By filing a chapter 11 petition, the debtor seizes the initiative in proposing a reorganization plan—which is to provide how soon, in what amount and in what manner creditors’ claims are paid.[i] But a debtor does not necessarily get its way. A class of creditors who are not getting paid in full may reject the plan, which will prevent confirmation on a consensual basis. Ah, but the debtor may, by fulfilling additional requirements, “cram down” the plan on those creditors and win confirmation. Among parties represented by competent counsel, these rules help shape negotiations over the debtor’s plan from the get-go, perhaps creating consent by virtue of improved claims treatment. This article discusses in detail some of the main rules.
Only the debtor may file a plan of reorganization during the first 120 days after the petition is filed beginning the case [ii], and such plan must be accepted (after solicitation of and voting by creditors) “by each class of claims that is impaired under the plan” within 180 days after the petition is filed (the “exclusivity” periods). [iii] If an impaired class of claims does not accept the plan within the exclusivity periods, the debtor loses the initiative and another party, such as a secured lender or a creditors committee as representative of unsecured creditors, may propose a plan.
Section 1129(a) of the Bankruptcy Code governs consensual confirmation of a reorganization plan, and requires that the plan be accepted by each class of claims or interests, or else must leave the claims of non-accepting classes unimpaired.[iv] Generally speaking, a class is “impaired” if its legal, equitable, and contractual rights are altered by the plan[v], which includes claims receiving payment of less than their full allowed amount, i.e. getting a “haircut.”
Section 1129(b) provides that the debtor may confirm its plan over the dissent of an impaired class of claims or equity interests. This is the “cram down” of a plan on those taking that haircut. Upon the debtor’s request, the court is required to confirm the plan—provided that the plan satisfies § 1129(a)’s remaining requirements—over the dissent of an impaired class of claims or interests, if the plan does not discriminate unfairly and is fair and equitable with respect to each dissenting, impaired class of claims or interests.
In order to be crammed down, the plan must satisfy the remaining requirements of § 1129(a)—leaving aside subsection (a)(8)’s mandate that each class of impaired claims accept. Thus, the plan must provide that: each creditor or interest holder who does not accept the plan must receive no less under the plan than it otherwise would if the debtor were liquidated ((a)(7)); at least one impaired class must vote to accept the plan ((a)(10))[vi]; and the plan must be “feasible”—i.e. not likely to be followed by liquidation or another reorganization of the debtor ((a)(11)). A “cram down” confirmation still must not unfairly discriminate against any dissenting impaired class and must provide for fair and equitable treatment of all dissenting and impaired classes.
A plan may be confirmed even though it discriminates in its treatment of similarly situated classes. It cannot be confirmed if it discriminates unfairly with respect to a dissenting class. Though courts employ different tests in determining whether a plan discriminates unfairly, “[i]n essence, a plan does not ‘discriminate unfairly’ with respect to a dissenting class if the plan protects the legal rights of the class in a manner consistent with the treatment of other” classes that hold similar legal rights.[vii]
To determine whether a plan discriminates unfairly, many courts ask whether the discrimination has a reasonable basis and is proposed in good faith, whether the debtor can confirm the plan without the discrimination, and whether the degree of discrimination is proportionate to its rationale. For example, unfair discrimination was found in In re Aztec Co. when the debtor’s plan provided for the full payment of insider unsecured creditors while proposing to pay three percent of a lender’s (also unsecured) deficiency claim.[viii] On the flip side, in In re Creekstone Apartments Associates, L.P., the court confirmed the debtor’s plan even though it provided for only ten percent payment on an unsecured creditor’s claim while paying (separately classified) unsecured trade creditors in full, because the court found that the payment of trade creditors was necessary to maintain relationships with the debtor’s vendors that were critical to the reorganization’s success.[ix]
Other courts presume unfair discrimination in a plan which provides (1) a dissenting impaired class, (2) another class of the same priority, and (3) a difference in the plan’s treatment of the two classes that results in either a materially lower percentage of recovery for the dissenting class—measured by the net present value of all payments—or, regardless of the percentage of recovery, an allocation of materially greater risk to the dissenting class.[x] For example, in In re Barney & Carey Co., the plan provided for full payment of lenders’ (unsecured) deficiency claims while paying general unsecured creditors 15 percent; the court found that the “substantially greater” payment to the deficiency claim rendered the plan unfairly discriminatory and therefore unconfirmable.[xi] Similarly, the court found the debtor’s plan to be unfair in In re Cranberry Hills Assocs. Ltd. P’ship where, though all creditors would be paid in full, the plan provided for trade creditors to be paid in cash on the effective date of the plan while a (separately classified) deficiency creditor was to be paid over nine years without interest.[xii]
Additionally, a cram down plan must provide for the fair and equitable treatment of any impaired and dissenting class. Section 1129(b)(2) establishes separate standards to determine whether a plan is fair and equitable with respect to a dissenting impaired class, depending on whether the class is composed of secured claims, unsecured claims, or ownership interests.
