Preferred Alternatives, Inc.

1 The cases have been administratively, but not substantively,
consolidated.
UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
FAYETTEVILLE DIVISION
IN RE:
PREFERRED ALTERNATIVES, INC.
DEBTOR
CASE NO.
05-03960-8-ATS
MEMORANDUM OPINION AND ORDER
REGARDING CONFIRMATION OF PLAN
AND DENYING MOTION TO APPOINT TRUSTEE
The matters before the court are whether to confirm, pursuant to
the Bankruptcy Code's "cramdown provision," 11 U.S.C. § 1129(b), the
plan of reorganization proposed by the chapter 11 debtors in
possession, Preferred Alternatives, Inc. and Preferred Alternatives of
Tennessee, Inc.1 (collectively, "PAI"), over the objection of the
Internal Revenue Service and the IRS's motion to appoint a chapter 11
trustee. A hearing took place in Raleigh, North Carolina on March 23
and 24, 2006.
SO ORDERED.
SIGNED this 07 day of April, 2006.
________________________________________
A. Thomas Small
United States Bankruptcy Judge
____________________________________________________________
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PAI provides services to individuals with developmental
disabilities and mental illnesses. In North Carolina, they provide
six categories of services: hospital services, in which PAI employs
individuals with a personal history of mental illness and trains them
to work with support groups and to provide one-on-one services to other
mentally ill individuals with a goal toward preventing re-
hospitalization; supported employment, or training individuals to enter
the workforce and maintain employment; community integration, or
assisting individuals with life skills and gaining independence;
residential services, providing 24-hour supervision for people with
developmental disabilities; children's services, including teaching
children and families adaptive skills; and personal care, in which
certified nursing assistants assist individuals with everyday needs
including bathing, dressing, housework and grocery shopping. The
Tennessee business focuses almost exclusively on residential services.
PAI is known for working with clients that other health services
companies reject, including those with very difficult behavioral
problems and those with "dual diagnoses" of both developmental
disabilities and mental illness.
PAI was founded in North Carolina by Neill Guy and James Elliott,
Ph.D. in 1997, while PAI Tennessee was incorporated in 2000. Mr. Guy
owns a 40% share of the North Carolina corporation and a 36% share of
the Tennessee corporation. Mr. Guy's father, Samuel Guy, owns a 20%
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share of the North Carolina corporation and an 18% share of the
Tennessee corporation. Dr. Elliott owns a 40% share of the North
Carolina corporation and a 36% share of the Tennessee corporation.
Carl Noyes owns a 10% share of the Tennessee corporation. On the
filing date, these four individuals were also the officers and board of
directors of PAI.
PAI began with approximately 10 employees, and now has over 900
employees in two states. Unfortunately, while the company grew
exponentially, its management and corporate operations did not. PAI
lacked financial policies and controls, lacked any accounting personnel
with the experience to operate a large company, and had no methods for
determining what aspects of its business were profitable and what
services were losing money. The issue came to a head in 2005, when an
employee came to Mr. Guy with a question about withholding taxes and
Mr. Guy discovered that no payroll taxes had been paid by PAI for
approximately 5 years.
Upon this discovery, Mr. Guy immediately consulted with a tax
attorney and PAI reported its failure to file to the IRS. PAI then
filed its chapter 11 petition to devise a plan to repay the
approximately $12 million owed in priority taxes. Since filing, PAI
has retained outside accountants, the Adams Martin firm, to help put
new accounting procedures and software in place, to reconstruct past
accounting information and file the payroll tax returns, to prepare
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monthly reports as required by this court, and to interview candidates
for the position of controller. Adams Martin did interview candidates
and recommended that PAI hire James "Butch" Wilson. Mr. Wilson has
substantial accounting experience in the health care industry and has
overseen the financial turnaround of at least one health care company.
See Ex. 1.
PAI followed its accountants' recommendation and hired Mr. Wilson.
Not only did PAI retain Mr. Wilson as its controller, but it hired him
as its president. In March 2006, Mr. Wilson also replaced Mr. Guy as
Chairman of the Board. Since joining PAI, Mr. Wilson has continued the
work begun by Adams Martin, implementing new accounting procedures and
overseeing all aspects of the company's financial management. PAI has
filed its prepetition payroll tax returns, made all postpetition tax
payments, filed all postpetition tax returns, filed all monthly reports
due to this court, and paid all quarterly fees due to this court. In
addition, Mr. Guy has prepared and filed the prepetition corporate
income tax returns.
