This is the latest in the series, Dealing with Distress for Fun & Profit, which you can read from the beginning if you like1. Our last installment focused on the basics of confirming a plan. In this installment, our fearless authors drill down into the various ways of confirming a plan with respect to individual classes of creditors.
You’ve made it! Hard work, effort, and time have paid off, and a chapter 11 plan is ready for solicitation and acceptance by creditors. but now comes the (possibly) final hurdle: creditors must accept the plan. In this installment, we’ll walk you through Chapter 11 plan acceptance and the means by which a plan proponent2 can convince (or force) each class of creditors to accept the plan.
[Editor’s note: For more information on Chapter 11 plans, please see The Nuts and Bolts of a Chapter 11 plan.]
There are three ways for a plan proponent to acquire chapter 11 plan acceptance from an individual class of creditors: (1) leave class members’ claims unimpaired (at least in the eyes of the court); (2) receive approval of the proposed plan by a majority of the voting creditors in the class; or (3) cramdown the proposed plan over the class’s objection. We discuss each in turn below.
[Editor’s note: For information on what happens when a plan is contested, please see Contesting Confirmation.]
If the plan proponent knows it does not have enough votes for class acceptance and will be unable to “cram down” (more on this later) its proposed plan, then the proponent can simply leave the class unimpaired. Alternatively, the proponent may have other reasons to leave a class unimpaired. For instance, the plan proponent may want to create an unimpaired class because it enables reversal of contractual or legal acceleration and retention of advantageous contract terms.
Under Bankruptcy Code §§ 1126 and 1129(a)(8)(B), unimpaired classes are deemed to accept a plan because they’re conclusively presumed to, whether they like it or not.
But what does it mean to be “unimpaired?” For the answer to this question, we look to § 1124. Section 1124 tells us that a class of claims is presumptively impaired under a plan unless one of two things is true:
(a) cures the default (returning the creditor to pre-default conditions);
(b) reinstates the maturity of the claim (meaning that the original terms of the loan are reinstated);
(c) compensates the claim holder for damages incurred as a result of the claim holder’s reasonable reliance on account of the contract or law giving rise to the claim (the creditor must show it suffered damages from engaging in a course of conduct on the assumption that payment of the debt would be accelerated as a result of default); and
(d) compensates the claim holder for any pecuniary losses caused by the debtor’s failure to perform a non-monetary obligation (in other words, the debtor compensates the creditor for failing to perform a contracted duty in the required time).
The need to understand the Bankruptcy Code holistically is underscored by the impact of § 1122 on the strategy to leave a class unimpaired. Section 1122 states that a plan proponent can place a claim in a class so long as the other claims in that class are substantially similar to it. As such, a plan proponent can draft a plan that deliberately places claims into classes in a manner that will ensure unimpaired class(es), and at least one class that is both impaired and votes in favor of the plan. This approach creates optionality because the plan can be crammed down if necessary. Thus, the plan proponent may deliberately impair a class it might otherwise leave unimpaired if the class will be willing to support the plan despite its impairment.
If the claims in a class are impaired, then under § 1129(a)(8)(A), the plan proponent must solicit votes from the class members for chapter 11 plan acceptance. Section 1126, in turn, governs how a class accepts or rejects a plan. Not all class members must vote for a class to accept the plan. A voting class3 accepts a plan if a simple majority in number and a two-thirds majority in amount of claims actually voted, vote in favor of the plan.
For example: say there are 200 creditors in a class, and only 10 of these creditors cast ballots. You (we now assume you are the plan proponent) have a majority in number if you have 6 votes. Further, if all of the claims in the class total $1 million, but the total dollar value of the claims held by creditors who cast ballots is $100,000, then you have two thirds in amount if the creditors who voted to accept the plan hold claims totaling $66,667.
Once you have the votes, you can impose a plan on dissenters in the class. That is unless a creditor can establish that the plan does not meet § 1129(a)(7)’s “best interest” test. Under the best interest test, a creditor may block plan confirmation if it can show that it would receive less under the plan than it would in a chapter 7 liquidation. The logic behind the best interest test is that a creditor can only really complain if it’s getting a worse deal under the plan than it would in an outright liquidation. As such, it is common for courts to require the disclosure statement to provide a “liquidation analysis” showing whether the plan passes the best interest test.
Consider this example: suppose we have a class of claims totaling $100,000, and in a liquidation, this class would only be paid a total of $20,000. In our plan, we propose paying this class $10,000 next year, and $10,000 more the following year. Can we confirm with respect to this class? Since money now is worth more than money later, if the relevant interest rate is anything greater than zero, then two (deferred) payments of $10,000 do not have a present value of $20,000. In this example, the creditor class is getting less than it would get in a chapter 7. Long story short: no confirmation.
So let’s assume a class is impaired and votes to reject your plan. Does that mean you can’t confirm the plan? Well, § 1129(a)(8) tells us that this means the plan cannot be confirmed. But wait, there’s more! (tip of the hat to Ron Popeil). If you keep reading the Bankruptcy Code, you’ll note that § 1129(b) tells us that even though § 1129(a)(8) is not satisfied, there is still a way to confirm the plan—it’s called cramdown.
[Editor’s note: For more information on plan confirmation and cramdowns, please see Dealing With Distress For Fun & Profit – Installment #7 – Plan Confirmation.]
