Paths and Obstacles to Chapter 11 Confirmation:
Artificial Impairment, Gerrymandering, and Section 1111(b)
Russell M. Blain1
Daniel R. Fogarty2
STICHTER, RIEDEL, BLAIN & PROSSER, P.A.
Tampa | Fort Myers | Destin
1
[email protected]
2
[email protected]
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INTRODUCTION
Your borrower client owes a large amount to a bank. The debt is secured by a lien on all
assets of the borrower’s assets-say, a hotel or residential complex. The principals of your client
have given personal guaranties to the bank. Your borrower client is party to a capital lease
subject to recharacterization as a security interest. Vendors and tenants fill out the list of
unsecured creditors, who hold claims small in contrast to the bank’s potentially veto-wielding
deficiency claim. Equity comprises the guaranty-signing principals.
Various issues can stand in the path of plan confirmation. Three recurrent themes appear
in this type of case: claim impairment, claim classification, and a secured creditor’s right of
election under § 1111(b). When impairment becomes artificial, claim classification transforms
to gerrymandering, and § 1111(b) becomes a sword rather than a shield, creditors grouse and
consensual morphs to contested. This paper will discuss, first, how a plan proponent can
structure a plan using class impairment, claim classification, and secured-claim treatment
strategies to enhance its chance of being confirmed. Second, it will focus on paths that creditors
can employ to block those strategies. Finally, the paper will discuss prefiling and
preconfirmation options available to debtors and creditors.
CONFIRMATION REQUIREMENTS
To be confirmed, a plan must meet the requirements of § 1129(a). Although conflicting
authority exists, a court likely will require that the plan proponent meet the burden of proof using
preponderance of the evidence as the standard.3 Section 1123(a) of the Bankruptcy Code sets
forth the provisions that a plan of reorganization must contain. The first of these is to designate
3
In re J.C. Householder Land Trust #1, 501 B.R. 441, 447 (Bankr. M.D. Fla. 2013) (stating that the
"overwhelming majority of courts have held that a debtor need only satisfy the preponderance of the evidence
standard.").
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classes of claims and interests as prescribed by § 1123(a)(1). The provisions relating to
classification of claims require that, notwithstanding any otherwise applicable nonbankruptcy
law, a plan must designate classes of claims and interests, other than claims of a kind specified in
§§507(a)(1), (2), or (8) of the Bankruptcy Code.4 The plan must also specify any class of claims
or interests that is not impaired under the plan.5 The plan must specify the treatment of any class
of claims or interests that is impaired under the plan6 and must provide the same treatment for
each claim or interest of a particular class, unless the holder of a particular claim or interest
agrees to treatment less favorable.7 The plan must be feasible8 and must have been proposed in
good faith.9 To be confirmed, the plan must either be accepted by all impaired classes10 or by at
least one impaired class of claims (without including insiders)11 and must meet the cramdown
requirements of § 1129(b) as to any impaired nonaccepting classes. If nonacceptance by an
impaired class requires compliance with the § 1129(b) requirement as to an impaired, rejecting
class, the plan cannot "discriminate unfairly."12
The interplay of these various sections of the Bankruptcy Code depends to a great degree
on the capital structure of the debtor and the placement of the primary secured creditor in that
4
11 U.S.C. § 1123(a)(1).
5
11 U.S.C. § 1123(a)(2).
6
11 U.S.C. § 1123(a)(3).
7
11 U.S.C. § 1123(a)(4).
8
11 U.S.C. § 1129(a)(11).
9
11 U.S.C. § 1129(a)(3).
10
11 U.S.C. § 1129(a)(8).
11
11 U.S.C. § 1129(a)(10).
12
11 U.S.C. § 1129(b)(1) and (2).
2
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structure. The most important element of that consideration, if the primary secured creditor is
expected to oppose the plan, is whether that creditor is oversecured or undersecured. If the
creditor is undersecured, the debtor needs to ensure the existence of an impaired accepting class
in the event the secured creditor rejects by voting both its secured and unsecured claims against
the plan. If the creditor is oversecured, the debtor will want to ensure the vote of unsecured
creditors by treating those claims in the best way possible to secure an accepting vote, often by
paying claims in full over a short period of time.
If the creditor is undersecured, the debtor needs to properly construct the classification
provisions in the plan to isolate the secured and deficiency claims and thereby overcome veto
votes, while at the same time minimizing risks in the event the creditor makes an election under
§ 1111(b). On the other hand, if the creditor is oversecured, the debtor needs to ensure that there
exists an impaired class of claims to accept the plan.
Another critical component is the existence-or not-of other secured or arguably secured
creditors. Also important are the number, amount, and character of unsecured claims in the case.
The upfront assessment of the manner in which these factors will interact in a plan structure is
crucial to plan confirmation.
ARTIFICIAL IMPAIRMENT: DEALING WITH THE OVERSECURED CREDITOR
If any class under a plan is impaired, the plan must be accepted by at least one of the
impaired classes.13 In the oversecured-creditor scenario, the treatment of the secured creditor’s
fully secured claim in a single class will result in an impaired, rejecting class. A plan proponent
will need to balance creation of an impaired class with acceptable treatment. Assuming there are
no financial limitations based on either available cash flow from debtor or nondebtor sources, the
13
11 U.S.C. § 1129(a)(8).
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amount of unsecured claims, or both, the plan proponent may want to pay unsecured claims in
full but in such a way as to leave the unsecured class impaired. Can it be done, and what options
and limitations arise in doing so?
A class is impaired, under § 1124(1), "unless, with respect to each claim or interest of
such class, the plan ... (i) leaves unaltered the legal, equitable, and contractual rights to which
such claim or interest entitles the holder of such claim or interest."14 Unimpaired classes do not
vote. The definition of impairment is defined broadly and intended to be a bright line.15 The two
most basic impairments are payment of less than the full amount of claims and payment of
distributions over time.
Section 1124(3) formerly had provided that a class is unimpaired if the claims were paid
in full in cash on the effective date. A result of 1994 amendments to the Bankruptcy Code is that
a class can be impaired by a plan16 even if paid in full on the effective date if the claims in that
class are not paid with interest.17 Enhancement of rights also can be considered impairment.18
The 1994 amendments and the elimination of payment in full without interest as
impairment were thought by some to simplify the issue of impairment and focus courts on the
14
11 U.S.C. § 1124(1).
15
In re Jones, 32 B.R. 951, 957 (Bankr. D. Utah 1983).
16
Impairment by the Bankruptcy Code, but not the plan, is not impairment. E.g., In re Coram Healthcare Corp.,
315 B.R. 321, 351 (Bankr. D. Del. 2004) (distinguishing plan from statutory impairment); In re SM 104 Ltd., 160
B.R. 202, 215 n. 25 (Bankr. S.D. Fla. 1993) (incorporation of prepetition modifications not impairment by plan).