PAI and PAI of Tennessee filed two separate plans of
reorganization, though they differ only with respect to the monthly
payment amounts provided in Class 2 and PAI of Tennessee's treatment of
Class 3. Accordingly, the following discussion of the plans is
directed to both plans unless otherwise specified. The debtors have
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received the requisite acceptances of the plan, with the exception of
the IRS.
Class 1 is the administrative claims that will be paid in full on
the effective date or within 10 days after the claims are allowed.
This class is estimated to include approximately $50,000 in attorney's
fees. Other administrative claims, including those of the Adams Martin
firm, have been paid during the course of the chapter 11 proceeding as
allowed by the court.
Class 2 includes the allowed claims of the IRS, which are to be
paid in full within six years of the date of assessment, on the
following schedule:
For PAI of North Carolina:
November 1 and December 1, 2006: $ 5,000
1st day of each month during 2007:$10,000
1st day of each month during 2008:$20,000
1st day of each month during 2009:$40,000
1st day of each month during 2010:$60,000
For PAI of Tennessee:
July 1, 2006 $ 6,250
1st day of each month during 2006 thereafter: $ 6,250
1st day of each month during 2007:$30,000
1st day of each month during 2008:$40,000
1st day of each month during 2009:$60,000
1st day of each month during 2007:$90,000
In addition to the monthly payments, PAI proposes to make annual
payments to the IRS beginning on April 15, 2007, and each year on the
anniversary, including 2010, of 50% of its net distributable income.
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2 The only ballot against the plan, other than the rejection by
the IRS, was filed by North State Communications, which was scheduled
with a claim of $0 and has not filed a proof of claim nor did it
indicate an amount for its claim on its ballot. Accordingly, all
impaired creditors holding legitimate claims, with the exception of the
IRS, have voted in favor of the plans.
6
Finally, PAI proposes a lump sum payment of the balance to be paid on
May 31, 2011.
Class 3 includes the other priority claims. PAI of North Carolina
will pay these claims in full within 90 days of the effective date.
Class 3 voted in favor of the plan in North Carolina. PAI of Tennessee
will pay these claims in full on the effective date, so Class 3 is
unimpaired in the PAI of Tennessee plan and no ballot is necessary.
Class 4 includes secured claims held by RBC Centura. PAI proposes to
add any arrears to the end of the regularly scheduled payments, and RBC
Centura accepted this treatment. Class 5 includes general unsecured
claims, which are to be paid in full within 180 days of the effective
date. PAI noted at the hearing that while this class is relatively
small, if the plan is not confirmed, there will be numerous lease
rejection claims that would be added to the general unsecured claims.
Class 5 voted in favor of the plan.2 Finally, Class 6 provides that the
shareholders will retain their interests in the debtor.
In addition to the class treatment, the plans provide, at the
option of the IRS, for the retention of an attorney unrelated to the
debtors to investigate and, if the attorney deems it advisable, to
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bring actions against insiders as an additional source of funds for
payment to creditors. At the confirmation hearing, PAI proposed an
amendment to provide for the liquidation of the debtor should the
debtor fail to make any payment due to the Class 2 claimants under the
plan, should the debtor fail to file any federal tax return due
postconfirmation, and should the debtor fail to pay any federal tax due
postconfirmation when due.
The IRS vehemently opposes confirmation and contends that a
chapter 11 trustee should be appointed to begin liquidating the debtor
immediately. The IRS contends that PAI should not be allowed to stair-
step its payments to the IRS with a balloon payment at the end of the
statutory six-year repayment period. The IRS also contends that the
plan is not feasible, and that it is designed to delay an inevitable
sale, rather than to reorganize. The IRS also contends that the plan
is not fair and equitable as required to confirm the plan over its
objection pursuant to § 1129(b)(1). Finally, the IRS opposes any
plan modifications proposed at the confirmation hearing.
Modification of Plan Procedure
The debtor submitted an amended order confirming plan at the
opening of the confirmation hearing, and advised the court during its
closing argument of further modifications it would make to add
protections to the IRS. The IRS opposes any such modifications.
