Chapter IV Credit Bidding Under a Plan

• Jurisdiction: United States

Chapter IV Credit Bidding Under a Plan

A. Requirements for Confirmation of a Plan

The goal of a chapter 11 reorganization is the agreement among parties in interest on a consensual plan of reorganization.¹⁴⁰ The Bankruptcy Code sets forth the rules of the game, and the rules are designed to assist the implementation of the principle of equality of distribution to creditors of equal rank in accordance with their legal rights under a plan.

The Bankruptcy Code's requirements for confirmation of a plan are simple — at least, on their face. Initially, the plan proponent must classify all creditor claims and equity interests into separate classes for purposes of voting and treatment. There are two rules for classification. First, to be in the same class, a claim or interest must be "substantially similar to the other claims or interests of such class."¹⁴¹ Second, claims or interests can be placed into separate classes only if there is a "legitimate business reason" for the separate classification¹⁴² and not for the purpose of creating an accepting class of impaired creditors (a "gerrymander").¹⁴³

Once claims and interests are classified, the plan proponent solicits votes from all "impaired" classes entitled to vote on the plan through the dissemination of a court-approved "disclosure statement" and ballots to all holders of claims and interests in such classes.¹⁴⁴ A class is unimpaired if the plan (1) "leaves unaltered the legal, equitable and contractual rights to which such claim or interest entitles the holder of such claim or inter-est"¹⁴⁵ or (2) cures any defaults, reinstates the maturity of the pre-petition claim or interest, compensates the holder for any damages, and does not otherwise alter the legal, equitable or contractual rights to which such claim or interest entitles the holder.¹⁴⁶ Only impaired classes are entitled to vote on the plan,¹⁴⁷ and in order to confirm a plan, at least one impaired class of claims must vote to accept the plan (without including acceptances by an insider).

After the plan proponent solicits votes, it must demonstrate that it has satisfied the 13 requirements of § 1129(a) of the Bankruptcy Code. Among those requirements are the voting requirements. First, as noted, § 1129(a)(10) provides that at least one class of impaired claims must have voted to accept the plan (without including the votes of insiders). Second, § 1129(a) (8) provides that every class must either (1) be unimpaired or (2) have accepted the plan. A class of claims has accepted the plan if creditors holding at least (a) two-thirds in amount and (b) one-half in number of the allowed claims in the class who have voted on the plan have voted to accept the plan.¹⁴⁸

While § 1129(a) sets forth the requirements of a consensual plan (i.e., one in which all impaired classes accept the plan), § 1129(b) permits the plan to be confirmed if requested by the plan proponent if all the requirements of § 1129(a) other than § 1129(a)(8) (acceptances by all impaired classes) have been satisfied. Specifically, § 1129(b)(1) of the Bankruptcy Code provides that if all requirements of § 1129(a) other than § 1129(a)(8) are met and the plan proponent has requested application of § 1129(b), the court shall confirm the plan if it meets two requirements as to each impaired class of claims or interests that has not accepted the plan. First, it cannot "discriminate unfairly." Second, it must be "fair and equitable." This process is colloquially referred to as "cramdown."

Because the unfair-discrimination prohibition and the absolute priority rule are set forth in § 1129(b), they only apply when confirmation of a nonconsensual plan is requested. Therefore, a plan that discriminates unfairly or does not comply with the absolute priority rule is confirmable if the classes that are discriminated against vote to accept the plan or the classes of higher priority who are not paid in full vote to accept the plan despite a return being provided to junior classes.¹⁴⁹ As an initial matter, because it is the exception that equity is unimpaired (and indeed, equity usually does not participate in the reorganization value, it is generally deemed to have rejected the plan),¹⁵⁰ a plan proponent will almost always have to use cramdown as to classes of equity interests. However, compliance with the absolute priority rule and lack of unfair discrimination is relatively easy to establish when equity is the only impaired rejecting class. Cramming down a class of creditors, particularly a secured class of creditors, is the more interesting scenario.