17
E.g., In re New Midland Plaza Assocs., 247 B.R. 877, 896 (Bankr. S.D. Fla. 2000) ("[U]nder § 1124 as amended,
if a class of claims is not paid in full with interest on the effective date, the class is impaired").
18
In re Wabash Valley Power Assoc., Inc., 72 F.3d 1305, 1321 (7th Cir.1995); L & J Anaheim Assocs. v. Kawasaki
Leasing Int’l., Inc. (In re L & J Anaheim Assocs.), 995 F.2d 940, 943 (9th Cir. 1993).
4
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more critical elements of a plan.19 Under this standard of impairment, the debtor could propose
to pay unsecured claims in full, but without interest, in cash on the effective date from cash on
hand. The class would be impaired and likely to accept the plan. The practical effect of this
would be that the debtor could move to a cramdown of the oversecured creditor and confirm the
plan, provided that the treatment of the secured claim is fair and equitable under § 1129(b)(2).
To combat a perceived abuse of the Chapter 11 process over the objection of a primary
secured creditor, some courts identified the concept of artificial impairment. Artificial
impairment occurs when the plan proponent causes the class to be impaired for the purpose of
obtaining the required vote of an impaired class. If determined to be artificial, even though the
class is impaired within the meaning of § 1124, impairment would be ignored for purposes of §
1129(a)(10). Other courts find that the plain language of the Bankruptcy Code does not give rise
to artificial impairment as an exception to § 1124. Still other courts agree with the logical
underpinnings of the concept but analyze the issue under the good-faith confirmation
requirement.
The first significant court of appeals case on artificial impairment was the Eight Circuit’s
decision in In re Windsor on the River Assocs., Ltd.,20 in which the debtor owned an apartment
complex subject to a lien in favor of a secured creditor that was slightly oversecured. The plan
provided for payment in full of trade creditors within 60 days. The court set out the
19
In re Atlanta-Stewart Partners, 193 B.R. 79, 81-82 (Bankr. N.D. Ga. 1996) ("Although treating a class of
creditors receiving payment in full as impaired seems contrary to the way we have traditionally thought of
impairment under the Code, it does have some advantages. For example, litigation over artificial impairment will
now be avoided, because debtors will not be forced to contrive an impaired class by placing certain creditors in a
separate class and paying that class less than 100 cents on the dollar. In addition, the fight over confirmation will
now focus on the heart of the plan and whether the plan is "fair and equitable" and in the "best interest of
creditors.").
20
7 F.3d 127 (8th Cir. 1993)
5
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nonimpairment standard under § 1124 as leaving unaltered all rights and that any alteration, no
matter how minor, constitutes impairment. To the Windsor court, the question is whether
impairment may be "manufactured at the will of the debtor ‘just to stave off the evil day of
liquidation.’"21.
In reaching its ruling, the Windsor court discussed the history of amendments to §§ 1124
and 1129(a)(10) and found that the provisions were all for the benefit of lenders. Because the
purpose of § 1129(a)(10) is to "provide some indicia of support by affected creditors and prevent
confirmation where such support is lacking," the court said that confirming a plan that provides
for unsecured creditors to be paid in full over the objection of a secured creditor would render §
1129(a)(10) protections for secured creditors a nullity.22 The court stated its view that "a claim is
not impaired if the alteration of rights in question arises solely from the debtor’s exercise of
discretion."23 In Windsor, the unsecured class was found to be unimpaired because the debtor
could have funded less to the lender from an effective-date equity infusion and have paid
unsecured creditors in full. The court ultimately reversed and remanded to dismiss, finding it
"unlikely that [the lender] would accept any plan [the debtor] might propose."24
Some courts have followed Windsor.25 Others, while not deciding the issue, have
articulated the same concerns as the Windsor court. In the Fourth Circuit case of In re
21
Id. at 131 (citations omitted).
22
Id.
23
Id.
24
Id. at 133.
25
E.g., Boston Post Road Ltd. P’ship v. F.D.I.C. (In re Boston Post Road Ltd. P’ship), 21 F.3d 477 (2d. Cir. 1994);
In re All Land Invs., LLC, 468 B.R. 676, 691 (Bankr. D. Del. 2012).
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Combustion Engineering, Inc.,26 the debtor, a manufacturer of asbestos products, before the
bankruptcy filing had negotiated with a group of tort claimants for preferred treatment under a
plan in exchange for the claimants’ vote as the impaired accepting class. Although the Fourth
Circuit did not rule on that basis,27 the court cited Windsor for the proposition that confirmation
of a plan based on claimants as the impaired accepting class would be troubling, particularly in
using such a class to satisfy the purpose of § 1129(a)(10) in demonstrating some creditor
support.28
Not all courts have distinguished between discretionary and economically driven
impairment. The Ninth Circuit in L & J Anaheim29 rejected an objection to confirmation based
on the artificial impairment of the single impaired accepting class, holding that the statutory
provisions did not made the discretionary/economic distinction. In L & J, the secured creditor
was the plan proponent of a liquidating plan and also served as the sole impaired accepting class.
The court held that the plan proponent’s motives were relevant only under the good-faith
analysis of § 1129(a)(3). The court analyzed the standards for impairment-any alteration-and the
history of the provisions for impairment, in which the Code was changed from the Bankruptcy
Act standard of "material and adverse effect," and found that even an improvement of existing
rights could constitute impairment. The court stated that good faith was the proper context
26
391 F.3d 190 (3d Cir. 2004)
27
Some courts have reasoned that the Fourth Circuit’s decision on artificial classification indicate it would not
condone artificial impairment. In re Swartville, LLC, citing cases interpreting In re Bryan Properties, 961 F.2d 496
(4th Cir. 1992).
28
Combustion Engineering, 391 F.3d at 243-244.
29
L & J Anaheim Assocs. v. Kawasaki Leasing Int’l., Inc. (In re L & J Anaheim Assocs.), 995 F.2d 940, 943 (9th Cir.
1993).
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within which to consider abusive impairment.30
Recently, the Fifth Circuit followed the plain-meaning approach in L & J and rejected the
justification requirement of Windsor.31 The court ruled that, because the definition of
impairment does not have a materiality or motive aspect, such considerations should be
considered under only the good-faith standard. As a matter of interpretation, the court found that
the statute was unambiguous and that the legislative history suggests the congressional rejection
of motive as a test for impairment. The court also dismissed the Windsor court’s concern over
using § 1129(a)(10) in an abusive way by saying that abuse occurs only where there is an
undersecured creditor and deficiency claim and distinguishing between Fifth Circuit artificial
impairment cases by saying that those cases did not establish a voting process rule. The court
affirmed the bankruptcy court’s finding of good faith, where the debtor had the intent to
reorganize to preserve equity in project, and third-party unsecured creditors, and distinguished
Combustion Engineering and other cases of prepetition action to generate votes.
