Chapter 18 The Plan

• Jurisdiction: United States

Chapter 18 The Plan

§ 18.1 ~ Introduction: The Anvil

There are two reasons to understand the confirmation process in chapter 11 of the Bankruptcy Code. One is obvious: to know what you have to do to obtain plan confirmation, or to block it, as the case may be. The other is less obvious but perhaps equally important. Chapter 11 is the anvil upon which settlements are hammered out. In order to know what to settle for, you need to know what can be achieved through the chapter 11 plan process. In this section, we outline the basics of confirmation. Next, we work through an example to show the basics at work. Finally, we elaborate on some of the general principles with which we began.

The bottom line at the outset is this: A plan is a collective contract among the debtor, its creditors, equity interest-holders, and administrative claimants. Creditors and interest-holders are divided into classes made up of similarly situated parties to consider and vote upon a plan after receiving disclosure about the plan and related matters. A majority of a class can approve the plan over the dissent of a minority. The results of this vote are considered by the bankruptcy court, which may confirm the plan, in which case it will become effective and supersede all prior contracts and legal relationships between the parties unless they are incorporated into the plan.

"Consensual" confirmation means that each class (not each creditor or interest-holder) has accepted the plan. If the plan cannot be consensually confirmed, then the plan proponents can seek to "cram down" the plan on the nonaccepting classes, which requires compliance with the "absolute priority rule": the requirement that no junior class may receive anything under the plan until senior classes have been paid in full, unless the senior classes don't object to the junior class taking when they have not been paid or provided for in full. Plan strategists will want to compare and contrast the possibility of doing a § 363 sale in lieu of a plan.¹

§ 18.2 ~ How Does it work?

One of the toughest problems for an outsider is to visualize how a chapter 11 case unfolds. Who does what, and when? As a step toward answering that question, here is a typical outline:

- Debtor files the petition, initiating the case.
- Debtor negotiates with creditors — sometimes with the participation of committees.
- After reaching a tentative agreement, debtor drafts a plan and disclosure statement. If the court approves of the disclosure statement, the debtor distributes it to creditors and equity security-holders along with the plan and a ballot.
- If the plan gets the requisite votes, the debtor then asks the court for confirmation.
- After a hearing, the court enters an order of confirmation.²
- The debtor pays creditors as provided by the plan.

There is an almost infinite range of variations possible within this bare-bones scenario. For example, in some cases, the plan may accompany the petition along with acceptances that have been previously obtained from key creditors (a "prepackaged plan;" see infra § 18.33), or at least much of the negotiation may have occurred pre-petition. In some cases, the creditors will get paid at confirmation, and in others, over time after confirmation. Sometimes it is a creditor — or creditors, or a committee — that proposes the plan. There may even be competing plans. If the plan proposes to merely reinstate all claims and interests, there will be no voting (and probably no disclosure statement), but you will not see that very often.

§ 18.3 ~ How to Design a Confirmable Plan: "Unimpaired" or "Acceptance"

To obtain confirmation of a plan, the plan proponent must satisfy the requirements of chapter 11. The basic chapter 11 plan confirmation requirements are in § 1129(a).³ It provides, "The court shall confirm a plan only if all the following requirements are met...." It then goes on to list 16 requirements.⁴ So, we have 16 issues to deal with, but here is some good news: Most of the 16 are little more than boilerplate requirements or are inapplicable in most cases. To focus on the most important confirmation requirements, do this: Divide your creditors into "classes" of similarly situated claims.⁵ With respect to each class, first ask:

- Is the class "unimpaired"? "Impairment" is a term of art. In short, it means that the plan modifies the rights that the class of creditors would otherwise have. If the class is "unimpaired," then you do not have to worry much about it. So if the answer to this question is "yes," go on to the next class. If the answer is "no," then ask...
- Do you have sufficient votes in this class so that the class is deemed to have accepted the plan? In other words, did a majority in number and two-thirds in amount of voting claims vote to accept your plan?⁶

If you get a "yes" answer with respect to all classes, then congratulations: You are on the road to confirmation. If you get a "no" to both questions with respect to any one class, you may be in trouble. In that case, you have two choices: One, try for the "cramdown," as outlined below,⁷ or two, modify the plan, at least as it relates to that class, to cure the problem. But even if you get a "yes" answer for each class (or manage a cramdown of any class that votes "no"), you are not there yet; you still need to satisfy the "best interest" test, which we turn to now.