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As discussed in this court's opinion in In re Accu-Fab, Case No.
04-00651-5-ATS (Bankr. E.D.N.C. Oct. 27, 2004), this court has, for
many years, permitted debtors to make oral modifications to their plans
at confirmation hearings as part of the court's small business fast-
track procedures. "The modifications, if approved, are incorporated
into the order confirming the plan. The court is always careful to
protect the due process rights of any creditor affected by any oral
modification." Accu-Fab at 9. In this case, like in Accu-Fab, the
IRS's due process rights have not been denied. The court heard two
days of testimony and is well-informed concerning the contentions of
each party. In addition, the IRS has been given additional time to
craft its own language regarding the liquidation provisions to address
some of its concerns regarding the modifications (as discussed below).
Accordingly, the court will not deny the modifications on the basis
that they were submitted at the confirmation hearing.
Feasibility
The debtor's most difficult hurdle is to show that its plan is
feasible, and evaluation of other confirmation requirements also turns
on the analysis of the same facts. As noted above, the plans provide
for monthly payments to the IRS, with annual payments based on net
distributable income and a balloon payment in 2011. The IRS contends
that the debtor simply will not be able to make even the monthly
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payments, and that if it does, it will only have paid down interest and
will still have an enormous balloon payment due in May 2011.
As the court discussed in Accu-Fab, "a chapter 11 plan proponent
need only demonstrate that '[c]onfirmation of the plan is 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.'" Accu-Fab at 14 (citing § 1129(a)(11); In re Grandfather
Mountain Ltd. Partnership, 207 B.R. 475 (Bankr. M.D.N.C. 1996); In re
Beare Co., 177 B.R. 886 (Bankr. W.D. Tenn, 1994); In re Harbour Pointe
Assoc. Ltd. Partnership, Case No. 92-00033-5-ATS (Bankr. E.D.N.C. Feb.
18, 1993)). With its modification, the debtor's proposed plan does
propose that if payments are not made or there are other defaults, the
debtor's assets will be liquidated. "Although a chapter 11 debtor need
not show that all payments will be made, the debtor must demonstrate
that there is a reasonable prospect that the reorganization will be
successful." Accu-Fab at 15 (citation omitted).
Monthly and Annual Payments
The debtor's evidence of its ability to make the required plan
payment hinges entirely on projections prepared by Mr. Wilson. Mr.
Wilson joined PAI on October 27, 2005. Prior to that time, there were
no reliable historical financial records due to the debtor's failure to
have in place a comprehensive accounting system while it grew to over
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900 employees. Accordingly, Mr. Wilson took the actual revenue and
expenses from October and November 2005 and prepared a five-year
projection based on those numbers. Exs. 3, 3A, 3B. Mr. Wilson assumed
10% growth each year, and added a 6% increase in personnel-related
expenses per year and a 3% annual increase in other expenses, based on
the likely inflation rate. Mr. Wilson used the current client
authorizations, with a 95% utilization rate in Tennessee and a 90%
utilization rate in North Carolina, and he did not assume any increase
in reimbursement rates. Ex. 4.
Of course it would be preferable to have projections based on more
than two months' actual data. However, this debtor has spent its
chapter 11 case putting accounting procedures in place, determining
where it was losing money, cutting out unprofitable contracts, and
better controlling its spending across its offices. The costs
associated with the Adams Martin firm's work have been enormous. Had
the confirmation hearing been delayed by several months, Mr. Wilson
could have compiled projections based on additional data. The debtor
should not be penalized for its efforts to have its plan confirmed
sooner rather than later because its data shows the costs, but not
necessarily the benefits, of its work early in the case.
In addition, the court finds the projections to be reasonable.
Even if the 10% growth rate is optimistic, the projections do not
account for substantial rate increases that have already occurred, nor
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3 There was substantial testimony about a change in the law that
went into effect on March 20, 2006, effectively tripling the rate for
many of PAI's services in North Carolina, as well as starting
reimbursement for certain services that were previously unbillable. In
addition, Mr. Wilson testified about over $300,000 in expenses that
have recently been eliminated on an annual basis.
