The debtor sought confirmation of a plan of reorganization where the impaired accepting class consisted of two claims totaling less than $2400 which were to be paid over 60 days. The secured creditor objected that this did not satisfy the Bankruptcy Code confirmation requirements. The bankruptcy court initially confirmed the plan. After bouncing back and forth between the bankruptcy court and the district court, the case was dismissed and the automatic stay lifted. An appeal to the 6th Circuit followed.
Section 1129 of the Bankruptcy Code sets forth requirements for confirmation of a plan. Among other things, subsection (a)(10) provides that if any class of claims is impaired then at least one impaired class must accept the plan without counting the votes of any insiders.
In this case the debtor’s creditors consisted of (1) a secured creditor (FNMA) with an $8.6 million claim secured by an apartment building worth $5.4 million, and (2) unsecured claims of the debtor’s former lawyer and accountant totaling less than $2400. Under the plan the small unsecured claims were to be paid over 60 days, as opposed to being paid in full upon confirmation.
As for Fannie Mae’s loan, the plan provided for relatively slow amortization so that there would still be a balance of ~$6.6 million after 10 years. It also stripped FNMA of several protections in the loan agreement, including a requirement that the debtor maintain the apartment building and carry adequate insurance.
The unsecured creditors voted to accept the plan, while FNMA rejected it (surprise, surprise). The bankruptcy court found that the small unsecured class was impaired since the creditors were entitled to payment in full upon confirmation (as opposed to stretched out over 60 days), and acceptance by that class was sufficient to meet the requirement of section 1129(a)(10). Thus it confirmed the plan.
FNMA appealed to the district court. The district court vacated the confirmation order and remanded to the bankruptcy court to determine whether the plan was proposed in good faith. On remand the bankruptcy court concluded the plan was proposed in good faith, and once again confirmed the plan. On appeal the district court once again vacated and remanded, which caused the bankruptcy court to dismiss the case and lift the automatic stay. This led to the debtor’s appeal to the 6th Circuit.
On appeal the first issue was whether the unsecured claims were “impaired” for purposes of subsection (a)(10). The 6th circuit noted that section 1124(1) provides that a claim is impaired 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.” Since the unsecured creditors were entitled to payment immediately as opposed to over 60 days, the court found that the plan “undisputedly” altered their rights.
In its view, although the impairment appeared to be contrived solely to create an accepting class, the debtor’s motive in creating the impairment was irrelevant. The “debtor’s motives instead are expressly the business of § 1129(a)(3)” – which provides that a plan must be proposed in good faith.
The bankruptcy court had concluded the plan was proposed in good faith because “[the debtor] was economically justified in rationing every dollar.” The 6th Circuit did not find this to be a credible justification. It noted that the debtor’s projections supporting feasibility of the plan showed average net income of $71,400 per month during the first year, which “renders dubious at best” the assertion that less than $2400 in claims could not be paid up front as opposed to over the first 60 days. This assessment was bolstered by the fact that the two unsecured claimants were closely allied with the debtor and refused payment when FNMA sought to pay their claims upfront by tendering checks for full payment.
Consequently, the 6th Circuit found that the requirement for acceptance by an impaired class had been met, but agreed with the district court that the plan could not be confirmed because it was not proposed in good faith.
A real estate debtor whose primary creditor is an underwater mortgagee with a significant deficiency claim can find it very difficult to obtain confirmation of a plan. One major issue is whether the “new value” rule will allow the equity holders to retain control of the debtor post-confirmation over the objection of the mortgagee. However, you do not even reach that issue unless you can come up with an impaired accepting class. Although courts certainly do not take a uniform approach, many will balk at confirming a plan where “artificial impairment” is apparent.
Vicki R Harding, Esq.
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