Compelling circumstances” are required to amend claims post-Chapter 11 plan confirmation

In the Highland Capital Management, L.P. bankruptcy cases, the United States Court of Appeals for the Fifth Circuit held that a creditor must show “compelling circumstances” to justify amending its proof of claim after confirmation of a Chapter 11 plan.

The Chapter 11 cases arose from the wind down and liquidation of Highland Capital Management, L.P., the investment manager of a fund that had been inundated with investor redemption requests during the 2008 financial crisis. CLO HoldCo (CLO) asserted a general unsecured claim of approximately USD 11 million against Highland, representing alleged participation interests in certain claims to redeem equity in Highland, which it had purchased prepetition.

During the Chapter 11 cases, Highland reached a settlement with other creditors, by which it agreed to cancel the redemption interests forming the basis for CLO’s claim. After the settlement was approved by the bankruptcy court, CLO amended its proof of claim to USD 0.

The bankruptcy court confirmed Highland’s Chapter 11 plan of liquidation, and a liquidating trustee was appointed to oversee the liquidation of the firm’s remaining assets. When the liquidating trustee assumed control of Highland’s bankruptcy estate, it initiated a lawsuit against numerous parties, including CLO, and objected to CLO’s amended USD 0 proof of claim.

CLO filed and sought the bankruptcy court’s ratification of a second amendment to its claim, alleging that the cancellation of redemption claims gave rise to a credit in CLO’s favour of approximately USD 4 million. The bankruptcy court denied CLO’s ratification motion. CLO appealed to the Fifth Circuit Court of Appeals, which adopted the bankruptcy court’s reasoning for effectively expunging the second amended claim, holding that compelling circumstances were required for a creditor to amend its proof of claim post-plan confirmation.

The Fifth Circuit, citing case law from the Seventh and Eleventh Circuits, held that a high standard is required post-confirmation because “a confirmed plan of reorganisation is equivalent to a final judgment in civil litigation…This potential res judicata effect justifies ratcheting up the legal standard because post-confirmation amendments may ‘mak[e] the plan infeasible’, ‘disrupt the orderly process of adjudication’, and ‘alter the distribution[s] to other creditors’.”

The Fifth Circuit affirmed the bankruptcy court’s decision to expunge the second amended claim because the bankruptcy judge had “considered several equitable factors, including the fact that [CLO] did not identify any appropriate reason – let alone a compelling reason – for its nearly year-long delay in seeking a post-confirmation amendment”.

While the facts of this case were complex, creditors and their counsel must beware of the potential for their claims to be fixed as of the time a Chapter 11 plan is confirmed, and vet the potential theories and bases for claims against a debtor to protect their interests in Chapter 11.

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Jack R. O'Connor, a partner in Levenfeld Pearlstein’s Financial Services & Restructuring Group, specializes in commercial restructuring, insolvency, bankruptcy, and debtor matters.

Harold D. Israel, a partner in Levenfeld Pearlstein’s Financial Services & Restructuring Group, represents debtors, fiduciaries asset purchasers and creditors in national workouts and reorganizations.