In his recent decision in In re All Land Investments (D. Del. March 9, 2012), U.S. Bankruptcy Judge Kevin J. Carey of the District of Delaware refused to confirm a Chapter 11 plan of reorganization that sought to "cram down" a secured lender. Carey found that the two classes that had accepted the plan were "artificially impaired." Therefore, there was no impaired accepting class of creditors to support a cram-down under 11 U.S.C. §1129(b). Carey's decision demonstrates that there are limits to a debtor's ability to successfully manipulate plan distributions so as to "impair" a class of creditors likely to vote to accept a plan.
In All Land Investments, the debtor was a developer that had sought to develop a subdivision in Kent County, Del. According to the opinion, RBS Citizens N.A. had made loans to the debtor that were secured by substantially all of the debtor's assets. The court found that Citizens' claim at the time of the confirmation hearing was $14.7 million, the value of Citizens' collateral was no more than $6.5 million and that Citizens' deficiency claim was at least $8.2 million.
Under the debtor's plan, Citizens' secured claim would be satisfied by permitting Citizens to foreclose on the effective date or by deeding to Citizens its collateral. Citizens' deficiency claim was placed in Class 5 with other general unsecured claims. Unless Citizens' claim was satisfied by the value of its collateral, Citizens would retain its rights to pursue nondebtor sureties and guarantors. The opinion suggests that there was a dispute between the debtor and Citizens as the scope of Citizens' collateral.
In any event, Citizens voted against the plan and objected to confirmation on three grounds: (1) the plan was not filed in good faith and therefore could not satisfy the requirements of 11 U.S.C. §1129(a)(3); (2) under the plan, Citizens would not receive an amount that is not less than Citizens would receive in a Chapter 7 liquidation and the plan therefore did not satisfy the requirements of 11 U.S.C. §1129(a)(7); and (3) no impaired class accepted the plan and the plan could not satisfy the requirements of 11 U.S.C. §1129(a)(10). Carey denied confirmation because of the plan's failure to satisfy the requirements of §1129(a)(10).
Citizens' deficiency claim swamped Class 5 (general unsecured claims), which rejected the plan. Only Class 1 (pre-petition real estate tax claims and other secured claims of government units) and Class 3 (the secured claim of KSJS Investment Associates) voted to accept the plan. The plan characterized these classes as "impaired."
Under the plan, Class 1 claimants would retain their liens on the debtor's real estate, and any subsequent conveyance would be subject to those liens, unless the liens were paid in full. Similarly, the Class 3 claimant was to receive a deed to its collateral in full satisfaction of its claim.
Under the Bankruptcy Code, a plan impairs a class of claims unless the plan leaves unaltered the legal, equitable and contractual rights to which such claim or interest entitles the holder of such claim or interest." (See 11 U.S.C. §1124.) "Artificial" impairment arises when a plan imposes an insignificant alteration of a creditor's rights so as to encourage acceptance of the plan while imposing no true economic burden on the voting creditor. As the U.S. Court of Appeals for the Third Circuit noted in In re Combustion Eng'g , 391 F.3d 190, 243-44 (3d Cir. 2004), the requirement that an impaired class accept a plan assures that a plan may only be confirmed with the support of creditors whose rights are truly altered by the plan (i.e., by creditors who have a true financial stake in the outcome of a plan). Artificial impairment undermines this concept. Although the Third Circuit noted that the Bankruptcy Code doesn't expressly prohibit artificial impairment, the court noted that its use can be "troubling." (See Combustion Eng'g .)
In light of this jurisprudence, Carey found that neither Class 1 nor Class 3 was impaired. First, each class was a secured class and the claimant in each class was receiving its collateral in support of its claim. Each class was oversecured. Carey questioned whether, in each instance, the claim was impaired under Section 1124. Second, the only creditor in Class 1 was the city of Clayton, Del., which held a claim in the amount of $3,000. The court found that the debtor had the means to pay this claim in full on the effective date.
In each instance, the court could find no business reason to impair Class 1 or Class 3 and concluded that those classes were only impaired in order to obtain the consenting votes necessary for a cram-down. Under these circumstances, the court disqualified the votes "for purposes of determining whether the debtor has obtained the affirmative vote of an impaired class as required by §1129(a)(10)." Plan confirmation was denied, and the court granted Citizens relief from the automatic stay to foreclose on its collateral.
While the All Land Investments decision presents a fairly obvious example of artificial impairment, the decision is nevertheless instructive. In instances where a debtor has the means to pay a claim in full, but decides, instead, to "treat" the claim under a plan, a court will be persuaded that this treatment results in artificial impairment. While debtors often need to be creative in structuring treatment under a plan in order to gain creditor support, a plan's structure must impose some concession upon a class of creditors if that class is to serve as an impaired class whose vote in favor of the plan is to support a cram-down.
Michael R. Lastowski is a member of Duane Morris and the head of its Wilmington office. Licensed to practice in Delaware, Pennsylvania and New York, he primarily represents Chapter 11 debtors.
Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.