The fair and equitable tests for unsecured creditors ensure that they will be paid in full on a present value basis before any class junior to them is to receive anything at all. A plan is fair and equitable in its treatment of a dissenting unsecured class where either the claimant receives cash (or “property of a value”) equal to the allowed amount of the claim or no holder of a junior claim will receive any property under the plan.[xiii] A plan treats a class of equity interests fairly and equitably if it provides that each interest holder will receive or retain property of a value, as of the effective date of the plan, equal to the greatest of (1) the allowed amount of any fixed liquidation preference that the interest holder is entitled to, (2) any fixed redemption price to which the interest holder is entitled, or (3) the value of such interest, or, that the holder of any interest that is junior to the interests of the class will not receive or retain any property under the plan.[xiv]
In order for a plan to be fair and equitable with respect to a dissenting class of secured claims, it must satisfy one of three requirements. First, the plan may provide that the reorganized debtor will keep the collateral and that the class of secured claims with liens on that collateral will retain liens that secure distribution to them of the allowed amount of their claims.[xv]
There are two distinct ways of understanding the allowed amount of a secured claim. Under section 506(a) of the Bankruptcy Code, the secured amount of an allowed claim is equal to the value of the collateral at the time of plan confirmation (the deficiency, if any, becomes an allowed unsecured claim). However, an undersecured creditor may elect to apply section 1111(b)(2) of the Bankruptcy Code, pursuant to which the claim is treated as a fully secured in the allowed amount of the debt owed to the undersecured creditor (and is subject to other treatment rules).[xvi] Whatever the allowed amount of the secured claim, the plan must provide for the class to receive deferred cash payments with a total present value equal to the secured claim.[xvii]
Second, the plan may provide for the sale of the collateral—free and clear of the lien held by the dissenting class—subject to section 363(k) of the Bankruptcy Code. Once the sale under a plan is closed, the creditor’s lien attaches no longer to the collateral but instead to the proceeds of the sale to the allowed amount of its secured claim.[xviii] Section 363(k) provides that “unless the court for cause orders otherwise, the holder of such claim may bid at such sale” up to the amount of its claim.[xix] In the RadLAX Gateway Hotel, LLC case, the Supreme Court held that the credit bid right is a fundamental creditor protection when collateral is sold free and clear of the lien at issue.[xx]
Third, a plan may be found fair and equitable with respect to a dissenting class of impaired secured claims if the plan provides the class with the “indubitable equivalent” of its claims.[xxi] The plan may provide the indubitable equivalent of the claim by abandoning the collateral to the secured creditor or by providing a lien on similar, substitute collateral. The “indubitable equivalent” standard is derived from In re Murel Holding Corp., and was intended to provide adequate protection to the dissenting secured creditor, alleviating concerns about a possible taking under the 5th Amendment.[xxii]
For example, in In re Arnold and Baker Farms, the debtor’s plan proposed for the satisfaction of a secured claim by providing the creditor with a partial transfer of the real property that secured it.[xxiii] The court stated that, though a partial transfer in satisfaction of the entire claim may provide the “indubitable equivalent” of the claim, it only does so if it ensures the “safety of or prevent[s] jeopardy to the principal.” The court held that the property in question did not ensure the creditor’s safety because unfavorable market conditions subjected the creditor to the possibility that it would have to sell the property for less than the value determined by the court — the value of the claim. Because the transfer of the property did not constitute an “indubitable equivalent” of the creditor’s claim; the plan was not fair and equitable and could not be confirmed over the creditor’s dissent.