11
do they account for expenses that have already been reduced.3 In the
past, PAI has grown much more than 10% per year, but as Mr. Wilson
testified, that growth was not well-managed and the expenses grew at an
equal rate or more. It is Mr. Wilson's intent, as the leader of the
company, to limit the growth to 10 percent, as well as to have the
managers of each local office of the company become more directly
active in the financial performance of the company (he called them
"mini-CEOs"). Finally, Mr. Wilson, Dr. Elliott and Mr. Noyes all
testified unequivocally that they believe PAI will be able to meet the
projections.
Mr. Wilson's projections show that the debtor will be able to make
the required monthly payments under the plan, and that each year there
will be sufficient net cash flow to fund the annual payments to the
IRS. In fact, his projections are such that the tax liability will be
nearly paid at the end of 2010, so that the balloon payment will be
minimal. If no annual payments are made, however, the remaining tax
liability in May 2011 will be close to $12 million, and the debtor's
ability to make that payment is the subject of the debtor's expert's
testimony, discussed below.
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The court does have some concerns about whether the debtor will
be able to meet its projections, and thus the court will require
greater oversight and reporting than is usually necessary
postconfirmation. The specific requirements are fully set forth in the
latter part of this opinion, and shall be incorporated into the Order
Confirming Plan. With this higher scrutiny, the court finds that the
debtor has met its burden of showing feasibility with respect to the
monthly payments and the likelihood of making significant annual
payments.
Balloon Payment and Daubert Analysis
With respect to the debtor's ability to make the balloon payment
in May 2011, the decision turns on whether the value of the debtor in
2011 will be such that it could refinance or liquidate for an amount
sufficient to pay the balance of the IRS claim in full. In support of
its plan, the debtor presented the testimony of James B. Lurie as an
expert on business valuation. Mr. Lurie prepared a report setting
forth his assumptions and hypotheses, and reached a conclusion about
the value of PAI in December 2005 and the prospective value of PAI in
December 2010. The IRS objected to the admission of Mr. Lurie's
testimony and report, contending that the valuation evidence is not
reliable or based on sound methodology.
Rule 702 of the Federal Rules of Evidence provides that expert
testimony is admissible if offered by "a witness qualified as an expert
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by knowledge, skill, experience, training, or education," and "if (1)
the testimony is based upon sufficient facts or data, (2) the testimony
is the product of reliable principles and methods, and (3) the witness
has applied the principles and methods reliably to the facts of the
case." Fed. R. Evid. 702. The rule was revised in 2000 in response to
the Supreme Court's decision in Daubert v. Merrell Dow Pharmaceuticals,
Inc., 509 U.S. 579, 113 S. Ct. 2786, 125 L. Ed. 2d 469 (1993). See
Fed. R. Evid. 702 Advisory Committee Notes, 2000 Amendments; see also
United States v. Parra, 402 F.3d 752, 758 (7th Cir. 2005).
Daubert set forth a list of factors for a court to consider
conducting a "preliminary assessment of whether the reasoning or
methodology underlying the testimony is scientifically valid and of
whether that reasoning or methodology properly can be applied to the
facts in issue." 509 U.S. at 593, 113 S. Ct. at 2796. Because of the
amendments to Rule 702, "the Daubert factors do not have to be 'met'
before expert testimony can be found reliable," though "many cases rely
on the Daubert factors as evidence of the three new criteria in Rule
702." Huber v. JLG Industries, Inc., 344 F. Supp. 2d 769, 773 (D.
Mass. 2003).
Because the Daubert factors are helpful in assessing whether
evidence complies with Rule 702, the court will take them into
consideration. Those factors include
• whether a theory or technique can be (and has been)
tested;
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• whether the theory or technique has been subjected to
peer review and publication;
• the known or potential rate of error and the existence
and maintenance of standards controlling the
technique's operation; and
• identification of a relevant scientific community and
an express determination of a particular degree of
acceptance within that community.
See Daubert, 509 U.S. at 593-94, 113 S. Ct. at 2796-97. "The focus, of
course, must be solely on principles and methodology, not on the
conclusions that they generate." 509 U.S. at 595, 113 S. Ct. at 2797.
