Zante, Inc. v. Wilmington Trust Company et al

Filing 32

ORDER. IT IS HEREBY ORDERED that the order of the bankruptcy court is AFFIRMED. Signed by Chief Judge Robert C. Jones on 1/10/2012. (Copies have been distributed pursuant to the NEF - KO) Modified on 1/10/2012 to reflect bankruptcy appeals court received copy of this order via CM/ECF, see NEF for details. (KO)

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UNITED STATES DISTRICT COURT

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DISTRICT OF NEVADA

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In re ZANTE, INC. et al.,
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Debtors.
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ZANTE, INC. et al.,

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Appellants,

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vs.
JUAN DELGADO, SR. et al.,

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Appellees.

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3:10-cv-00131-RCJ-WGC
ORDER

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This bankruptcy appeal arises out of the reclassification of a punitive damages claim in a

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Chapter 11 confirmation order. For the reasons given herein, the Court affirms.

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I.

FACTS AND PROCEDURAL HISTORY

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E-T-T, Inc. (“ETT”) is one of several Debtors in a consolidated Chapter 11 bankruptcy

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along with several other Herbst Gaming-related entities. (See Appellants’ Opening Br. 2, Apr.

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19, 2010, ECF No. 6). Appellees Juan Delegado, Sr., individually and in his capacity as the

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administrator of the Estate of Rosa Delegado, sued ETT in state court, winning compensatory

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damages of $4,183,250.50 and punitive damages in the same amount after remittitur. (Id. 2–3).

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The amended judgment is under consideration by the Nevada Supreme Court on rehearing en

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banc. (Id. 3–4).
In this bankruptcy case, Appellees filed unsecured proofs of claim against ETT based

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upon the punitive damages award (the “Claim”). (Id. 6). At least two other claimants filed

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proofs of claim against ETT or other of the Debtors based in part upon punitive damages, but

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those claims had not ben reduced to judgment. (Id. 6–7).

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Debtors’ proposed plan (the “Plan”) would have put all general unsecured claims in Class

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4, to be paid in full, but would have put all claims for punitive damages in Class 6, to be totally

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impaired. (Id. 5). Appellees filed an objection to the Plan, arguing that it unfairly discriminated

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against Class 6 claims because they were unsecured claims like those in Class 4 and therefore

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should have been included with them under § 726(a)(4). (Id. 8). The bankruptcy court ruled that

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all Appellees’ claims, compensatory and punitive, had to be included in Class 4, because to put

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them in another class would have been unfairly discriminatory. (Id. 9). The bankruptcy court

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noted that § 726(a) was a mandatory classification scheme for Chapter 7 cases, but although not

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mandatory in Chapter 11 cases, could be used as a basis for appealing to a bankruptcy judge’s

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discretion under § 1122(a) in Chapter 11 cases. (See Hr’g Tr. 68:14–19, Oct. 28, 2009, AER 987

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(Tab T)). The bankruptcy judge then ruled that putting the Claim into Class 6, or any class apart

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from Class 4, would not comport with the Bankruptcy Code because it would constitute unfair

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discrimination. (See id. 69:6–21). The bankruptcy court reasoned that because the Claim was the

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only claim based upon punitive damages that had been reduced to judgment, it would be unfair

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to separate the Claim from other unsecured claims. (See id. 69:11–17). The bankruptcy court

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issued the confirmation order (the “Confirmation Order”), adopting the Plan, modified as

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follows: (1) the Plan did not comply with the “best interests of creditors” test under § 1129(a)(7)

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as to the proposed Class 6 claims; (2) modification of Class 6 claims was required under §§

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1122(a) and 1123(a)(1)–(2); and (3) the Plan unfairly discriminated against Class 6 claims under

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§ 1129(b). (Appellants’ Opening Br. 9–10). The Confirmation Order therefore moved all

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proposed Class 6 claims into Class 4. (Id. 10).

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Appellants have appealed the Confirmation Order to the extent it puts the proposed Class

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6 claims into Class 4. Two other appeals of the Confirmation Order have since been voluntarily

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dismissed. The propriety of the punitive damages award underlying the Claim is currently under

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en banc reconsideration by the Nevada Supreme Court in Case No. 46901. That Court heard the

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case in January of 2011 but has yet to issue a ruling. This Court stayed the present case pending

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the Nevada Supreme Court’s ruling, but at a recent status conference the Court determined to

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hold oral argument and rule in the present case directly.

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II.

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LEGAL STANDARDS
The bankruptcy court’s conclusions of law, including its interpretations of the bankruptcy

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code, are reviewed de novo, and its factual findings are reviewed for clear error. See Blausey v.

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U.S. Trustee, 552 F.3d 1124, 1132 (9th Cir. 2009). A reviewing court must accept the

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bankruptcy court’s findings of fact unless it is left with the definite and firm conviction that a

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mistake has been committed. See In re Straightline Invs., Inc., 525 F.3d 870, 876 (9th Cir. 2008).

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Apart from an administrative-convenience exception that does not apply in this case, “a

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plan may place a claim or an interest in a particular class only if such claim or interest is

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substantially similar to the other claims or interests of such class.” 11 U.S.C. § 1122(a).

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Whether claims are “substantially similar” under 11 U.S.C. § 1122(a) is a question of fact; a

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bankruptcy court has broad latitude in making this determination, which is reviewed for clear

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error. In re Johnston, 21 F.3d 323, 327 (9th Cir. 1994).

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Section 1122(a) requires only that claims must be “substantially similar” to be placed

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into the same class, i.e., it prevents dissimilar claims from being placed into the same class, but it

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does not prevent substantially similar claims from being placed into different classes. 7 Alan N.

