Maurice A. Deane School of Law at Hofstra University Scholarly Commons at Hofstra Law

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1983 From the Courts: Cram-Down of the Unsecured : Section 1111(B)(2) Relief Benjamin Weintraub

Alan N. Resnick Maurice A. Deane School of Law at Hofstra University

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Recommended Citation Benjamin Weintraub and Alan N. Resnick, From the Bankruptcy Courts: Cram-Down of the : Section 1111(B)(2) Relief, 16 UCC L.J. 159 (1983) Available at: https://scholarlycommons.law.hofstra.edu/faculty_scholarship/884

This Article is brought to you for free and open access by Scholarly Commons at Hofstra Law. It has been accepted for inclusion in Hofstra Law Faculty Scholarship by an authorized administrator of Scholarly Commons at Hofstra Law. For more information, please contact [email protected]. From the Bankruptcy Courts

Benjamin Weintraub* and Alan N. Resnick**

CRAM-DOWN OF THE tially secured the right to UNSECURED CREDITOR: elect to be treated as having fully SECTION 1111(b)(2) RELIEF secured claims for reorganization "Cram-down" is an expression purposes. This election, which that any creditor would rather not requires approval by more than hear in a chapter 11 case, but half of the class members in num­ could be most disturbing when ber holding at least two thirds of applied to the partially secured the claims in amount, may not be creditor. The concern is based on made, however, if the actual col­ the fear that the would lateral is of inconsequential value merely "cash out" the secured or the collateral is sold by the claim by paying the current value debtor in possession or the trustee of the collateral at a time when the or is sold pursuant to the reorga­ market with respect to the collat­ nization plan. 2 eral is temporarily depressed, The effect of Section 1111(b)(2) thus leaving the undersecured is best understood when consid­ creditor with a sizable unsecured ered in connection with the re­ deficiency. quirements for confirmation gov­ Congress reduced this fear of erned by Section 1129. Most partially secured creditors by in­ chapter 11 plans are confirmed cluding Section 1111(b)(2) in the pursuant to the acceptance meth­ Bankruptcy Code. 1 In essence, od under Section 1129(a). How­ this section gives a class of par- ever, in the event that any class of claims or interests impaired under * Counsel to the law firm of Levin & the plan fails to accept it by the Weintraub & Crames, New York City; minimum percentage of votes,3 member of the National Bankruptcy Con­ the proponent of the plan may re­ ference. ** ProfessorofLaw, Hofstra University quest confirmation by the alter­ School of Law, Hempstead, New York; native method under Section associated with the law firm of Moritt, 1129(b), commonly called the Wolfeld & Resnick, Garden City, New York; associate member of the N a tiona! ''cram-down.'' Bankruptcy Conference. 1 11 U.S.C. § 1111(b)(2). See B. Wein­ 2 11 U.S.C. §§ llll(b)(l)(B)(i), 1111 traub & A. Resnick, Bankruptcy Law (b)( l)(B)(ii). Manua/1! 8.18 (1980). 3 See id. § 1126. 159 UNIFORM COMMERCIAL CODE LAW JOURNAL [VOL. 16 : 159 1983]

The "Fair and Equitable" tor loaned $15 million to a debtor Standard secured by real estate worth $18 million and the value of the real In addition to the other re­ estate has dropped to $12 million quirements for cram-down set by the date when the debtor filed a forth in Section 1129(b), the plan chapter 11 petition. If the creditor must satisfy the "fair and equita­ is alone in a class, makes a Sec­ ble'' standard with respect to the tion llll(b)(2) election, and does dissenting classes in order to qual­ not accept the plan, the plan will ify for confirmation. 4 A plan is fair be fair and equitable with respect and equitable with respect to a to the if it pro­ dissenting class of secured credi­ vides that the mortgage will tors if any one of three alternative remain on the land to secure the conditions is satisfied. entire $15 million , the face The first way is ( 1) to provide amount of deferred cash pay­ that class members retain their ments to be made are at least $15 security interests, whether the million, and the present value of collateral is kept or is transferred the present or deferred payments by the debtor, to the extent of is at least $12 million. Because of their allowed secured claims and the Section 1111 (b )(2) election, (2) to give each secured creditor in the entire $15 million claim is the class deferred cash payments deemed secured and must be paid which aggregate to at least the in full eventually despite the $12 amount of the allowed secured million value of the collateral. claim and which have a present It is easy to see that the Bank­ value equal to the value of the col­ ruptcy Code is designed to pre­ lateral.5 vent the debtor from buying off This standard is complicated by the partially secured creditor by the application of Section 1111 reducing the secured claim to the (b)(2) of the Code. The mean­ value of the collateral. In order tQ ing of "allowed secured claim" as determine the present value of used in the preceding paragraph cash payments, the court must will depend on whether the se­ take into account the prevailing cured class makes a Section interest and discount rates. If the 1111(b)(2) election to be treated secured creditor does not elect as fully secured despite the fact under Section 11ll(b)(2), such that the collateral may be worth creditor will not be entitled to the less than the amount of the claim. full $15 million in cash payments For example, assume that a credi- because the total allowed secured claim will be only $12 million and