In addition to the Daubert factors, the court is to consider "a
proposed expert's full range of practical experience as well as
academic or technical training when determining whether that expert is
qualified to render an opinion in a given area." Parra, 402 F.3d at
758 (citations omitted).
Mr. Lurie is a certified public accountant, a certified business
appraiser, and a certified valuation analyst, and is a member of at
least six professional associations for accountants, appraisers, and
valuation analysts. Mr. Lurie has worked in the financial industry
since 1973, and has experience in restructuring, capital management,
insolvency analysis, valuation, corporate planning and asset recovery.
Mr. Lurie has focused on business valuation since 1993, and has
published extensively on valuation and appraisals. See generally Ex.
12 at 60-63.
Mr. Lurie prepared an opinion of fair market value of PAI in
conformance with the standards set forth in the Uniform Standards of
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4 The USPAP is published by The Appraisal Foundation. According
to its website at www.appraisalfoundation.org, "The Financial
Institutions Reform, Recovery and Enforcement Act of 1989 recognizes
USPAP as the generally accepted appraisal standards and requires USPAP
compliance for appraisers in federally related transactions. State
Appraiser Certification and Licensing Boards; federal, state, and local
agencies, appraisal services; and appraisal trade associations require
compliance with USPAP."
5 USPAP defines a Hypothetical Condition as "that which is
contrary to what exists but is supposed for the purpose of analysis.
Comment: Hypothetical conditions assume conditions contrary to known
facts about physical, legal, or economic characteristics of the subject
property; or about conditions external to the property, such as market
conditions or trends; or about the integrity of data used in an
analysis."
6 "Extraordinary Assumption" is a term of art defined by USPAP as
"an assumption, directly related to a specific assignment, which, if
found to be false, could alter the appraiser’s opinions or conclusions.
Comment: Extraordinary assumptions presume as fact otherwise uncertain
information about physical, legal, or economic characteristics of the
subject property; or about conditions external to the property, such as
market conditions or trends; or about the integrity of data used in an
analysis." Mr. Lurie testified that the Extraordinary Assumptions used
15
Professional Appraisal Practice, 2005 edition ("USPAP").4 For purposes
of appraising PAI, Mr. Lurie treated the two separate legal entities,
PAI and PAI of Tennessee, as one operating unit, and stated that this
treatment constitutes a Hypothetical Condition as defined by USPAP.5
Ex. 12 at 9. Mr. Lurie relied upon "information, estimates, and
assumptions . . . obtained from the management of the Debtors, [their]
representatives, and other sources considered to be reliable. The
accuracy of that information and the assumptions was not independently
verified." Ex. 12 at 12. In addition, Mr. Lurie set forth the
following "Extraordinary Assumptions:"6
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in his analysis were really "ordinary extraordinary assumptions."
16
We have reviewed and accepted as reasonable the operating
projections of management of the Debtors. While we have
challenged certain of management's assumptions underlying
those projections, we have not reviewed them in light of
historic financial data, which does not exist in reliable
form. We have not audited, reviewed or compiled those
projections in accordance with the relevant pronouncement of
the American Institue of Certified Public Accountants, and
we express no opinion or any other form of assurance with
respect to those projections. Our acceptance of those
projections, and their utilization as a basis for additional
analysis by us, constitutes an Extraordinary Assumption
under USPAP.
This valuation assumes that general economic and market
conditions prevailing at December 31, 2005 will approximate
those at December 31, 2010. This assumption constitutes an
Extraordinary Assumption under USPAP.
Ex. 12 at 12-13. Finally, Mr. Lurie's opinion is based on the
assumptions of "willing seller, lack of compulsion, and reasonable
marketplace exposure implicit within the definition of Fair Market
Value." Ex. 12 at 42.
Mr. Lurie used three methods to determine the value of PAI: one
for the value as of December 31, 2005, and two for the projected value
as of December 31, 2010. Those methods are the Discounted Future
Returns method (for 2005), the Single Period Capitalization method (for
2010), and the Guideline Public Company method (for 2010). Mr. Lurie
specifically rejected other methods, including the Guideline
Transaction and Direct Market Data methods due to "an insufficient
number of reliable transactions to provide a reliable base for
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analysis," and several asset-based approaches due to the substantially
intangible nature of the debtors' business. Ex. 12 at 40. Mr. Lurie's
report walks through the calculations and methodology in detail, and
his appendices set forth his calculation of discount rates,
capitalization rates, and present value factors.
