm Debtor's Chapter 11 plan, which treated one member of a class of unsecured creditors differently than other members, enjoined a creditor from collecting on a nondischargeable debt while Debtor made payments on that debt through the plan, and treated the individual Debtor's contribution of exempt property as "new value" in order to satisfy an exception to the "absolute priority rule" in 11 U.S.C. § 1129(b). We REVERSE and REMAND the case to the bankruptcy court for further proceedings.

BACKGROUND

Debtor is a computer security consultant. From 1995 until April, 1997, Debtor worked for CTG. During this time, as an employee of CTG, Debtor provided consulting services to a company in Alaska. After leaving CTG's employment, Debtor continued to provide the Alaskan company with consulting services, although on an independent basis. CTG filed suit against Debtor in federal district court in Alaska, alleging Debtor's continued relationship with the Alaskan company violated Debtor's employment contract with CTG. The district court eventually entered judgment against Debtor on October 1, 2001, awarding damages of $132,000 plus $167,250 in attorney fees and costs. Debtor timely appealed this judgment to the Ninth Circuit Court of Appeals, which appeal remains pending at this time.

BANKRUPTCY COURT PROCEEDINGS

On October 18, 2001, Debtor filed a petition for relief under Chapter 7 of the Bankruptcy Code. On February 25, 2002, Debtor's case was converted at his request to a Chapter 11 case. Debtor's bankruptcy schedules list only three secured creditors: Provident Bank of Maryland, which holds a lien on the boat Debtor uses as a residence; Jaguar Credit, which claims a lien on Debtor's vehicle; and the California Board of Equalization, which asserts a tax lien against Debtor's boat. In addition, nine unsecured nonpriority claims are listed in Debtor's schedules. Four are attorney fee claims associated with the Alaska litigation, and four appear to be for modest amounts of consumer debt. The largest unsecured claim is that of CTG, which is based upon the federal court judgment.

During Debtor's Chapter 11 case, CTG commenced an adversary proceeding against Debtor seeking a determination by the bankruptcy court that a portion of the amounts owed by Debtor under the district court judgment should be excepted from discharge pursuant to § 523(a)(6).² CTG obtained a judgment declaring $157,715.75 to be nondischargeable. The bankruptcy court judgment was entered on August 27, 2002.

Thereafter, Debtor and CTG negotiated and executed a stipulation providing, inter alia, that CTG's claim would be deemed allowed in the amount of $362,986.16 for purposes of the Chapter 11 case. The bankruptcy judge entered an order approving this stipulation on September 17, 2002. Appellant's E.R. at 517.

The bankruptcy court conducted a hearing on Debtor's proposed Second Amended Disclosure Statement on October 1, 2002. After entertaining CTG's objections to the disclosure statement, the bankruptcy court ordered that several additions and corrections be incorporated in a Third Amended Disclosure Statement (hereinafter "Disclosure Statement"), which Debtor filed on October 8, 2002. The Disclosure Statement contained financial projections concerning Debtor's future income, the primary source of payments under Debtor's Plan. The projections were preceded in the Disclosure Statement by a cover page indicating that this financial information was prepared by a certified accounting firm in accord with accepted national accounting standards. In fact, the accounting firm had prepared the projections contained in Debtor's earlier disclosure statement. However, a clerk employed by counsel for Debtor actually prepared the projections found in the later Disclosure Statement, with Debtor's help. For whatever reason, it appears the cover page was not removed after these revisions were made and the new Disclosure Statement was submitted to the bankruptcy court.

Although the details of the Plan are somewhat complex, for purposes of this appeal, the relevant provisions can be simply summarized. With respect to the secured creditors, Provident Bank's claim was unimpaired. The claims of both Jaguar Credit and the Board of Equalization were impaired. Jaguar Credit voted to accept the Plan and the Board did not vote. All secured creditors retained their liens and were to receive monthly payments on their claims.

