The Toolbox, Monthly column contributed by Judge D. Michael Lynn, United States Bankruptcy Court for the Northern District of Texas
This month’s topic is cramdown. Generally, we think of cramdown in terms of chapter 11 (or chapter 9), but 11 U.S.C. §§ 1225(a)(5) and 1325(a)(5) also provide a tool similar to that found in 11 U.S.C. § 1129(b)(2)(A)(i) for dealing with secured creditors, and, in fact, if speaking of actual use – as opposed to the threat of use – the cramdown provisions of chapters 12 and 13 are seen in operation far more often.
Before turning to the most important use for cramdown in chapter 11, I want to point out that cramdown is, in fact, invoked all the time in reorganization cases, and no one even notices. Unfortunately, it is true that most plans wipe out common stock or other junior equity interests. Because equity owners receive nothing under the plan, they are deemed to reject it. 11 U.S.C. § 1126(g). Thus, as to a dissenting equity class, the plan must satisfy 11 U.S.C. § 1129(b). Since it is self-evident that the requirement of 11 U.S.C. § 1129(b)(2)(C)(ii) is met, however, there is no need for meaningful proof that the plan may be crammed down.
Similarly, it is often the case that a single creditor class (typically a secured creditor) will not vote at all on a plan. Though I sometimes get blank stares from attorneys when I ask if the class’s treatment meets the requirements of § 1129(b), if a class does not accept a plan – even if it also does not reject it – the class must be crammed down.1 Because the creditor that constitutes the class did not vote, it is likely that proof in support of cramdown will be necessarily perfunctory.
This brings me to what I think is the most important use for cramdown — a negotiation tool. Cramdown treatment provides a yardstick for parties to judge their positions and for negotiations. By assessing treatment that can be forced on a class – treatment meeting the tests of § 1129(b) – a plan proponent can identify its best case scenario, and, at the same time, a class of creditors or interest holders can gauge its worst case scenario. Thus, calculating potential treatment under § 1129(b) gives the parties a means to measure treatment offered in negotiation and fix positions that amount to lines drawn in the sand.
Using cramdown as a yardstick like this, however, means that the parties are likely to have different views about what treatment is sufficient for cramdown purposes. While disagreement over what is necessary for cramdown may make negotiations more complex, as discussed below, the uncertainties about what is required and the effort involved in putting on a case for cramdown serve as incentives to reach agreement.
Section 1129(b)(1) requires that the treatment of the (potentially) dissenting class “not discriminate unfairly” and that it be “fair and equitable.” Section 1129(b)(2) goes on to set minimal requirements for what constitutes fair and equitable treatment. Besides the variables created by the words of the statute, the open-ended nature of § 1129(b)(2) means that there can be disagreement about the terms of an obligation – length of payout, remedies on default, cure opportunities and nature of documentation. These issues create possible negotiating points – if the potentially dissenting class negotiates, cure periods may be reduced and default remedies enhanced; if not, the more onerous terms proposed by the plan proponent may become binding.
The problem with a plan proponent using this tactic is that it could result in denial of confirmation. Some courts will countenance a plan term that allows the court to adjust treatment as necessary to be fair and equitable. However, such a term also gives the dissenters comfort that they can defer fixing that sort of problem until confirmation – they will rely on the judge to protect them.
Flexibility is also possible in dealing with some of the statutorily established variables – value under 11 U.S.C. § 1129(b)(2)(B)(i) or interest rate under 11 U.S.C. § 1129(b)(2)(A)(i)(II). By providing for an interest rate of x% “or such other rate as the court may determine,” a plan may be confirmed that otherwise would not meet the test of the latter section.
The unfair discrimination requirement of § 1129(b)(1) has not often been at issue in chapter 11 cases. The term “unfair discrimination” is also found in 11 U.S.C. § 1322(b)(1) (and 11 U.S.C.§ 1222(b)(1)), and courts have more often dealt with the meaning of the term in those chapters. Generally, in chapter 11, the question is posed as to whether a plan proponent may treat trade creditors more favorably than other unsecured creditors – e.g., bond and tort creditors. At least to the extent the class discriminated against is no worse off than it would be absent the discrimination, the different treatment will often be permissible. See In re Dow Corning Corp., 244 B.R. 705, 710 (Bankr. E.D. Mich. 1999) (discussing the various approaches to determining whether a plan is unfairly discriminatory and compiling cases).
The discrimination question is not a matter of degree: either there is justification for treating one class better than another when each have equal rights against the estate or there is not. While reducing the extent of discrimination may be a useful tactic in negotiation, it will not cure the problem.2 Fair and equitable treatment, on the other hand, provides a more nuanced area for disagreement.
