Once upon a time, before the Bankruptcy Code replaced the Bankruptcy Act, there lived two distinct bankruptcy reorganization paths for businesses: Chapter X for public companies and Chapter XI for others. And it was even earlier when the Supreme Court articulated the earliest form of what it would later refer to as the ‘absolute priority rule,’ in 1868, by pronouncing “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”2
Fast-forward, however, and from 1952 until 1978, there was no absolute priority rule for Chapter XI debtors.3 It was the Bankruptcy Code of 1978, which put all debtors, regardless of size or public/private company status, into a single chapter 11 bucket. And in so doing, it codified for the first time the absolute priority rule for all debtors large and small.
Fast-forward some more: Congress created Subchapter V in 2018 because it came to realize that business bankruptcy cases should not be treated with a ‘one size fits all” approach. And, so, when it went into effect the following year, it eliminated many of the obstacles and costs smaller businesses faced while seeking to reorganize under traditional Chapter 11. – – albeit at the expense of unsecured creditors.4
Each of these changes, except the last, is quite straightforward. The remainder of this article delves deeper into just that, the relaxed cramdown requirements of §1191(b), which supplant those of §1129(b).
A traditional chapter 11 plan (i.e., one proposed other than in Subchapter V) must meet the requirements set out in §1129(a) to be confirmed, with the notable exception that the requirement stated in §1129(a)(8) (that each class of claims or interests accept the Plan or is not impaired under the Plan) is excused if the plan proponent crams down the plan under §1129(b).10 “Cram down” is an expression used by bankruptcy practitioners to signify the confirmation of a plan notwithstanding the rejection of the plan by an impaired class of creditors; in other words, the bankruptcy court is said to “cram the plan down the throat of a dissenting class.”
Section 1129(b)(1) in turn, requires a traditional cram-down plan to not “discriminate unfairly” and to be “fair and equitable” as to each class of claims or interests that is impaired under, and has not accepted, the plan.
Section 1129(b)(2), in subsequent turn, defines “fair and equitable,” and it does so differently based on whether the class at issue is comprised of a secured claim, one comprised of unsecured claims, or one comprised of equity interests.11 A plan is fair and equitable as to a class of unsecured claims if the plan provides that either (a) each holder of a claim in that class “will receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (b) no junior class will receive or retain anything under the plan on account of its claim.” “Anything under the plan” includes the owners retaining their equity interests in the debtor. This Is the Absolute Priority Rule.
The first confirmation game-changer of Subchapter V is that cram down does not merely eliminate the need for a plan to satisfy §1129(a)(8)’s requirement that all impaired classes accept the plan.12 It also excuses the need to satisfy §1129(a)(10) that at least one impaired class of creditors accepted the plan. Dayenu! Arguably, the only practical reason to bother soliciting votes to accept or reject a Subchapter V plan (other than it being required under the Code) is the rare chance that the plan is accepted by all impaired classes of creditors and, therefore a consensual plan.
The second game-changer is the total displacement of the absolute priority rule in the case of unsecured claims by a projected disposable income requirement. To be clear, the surgery Congress did to the Code to create Subchapter V still requires (under §1191(b)), as to the holder of an impaired claim or interest who has not accepted the plan, that the plan not discriminate unfairly and be fair and equitable to such holder.
The difference is that the definition of “fair and equitable” in Subchapter V does not, like in traditional chapter 11, mean the plan contemplates paying holders of allowed claims in a senior class 100% or that holders of junior claims and interests will be paid nothing. Instead, in Subchapter V, §1191(c)(2) now provides that a plan is fair and equitable as to a class of unsecured creditors or to a class of interests if either the plan applies all of its “projected disposable income” over three to five years to payments under the plan or the value of the property to be distributed under the plan in that same timeframe is not less than the debtor’s projected disposable income.13
As discussed above, the Subchapter V ‘fair and equitable’ requirement requires a debtor to commit all its “projected disposable income” during the life of the plan to paying claims under the plan.14
Section 1191(d) tells us that in subchapter V, a debtor’s “disposable income” is “the income that is received by the debtor and that is not reasonably necessary to be expended” for the following specific purposes:
Of course, in the Subchapter V of a business, only this last element applies. And, while the case law on Subchapter V is generally developing rapidly,16 there is a vast and sparse desert when it comes to published case law guidance on what expenditures a court should consider to be “necessary for the continuation, preservation, or operation of the business of the debtor.”
Believe us, we looked for it. And we’ll keep looking for it as we continue to represent Subchapter V debtors. But published decisions that address this issue simply have not yet been written. Sure, in the context of deciding other issues, courts have said things like:
Debtor’s net cash flow is comprised of revenue left over after all expenses and debt service payments are made. In other words, Debtor’s profit. As stated previously, the Plan implicitly provides that the net cash flows will be deposited into the Fund each month. If Debtor had done this, it would be allowed for payment of expenses “necessary for the continuation, preservation, or operation of the business” under § 1191(d)(2) which includes such expenditures as the replacement of the HVAC units and to make payments under the Plan when revenues fall short. However, because Debtor did not escrow its profits into the Fund and provided no explanation as to where this revenue went, Debtor has failed to comply with § 1191(c)(2)(A).
In re Samurai Martial Sports, 644 B.R. 667, 684 (Bankr. S.D.Tex. 2022).
Great, we now know that in one particular case concerning whether a confirmed plan could be modified because a broken A/C unit caused lots of customers to stay away from a workout club, and where that, in turn, caused the debtor to miss some plan payments, that that the Judge thought that replacing the A/C unit would have constituted an expense that was “necessary for the continuation, preservation, or operation of the business of the debtor.”
But does that help you, reader, draw any general rules to practice by on the question of what is in and what is out? Of course not. What about- – –
The inquiry is always going to be extremely, if not entirely, fact specific. Case law will surely develop, but each situation will as surely be unique. But this begs the question of how much weight will be given to the debtor’s view on the factual question. In other words, the key legal issue in this context that courts will grapple with, it seems obvious to us, is the extent to which debtors will be afforded the business judgment rule standard (or something like it) in deciding what expenditures are necessary for the continuation, preservation, or operation of the business of the debtor.
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Jonathan Friedland is a principal at Much Shelist. 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 Magazine; Smart Business Magazine; The M&A…
Rob is a principal at Much Shelist and has more than three decades of experience counseling financial institutions and debtors in all areas of creditors’ rights, bankruptcy, and financing matters. He brings a wealth of experience to clients in need of representation in bankruptcy proceedings, commercial foreclosures, bankruptcy litigation, out-of-court workouts, and the acquisition and…
Jeff is a partner in Much Shelist's Creditors' Rights, Insolvency & Bankruptcy group where he focuses on the representation of buyers and sellers of financially distressed assets and the representation of secured and unsecured creditors in business reorganizations under Chapter 11 of the Bankruptcy Code and in out-of-court restructurings. He regularly advises lenders, debtors and…
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