Author: Mindy Mora of Billzin Sumberg Baena Price & Axelrod, LLP
In an unusual but practical decision, the U.S. District Court for the District of Delaware affirmed a bankruptcy court order which approved both a sale of the debtors’ assets and the establishment of an escrow account to provide a “gift” to fund a distribution to the debtors’ unsecured creditors. What is significant about this decision is that it approved the use of gifting in a chapter 11 bankruptcy case. LCI Holding Company, Inc., civ. no. 13-924 (D. Del. March 10, 2014).
The concept of gifting in a bankruptcy case allows a secured creditor or purchaser to overcome objections to a sale of assets interposed by the debtor’s unsecured creditors. Often, the gift consists of a pool of funds for distribution to the debtors’ unsecured creditors, and bypasses the claims of priority creditors with more senior claims. See In re SPM Mfg. Corp., 984 F.2d 1305 (1st Cir. 1993).
A distribution that bypasses priority claims raises the issue of whether gifting is permissible in a chapter 11 case, based upon the requirement that distributions under a plan of reorganization must comply with the Bankruptcy Code, including the priority scheme for distributions to creditors and the absolute priority rule set forth in Bankruptcy Code § 1129(b)(2)(B). This type of compliance is not mandated in chapter 7 cases, in which bankruptcy courts have authorized gifting more regularly. See id. Apparently in Delaware, gifting is permitted in a chapter 11 case, so long as the sale of assets is followed by a dismissal of the case without the confirmation of a plan.