There are three areas where there can be serious questions of whether the treatment the plan provides satisfies § 1129(b)(2). Let’s first dispose of where those questions will not arise. 11 U.S.C. § 1129(b)(2)(A)(ii) allows for cramming down a secured creditor where its collateral is to be sold and the creditor retains the right to credit bid; cramdown is pretty much automatic. Similarly, if all classes junior to the dissenting class receive nothing under the plan, 11 U.S.C. § 1129(b)(2)(B)(ii) is satisfied and cramdown may occur.3
The first of the three areas where serious questions can arise as to whether the criteria of § 1129(b)(2) have been satisfied involves § 1129(b)(2)(A)(iii). 11 U.S.C. § 1129(b)(2)(A)(iii) permits cramdown of a secured claim if the holder receives the “indubitable equivalent” of its secured claim. This provision is subject to interpretation by the courts. Courts have approved cramdown under this provision where the creditor’s collateral is to be sold and the creditor is not allowed to credit bid. See In re Pacific Lumber Co.¸ 584 F.3d 229, 246 (5th Cir. 2009); In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d. Cir. 2010). Putting a creditor’s collateral to it has been deemed providing it with the “indubitable equivalent” of its secured claim. See In re Sandy Ridge Development Corp., 889 F.2d 663 (5th Cir. 1989). A change in a creditor’s collateral – including reducing its value – has been deemed sufficient. See In re Sun Country Development, Inc., 764 F.2d 406 (5th Cir. 1985).
In short, § 1129(b)(2)(A)(iii) approves of any treatment that provides the crammed down secured claimant with value at least equal to the value of the secured claim.4 The sort of treatment that meets this test will depend on the facts of the individual case. Like so many other provisions of the Bankruptcy Code, it invites creativity on the part of the practitioner.
This leaves two remaining areas where serious questions can arise: cramdown of a class of unsecured claims pursuant to § 1129(b)(2)(B)(i)5 and cramdown of a class of secured claims pursuant to section 1129(b)(2)(A)(i). Turning first to the latter of these provisions, a class of secured claims may be crammed down if it retains its lien on its collateral and is paid the amount of its secured claims over time at an interest rate such that the present value of the payments is equal to the amount of the secured claims. If this type of treatment – surely the most common – is selected the principal issue will be what interest rate is necessary to provide the required present value.
The most important case addressing interest rates for cramdown purposes is Till v. SCS Credit Corp., 541 U.S. 465, 124 S.Ct. 1951, 158 L.Ed.2d 787 (2004). In that case the Supreme Court elected a formula approach for determining an interest rate rather than either a forced loan or contract rate approach, using prime rate as a base and adding 1-3% to that rate to account for risk. Though the Court also left open the possibility that a market could exist for determining an interest rate in a chapter 11 case (see Till, 541 U.S. at 476, n.14), I have not seen many instances where there is a market for exit financing for a chapter 11 debtor, so the formula approach must be relied on. However, another formula might be used in a given case. One might start with a different base – a treasury bill rate or a judgment rate, for example, with additions that measure risk based in part on hypothetical investor expectations. See, e.g., In re Camp Bowie I, L.P., 454 B.R. 702, 713, 2011 BL 202515 (Bankr. N.D. Tex. 2011). The point is that the court will choose a route that leads to an obviously reasonable rate. As is clear from Till, a determination of an interest rate is essentially a finding of fact. The formula selected by the court will be the one it concludes is most credibly supported and likely to lead to a reasonable interest rate.
A more complex set of variables often comes into play when evaluating treatment of a class under § 1129(b)(2)(B)(i). Because the value of the treatment – often a share of equity in the debtor – is dependent on the value of the debtor itself, an enterprise valuation must be undertaken. The two most common ways this will be done are by comparison of the debtor to other similar corporations based on projected cash flow and the discounted cash flow method. Both of these valuation methods produce a result based on projected cash flow. Because projections are themselves a product of underlying assumptions, there are many areas in which parties can and will disagree that will ultimately affect a determination of value.
In addition, using the comparable company method requires identifying comparables. As no two companies will be precisely alike, adjustments are required to make the comparison a useful tool. With respect to the discounted cash flow method, the discount rate will be key to arriving at a value. The discount rate, in turn, will be calculated on a formulaic basis, which, again, offers numerous points for disagreement.
In conclusion, persuading a court to confirm a plan under § 1129(b) over the vigorous dissent of a class of creditors is likely to be complicated at least, surely problematic and, quite possibly, an exercise in futility. It will require an extensive evidentiary presentation supported by expert testimony as well as evidence of the accuracy of cash flow projections. While the requirements for cramdown provide a valuable yardstick for parties to evaluate the treatment proposed by a plan, at the same time, the uncertainties and complexities surrounding cramdown act to discourage parties from litigating cramdown issues. It is for these reasons that cramdown is most useful as a tool in negotiation.
Judge D. Michael Lynn
U.S. Bankruptcy Court
501 W. 10th St., Room 128
Fort Worth, TX 76102
D. Michael Lynn has served as United States Bankruptcy Judge for the Northern District of Texas in Fort Worth since 2001. During his tenure on the bench, he has presided over such large chapter 11 cases as Mirant Corporation and Pilgrim’s Pride Corporation, as well as thousands of consumer cases. Prior to his appointment to the bench, he spent 29 years practicing bankruptcy law, specializing in corporate reorganizations. Judge Lynn was a Visiting Professor of Law at Southern Methodist University’s Dedman School of Law for 15 years and now serves as Adjunct Professor of Law at Texas Wesleyan University, where he teaches courses in corporate reorganization law, legal drafting, and legal ethics. He has served as a contributing author for Collier on Bankruptcy and the Collier Bankruptcy Practice Guide, is presently co-author of The Collier Handbook for Trustees and Debtors in Possession, and has spoken frequently at continuing legal education events.
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