Mr. Lurie's three methods for valuing PAI, the Discounted Future
Returns method, the Single Period Capitalization method, and the
Guideline Public Company method, are well accepted practices for
business appraisers. These methods have been peer reviewed and there
are numerous publications explaining their use. As Mr. Lurie
testified, the methods are arithmetical; to the extent underlying
numbers change, the calculations would be reworked and the conclusion
would similarly be revised. In sum, the court finds that the
methodology chosen by Mr. Lurie meets the Daubert factors, and the
methodology is reliable.
Turning to the elements of Rule 702, Mr. Lurie is clearly
qualified to testify as an expert by knowledge, skill, experience,
training and education. His testimony is based upon sufficient facts
or data, as explained in the discussion in this opinion of Mr. Wilson's
projections. Mr. Lurie's testimony is the product of reliable
principles and methods, and Mr. Lurie has applied the valuation
methodology reliably to the facts in this case.
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Mr. Lurie's report clearly sets forth the hypotheses and
assumptions made. He acknowledges that his valuation is based entirely
on the projections provided by PAI, after Mr. Lurie challenged PAI on
those projections. It is evident to the court that the expert opinion
on value is only as good as the information on which it is based: the
valuation methodology is the industry standard. If the projections are
good, the valuation is good. If the projections have no validity, by
extension the valuation is invalid. But any invalidation of the expert
opinion is not due to Mr. Lurie's methods, and the court is able to
assess the credibility of the conclusion in connection with its
evaluation of the credibility of the underlying data. Accordingly, the
court sees no reason to exclude the testimony and report of Mr. Lurie
under Rule 702 or Daubert.
Because the court has found Mr. Wilson's projections to be
reasonable, the court will consider Mr. Lurie's opinions on value. Mr.
Lurie concluded that the value of PAI in December 2005 was $4,240,000.
Ex. 12 at 42. He projects that its value in December 2010 will be
$17,700,000 (Mr. Lurie's report shows a value of $18,550,000, but he
modified this value at the hearing). Ex. 12 at 49, as supplemented by
testimony. The value in 2010 will be more than sufficient to pay any
balloon payment required to pay the IRS in full.
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Liquidation Provision
As noted above, the definition of feasibility in chapter 11
includes the requirement that confirmation is not likely to be followed
by liquidation, unless liquidation is contemplated in the plan. The
debtor's proposed plan does provide that if payments are not made or
there are other defaults, the debtor's assets will be liquidated.
After receiving post-hearing suggestions from the parties, the court
has determined that additional liquidation provisions should be
incorporated into the Order Confirming Plan, and those provisions are
set forth later in this opinion.
The IRS contends that merely adding a provision that says the
debtor will liquidate if it defaults is not sufficient. In support of
its position, the IRS cites In re Danny Thomas Properties L.P., 241
F.3d 959 (8th Cir. 2001). While Danny Thomas does hold that providing
for liquidation in the event of a default in a reorganization plan
cannot render a plan feasible as a matter of law, that case and those
cited therein were real estate cases addressing the claims of secured
creditors. The Danny Thomas court specifically noted that the value of
the real estate was decreasing, and that execution of the "drop dead"
provisions in the plan would not fully satisfy the secured claim. 241
F.3d at 964-65.
In this case, the debtor's value is as a going concern. If it
were liquidated today, the IRS would not get paid in full; in fact, it
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would receive very little of its priority claim. With each month that
PAI continues to operate under the new controls imposed by Mr. Wilson,
it increases in value. Thus, even if the debtor defaults on its
payments and the liquidation clause is triggered in one year, the IRS
will be paid more than if the debtor is liquidated today.
In summary, the court finds that the plan is feasible. The debtor
has made great strides in establishing internal controls and
procedures, it has a new president and chairman of the board who is
focused on a successful reorganization, the entire management team is
committed to repaying the IRS, and the company fills a unique niche
within its industry that is recognized by its clients. The court finds
there is a reasonable prospect that the plan will be successful, and in
any event, if it is not successful, the plan provides for liquidation
of the debtor's assets.