Instead of relying on an overlay to §§ 1124 and 1129(a)(10)32 to curb perceived abuses,
other courts have analyzed artificial impairment specifically in the context of good faith, similar
to statements in Camp Bowie and L & J. For these courts, artificial impairment as an objection is
30
In re Hotel Assocs. of Tucson, 165 B.R. 470, 475 (B.A.P. 9th Cir. 1994) (stating that the court’s role is not "to ask
whether alternative payment structures could produce a different scenario in regard to impairment of classes," but
remanding with instruction that "the act of impairment in an attempt to gerrymander a voting class of creditors is
indicative of bad faith").
31
Western Real Estate Equities, L.L.C. v. Village at Camp Bowie I, L.P. (In re Village at Camp Bowie I, L.P.), 710
F.3d 239 (5th Cir. 2013).
32
Section 1129(a)(10) has been criticized as not adding to the other protections of § 1129(a). The National
Bankruptcy Conference suggested the deletion of § 1129(a)(10) of the Bankruptcy Code stating that "[i]n practical
terms, however, this particular rule [§ 1129(a)(10)] adds little to the existing statutory protection [of § 1129]."
Congress declined to adopt this recommendation when it enacted the 1994 Reform Act. Bernard Shapiro, National
B.R. Conf., Reforming the Bankruptcy Code: Final Report (May 1, 1994) at 276–77.
8
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best seen, not as a ground for finding noncompliance with § 1129(a)(10), but instead as an
argument that a plan has not been proposed in good faith.33 Some courts analyzing good faith
have reached the same result that a court applying the Windsor test would likely reach-that, if
there is sufficient cash to pay claims in full at confirmation should the debtor choose, then the
plan should not be confirmed.34 In effect, the court reached the same result but in a different
way.
Courts in the Eleventh Circuit have split on the issue of artificial impairment. In the
Northern District of Florida, a bankruptcy court applied the analysis from Windsor.35 In the
Southern District of Florida, a bankruptcy court rejected an argument of artificial impairment
based on the fact that the debtor’s cash flow supported payments over time, rather than up front,
appearing to acknowledge, if not accept, the artificial impairment objection.36 Bankruptcy courts
in the Northern District of Georgia, considering the argument following the amendments to §
1124, held that a plan could satisfy § 1129(a)(10) where the impaired class was paid in full on
33
In re 203 N. LaSalle St. Ltd. P'ship, 190 B.R. 567, 593 (Bankr. N.D. Ill. 1995) rev’d on other grounds; In re
Bataa/Kierland, LLC, 476 B.R. 558 (Bankr. D. Ariz. 2012) (no bad faith as long as there is no fraud, no injury to
anyone's rights or interests, and no attempt to extort more than either that accepting creditor or debtor/plan
proponent would be entitled to under other confirmation requirements"); In re Beauchesne, 209 B.R. 266, 275
(Bankr. D.N.H. 1997) ("Once it is determined that section 1129(a)(10) is satisfied, it is not appropriate or
permissible to use the generalized good faith requirement in section 1129(a)(3) to in effect override that
determination.").
34
For example, in In re Swartville, LLC, 2012 WL 35644171 (Bankr. E.D.N.Y. 2012) the court found bad faith
where the plan proposed to pay the noninsider unsecured claims totaling approximately $8,000 within 60 days of the
effective date from contributions by guarantors/principals, where the debtor at confirmation had less than $200 in its
bank accounts.
35
In re Investors Florida Aggressive Growth Fund, Ltd., 168 B.R. 760, 766-67 (Bankr. N.D. Fla. 1994) (finding
debtor "used its discretion to artificially impair" class of unsecured creditors where plan proposed four quarterly
installment payments of $16,000 in unsecured claims, notwithstanding significant cash on hand, citing Windsor).
36
In re New Midland Plaza Assocs., 247 B.R. 877, 896 (Bankr. S.D. Fla. 2000).
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the effective date, finding that impairment had been met and good faith was present.37
Cases generally go in one of two directions-either toward a plain reading of the statute or
to the requirement that the plan proponent establish a valid business or economic justification or
purpose for the treatment provisions. If a court follows the latter, the concern is that the §
1129(a)(10) standard is not addressed where small claims that were not materially impaired drive
the reorganization process or part of it. Effectively, it allows a small class not making economic
sacrifices to take the plan proponent to cramdown. The purpose of § 1129(a)(10),38 however, is
to ensure some creditor support by way of an impaired accepting class. Whether the impairment
is "enough" or a "material" amount arguably is not part of the statutory scheme.39 Various courts
have found that there are other provisions in the Code that provide safeguards for secured
creditors and that the requirements of § 1129(a)(10) arguably should not be augmented with a
motive aspect.40
In the Fifth Circuit, Camp Bowie seems to make confirmation clear in all but unique
cases similar to what was identified in Camp Bowie as to good faith. In courts that do not follow
Camp Bowie, the proponent needs to identify a business or economic justification. The issue
generally boils down to one of cash. As the ability to fund payment in full to unsecured creditors
at or shortly after the effective date increases, so does the likelihood that a challenge will be
successful. In cases finding the presence of artificial impairment or bad faith, the debtor most
37
In re Park Forest Dev. Corp., 197 B.R. 388, 395 (Bankr. N.D. Ga. 1996); In re Atlanta-Stewart Partners, 193
B.R. 79, 82 (Bankr. N.D. Ga. 1996).
38
An interesting summary of the inclusion of 1129(a)(10) is found in In re Barrington Oaks Gen. P'ship, 15 B.R.
952, 967 (Bankr. D. Utah 1981).
39
In re Vill. at Camp Bowie I, L.P., 710 F.3d 239, 246 n. 27 (5th Cir. 2013) (impairment standard including
requirement of "materially and adversely affected" was rejected).
40
E.g., Swartville, 2012 WL 3564171, *3.
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often had cash on hand to pay claims.41
One option includes the incurrence of sufficient debt to establish economic reasons to
create a longer payout, while not engaging in behavior that may be challenged as having been in
bad faith.42 Alternatively, the Debtor must be able to articulate a business reason for treatment.
This would include building into the plan and plan projections sufficient cash outlays on exit
such that a delay or reduction in payment to unsecured creditors is a reasonable business
decision. This would be manifested by capital or tenant improvements, reserves for operations
or debt service, and payment of secured tax claims in lieu of treatment under § 1129(a)(9).
Another alternative is to structure the plan with a longer payoff necessitated by cash flow
concerns, possibly by staging equity contributions. Although proposing to pay claims in one
year versus 60 days may not be determinative in a situation in which payment on the effective
date is possible, a longer payout is less likely to be clearly problematic. In certain cases this may
be impossible, based on the amount of unsecured claims or net cash flow of the debtor. Still
another structure occurs if a longer payout is required because of a paydown of secured debt.43
CLASS GERRYMANDERING: DEALING WITH THE UNDERSECURED CREDITOR
A similar concept to artificial impairment is artificial classification or "gerrymandering,"
in which one or more separate classes are created to try to isolate the rejecting vote of a large
creditor. Artificial classification becomes an issue if there are an insufficient number of
potentially impaired, accepting classes in single-asset cases, predominantly where a large
41
E.g., In re Investors Florida Aggressive Growth Fund, Ltd., supra ($16,000 in claims, between $100,000 and
$500,000 in cash); RYYZ ($2,000 in claims).
