Cramdown in Chapter 11: 6 Rules for Confirming Over a Secured Creditor's Objection

A secured lender that votes no has not ended the case. It has moved the argument from the ballot to the appraisal, and from there to an interest rate that neither side chose.

The provision that permits the move is section 1129(b), which lets a court confirm a plan over a rejecting class if the plan "does not discriminate unfairly, and is fair and equitable" toward it. For a class of secured claims the statute then spells out what fair and equitable requires, in three alternatives set out in section 1129(b)(2)(A). The six rules below come from that subparagraph and from the two Supreme Court decisions that have done most to read it.

1. Every Other Confirmation Test Must Already Be Met, Including One Accepting Class

Cramdown excuses one requirement and one only: section 1129(a)(8), which demands that every class accept or be left unimpaired. Everything else in section 1129(a) still applies. The plan must be proposed in good faith, must give each dissenting creditor at least what a Chapter 7 liquidation would, and must be feasible, meaning confirmation is not likely to be followed by liquidation or a further financial reorganization.

The requirement an owner should check first sits in section 1129(a)(10). If any class is impaired, at least one impaired class must accept, counted without insiders. A company whose only impaired creditor is the objecting bank has no one left to supply that acceptance. A company whose bank also holds most of the unsecured debt, through a deficiency claim, may find the bank voting no in two classes at once.

Subchapter V is different on this point. Section 1191(b) lists paragraph (10) among the requirements a small business debtor may bypass in a nonconsensual confirmation, though the secured-creditor protections of section 1129(b)(2)(A) still apply there in full.

2. The Lien Stays Until the Allowed Claim Is Paid

Under the first alternative, the holders must "retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims." The equipment may move to a new company under the plan. The lien travels with it.

You cut the payment, you stretch the term, and the lender still holds the lien until the last check clears.

3. The Payments Must Satisfy Two Different Numbers at the Same Time

The same alternative requires "deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property." One number is a sum. The other is a present value. The two are different numbers, and a plan has to clear both.

Suppose a lender is owed $800,000 against equipment worth $500,000. Without any election, section 506(a) makes the allowed secured claim $500,000 and sends the remaining $300,000 to the unsecured class. The deferred payments must total at least $500,000 and must also be worth $500,000 on the effective date, which is impossible without interest, since a dollar paid in year four is worth less than a dollar paid at confirmation. Present value behaves like the claim check at a dry cleaner that has posted notice of its closing: the garment is still yours, and each month you wait, the ticket is worth a little less.

The interest rate is where the argument goes next. In 2004, in Till v. SCS Credit Corp., a Chapter 13 debtor proposed to pay a $4,000 secured claim on a truck at 9.5 percent, the national prime rate of 8 percent plus a risk adjustment, and the lender insisted on its contract rate of 21 percent. The plurality endorsed the "prime-plus or formula rate," observed that courts had "generally approved 1% to 3%" risk adjustments without deciding the proper scale, and said the rate must be "high enough to compensate a creditor for its risk but not so high as to doom the bankruptcy plan" (four Justices joined that opinion; Justice Thomas agreed with the result on separate reasoning and four dissented, which leaves the formula resting on a plurality even in the chapter it addressed, and a footnote in the plurality opinion then remarked that in a Chapter 11 case "it might make sense to ask what rate an efficient market would produce," a remark courts have been left to weigh). Most of cramdown is arithmetic that the statute has agreed to call fairness. What rate a Chapter 11 court will apply to a particular lender is a question for counsel in that district, and the answer can move the monthly payment more than any concession in the plan.

The lender cannot be forced to accept less than its collateral is worth. It can be forced to wait for it, at a rate the court selects.

4. Valuation Decides Which Number Is Which

Every figure in the preceding rule depended on a value, and section 506(a) tells the court how to find it: value "shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property." Equipment the company will keep using is valued for that use, and the statute contemplates fixing the figure in conjunction with the hearing on the plan. Two appraisers can reach two numbers.

The lender holds one counter to a low valuation. Section 1111(b) lets the class elect, by a two-thirds share of the class's dollars and a majority of its members, to have its entire allowed claim treated as secured. In the example above, an electing lender's allowed secured claim becomes $800,000, so the payments must total at least $800,000 while their present value need only reach the $500,000 collateral value. The lender gives up its unsecured deficiency vote and distribution. It gains a larger total that the plan must pay. The election is unavailable where the lender's interest in the property is of inconsequential value, or where the lender has recourse and the property is being sold under section 363 or the plan.

5. A Plan Sale Must Let the Lender Bid Its Debt

The second alternative permits a sale of the collateral free and clear of the lien, "subject to section 363(k)," with the lien attaching to the proceeds. Section 363(k) allows the lienholder to bid at the sale and offset its claim against the price, unless the court for cause orders otherwise.

The debtors in RadLAX Gateway Hotel, LLC v. Amalgamated Bank proposed to auction their property without allowing the bank to credit bid, and argued that cash from the auction was the "indubitable equivalent" of the bank's claim under the third alternative. In 2012 the Supreme Court held that a cramdown plan may not sell collateral free and clear of the lien without permitting the lender to credit bid, calling the debtors' reading "hyperliteral and contrary to common sense." The specific clause governs the general one.

6. The Indubitable Equivalent Is a Narrow Door

The third alternative reads, in full, "for the realization by such holders of the indubitable equivalent of such claims." The statute does not define the phrase, and after RadLAX it cannot be used to achieve what the sale clause forbids.

The separate requirement that the plan not "discriminate unfairly" is undefined as well. It matters less for a secured lender in a class by itself than for creditors sharing a class with others.

Before the Appraisers Are Retained

A cramdown fight is paid for by the estate, which means by the creditors ranked below the lender and, through the value of the shares, by the owner. An owner whose real problem is the unsecured layer above the secured loan, merchant cash advances most of all, may find that layer negotiable without a petition. Delancey Street reviews that debt in confidence and without charge. It is not a law firm, it does not appear in bankruptcy court, and when a matter requires legal work it relies on independently licensed counsel. An owner facing a secured lender that is days from repossessing the equipment the business runs on should be speaking with bankruptcy counsel instead, since the automatic stay that halts a repossession arrives only with a petition.

The lien, the rate, and the appraisal will all be argued. The equipment, meanwhile, keeps running.