On August 4, 2015, the Second Circuit weighed in for the first time on the circumstances in which the confirmation of a Chapter 11 plan could strip a secured creditor of its lien. In City of Concord, N.H. v. Northern New England Telephone Operations LLC (In re Northern New England Telephone Operations, LLC), the Second Circuit held that, although the general rule is that liens and security interests pass through bankruptcy unaffected, section 1141(c) of the Bankruptcy Code provides an exception where four factors are met:
(1) the text of the plan does not preserve the lien;
(2) the plan is confirmed;
(3) the property subject to the lien is “dealt with” by the terms of the plan; and
(4) the lienholder participated in the bankruptcy proceedings.
The fourth factor requiring lienholder participation is not expressly mentioned in section 1141(c), but the Court concluded, relying on principles of equity, that the requirement “falls squarely within” section 1141(c) anyway. Lienholder participation is necessary if property can said to be fairly “dealt with” by a plan. Furthermore, it is the flip side of the coin with respect to section 506(d)’s preservation of certain liens where a lienholder does not participate in the bankruptcy.
The first two factors are simple and straightforward in their application. It will be the rare case that involves a question as to whether either of those two factors has been satisfied. The area ripe for dispute is whether factors three and four have been met. When is property sufficiently “dealt with” under a plan and how much participation is necessary before a secured creditor’s liens will be at risk of being extinguished? There is no clear answer.
However, in the City of Concord case, the Second Circuit gives secured lenders some guidance. In that case, the Court held that a catch-all provision in a confirmed plan providing that, as of the plan effective date, all of the debtor’s property shall be free and clear of all claims, liens and interests (except as specifically provided in the plan and various other documents) was sufficient to “deal with” the property at issue, which property was previously subject to real property tax liens. If a plan has catch-all language like this, a secured creditor may be at risk for having its liens extinguished unless the plan separately and specifically addresses and preserves them.
The Court also held that the taxing authority sufficiently participated in the bankruptcy case by filing a number of proofs of claim relating to the same property and the same liens that were in dispute. While there is no clear participation threshold, if a secured creditor files a proof of claim asserting its liens, it may be considered to have sufficiently participated in the bankruptcy case for purposes of section 1141(c).
Needless to say, a secured creditor must be vigilant in protecting its liens and security interests in bankruptcy cases and must proceed with caution when determining whether and to what extent it will participate in a given case. In chapter 11 cases in particular, a secured creditor must be aware of the risk that its liens might be extinguished through plan confirmation if the four factors above are met. If those factors can be met, the key for a secured creditor will be to make sure the plan separately and specifically addresses and preserves its liens.