42
See Combustion Engineering.
43
Windsor identified the issue that a creditor was put in a position to ask for less payment to pay unsecured creditors
in full. Windsor at 133.
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deficiency claim held by an undersecured creditor would control both its secured and unsecured
classes if all unsecured claims were to be placed into a single class.44 In many commercial cases,
there will be so many different secured creditors that obtaining the acceptance of one impaired
class should not be difficult and gerrymandering unnecessary.
Similar to artificial impairment, an objection to artificial classification is to the plan
proponent’s manipulation of the plan structure to create a confirmable plan over the dissent of
the objecting party. Although the textual arguments in artificial classification are similar to those
in artificial impairment-that the applicable Bankruptcy Code provisions do not forbid artificial
classification-the circuits are generally in agreement that, under certain circumstances,
classification can go too far. Similar to the motivation test articulated in determining whether
impairment is artificial-whether the impairment is based on the discretion of the plan proponent
rather than based on an economic or business justification-courts dealing with arguable artificial
classification take into consideration whether there is a legitimate business justification.
Applicable Code Provisions
As with artificial impairment, gerrymandering relates to a plan proponent’s attempts to
ensure compliance with the requirement of at least one impaired accepting class.45 Section
1123(a) requires that a plan classify claims and interests, and provides that a plan shall "(1)
designate, subject to section 1122 of this title, classes of claims, other than claims of a kind
specified in section 507(a)(2), 507(a)(3), or 507(a)(8) of this title,46 and classes of interests."
44
In re RYYZ, LLC, 490 B.R. 29, 40 (Bankr. E.D.N.Y. 2013) ("[A] substantial deficiency claim held by a recalcitrant
lender will almost always sound the death knell in a single asset real estate case.").
45
§ 1129(a)(10).
46
Although these claims are excluded from the requirement that a plan shall classify claims, it does not necessarily
follow that a plan cannot classify the claims. A number of courts have said that such claims may not be classified. In
re Bryson Properties, XVIII, 961 F.2d 496, 501 n. 8 (4th Cir. 1992). A previous version of § 1129(a)(10), prior to the
12
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Section 1122 governs classification, and provides that "[e]xcept as provided in subsection (b)47
of this section, a plan may place a claim or an interest in a particular class only if such claim or
interest is substantially similar to the other claims or interests of such class." Separate
classification involves potential issues under § 1129(b)-particularly the requirement that, as to
any impaired rejecting class, the plan not discriminate unfairly. Finally, the good faith
requirement under § 1129(a)(3) lurks in the background.
Classification
A plan proponent has significant freedom and discretion in classifying claims and
interests in a Chapter 11 reorganization plan.48 Because the goal in filing a plan is to obtain
confirmation, "[e]very plan proponent creates its classification scheme with the goal of
maximizing the probability that its plan will be confirmed."49 Classes generally fall into the
categories of unclassified claims, secured claims, priority unsecured claims, unsecured claims,
and interests.
Although classes may be affected by the plan, priority claims must be paid in full and
therefore cannot be impaired by the plan. This concept provides a window into congressional
intent. Creditors, the claims of which the debtor may be able to alter under the plan, should have
1994 amendments, allowed acceptance by any class, which some courts allowed to include those deemed to accept
under § 1126(f). E.g., In re Jartran, Inc., 44 B.R. 331, 395-96 (Bankr. N.D. Ill. 1984) (discussing split in authority).
In re Distrigas Corp., 66 B.R. 382. ("As a contingent administrative claimant, New Jersey has voluntarily waived
some of its rights but that doesn’t allow them to claim impairment. Free choice is not synonymous with
compulsion.").
47
Section 1122(b) authorizes a separate administrative convenience class of unsecured claims: “ A plan may
designate a separate class of claims consisting only of every unsecured claim that is less than or reduced to an
amount that the court approves as reasonable and necessary for administrative convenience.”
48
E.g., In re Piece Goods Shops Co., L.P., 188 B.R. 778, 788 (Bankr. M.D.N.C. 1995) ("[p]lan proponents are to be
given considerable discretion in classifying claims according to the facts and circumstances of their cases").
49
In re Bloomingdale Partners, 170 B.R. 984, 996 (Bankr. N.D. Ill. 1994).
13
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an opportunity to vote. Conversely, creditors, the claims of which have to be paid in full in cash
on the effective date of the plan, have no interest at stake and therefore need not be placed into
voting classes.
Because each secured claim is not substantially similar to other secured claims, each
secured claim is generally separately classified.50
Several courts have found that secured priority tax claims cannot be impaired and
therefore are not entitled to vote on a plan of reorganization.51 Other courts have held that
secured tax claims may be an impaired accepting class.52
Unsecured Claims
Because secured claims and priority claims, being substantially dissimilar to other classes
of claims, are separately classified, classification issues almost exclusively arise with respect to
plans that create multiple unsecured classes. Except for an administrative convenience class,
there is no specific statutory recognition of any other appropriate separate classification of
general unsecured creditors.
Section 1122 governs classification and merely provides a negative rule53 against
50
FGH Realty Credit Corp. v. Newark Airport/Hotel Ltd. Partnership, 155 B.R. 93, 99 (D.N.J. 1993) ("Holding that
‘each secured claim is generally not substantially similar to other secured claims’").
51
In re Greenwood Point, LP, 445 B.R. 885, 906 (Bankr. S.D. Ind. 2011) (collecting cases dealing with impairment
of tax claims entitled to priority status). See, In re Bryson Properties, XVIII, 961 F.2d 496, 501 (4th Cir. 1992),
"priority tax claimants, which receive preferential treatment under § 1129(a)(9)(C), are not an impaired class that
can accept a plan and bind other truly impaired creditors to a cram down." 961 F.2d, at 501; Boston Post Road, 21
F.3d, at 484 and Greystone III, 995 F.2d, at 1281 (holders of § 507(a)(1) administrative lease claims not entitled to
vote); In re Perdido Motel Group, Inc., 101 B.R. 289 (Bankr.N.D.Ala.1989) (§ 507(a)(8) priority tax claimants not
entitled to vote); In re Winters, 99 B.R. 658 (Bankr.W.D.Pa.1989) (whether paid in full or paid a lesser amount by
agreement, priority tax creditors are not an impaired class for purposes of cramdown); In re Equitable Dev. Corp.,
196 B.R. 889, 893-894 (Bankr. S.D. Ala. 1996).
52
In re OBT Partners, 214 B.R. 863, 869 (Bankr. N.D. Ill. 1997); In re Curtis Center Ltd. P’ship, 192 B.R. 648
(Bankr. E.D. Pa. 1996).
