Challenge of Secured Creditors’ Liens and Claims by a Plaintiff Without Court’s Prior Blessing and Grant of Standing Survives Defendants’ Motion for Summary Judgment

AI Int’l Holdings (BVI) Ltd. v. MUFG Union Bank, N.A., et al. (In re The Weinstein Co. Holdings, LLC, et al.), No. 18-10601 (MFW), 2018 WL 6841349 (Bankr. D. Del. Dec. 20, 2018)

In this Memorandum Opinion, Judge Walrath of the Delaware Bankruptcy Court was given the rare opportunity to review and interpret language contained in the final order authorizing the Weinstein debtors (the “Debtors”) to obtain post-petition financing (the “Final DIP Order”) governing the investigation and challenge of the liens and claims of the Debtors’ prepetition lenders (the “Defendants”).  More specifically, Her Honor was tasked with determining whether the plaintiff (the “Plaintiff”) complied with the process set forth in the Final DIP Order in commencing an adversary proceeding to invalidate the secured claims and liens of the Defendants under sections 502 and 506 of the Bankruptcy Code and possessed standing to bring such a challenge.

Provisions governing challenge periods and investigations are common place in DIP orders.  Although the verbiage may vary, they follow a general framework:  in return for the provision of post-petition financing (1) the debtor stipulates to, and agrees not to challenge, among other things, the validity, enforceability, or perfection of its prepetition lender’s claims and liens; (2) the debtor and the prepetition lender, with the court’s approval, (x) agree upon a time period (a “challenge period”) in which non-debtor parties may investigate and commence a challenge to the prepetition lender’s claims and liens and (y) either require the non-debtor parties to obtain authority and standing prior to commencing a challenge, confer standing upon one or more party to do so, or remain silent as to standing; and (3) absent a timely and proper challenge, the court agrees to extend the debtor’s stipulations regarding the prepetition lender’s claims and liens to all parties in interest to preclude future challenge.  In Weinstein, the Final DIP Order provided for a 75 day period for all non-debtor parties to investigate the Defendants’ claims and liens and assert a challenge.  It neither addressed the need for a party to obtain advance standing nor conveyed standing to a party.  Rather, it made clear that the Final DIP Order should not be deemed to confer standing on anyone.

In defense of the Plaintiff’s challenge, the Defendants argued that, among other things, the Plaintiff failed to follow the steps delineated by the Final DIP Order within the 75 day challenge period and, first, investigate the validity, perfection, and enforceability of the Defendants’ claims and liens, then, obtain an order from the Bankruptcy Court authorizing the challenge and granting the Plaintiff derivative standing, and, finally, commence the challenge.  The Plaintiff responded that the Final DIP Order did not require a pre-challenge investigation (it just preserved the right), that a pre-challenge investigation would be impractical, and that, as a creditor who filed an unchallenged secured proof of claim, it possessed standing to challenge the Defendants’ claims and liens under the Bankruptcy Code.

The Bankruptcy Court agreed with the Plaintiff.  In doing so, the Court held it reasonable to conclude that the Final DIP Order did not require a pre-challenge investigation given the short length of the challenge period.  The Court also found, without directly addressing the Defendants’ derivative standing argument, the Plaintiff to possess standing under the Bankruptcy Code and Article III to contest the validity of the Defendants’ claims and liens under sections 502 and 506.  As a creditor, the Court considered the Plaintiff entitled to be heard on any issue in the proceedings pursuant to section 1109(b), object to the claims of other creditors pursuant to section 502(a), and seek modification of other creditors’ claims pursuant to section 506(a).  Moreover, the Court held that the Plaintiff’s interest could be affected by the value and validity of the Defendants’ claims and liens and thus, possessed Article III standing.  The Defendants argued that seven contingencies must be met before the Plaintiff could obtain a recovery on account of its claim, including prevailing on its lien stripping action, overcoming Defendants’ adequate protection arguments, prevailing on its secured claim, and proving the availability of distributions.  Thus, it was the Defendants’ position that the Plaintiff’s asserted injury was too remote to give rise to Article III standing.  However, the Court explained that the asserted contingencies go to whether the Plaintiff will ultimately prevail and not whether it has a legally protected interest that could be affected by the Defendants receiving more than to which they were entitled.  Here, there was no dispute that the Plaintiff was a creditor of the Debtors and that it alleged harm if the Defendants received more than the value of their liens.  Accordingly, summary judgment in favor of the Defendants was held inappropriate.