Good Faith
The IRS contends that the plan is not proposed in good faith. The
court disagrees. While the debtor's predicament is the result of
mismanagement, it has made tremendous efforts to turn itself around and
proposes to pay the IRS in full within 6 years. All of the debtor's
witnesses testified that they believe the projections can be met and
that the IRS will be paid in full. The debtor has expressed a
willingness to do whatever the court requires to show its good faith,
including adding a provision to the by-laws that prevents Mr. Guy from
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7 The debtor contends that even BAPCPA does not require equal
monthly installments. The court does not express an opinion on the
requirements of the new law.
21
regaining his seat on the board of directors until after the IRS is
paid in full. The court simply does not find any evidence of bad
faith.
Section 1129(a)(9)
The IRS contends that the debtor must make equal monthly payments
to the IRS, rather than stepped payments with a balloon at the end.
While the IRS may find support for this proposition in the Bankruptcy
Abuse Protection and Consumer Protection Act of 2005,7 that Act was not
in effect when this case was filed, and the controlling law does not
require equal monthly payments.
In fact, the applicable § 1129(a)(9) requires only that the
payment be made in "deferred cash payments over a period not exceeding
six years after the date of assessment . . . ." 11 U.S.C. §
1129(a)(9). It is better to read this flexible provision to allow the
plan to propose payments that the debtor will actually be able to make,
rather than to guarantee failure by reading a requirement into the
statute that simply does not exist.
Fair and Equitable
The IRS contends that the treatment proposed by the debtor is not
fair and equitable to the IRS as required for "cramdown" under §
1129(b). The debtor questions whether § 1129(b) actually applies to
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the IRS's claim, citing to In re Gregory Boat Co., 144 B.R. 361 (Bankr.
E.D. Mich. 1992). The Gregory Boat court determined that the taxing
authorities are not a proper "class" under § 1123(a)(1), and thus they
are not an impaired class that has not accepted the plan. Without an
impaired class that has not accepted the plan, § 1129(b) does not
apply.
Without reaching the issue of whether § 1129(b) applies in this
case, the court finds that the treatment is fair and equitable to the
IRS. The debtor has dedicated new management in place, and proposes to
pay the IRS in full as required by the Code. The court will impose
heightened reporting requirements for the debtor and will exercise
careful oversight of its progress. Specific liquidation provisions,
should the debtor default, have been enhanced, and the debtor has set
forth a mechanism for actions against insiders to be investigated and
pursued. In short, procedures have been incorporated into this plan to
ensure that the IRS is paid in full, and the plan meets the
requirements of § 1129(b).
Interest Rate
The debtor proposes to pay the IRS back at the statutory interest
rate (which was 6% at the time the debtor filed its plan, but has since
increased to 7%). The IRS contends that the rate should be 10% under
Till v. SCS Credit Corp., 541 U.S. 465, 124 S. Ct. 1951 (2004),
contending that the risk factor in this case is substantial. The
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8 The IRS continues to maintain that the plans are not confirmable
and opposes confirmation. The submission of proposed language is not
a waiver of the IRS's continuing objections.
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debtor's proposal meets the statutory requirements, and the risk is
addressed by the provisions for immediate appointment of a liquidating
agent or conversion should the debtor default on a single payment to
the IRS. Accordingly, the statutory interest rate is the appropriate
rate.
Required Terms
At the conclusion of the hearing, the court gave the IRS the
opportunity to suggest language regarding the liquidation provisions
and reporting requirements that should be incorporated into the Order
Confirming Plan. Both the IRS and the debtor submitted proposed orders
of confirmation.8 The court has considered the submissions, and finds
that the following terms should be included in the orders of
confirmation:
Additional Reporting Requirements. The debtor shall provide the
IRS with copies of all reports required to be filed or provided to the
bankruptcy administrator after confirmation. In addition, beginning on
June 30, 2006, and on each September 30, December 31, March 31, and
June 30 thereafter until Class 2 is paid in full, the debtor shall
provide the IRS with Financial Statements compiled by a CPA.
Additionally, the debtor shall submit audited financial statements to
the IRS on May 31 of each year until Class 2 is paid in full, with the
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first such annual audit being for calendar year 2006, due on May 31,
2007.