53
The statutory provision provides as follows: "a plan may place a claim or an interest in a particular class only if
such claim or interest is substantially similar to the other claims or interests of such class." § 1122(a).
14
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classifying dissimilar claims in the same class. The statute does not state an inverse, positive
rule that all substantially similar claims be placed in the same class, and this is not a requirement
under the plain language of the statute.54
The case law on appropriate classification is less than crystal-clear, and it is difficult to
determine in advance what classification may meet court approval.55 Similar to the rationale for
artificial impairment, however, courts have created limitations on classification. The rule is not
based on the statutory language, which like § 1124 is unambiguous and limited, but rather on the
interplay between classification and confirmation in the context of §§ 1122, 1129(a)(8), and
1129(b)(1) (unfair discrimination), and similar reasoning on the purposes of § 1129(a)(10).
The argument for limitations on classification is similar to the § 1124 considerations.
Echoing the Windsor artificial impairment discussions, for example, the First Circuit in Boston
Post Road stated as follows:56
[A]pproving a plan that aims to disenfranchise the overwhelmingly largest
creditor through artificial classification is simply inconsistent with the principles
underlying the Bankruptcy Code. A key premise of the Code is that creditors
holding greater debt should have a comparably greater voice in reorganization. . .
Chapter 11 is far better served by allowing those creditors with the largest
unsecured claims to have a significant degree of input and participation in the
reorganization process, since they stand to gain or lose the most from the
reorganization of the debtor.
Other courts have stated that a debtor should be able to isolate an impaired assenting
54
E.g., In re ZRM-Oklahoma P’ship, 156 B.R. 67, 78 (Bankr. W.D. Okla. 1993) (stating that the "plain language of
the statute [§ 422(a)] does not alone support any other restriction" than prohibiting the single classification of
dissimilar claims); Class Five Nevada Claimants (00-2516) v. Dow Corning Corp. (In re Dow Corning Corp.), 280
F.2d 648, 662(6th Cir. 2002). Cf. In re Greystone III Joint Venture, 995 F.2d 1274, 1278 (5th Cir. 1991) (finding
textual support for limitations on separate classification in § 1122(b), stating "[I]f § 1122(a) is wholly permissive
regarding the creation of [different classes for similar claims], there would be no need for § 1122(b) specifically").
55
See, generally, Blair, "Classification of Unsecured Claims in Chapter 11 Reorganizations," 58 AM. BANKR. L.J.
197 (1984).
56
Boston Post Road Ltd. P’ship v. FDIC (In re Boston Post Road Ltd. P’ship), 21 F.3d 477, 483 (2d Cir.1994).
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class in order to achieve confirmation if that is the only way a plan can be confirmed.57 Rather
than treating classification issues on a stand-alone basis and adding motive tests to § 1122, other
courts have addressed classification as part of an unfair discrimination analysis.58 This analysis
is similar to the textual reading of the Fifth Circuit in Camp Bowie.
The principal rule articulated by the circuit courts of appeals is that similar claims cannot
be separately classified solely in order to create an impaired accepting class of claims. The Fifth
Circuit in Greystone applied the rule as follows:59
[T]he one clear rule that emerges from otherwise muddled case law on § 1122
claims classification: thou shalt not classify similar claims differently in order to
gerrymander an affirmative vote on a reorganization plan.
The inquiry in this analysis is whether there is some reason, other than the creation of an
impaired accepting class, to classify similar claims separately. The Second Circuit’s view was
articulated in Chateaugay:60
Classification is constrained by two straight-forward rules:
"Dissimilar claims may not be classified together; similar claims may be
classified separately only for a legitimate reason."
The Second, Third, Fourth, Fifth, Sixth, Eighth, Ninth, and Eleventh circuits follow this rule and
do not permit classification for the sole purpose of obtaining an accepting impaired class.61
57
Gato 183 B.R., at 22–23; SM 104 160 B.R., at 217.
58
In re City of Colorado Springs, Spring Creek Gen. Improvement Dist., 187 B.R. 683, 689 (Bankr. D. Colo. 1995)
("Issues of gerrymandering can and should be addressed as part of the ‘unfair discrimination’ analysis of §
1129(b).").
59
In re Greystone III Joint Venture, 995 F.2d 1274, 1278 (5th Cir. 1991).
60
In re Chateaugay Corp., 89 F.3d 942, 949 (2nd Cir. 1996).
61
In re Barakat, 99 F.3d 1520, 1523 (9th Cir. 1996); In re Boston Post Road Ltd. P’ship, 21 F.3d 477, 481– 83 (2d
Cir. 1994); John Hancock Mut. Life Ins. Co. v. Route 37 Bus. Park Assocs., 987 F.2d 154, 160 (3d Cir. 1993); In re
Windsor on the River Assocs., Ltd., 7 F.3d 127, 131 (8th Cir. 1993); In re Bryson Properties, XVIII, 961 F.2d 496,
501 (4th Cir. 1992); In re Greystone III Joint Venture, 995 F.2d 1274, 1279 (5th Cir. 1991) (“separate classification
may only be undertaken for reasons independent of the debtor's motivation to secure the vote of an impaired,
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When can unsecured claims be classified separately? The circuits have articulated
different standards for appropriate classification. The Eleventh Circuit’s articulation of the
standard is the following:62
Although the proponent of a plan of reorganization has considerable discretion to
classify claims and interests according to the facts and circumstances of the case,
this discretion is not unlimited. [T]here must be some limit on a debtor’s power
to classify creditors . . . The potential for abuse would be significant otherwise. If
the plan unfairly creates too many or too few classes, if the classifications are
designed to manipulate class voting, or if the classification scheme violates basic
priority rights, the plan cannot be confirmed.
Many courts use a four-factor test: First, is the discrimination reasonably based? Second,
can the debtor reorganize without the separate classification? Third, is the discrimination fair
and proposed in good faith, or is it only necessary to create an impaired consenting class? Last
is the degree of discrimination directly related to the rationale for the disparate treatment?63 The
most frequently articulated standard for the separate classification is "legitimate business
justification" or "legitimate business purpose."64 Alternatively, claims may be classified
separately if the claimants have sufficiently different interests in the plan.65
Unsecured claims can and in fact under § 1122 must be separately classified when the
assenting class of claims”); In re Holywell Corp., 913 F.2d 873 (11th Cir. 1990); Teamsters Nat'l Freight Indus.