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Resnick & Henry J. Sommer, Collier on Bankruptcy § 1122.03[1], at 1122-6 to 1122-7 (Matthew

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Bender & Co., Inc. 2011) (citing Class Five Nev. Claimants v. Dow Corning Corp. (In re Dow

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Corning Corp.), 280 F.3d 648, 661 (6th Cir. 2002)). “To the contrary, the bankruptcy court has

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substantial discretion to place similar claims in different classes.” In re Dow Corning Corp., 280

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F.3d at 661 (citing In re U.S. Truck Co., 800 F.2d 581, 585 (6th Cir. 1986)).

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III.

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ANALYSIS
Section 1122(a) permits substantially similar claims to be classed differently, so long as

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claims that are not substantially similar are not classed together. See 7 Resnick & Sommer,

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Collier on Bankruptcy § 1122.03[1], at 1122-6 to 1122-7 (citing In re Dow Corning Corp., 280

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F.3d at 661). The bankruptcy court was therefore within its discretion to reclassify Appellees’

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punitive claim into Class 4 under § 1122(a), because it was not clear error to find that punitive

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damages claims reduced to judgment are “substantially similar” to other unsecured claims.

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Moreover, where, as here, other unsecured claims will not be diluted thereby, it would have been

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unfair discrimination under § 1129(b)(1) for the bankruptcy court to have left Appellees’

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punitive claim in Class 6. The Court therefore affirms.

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Appellants argue that the “best interests of creditors” test of § 1129(a)(7) would have

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been satisfied under the Plan, because that test simply requires that any impaired creditor in a

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Chapter 11 plan that does not vote to accept the plan must receive at least as much as it would

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have received under Chapter 7, and in the present case the judgment debtors would have

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received nothing under a § 726(a)-prioritized Chapter 7 liquidation. The punitive damages

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claims under a putative Chapter 7 liquidation would have been prioritized with all fines,

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penalties, forfeitures, and the like, to be paid only after all other unsecured claims, which means

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Appellees would have received nothing on their punitive damages claims. See 11 U.S.C. §

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726(a)(2), (4). Because nothing is not less than nothing, the Plan satisfied § 1129(a)(7) without

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amendment. The Court agrees that placing the Claim into Class 6 would have satisfied §

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1129(a)(7).

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Appellants next argue that the Plan did not “discriminate unfairly” under § 1129(b)(1).

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“A classification scheme satisfies this requirement if there are reasonable, nondiscriminatory

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reasons for it.” In re Elmwood, Inc., 182 B.R. 845, 850 (D. Nev. 1995) (Pro., J.) (citing In re

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Johnston, 21 F.3d at 328). Could the bankruptcy court have found that putting punitive claims in

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a different class than other unsecured claims does not unfairly discriminate? After all, in

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Chapter 7 cases the Bankruptcy Code mandates precisely this discrimination. This is not a

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Chapter 7 case, however. Section 1122(a) does not prohibit putting substantially similar claims

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into different classes, but § 1129(b)(1) requires a rational reason for doing it.

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The usual rationale for subordinating punitive claims to other claims is that it is
inequitable to make a debtor’s innocent creditors suffer a prorated share of a debtor’s

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punishment by diluting their claims in favor of a punitive claim. See In re GAC Corp., 681 F.2d

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1295, 1301 (11th Cir. 1982). Neither does treating punitive claims like other claims in

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liquidation serve the purposes of punitive damages (deterrence and punishment), because a

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liquidated debtor will be none the worse whether the punitive claims are allowed or not. See id.

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This iniquity will always be the result where punitive claims are classed with non-punitive

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claims in liquidation cases, which is probably at least part of the reason Congress has mandated

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strict subordination of punitive claims to non-punitive claims under § 726(a). But in the present

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reorganization case, no creditors are heard to argue that their claims have been diluted by the

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reclassification of Appellees’ punitive claims. And the reason for their silence is clear: all Class

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4 claims are to be paid in full, in cash, or to be left otherwise unimpaired. (See Confirmation

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Order 14 ¶ 4.3, Jan. 2, 2010, ECF No. 1357 in Bankr. Case No. BK-N-09-50746). Appellants

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are debtors whose only grievance is that they will emerge from reorganization with less capital

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that they had hoped because the bankruptcy court has refused to impose a 100% cram-down

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against Appellees—judgment creditors who hold a state court judgment against them. This is

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not a liquidation case or even a reorganization case where the class of claims into which the

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punitive damages claim has been put is capped at some arbitrary amount with a prorated cram-

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down, and there is therefore no harm to innocent creditors from the payment of the punitive

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damages claim.

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There only remaining rationale Appellants propose is that had it not been for Debtors’

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supposition that punitive claims would remain totally impaired in Class 6, they would have

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offered no “gift” to the other unsecured creditors in Class 4, because they feared tens of millions

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of dollars in other potential punitive damages awards. But Appellees’ $4.2 million Claim cannot

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have contributed to any uncertainty over the potential for future punitive damages when

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Appellants proposed their plan, because Appellees’ claim had already been reduced to judgment

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in state court and was due and owing like every other unsecured claim. The Court therefore

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affirms the bankruptcy court that putting Appellees’ Claim into Class 6 in this case would have

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resulted in unfair discrimination under § 1129(b)(1).

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CONCLUSION

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IT IS HEREBY ORDERED that the order of the bankruptcy court is AFFIRMED.

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IT IS SO ORDERED.

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Dated this 10th day December, 2012.
Dated this 12th day of of January,2011.

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_____________________________________
ROBERT C. JONES
United States District Judge

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