The Plan treats the claims of all unsecured creditors, including CTG, in a single class, Class 5.³ The Plan provides that all Class 5 claimants will receive 25% of the amount of their claims. Except as to the claim of CTG, Debtor agreed to make monthly installment payments to Class 5 creditors for six years commencing on the effective date of the Plan.

As to CTG, Debtor was to deposit monthly payments into a "Disputed Claim Reserve" in the form of an interest-bearing trust account. The Alaska litigation shall continue, and if CTG ultimately prevails, CTG will be entitled to the money paid into the reserve account and to any remaining payments over the six year period. In addition, in that event, Debtor will make monthly payments to CTG for two more years in order to satisfy the entire nondischargeable portion of its claim. On the other hand, if Debtor ultimately succeeds in defeating CTG's claim from the district court litigation, all amounts in the reserve account will be applied to the unpaid balances owed on the other claims in Class 5. Under these circumstances, CTG would receive nothing. The Plan also provides that CTG shall be enjoined from any attempts to collect the nondischargeable portion of its claim other than through its receipt of Plan payments.⁴

CTG rejected the Plan and filed an objection to its confirmation. Based upon CTG's rejection, Class 5 did not accept the Plan.⁵ All other impediments to confirmation were resolved, and the only issue preventing confirmation of the Plan was CTG's objection.

The bankruptcy court conducted a confirmation hearing concerning the Plan on December 12, 2002. Prior to that hearing, CTG and Debtor had made written submissions to the bankruptcy court, and the bankruptcy judge had issued a tentative ruling on the confirmation issues. At the hearing, counsel for Debtor and counsel for CTG presented argument regarding the issues, including the erroneous inclusion of the accounting firm's cover page in the Disclosure Statement, CTG's treatment as compared to other creditors in the same class, the injunction language pertaining to CTG, application of the absolute priority rule and the new value exception, and the accuracy of the projections of Debtor's future income. After considering the arguments, the bankruptcy court ruled that the accountant's cover letter did not mislead creditors as to any material issue because Debtor had filed a declaration of the accountant stating that the figures prepared by Debtor's counsel's clerk were appropriate given certain new assumptions about Debtor's future. In addition, the bankruptcy court decided that CTG's treatment was the "same" as other Class 5 creditors and thus satisfied § 1123(a)(4), and that CTG could be enjoined from any collection activity during the pendency of the plan. However, the court continued the confirmation hearing so both parties could submit additional briefs on the applicability of the absolute priority rule and the new value exception, and to allow Debtor to submit new financial information.

The continued hearing was held on January 16, 2003. Counsel presented further argument concerning the Plan's injunction against CTG, the applicability of the new value exception, and Debtor's revised financial projections. A particular concern raised by CTG was that Debtor had by now submitted revised financial projections (hereinafter "new projections") to the bankruptcy court. While the projections contained in the Disclosure Statement showed Debtor would have positive net income during all six years of the Plan, and net earnings (i.e. earnings after deducting plan payments and living expenses) of approximately $600,000 at the Plan's completion, the new projections showed that Debtor would have negative net income in the first two years of the Plan and net earnings of approximately $125,000 at the end of the Plan.

Ultimately, the court overruled all CTG's remaining objections to confirmation and concluded that the Plan met the requirements of § 1129. An order confirming the Plan was entered on February 2, 2003, and CTG timely appealed.

ISSUES ON APPEAL

CTG contends the bankruptcy court erred in confirming the Plan and raises the following issues on appeal:

(1) Whether the Plan violates § 1123(a)(4) in its treatment of CTG's claim;

(2) Whether the Plan's provision enjoining CTG from collecting on the nondischargeable debt owed by Debtor violates § 1141(d)(2);

(3) Whether the Plan was feasible pursuant to § 1129(a)(11);

(4) Whether the disclosure statement was materially misleading;

(5) Whether Debtor may invoke the new value exception to the absolute priority rule...