Negotiating Comm. v. U.S. Truck Co. (In re U.S. Truck Co., Inc.), 800 F.2d 581, 586 (6th Cir.1986); Hanson v. First
Bank, 828 F.2d 1310, 1313 (8th Cir.1987). See also, Granada Wines, Inc. v. New England Teamsters and Trucking
Industry Pension Fund, 748 F.2d 42, 46 (1st Cir. 1984) (stating that “[t]he general rule regarding classification is
that ‘all creditors of equal rank with claims against the same property should be placed in the same class’”). See
also, Woodbrook, 19 F.3d at 317 (“Some limits are necessary to offset a debtor's incentive to manipulate a
classification scheme and ensure the affirmative vote of at least one impaired class....”) (citations omitted).
62
In re Holywell Corp., 913 F.2d 873, 880 (11th Cir. 1990).
63
In re Tucson Props. Corp., 193 B.R. 292, 301 (Bankr. D. Ariz. 1995).
64
In re Chateaugay Corp., 89 F.3d 942 (2nd Cir.1996); In re SunCruz Casinos, LLC, 298 B.R. 833, 837 (Bankr.
S.D. Fla. 2003) (“[C]ourts have uniformly held that [§ 1122] prohibits separate classification of similar claims
unless supported by legitimate business reasons.”); In re New Midland Plaza Assocs., 247 B.R. 877, 893 (Bankr.
S.D. Fla. 2000).
65
In re Wabash Valley Power Ass'n, Inc., 72 F.3d 1305, 1321 (7th Cir.1995).
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claims are not "substantially similar."66 In considering which unsecured claims are substantially
similar to one another, the importance generally is the legal rights of the claim, rather than the
holder of the claim.67 There are exceptions to this general rule, as in the case of claims subject to
equitable subordination under § 510.
Conceptually, there is frequent logical overlap between legitimate justification and
substantial dissimilarity.68 If two claims are substantially dissimilar, there is a justification for
their separate classification. If a legitimate business justification exists to separately classify
claims, it is likely because the claims are substantially dissimilar. It can be anticipated that the
plan proponent will argue both similarity and business reasons.
The Bankruptcy Code recognizes that small unsecured claims may be separately
classified to promote administrative convenience.69 With this exception, as to unsecured claims,
perhaps the most common issue is whether the deficiency claim of an undersecured creditor can
be separately classified. Most notably, the Seventh Circuit in Woodbrook has held that some
unsecured claims can be substantially dissimilar to others.70 Woodbrook appears to be limited to
66
In re Multiut Corp., 449 B.R. 323, 334 (Bankr. N.D. Ill. 2011).
67
In re Johnston, 21 F.3d 323, 327 (9th Cir.1994) (holding that bankruptcy court must evaluate “the nature of each
claim, i.e., the kind, species, or character of each category of claims.”); In re Frascella Enters., Inc., 360 BR 435
(Bankr. E.D. Pa. 2007) (separate classification based on insider not warranted, because focus for classification is
claim, not identity of holder); In re Coram Healthcare Corp., 315 B.R. 321, 349 (Bankr. D. Del. 2004) (“emphasis
is not upon the holder of the claim so much as it is upon what type of claim the holder has against the estate.)”
68
In re Bataa/Kierland, LLC, 476 B.R. 558, 563 (Bankr. D. Ariz. 2012) (“Once it is determined that separately
classified claims are dissimilar under § 1122, however, “there is no basis or reason to consider the Debtor’s motives
underlying such classification, whether they be gerrymandering or for business reasons, because the Code requires
such separate classification regardless of the Debtor’s motive.”) (citations omitted).
69
§ 1122(b). The debtor needs to be able to demonstrate that such treatment is “reasonable and necessary” for
administrative convenience.
70
In re Woodbrook Assocs., 19 F.3d 312, 319 (7th Cir. 1994) (“where the debtor is a partnership comprised of a
fully encumbered single asset, the legal rights of a § 1111(b) claimant are substantially different from those of a
general unsecured claimant... and require separate classification ....”). See also, In re Gato Realty Trust Corp., 183
B.R. 15 (Bankr.D.Mass.1995); In re SM 104 Ltd., 160 B.R. 202 (Bankr. S.D. Fla. 1993) (unsecured deficiency claim
18
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partnership debtors, where recourse exists against the principals, as opposed to corporate debtors
with nonrecourse loans. The legal distinction between nonrecourse deficiency claims under §
1111(b) and other unsecured claims has been rejected as the sole basis for separate classification
by the majority of circuits considering the issue.71 Courts have generally denied various
arguments justifying such claims as being substantially dissimilar.72
As for other unsecured claims, debtors have frequently viewed as being dissimilar to
other unsecured claims and thus subject to separate classification the claims of prepetition trade
creditors,73 the claims of prepetition trade creditors that have also granted trade credit to the
debtor since the Chapter 11 case was filed, trade creditors that make commitments to advance
postconfirmation trade credit,74 insider claims,75 claims of entities holding third-party
guaranties,76 claims held by labor unions pursuant to collective bargaining agreements,77 holders
that undersecured nonrecourse creditor acquired solely by virtue of bankruptcy statute was not substantially similar
to other general unsecured claims and could not be classified with them).
71
In re JRV Indus., Inc., 342 B.R. 635, 638 (Bankr. M.D. Fla. 2006) (“The Court agrees with the Second, Third,
Fourth, Fifth, Eighth and Ninth Circuits and holds that a non-recourse deficiency claim is not sufficiently dissimilar
from other unsecured claims to mandate separate classification.”)
72
E.g., In re SunCruz Casinos, LLC, 298 B.R. 833, 838 (Bankr. S.D. Fla. 2003) (rejecting separate classification of
secured creditor deficiency claims based upon election rights under § 1111(b) and different motivations for voting).
73
Brinkley v. Chase Manhattan Mortgage & Realty Trust (In re LeBlanc), 622 F.2d 872 (5th Cir.1980) (decided
under the Bankruptcy Act) (separately classifying trade creditor claims from insider debt). But see, In re Greystone
III Joint Venture, 995 F.2d 1274, 1280-81 (5th Cir. 1991) (rejecting separate classification of trade vendors from
deficiency claim where separate treatment was not proposed).
74
This structure avoids problems with relying on vendor support in cases where prepetition vendors are easily
replaced. In re Barakat, 99 F.3d 1520, 1528-29 (9th Cir. 1996) (no creditors were essential where the bankruptcy
court noted that "literally thousands of companies are available to provide the [ ] services" of the trade creditors).
75
In re Foxridge L.P., 238 B.R. 810 (Bankr. W.D. Mo. 1999) (permitting classification of two limited partners
separately from other limited partners where the two separately classified partners had been engaged in a battle for
control of the debtor). See also Brinkley v. Chase Manhattan Mortgage & Realty Trust (In re LeBlanc), 622 F.2d
872 (5th Cir. 1980) (separately classifying trade creditor claims from insider debt).
