This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece).We’ve switched over to Section F of the Report regarding “Plan Voting and Confirmation Issues.” Subsection 3, the focus of this post, addresses “Designation of Voting Rights.”


Under Section 1126(e) of the Bankruptcy Code, on the request of a party-in-interest and after notice and a hearing, the court may “designate any entity whose acceptance or rejection of [a Chapter 11] plan was not in good faith or was not solicited or procured in good faith or in accordance” with the requirements of Chapter 11. In other words, the court may disqualify votes that were not made in good faith. The requesting party has a heavy burden of proof.

Although self-interest, alone, is not enough, courts often find “bad faith” when a claimant: 

  • Attempts to obtain a personal advantage not available to other creditors in its class;
  • Has an “ulterior motive” (e.g., pursuit of collateral or competitive advantage unrelated to its claim);
  • Acts inconsistently with protecting its self-interest as a creditor;
  • Seeks to assume control of the debtor;
  • Attempts to put the debtor out of business;
  • Seeks to destroy the debtor out of “pure malice”; or
  • Seeks a benefit under a third party agreement that depends on a failed reorganization.

Commission Recommendations

The Commission concluded that Section 1126(e) is an effective means of addressing creditor conflicts of interest. However, it struggled in choosing a standard for determining when self-interested creditor conduct warrants a loss of voting rights. 

Ultimately, the Commission recommended that Section 1126(e) be amended to permit courts to consider whether the creditor’s vote was (i) “manifestly adverse” to other general creditors in the creditor’s class or (ii) cast in bad faith. “This hybrid standard would preserve creditor autonomy, but also provide courts with statutory authority to protect the estate and general creditors when a class vote has been infected by a creditor’s conflict of interest.”

Our Take

Vote designation is nice in theory. However, given the still-heavy, very fact-intensive burden of proof, it’s likely not a practical option for debtors except in egregious cases (i.e., cases where the need for vote designation is manifest, with or without an amendment to Section 1126). Claiming “ulterior motives” or “pure malice” is one thing; proving them up so clearly that they defeat the presumption that a creditor is merely protecting its self-interest is quite another. In short, Section 1126(e) is expensive to litigate for debtors and not exactly difficult to wiggle out of for creditors.

Notably, the Commission did not cite the leading case of In re DBSD North America, Inc., 634 F.3d 79 (2d Cir. 2011) (designating the vote of a late-on-the-scene claims buyer who bought an entire class of cla, ims with the intention of blocking any plan that did not provide it a strategic interest in the reorganized debtor and disregarding that class for purposes of Section 1129(a)(8), which section we touched on briefly here).

DBSD provides a good summary of Section 1126(e) (see pages 101-102):

The Code provides no guidance about what constitutes a bad faith vote to accept or reject a plan. Rather, § 1126(e)’s “good faith” test effectively delegates to the courts the task of deciding when a party steps over the boundary….Bankruptcy courts should employ § 1126(e) designation sparingly, as “the exception, not the rule….Merely purchasing claims in bankruptcy “for the purpose of securing the approval or rejection of a plan does not of itself amount to ‘bad faith.’” Nor will selfishness alone defeat a creditor’s good faith; the Code assumes that parties will act in their own self interest and allows them to do so….Section 1126(e) comes into play when voters venture beyond mere self-interested promotion of their claims. “[T]he section was intended to apply to those who were not attempting to protect their own proper interests, but who were, instead, attempting to obtain some benefit to which they were not entitled.” A bankruptcy court may, therefore, designate the vote of a party who votes “in the hope that someone would pay them more than the ratable equivalent of their proportionate part of the bankrupt assets,” or one who votes with an “ulterior motive,” that is, with “an interest other than an interest as a creditor.”

DBSD suggests that extra scrutiny is warranted for those who buy claims during a Chapter 11 case, especially after a plan has been proposed and especially if the party bought the claims above par.

Additionally, the Southern District of New York addressed Section 1126(e) and DBSD rather extensively last July in In re LightSquared Inc., 513 B.R. 56 (Bankr. S.D.N.Y. Jul. 11, 2014). That decision is useful because it tests the limits of DBSD, clarifies that Section 1126(e) is vote- and plan-specific (i.e., intent must be linked to the vote itself), and also warns against “conflating” the bad faith required under Section 1126(e) with the inequitable conduct required under Section 510, which section we covered here). Declining to designate, the court explained as follows:

[V]ote designation should not be ordered where a creditor can articulate a valid business reason for rejecting a plan even if such rejection may also be consistent with such creditor’s non-creditor interests….Here, there is an ample basis to find that, notwithstanding SPSO’s alleged ulterior motives, its non-creditor/competitor interests, and its demonstrably inequitable conduct in acquiring at least a substantial portion of its claim, it cast its vote to block a plan that provided it with abysmal treatment that no similarly-situated creditor would have accepted.

In our next post, we will address the Commission’s recommendations on Plan Settlements and Compromises.