Liquidation Triggering Event. Any of the following shall
constitute a Liquidation Triggering Event:
1. The failure by the debtor to make any payment due to
Class 2 claimants under the plan;
2. The failure by the debtor to file any federal tax
return due postconfirmation when due (including extensions);
3. The failure by the debtor to pay any federal tax due
postconfirmation when due; and
4. A determination by this court (which shall have
exclusive jurisdiction to make such determination), after
notice and a hearing, that the debtor has suffered a
material and significant adverse change in financial
condition that materially and significantly impacts the
feasibility of the debtor's plan such that it is in the best
interests of the debtor's then-existing creditors that the
debtor be liquidated.
Liquidation Process. In the event that any party gives notice to
the debtor of a Liquidation Triggering Event and the debtor does not
correct the failure that constituted the Liquidation Triggering Event
(by making the payment to the Class 2 claimant, by filing the tax
return or obtaining an extension, or by paying the tax in question)
within 10 business days of the debtor's receipt of the notice, then the
court will promptly appoint a liquidating agent and vest that
liquidating agent with all necessary powers to complete the
liquidation, or, alternatively, the case shall be converted to chapter
7. If the debtor disputes the occurrence of a Liquidation Triggering
Event, then the debtor may seek an expedited hearing on that issue.
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In the event a liquidating agent is appointed or the case is
converted to chapter 7 and a trustee appointed, the liquidating agent
or chapter 7 trustee may continue to operate the debtor until the
debtor's assets may be sold in a manner to maximize the remaining value
of the estate.
Limitations on Transfers. The debtor shall not (a) sell any
assets with a fair market value exceeding $20,000, (b) borrow any funds
on a secured basis (except purchase money security interests secured
only by the asset purchased), or (c) take any action outside the
ordinary course of business without the consent of the IRS. Should the
IRS refuse its consent, the debtor may reopen this case and seek
authorization from the court. For purposes of this paragraph, entering
leases, buying and selling vehicles, hiring and firing employees,
terminating unprofitable contracts, and entering new contracts are
considered to be within the ordinary course of business. Also for
purposes of this paragraph, transferring entire categories of services
or all services within a geographical area to other health care
providers are considered to be outside the ordinary course of business.
Retention of Jurisdiction. This court shall exercise exclusive
jurisdiction over the debtor's plan, the debtor's property, and the
claim of the IRS until such time as all allowed claims of the IRS are
paid in full. Additionally, the court shall retain jurisdiction of
this case to require the performance of any act that is necessary for
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the consummation of the plan including, without limitation, the
jurisdiction to hear and to determine all claims against the debtor and
to enforce all causes of action that may exist in the debtor's favor
and to modify the plan pursuant to the provisions of § 1127 of the
Bankruptcy Code. In the event an appeal is perfected from the order
confirming the plan, the court also retains jurisdiction to enter such
orders regarding the disbursement of funds under the plan or the
consummation thereof as may be necessary to protect the interests of
the debtor, its creditors, and other parties in interest.
Specifically, the court will retain jurisdiction for the following
purposes:
(i) Determination of the allowability of claims upon
objection to such claim by the debtor or any
other party in interest.
(ii) Determination of the request for professional
fees under § 330 of the Code incurred prior to
the confirmation of the plan.
(iii) Resolution of any disputes regarding the
interpretation of the plan.
(iv) Implementation of the provisions of the plan and
entry of any order in aid of consummation of the
plan, including, without limitation, appropriate
orders to protect the debtor from creditor
action.
(v) Modification of the plan pursuant to § 1127 of
the Code.
(vi) Adjudication of any causes of action, including
transfer avoidance actions, insider actions, and
adversary proceedings under the Code.
(vii) Entry of a final decree.
(viii) Adjudication of any liability of any party
arising out of or relating to the plan.
(ix) All other matters properly before the court by
provision of the Code or Bankruptcy Rules.
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With these heightened reporting requirements and liquidation
provisions, the court concludes that the debtor's plan is confirmable
and confirmation will be ALLOWED, and the IRS's motion to appoint a
trustee is DENIED. The debtor shall submit a proposed Order Confirming
Plan in each case within 15 days of the date of this memorandum
opinion, incorporating the terms as set forth herein.
SO ORDERED.
END OF DOCUMENT
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