76
In re Cello Energy, LLC, 2012 WL 1192784 (Bankr. S.D. Ala. 2012). In Cello Energy, the court found that the
fact that one unsecured creditor had the ability to collect at least some of its judgment before any of the other
creditors receive anything from the debtor, and to continue collecting even if the other creditors' claims are capped
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of disputed claims,78 claims of security-deposit holding parties,79 claims of a competitor,80 and
claims of taxing authorities with liens on the debtor’s property,81 and specific types of tort claims
or all tort claims generally.82 Arguably some justification may exist for separately classifying
each group of these classes of creditors, by way of either substantial dissimilarity to other
unsecured claims or good business reason for separate classification.
A plan proponent needs to consider classification along with claim treatment; otherwise a
by their treatment, thereby creating its own offset, rendered the claim substantially similar. But see, In re
Nat’l/Northway Ltd. P’ship, 279 B.R. 17 (Bankr. D. Mass. 2002). It is likely that a distinction would be drawn based
on an ability to collect from non-debtor sources, and other facts and circumstances. SPCP Group, LLC v. Biggins,
465 B.R. 316, 324 (M.D. Fla. 2011) (affirming bankruptcy court allowing separate class for one claim where claim
is 100% collateralized in related corporate case and creditor is receiving payments).
77
In re U.S. Truck Co., Inc., 800 F.2d 581 (6th Cir. 1986); FGH Realty Credit Corp. v. Newark Airport/Hotel Ltd.,
155 B.R. 93 (D. N.J. 1993) (permitting separate classification of rejection claims of union employees where union
had a non-creditor interest arising from its members’ employment).
78
In re Multiut Corp., 449 B.R. 323, 335 (Bankr. N.D. Ill. 2011) (claims that were disputed and subject to setoff
were properly separately classified). However, a number of cases also state that, because the legal status of the claim
and not its disputed status is the appropriate focus of classification, the segregation of unsecured claims that are
disputed generally is improper. See In re Midway Invs., Ltd., 187 B.R. 382, 392 (Bankr. S.D. Fla. 1995). In re
Porcelli, 319 B.R. 8, 11 (Bankr. M.D. Fla. 2004).
79
In re Lafayette Hotel P’ship, 227 B.R. 445 (S.D.N.Y. 1998) (permitting separate classification of tenant's
unsecured claim where tenant had non-creditor interest in keeping its lease). The majority of cases disallow separate
treatment of tenant security depositors where the debtor assumes the lease, on the basis either that the tenants "have
no provable claim against the bankruptcy estate," Boston Post Rd., 21 F.3d at 484, Greystone III, 995 F.2d at 1281
("A party to a lease is considered a ‘creditor’ who is allowed to vote [under] 11 U.S.C. § 1126(c), only when the
party has a claim against the estate that arises from rejection of a lease."), or that the obligations assumed by the
debtor under the continued leases constitute postpetition administrative expense claims under § 503(b)(1)(A) and are
entitled to priority under § 507(a)(1) and therefore not entitled to vote. In re Barakat, 99 F.3d 1520, 1528 (9th Cir.
1996).
80
In re Premiere Network Svcs., Inc., 333 B.R. 130 (Bankr. N.D. Tex. 2005) (permitting separate classification of
unsecured claim of direct competitor of the debtor who would benefit if the reorganization failed).
81
In re New Midland Plaza Assoc., 247 B.R. 877 (Bankr. S.D. Fla.2000) (permitting separate classification where
city, as a taxing authority, had a direct interest in the profitability of the debtor and an interest in preserving the
property for the benefit of citizens). See also In re HRC Joint Venture, 187 B.R. 202 (Bankr. S.D. Ohio 1995)
(permitting separate classification of city’s claim where city had an interest in maintaining the debtor’s hotel
property for the benefit of its citizens); In re Way Apts., D.T., 201 B.R. 444 (N.D. Tex. 1996) (permitting separate
classification where Department of Housing and Urban Development had a public interest under the National
Housing Act).
82
Class Five Nevada Claimants (00-2516) v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.2d 648, 662
(6th Cir. 2002).
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plan may encounter unfair discrimination issues.83 Courts have found that, if all unsecured
claims receive the same treatment in terms of plan distribution, separate classification of
unsecured claims is highly suspect.84
As a practical matter, it behooves a debtor to acknowledge that every additional class
created without the support of all creditors in the class increases the likelihood of rendering a
plan nonconsensual and will require cramdown to be confirmed, with the costs and other
potential attendant consequences. Consequently, creation of one large creditor class, with the
expectation that friendly creditors will outvote unfriendly ones, may be preferable. In addition to
other cramdown issues, the separate classification of unsecured claims will give rise to litigation
over whether the plan unfairly discriminates among various classes of unsecured creditors.
In a case with a large unsecured deficiency claim, the classification of claims will depend
upon a careful analysis of the facts and circumstances of the case and whether there is
justification for separate classifications of unsecured claims. Of critical importance is the basis
for justification of separate classes and the ability to create a factual record by articulating the
justification for the separate classification. Failure to do so will significantly affect confirmation
of a plan.85
83
In short, unfair discrimination is different treatment among classes, and is judged by "whether there is a
reasonable basis for the discrimination and whether the debtor can confirm a plan without it." In re Deming
Hospitality, LLC, 2013 WL 1397458 (Bankr. D.N.M. April 5, 2013).
84
In re Main Line Corp., 335 B.R. 476, 479 (Bankr. S.D. Fla. 2005) (no legitimate business reason to separately
classify judgment creditor from the vendor/attorney unsecured creditors); In re Deep River Warehouse, 2005 WL
2319201, at *7 (Bankr. M.D.N.C. Sept. 22, 2005).
85
E.g., In re One Times Square Assocs. Ltd. P’ship, 159 B.R. 695, 704 (Bankr. S.D.N.Y. 1993) (as an example of
trial preparation issues, the court stated that on cross at trial the debtor’s representative "admitted that the Debtor
separately classified Class 5 claims in order to gerrymander the vote but provided no reasonable basis for having
done so").
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SECTION 1111(b) ISSUES
In connection with other secured creditor protections, the Bankruptcy Code in § 1111(b)
allows a nonrecourse undersecured creditor an unsecured claim and allows a recourse
undersecured creditor a right to require that its claim be treated as being fully secured. Courts
have cited § 1111(b) allowance of an unsecured claim as creating a claim substantially dissimilar
to other unsecured claims. Section 1111(b) election rights complicate the decision-making and
planning by proponents and secured creditors. An election eliminates contestable issues for the
claimant as an unsecured creditor, including objection to noncompliance with the absolute
priority rule and to gerrymandering. The election, however, could generate greater economic
recovery or create other contestable issues such as feasibility.