Cram down confirmation is easy to threaten, but harder to accomplish. The tests discussed above provide the structure for making and evaluating such a threat. The debtor’s ability to demonstrate, early on, to a dissenting impaired class that the debtor’s plan can satisfy the cram down requirements may “soften up” the class members and make a negotiated, consensual plan confirmation possible.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: The Nuts and Bolts of a Chapter 11 Plan and The Nuts & Bolts of a 363 Motion. This is an updated version of an article originally published on March 12, 2014.]
[i] Lindsey Young Distinguished Professor of Law and Director of the James L. Clayton Center for Entrepreneurial Law, The University of Tennessee College of Law. The author thanks Sarah Ohlman, University of Tennessee College of Law class of 2016, and Alexander Brent, University of Tennessee College of Law class of 2020, for substantial assistance with research for and cite checking of this article.
[ii] 11 U.S.C. § 1121(b).
[iii] 11 U.S.C. § 1121(c)(3). The exclusivity periods may be extended upon motion and hearing. 11 & U.S.C. § 1121(d)(1).
[iv] 11 U.S.C. § 1129(a)(8). Conceivably, a non-impaired class could vote to reject a plan. Doing so would not affect consensual confirmation under section 1129(a).
[v] 11 U.S.C. § 1124. A claimant is not impaired if it agrees to a slighter set of rights. Id. & § 1123(a)(4).4
[vi] The acceptance of this class is measured without taking into account votes to accept made by insiders of the debtor. 11 U.S.C. § 1129(a)(7).
[vii] In re Buttonwood Partners, Ltd., 111 B.R. 57 (Bankr. S.D.N.Y. 1990).
[viii] In re Aztec Co.,107 B.R. 585 (Bankr. M.D. Tenn. 1989).
[ix] In re Creekstone Apartments Associates, L.P., 168 B.R. 639 (Bankr. M.D. Tenn. 1994).
[x] In re Dow Corning Corp., 244 B.R. 696 (Bankr. E.D. Mich. 1999). This presumption can be rebutted by evidence provided by the debtor.
[xi] In re Barney & Carey Co., 170 B.R. 17 (Bankr. D. Mass. 1994).
[xii] In re Cranberry Hills Assocs. Ltd. P’ship, 150 B.R. 289 (Bankr. D. Mass. 1993).
[xiii] 11 U.S.C. §1129(b)(2)(B).
[xiv] 11 U.S.C. § 1129(b)(2)(C). Because holders of interest are not entitled to a distribution unless unsecured creditors are paid in full, cram down plans rarely pay anything to holders of interests. Owners of a debtor may nevertheless retain ownership of the reorganized debtor – even when creditors are not paid in full — under certain somewhat controversial rules, a topic to be taken up in a future article on this site – ed.
[xv] 11 U.S.C. § 1129(b)(2)(A)(i)(I)
[xvi] 11 U.S.C. § 1111(b)(2). A separate article on the section 1111(b)(2) election is being prepared by this author for this site.
[xvii] 11 U.S.C.§ 1129(b)(2)(A)(i)(II)
[xviii] 11 U.S.C. § 1129(b)(2)(A)(ii).
[xix] 11 U.S.C. § 363(k).
[xx] RadLAX Gateway Hotel, LLC v. Amalgated Bank, 132 S.Ct. 2065 (2012).
[xxi] 11 U.S.C. 1129(b)(2)(A)(iii).
[xxii] In re Murel Holding Corp., 75 F.2d 941 (2d Cir. 1935).
[xxiii] In re Arnold and Baker Farms, 177 B.R. 648 (9th Cir. 1994).
Prior to joining the faculty in 2000, Professor Kuney was a partner in the San Diego office of Allen Matkins Leck Gamble & Mallory LLP where he concentrated his practice on insolvency and reorganization matters nationwide. Before that he received his legal training with the Howard, Rice and Morrison & Foerster firms in his hometown…
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