Cramdown Hurdles Round 3: Try, Try Again
In re Ramz Real Estate Co., LLC, 510 B.R. 712 (Bankr. S.D.N.Y. 2013) –
An undersecured mortgagee objected to a debtor’s proposed plan of reorganization on several grounds, including that (1) the plan was not approved by a proper impaired class and (2) retention of equity by the debtor’s members violated the absolute priority rule.
The debtor’s plan of reorganization provided for seven classes of claims and interests. Four classes were not impaired, and thus were not entitled to vote on the plan. The undersecured mortgagee’s claim was divided into a secured claim (based on the value of the property) and an unsecured claim (based on the deficiency). Each claim was in a separate class that was controlled by the mortgagee. So both classes voted to reject the plan. That left a class consisting of the secured property tax claim of a county. The county voted in favor of the plan.
In order to obtain a “cramdown” of the plan over the objections of the mortgagee, at least one impaired class entitled to vote had to approve the plan without counting the claims of insiders. The debtor contended that the class consisting of the county property tax claim satisfied this requirement.
Under the plan, the county’s claim would be paid in full over five years with 9% interest. Under the Bankruptcy Code, property taxes receive special treatment, which among other things means that the claims are entitled to interest at the rate provided under non‑bankruptcy law. In this case, this means that the county was entitled to interest at 12%, instead of 9%. A class is impaired if a plan alters the legal, equitable or contractual right of the holders. Thus, the court agreed with the debtor’s argument that the county’s claim was impaired.
However, if a debtor creates an impaired class by “minimally” changing the terms of the claim for the sole purpose of obtaining approval by at least one impaired class, the class is considered to be “artificially impaired” and cannot be used as the required accepting class. Although the mortgagee argued that the class containing the county property tax claim was artificially impaired, the court determined that the debtor had a legitimate business purpose in that the 3% decrease in interest was not de minimis. Consequently, the court determined that the requirement for an accepting class was satisfied.
The next major hurdle for the debtror was the “absolute priority rule.” In the context of a cramdown, under Section 1129(b)(2)(A) of the Bankruptcy Code a dissenting class of unsecured creditors must either receive payment in full or else “the holder of any claim or interest that is junior to the claims of such [impaired unsecured] class will not receive or retain under the plan on account of such junior claim or interest any property.” This is referred to as the absolute priority rule.
However, a “new value exception” developed under case law. The theory is that old equity puts in new value so that it is not retaining the equity “on account of” its prior interest. To qualify, the contribution must be new, substantial, money or money’s worth, necessary for the reorganization, and reasonably equivalent to the property that the equity is obtaining.
When the Supreme Court addressed the new value exception in Bank of Am. Nat’l Trust & Savs. Ass’n v 204 N. LaSalle P’ship 526 U.S. 434, 119 S. Ct. 1411, 143 L.Ed.2d 607 (1999), it required consideration of whether other parties ought to be given an opportunity to acquire the equity, as well indicating that there is some expectation that the value of the equity would be determined through the market. Thus, the Supreme Court stated that the plan in that case was “doomed… by its provision for vesting equity from the reorganized business in the Debtor’s partners without extending an opportunity to anyone else either to compete for that equity or to propose a competing reorganization plan.”
In light of this precedent, the bankruptcy court concluded that it had to deny confirmation of the debtor’s plan because it suffered from the same infirmities: the debtor did not allow a competing plan, nor was there any evidence that other parties were given an opportunity to bid on the equity.
Thus, although the plan was approved by an impaired class as required, the proposal to allow old equity to retain equity in the reorganized debtor violated the absolute priority rule so that the plan could not be confirmed.
As discussed in prior blogs (for example, see Cramdown Hurdles: How to Play the Classification Game (Or Not) and Cramdown Hurdles Round 2: Confirmation Can Be An Elusive Prize), confirming a plan of reorganization in a real estate bankruptcy can be very difficult because of the requirements for an accepting class together with the limitations on old equity retaining its interests.
In this case, after this decision the bankruptcy case was dismissed at the request of the debtor. A little over a month later, it refiled. The second time around the debtor initially attempted to address the new value issue by obtaining court approval of a procedure to value and possibly sell the equity interests of the sole member of the debtor. However, the mortgagee made an election under Section 1111(b) to have its entire claim treated as secured. Once the mortgagee was no longer able to invoke Section 1129(b)(2)(A) since it no longer held an unsecured claim, the debtor withdrew its motion regarding the equity interests.