4 Id. § 1129(b)(J). the creditor would be treated as s !d. § JJ29(b)(2)(A)(i). having an unsecured claim to the

160 FROM THE BANKRUPTCY COURTS

extent of $3 million.6 Also, to the The term "indubitable equiva­ extent that the deferred cash lent'' derives from Judge Learned payments exceed $12 million, Hand's opinion in In re Murel such a nonelecting creditor will be Holding Corp. 9 That case in­ unsecured in the event of a future volved a plan that provided that a . 7 mortgagee was compelled to forgo A second way of complying all amortization payments for ten with the fair and equitable stan­ years. Since the mortgagee had dard with respect to a class of dis­ only a 10 percent margin of value senting secured creditors is for the above the loan balance and had to plan to provide for the realization take its chances as to the ultimate of the "indubitable equivalent" of value of the property at the end of their secured claims. 8 Whether or the ten-year period, as no provi­ not the secured creditor class sion was made for amortization of makes a Section 1111(b) (2) elec­ principal, the mortgagee was not tion, abandoning the collateral to receiving "payment of the most the creditors or giving them a lien indubitable equivalence" at the on similar collateral may satisfy time of confirmation. It is con­ this standard. The electing class ceivable that the court could have may not be deprived of the future held that the "indubitable equiva­ appreciation of the collateral lence" might have been achieved which is the purpose of permitting by granting a lien on other prop­ such an election. Present cash erty which was self-liquidating or, payments less than the allowed if it were not needed for the debt­ secured claim will not be the "in­ or's rehabilitation, by a scale of dubitable equivalent" of the col­ the property. lateral. Again, if the class makes The third alternative is to pro­ an election under Section 1111 vide in the plan for the sale of the (b)(2), the allowed secured claim collateral free and clear of must equal the full amount of the and for the to at­ debt, not just the present value of tach to the sale proceeds. In addi­ the collateral. However, unse­ tion, the security interest in the cured notes or equity securities of proceeds must be treated in ac­ the reorganized debtor will not cordance with either of the first constitute the "indubitable equiv­ two alternatives discussed above alent" of the collateral. to meet the fair and equitable standard with respect to the dis­

6 See id. § 506(a). senting class of secured credi­ 7 This illustration is based on a similar tors.10 one contained in the Congressional Rec­ ord. See 124 Cong. Rec. H11104 (daily ed. Sept. 28, 1978). 9 75 F.2d 941, 942 (2d Cir. 1935). 8 II U.S.C. § 1129(b)(2)(A)(iii). Io 11 U.S.C. § 1129(b)(2)(A)(ii).