It is important to note that cramming down is not a cure-all: it can only be used to overcome the failure of a class to vote to accept a plan under § 1129(a)(8). In other words, before you can cramdown a plan to confirmation, you must show that all of § 1129’s other requirements have been met first.
Suppose a debtor owes $1 million to a creditor, under a contract providing for payment in annual installments over 10 years, at a 10% interest rate (roughly $162,000 a year). The debt is secured by Blackacre, which, luckily, is worth $1 million — exactly the same amount as the debt.
The creditor has made it clear that he favors no resolution except immediate payment in full. Unfortunately, you (as the debtor) can’t do that; indeed, you can’t even make the installment payments at their current rate. You determine that if you string the loan out from 10 to 20 years at the same rate of interest, then the payment would fall to around $127,000, which you figure you can pay.
Can you impose this deal under the cramdown rule? It’s a close call. The rule provides that you can cramdown a plan if the creditor gets a payment stream with a present value equal to the amount of its secured claim. Indeed, in the example, we are proposing to give him a payment stream with a value equal to his claim—if 10% is the right interest rate.
The creditor will say that a 20-year loan is riskier than a 10-year loan, and so he has a right to a higher interest rate. But if the interest rate is higher than 10%, a stream of 20 payments of $127,000 has a present value that is less than $1 million. In this case, we may be heading for a fight over the question: “what’s the right interest rate?”
In Till v. SCS Credit Corp. , 541 U. S. 465 (2004), the Supreme Court adopted the “formula approach” for determining the appropriate interest rate on a stream of payments, which uses the national prime rate as a starting point. This rate is increased based upon the risk of default in the particular case. The Till Court rejected the “coerced loan,” “presumptive contract rate,” and “cost of funds” approaches.
Till involved payments to a secured creditor under a chapter 13 plan. The case raises—but does not definitively answer—whether the same approach should be used in chapter 11 wherever the Bankruptcy Code requires a plan to provide a secured, priority, or unsecured creditor with payments having “a value, as of the effective date of a plan, equal to” the allowed amount of its claim.
If the collateral value is less than the amount of debt, then a plan will treat the claim as two claims—one secured, and one unsecured (This process is commonly referred to as “bifurcation”). For example, if a creditor holds a debt of $50 million against a debtor, which is secured by collateral valued at $35 million, then under § 506(a), the creditor has a $35 million secured claim and a $15 million unsecured deficiency claim. If the $50 million debt carried a 13% interest rate, scheduled to mature six months after the debtor filed for bankruptcy, a plan can cram down the secured claim by giving the creditor a stream of payments with a present value of $35 million, just as the creditor in the earlier hypothetical was entitled to a stream of payments with a present value of $1 million. As a result, this secured creditor’s note has a smaller principal balance than his original note, an extended maturity, and (perhaps) a lower interest rate.
If a plan proponent seeks to cramdown a class of unsecured creditors, then no junior class can receive anything on account of its pre-bankruptcy claim unless a plan provides that each holder in the class “receive or retain on account of such claim property of a value, as of the effective date of a plan, equal to the allowed amount of such claim. ” This means that the equity class will ordinarily not support a cramdown plan (unless the plan pays the whole of the cramdown debt) because if it refuses to support the plan, the equity class members cannot receive anything under the plan since they’re junior to the unsecured creditors.
[Editor’s Note: For more information on cramdowns, please see KUNEY’S CORNER – Cramdown: An Impaired Class of Claims Says “No” But the Plan is Confirmed Anyway.]
Remember, § 1129(b) can only be leveraged to excuse a plan’s failure to satisfy § 1129(a)(8). If you propose to impose a plan on a dissenting class of claim holders, then you must show that at least one impaired class of claims has voted to accept the plan. See § 1129(a)(10).
Think of this as the “somebody has to like it,” rule.
As you can see there are a lot of moving parts to Chapter 11 plan acceptance. To learn more about the basics of bankruptcy, please read the other installments in this series.
[Editor’s Note: For a great discussion on insolvency, we recommend What to Expect and Do When Your Customer Becomes Insolvent and Opportunity Amidst Crisis- Buying Distressed Assets, Claims, and Securities for Fun & Profit. You can also learn about federal equity receiverships, and get advice on what to do when your business is struggling].
1 This series of articles was inspired by a similar series published many years ago by the American Bankruptcy Institute, titled “Chapter 11-101,” and authored by Professor Jack D. Ayer, Professor George Kuney, Michael Bernstein, and Jonathan Friedland.
2 A “plan proponent” is the party advocating in favor of the plan. Plan proponents are commonly (but not always) the debtor.
3 Despite having the right and being given the opportunity, some classes may not vote.
Jonathan Friedland is a partner in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized as a “SuperLawyer”, by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has received numerous other accolades. He has been profiled, interviewed, and/or quoted in publications such as Buyouts…
Jack O’Connor is an associate in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He has been recognized repeatedly as a “Rising Star” by SuperLawyers Magazine in the area of Bankruptcy & Creditor/Debtor Rights and has been named an “Emerging Lawyer,” by Leading Lawyers Magazine.
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90 Second Lesson: Secured Creditors and Toll Charges
Chapter 11 Debtor’s Reporting Obligations
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