The Bankruptcy Code does not provide any guidance on the unfair-discrimination prohibition. Its purpose, however, is fairly clear in light of the classification rules. Because the Bankruptcy Code grants debtors some flexibility in how it allocates its creditors into classes,¹⁵¹ this flexibility presents debtors with the opportunity to "stack the deck" for voting purposes. The unfair-discrimination prohibition was developed to ensure that (nonconsenting) creditors were not being unfairly classified, isolated from similarly situated creditors, and treated poorly relative to those similar creditors (or favored creditors were not being similarly isolated for the purposes of some sort of unjustified bonus recovery).

In contrast to the unfair discrimination prohibition, the Bankruptcy Code explicitly sets forth the requirements for the absolute priority rule. There are three variants on the absolute priority rule depending on whether the objecting class, which is being crammed down under the plan, consists of secured creditors, unsecured creditors¹⁵² or equity-holders.¹⁵³ This section of the book focuses on cramdown on a class of secured creditors.

B. Secured Creditor Cramdown: § 1129(b)(2)(A)

The first subparagraph of § 1129(b)(2) states that it applies with respect to a class of "secured claims." Under the Bankruptcy Code, a secured claim is one that is either "secured by a lien on property in which the estate has an interest" or one that is "subject to setoff under section 553."¹⁵⁴ The amount of the claim secured is limited "to the extent of the value of such creditor's interest in the estate's interest in such property" or "to the extent of the amount subject to setoff.."¹⁵⁵

Section 1129(b)(2)(A) lists three possible treatments of a secured claim; any one of them will independently satisfy the "fair and equitable" requirement. The plan proponent may seek to satisfy the claim in full by giving the creditor a note in the amount of the secured claim secured by the same collateral. Alternatively, the plan proponent may seek to sell the collateral free and clear of the lien, and transfer the lien to the proceeds of the sale. Finally, the proponent may seek to give the creditor the "indubitable equivalent" of its claim.¹⁵⁶ Specifically, § 1129(b)(2)(A) contemplates that for the plan to be fair and equitable with respect to a class of secured creditors objecting to a plan, the plan must provide one of the following:

(i) (I) that the holders of such claims 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; and

(II) that each holder of a claim of such class receive on account of such claim 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;

(ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or
(iii) for the realization by such holders of the indubitable equivalent of such claims.¹⁵⁷

Under subsection (i), the secured creditor retains a lien on its collateral and is provided deferred cash payments with a present value equal to the value of its collateral. Under subsection (ii), the secured creditor's collateral is sold free and clear, subject to its right to credit bid pursuant to § 363(k), with the secured creditor's lien attaching to the proceeds of the sale. Under subsection (iii), the secured party receives the indubitable equivalent of its secured claim.¹⁵⁸

C. Credit Bidding in a Cramdown Sale and RadLAX

For decades there were few, if any, significant opinions that considered a secured creditor's right to credit bid its claim in an asset sale under a chapter 11 plan. Indeed, until September 2009, the right to credit bid was generally considered a noncontroversial topic. In recent years, however, the Courts of Appeals in the Third, Fifth and Seventh Circuits, and thereafter the U.S. Supreme Court, rendered important and far-reaching decisions addressing a secured creditor's right to credit bid in chapter 11 plan sales.

In In re Philadelphia Newspapers LLC¹⁵⁹ and In re Pacific Lumber Co.,¹⁶⁰the Third Circuit Court of Appeals and the Fifth Circuit Court of Appeals (respectively) held that when a debtor proposes to sell an asset in which a creditor has a security interest under a chapter 11 plan, the secured creditor is not necessarily entitled to bid the value of its secured claim as long as it receives the "indubitable equivalent" of its secured claim as a result of the sale.¹⁶¹ These courts read the "or" between subparagraphs (ii) and (iii) of § 1129(b)(2)(A) as isolating each subparagraph. In other words, as long as a proposed cramdown plan contemplating a sale of assets subject to a security interest satisfied either subparagraph (ii) or (iii) in § 1129(b)(2)(A), the plan was confirmable. The essence of the decisions of the Third and Fifth Circuits is that cash received from an auction or private sale of collateral is the "indubitable equivalent" of the value of the...