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In re Griffiths class by itself, and the plan could An illustration of the applica­ be confirmed without their accep­ tion of the cram-down provisions tance. as applied to the partially se­ After analyzing Sections 1111 cured creditor electing Section (b )(2) and 1129(b )(2)(A), the bank­ llll(b)(2) may be found in the ruptcy court rejected the debt­ recent case of In re Griffiths. 11 ors' position and held that the The were farmers who plan did not offer USB the "in­ filed petitions under chapter 11 on dubitable equivalent'' of its al­ August 4, 1982. A month later, lowed secured claim. The court Union State Bank (USB), which listed several reasons why the had a security interest in personal debtors could not return a portion property including machinery, of the collateral and pay the value equipment, livestock, and stored of the remaining property as a grain, filed a Section 1111(b)(2) means of effectuating a cram­ election and indicated an intention down. First, said the court, the to reject the proposed plan which debtors owed USB $570,670, less provided for the return of a por­ the value of any property re­ tion of the collateral together with turned. a lump-sum payment equal to the The debtors must pay the indubita­ value of the remaining collateral ble equivalent of the remaining in total satisfaction of USB's amount owed, and not simply the claim. Since the value of the col­ indubitable equivalent of the value lateral was less than the $570,670 of the remaining property. The in­ debt owed to USB, the bank was dubitable equivalent of the claim undersecured. must be realized. The post-election The debtor's position in Grif­ claim is something more than the value of the remaining property. 13 fiths was that the combination of the collateral to be returned to In many cases a creditor would USB and payment in a lump sum not elect under Section 1111 (b )(2) of the value of the property to be because it would "be reluctant to retained by the debtors as being give up the distribution to unse­ "beneficial to the rehabilitative ef­ cured creditors under the plan in forts" is the "indubitable equiva­ exchange for a lien for the full lent" of the creditor's allowed se­ amount of their secured and unse­ cured claim. 12 Thus, the debtors cured claims." 14 The effect of the contended that the proposed plan election, however, is to prevent a was "fair and equitable" as "cash-out" since without the applied to USB, which was in a 13 ld. at 876. 14 Id. This language was quoted from 3 11 27 Bankr. 873 (D. Kan. 1983). Norton, Bankruptcy Law and Practice 12 !d. at 875. § 57.02, at 14-15 (Supp. 1982). 162 FROM THE BANKRUPTCY COURTS election the debtors could offer a The debtors' argument that plan that would pay the secured they could return all the collateral creditor only the value of the ·in satisfaction of the post-election collateral plus a pro rata share secured ·claim was not contested with respect to the unsecured by the bank. The debtors argued deficiency. In Griffiths, the debt­ that "there is equitably no differ­ ors were essentially proposing a ence between returning collateral cash-out for the bank for the value that could be sold by USB for $X, of the remaining collateral. ''The or just giving USB $X. " 17 While Court cannot agree that a cash out the court found the argument to payment is the indubitable equiva­ be "alluring," nonetheless, it still lent of a post election claim that amounted to a cash-out and was prevented a cash out.' ' 15 not the indubitable equivalent of The court further observed that the electing creditor's claim. For the first alternative way to satisfy the reasons stated above, the the fair and equitable standard court in Griffiths held that the under Section 1129(b)(2)(A)(i) proposed plan could not be (In requires that the proposed confirmed without USB's consent payments to the dissenting elect­ and the debtors were given fifteen ing creditor pass two tests, i.e., days to modify the plan accord­ (1) total payments must at least ingly. equal the/ total claim allowed, which would be $570,670 less the Conclusion returned collateral and (2) the As illustrated in Griffiths, the payments must have a present congressional policy that fostered value equal to the value of Section llll(b)(2) was to prevent the collateral. In Griffiths, the the undersecured creditor from debtors did not propose to pay being "cashed out" at the current the total remaining allowed claim market value of its collateral. By of the bank but only proposed to electing under Section 1111 (b) (2), pay the value of the collateral. the claimant sacrifices the right to "Thus," observed the court, participate as an unsecured credi­ "under § 1129(b)(2)(A)(i)(II), the tor to the extent of any deficiency first requirement of cash pay­ if there is default under the plan, ment cram down would not be but gains protection against a satisfied. The Court does not be­ cash-out for less than the amount lieve § 1129(b)(2)(A)(iii) was in­ of the entire debt owed. This rep­ tended as an alternative to the resents a proper balancing of the cash payment requirements of interests of the debtor, who needs § 1129(b)(2)(A)(i)(II)."'6

rs 27 Bankr. at 876. 16 /d. at 877. '' Id. 163 UNIFORM COMMERCIAL CODE LAW JOURNAL [VOL. 16 : 159 1983] contiimed possession and use of may be unfairly prejudiced by a the collateral to enable it to be cash-out equal to the temporarily rehabilitated effectively, and the depressed market value of the col­ partially secured creditor who lateral.

DRIVE-THRU DENTIST "In East Palestine, Ohio, a dental clinic and a Ford dealership have teamed up to promote themselves. A dental chair will be put in the auto showroom. Persons who test-drive a car will get their teeth cleaned free." -The Wall Street Journal August 26, 1982

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