§ 18.4 ~ How to design a Confirmable plan: best interest

In the previous section, we saw that if you had sufficient votes, you could impose a plan on dissenters in a class. There is one important qualification, however: A dissenter may defeat confirmation, even if his class has voted by the requisite majority to accept the plan, if he can show the court that he is getting less than he would get in a chapter 7 liquidation. This is the "best interest" rule, which is set forth in § 1129(a)(7)(A).

Example: There are 100 creditors with claims totaling $100,000. The plan proposes to pay 10 percent of all claims. Of these, 99 creditors, holding claims totaling $99,000, vote to accept. The remaining creditor, with a claim of $1,000, votes to reject.

Under § 1129(a)(8), the plan would appear to be binding on the dissenter because her class has accepted the plan. But this is not the case: The best-interest test is applied to each creditor, not to the class.

Since the plan proposes to pay 10 percent of each claim, if the dissenter can show that in a chapter 7 case she would get 11 percent or more of her claim, then the best interest-test will not be met. By corollary, if the plan provides for payment of 12 percent of all claims, then the dissenter would have been bound by the plan. This is the one case where a dissenting creditor may bring down a plan, even though a majority in number and two-thirds in amount of those voting in his class vote for it.

There is an intriguing premise that underlies the best-interest test: It seems to envision a debtor with two values — one a (higher) value as a going concern, and the other a lower value in liquidation. This is sometimes the case, but not always. It is easy to imagine cases in which the debtor is worth more in liquidation than as a going concern. Perhaps the most obvious examples of this come from cases of "bad business, good dirt," where the debtor is occupying real estate that could be more profitably deployed in another business.⁸ In these cases, even a reorganization plan that appears reasonable may fail the best-interest test because maximum value would be achieved by a liquidation.

In other cases, going concern and liquidation value may be the same. This may occur, for example, in single-asset real estate cases, where the debtor is a single real estate venture — say, a medical office building or a strip shopping center that will either continue in the hands of the original owners or be sold to someone else, who will continue the same business.

§ 18.5 ~ How to Design a Confirmable Plan: Cramdown

As we noted above, even if you do not have the votes, you may be able to impose your plan on a class under § 1129(b) if it is "fair and equitable." This is the so-called "cramdown" rule.

The cramdown is a device whereby the proponent imposes the plan on a class or classes without its or their consent. To do a cramdown, you must show that at least one impaired class of creditors voted in favor of the plan.⁹ In other words, you cannot confirm a plan that crams down every class of creditors.¹⁰

If you get at least one impaired accepting class, then you can cram down a dissenting class by satisfying the requirements of § 1129(b). These requirements differ depending on whether the class being crammed down is a secured creditor, unsecured creditors, or equity interests. The requirements are discussed in § 18.10 below.

To review, the ways to obtain confirmation with respect to an individual class are:

1. leave the class unimpaired;
2. obtain the requisite votes plus satisfy the best interest test; or
3. cram down the class.

§ 18.6 ~ How to Design a Confirmable Plan: Feasibility

There is only one other mandate of § 1129 that needs to concern us now: § 1129(a)(11), which provides that the court may not confirm unless it finds that "[c]onfirmation is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor ... unless such liquidation or reorganization is proposed in the plan." This is the so-called "feasibility rule." Note that the feasibility rule has the effect of imposing on the judge the job of making findings as to the prospective viability of the debtor's reorganized business.

Courts will sometimes balk at a finding of "feasibility"; think of a plan with, for example, "negative amortization" and then a big balloon payment 20 years down the line.¹¹ The court does not need to find that success is a sure thing in order to make the feasibility finding. If it did, few plans would get confirmed. But in some cases, such as our negative-amortization...