Prior to the enactment of the Code, the Bankruptcy Act allowed a plan to strip down a
nonrecourse undersecured claim and sell the collateral shortly after confirmation without
satisfying in full any deficiency claim. This problem, named for the pre-Code Pine Gate86 case
that faced the problem, was addressed by § 1111(b), articulated as follows:
Congress addressed the Pine Gate problem by enacting section 1111(b), which
was intended to preserve the undersecured nonrecourse creditor's benefit of the
bargain, while preserving the debtor’s ability to retain encumbered property
essential to its reorganization plan. By providing such creditors with an
opportunity to elect to have their liens treated as recourse claims if their debtors
intend to retain the property, Congress protected both interests.87
Mechanics of § 1111(b) Election
Bankruptcy Rule 3014 governs § 1111(b) election rights. Under that rule, the election
may be made before the conclusion of a disclosure statement hearing or "within such later time
86
In re Pine Gate Assocs., Ltd., 2 B.C.D. 1478 (Bankr. N.D. Ga. 1976).
87
Tampa Bay Assocs., Ltd. v. DRW Worthington, Ltd. (In re Tampa Bay Assocs., Ltd.), 864 F.2d 47, 50 (5th Cir.
1989).
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as the court may fix."88 In a small business case or a case in which final approval of a disclosure
statement is considered in a hearing combined with the confirmation hearing, the deadline is
generally set either before or at the confirmation hearing. An election, once made, is binding as
to the plan as to which it was made, absent a material modification to the plan, and even then
may be limited if not made timely.89
If a secured creditor makes the election, then, notwithstanding the value of the collateral
and the application of § 506, the electing creditor’s secured claim for purposes of the plan equals
the amount of its allowed claim, rather than the value of its collateral (its interests in the debtor’s
property). In the event of an election, the present value of the electing creditor’s stream of
payments need only equal the present value of the collateral, which is the same amount that must
be received by the nonelecting creditor, but the sum of the payments must be in an amount equal
to at least the creditor’s total claim.
The election cannot be made in two instances. If the collateral of the electing creditor is
of inconsequential value, a § 1111(b) election is not warranted. Sale of the electing creditor’s
collateral under the plan also will preclude a § 1111(b) election. In the event of a sale,
protections to the secured creditor theoretically would be provided by credit bid rights under §
363(k) and 1129(b)(2)(A)(ii), addressed by the Supreme Court in its RadLAX decision.90
88
The rule specifically states "at any time prior to the conclusion of the hearing on the disclosure statement or within
such later time as the court may fix. If the disclosure statement is conditionally approved pursuant to Rule 3017.1,
and a final hearing on the disclosure statement is not held, the election of application of § 1111(b)(2) may be made
not later than the date fixed pursuant to Rule 3017.1(a)(2) or another date the court may fix." Fed. R. Bankr. P. 3014.
89
In re Bloomingdale Partners, 155 B.R. 961, 971 (Bankr. N.D. Ill. 1993); In re IPC Atlanta Ltd. P’ship, 142 B.R.
547, 554 (Bankr. N.D. Ga. 1992) (creditor does not have an unlimited time period to withdraw election after
material modification); In re Keller, 47 B.R. 725, 728–30 (Bankr. N.D. Iowa 1985).
90
The issue of credit bidding and indubitable equivalence was resolved by the Supreme Court in RadLAX Gateway
Hotel v. Amalgamated Bank, 132 S. Ct. 2065 (2012).
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The test for cramdown of a secured claim includes components of both the net present
value of the collateral and deferred payments equal to the amount of the allowed claim, including
principal and interest. A plan must provide a secured creditor with a payment stream equal to the
amount of the allowed claim, and the payment stream must have a present value equal to the
value of the collateral. An undersecured creditor may want to forego the election, even if
economic benefits under the plan would accrue were the election to be made, if the creditor’s
ability to oppose confirmation is enhanced by having both a secured claim and an unsecured
deficiency claim. An undersecured creditor may want to oppose confirmation by voting its
deficiency claim against the plan to control the unsecured class if there is no other potentially
impaired class, or by keeping its unsecured vote to argue gerrymandering if there are
classification issues. Additionally, if the creditor keeps the unsecured claim, and is part of a
rejecting unsecured class, the creditor can insist on compliance with the absolute priority rule,
thereby perhaps blocking confirmation.
Cramdown of a creditor making the election must meet both the test that total payments
be at least equal to the allowed claim amount and the requirement that the present value of the
payment stream be at least equal to value of the creditor’s collateral. Particularly due to the first
test, an election is most powerful for a secured creditor and difficult for a debtor to address,
where there is a large difference between the collateral value and the claim amount. Where this
disparity exists, the net cash flow of the assets may not support a total payment stream under the
time period covered by the economic useful life of the assets. In that circumstance, the property
will not generate enough revenue over its remaining life to cover total payments equal to the face
amount of the allowed claim of the creditor.
The decision whether to elect treatment under § 1111(b) invokes a number of economic
24
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considerations.91 The creditor will need to consider the opportunity to participate fully in any
future appreciation of the collateral, including the horizon of an event such as default,
enforcement, or sale, that would allow the creditor to realize the benefits of appreciation. The
creditor will also want to take into account the difference between recoveries under the plan as a
secured and an unsecured creditor, in contrast to recovery as an electing secured creditor, with a
view toward the likelihood of default.
There are also considerations based on the ability to defeat confirmation of a plan. These
would include a feasibility challenge based upon the spread between the present value of the
collateral and the amount of the allowed claim, coupled with the stream of payments the property
can support. The creditor may want to create a scenario in which the plan results in an
unattractive asset for current equity, economically motivating equity to relinquish the property.
What can a plan proponent do to § 1111(b)-election-proof a plan?92 One course would be
to ensure to the extent possible that the payment stream without election matches what would be
required in the event of a § 1111(b) election. A proponent may also want to seek an early
determination under Bankruptcy Rule 3014 by requesting a disclosure statement hearing. As
discussed in the Advisory Committee notes,93 whether an election will be made is critical in
making decisions about the plan, including potential modifications. The debtor could provide for
a plan sale. Prior to the RadLAX decision, the Fifth Circuit allowed for limited credit bid rights
91
For a list of factors to consider in making the election, see, Steven R. Haydon, "The 1111(b)(2) Election: A
Primer," 13 BANKR. DEV. J. 99, 132 (1996), and Jo Ann J. Brighton, "The Resurrection of Section 1111(b) in a
Depressed Economy," 2010 ANN. SURV. OF BANKR.LAW 12.
92
In re 222 Liberty Associates, 108 B.R. 971, 995–96 (Bankr. E.D. Pa. 1990) (discussing terms which contribute to
the cumulative effect of terms which fail to allow an adequate § 1111(b) election.]
93
The Advisory Committee notes to Rule 3014 recognize the importance of an early determination of whether the
election will be made. Fed.R.Bankr.P. 3014 (Advisory Committee note) ("Generally, it is important that the
proponent of a plan ascertain the position of the secured creditor class before the plan is proposed.").
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in the context of plan sale in a case in which the creditor had not made the § 1111(b) election.
Although the Supreme Court’s decision does not mention the section, the § 1111(b) election is
arguably the flip side of the § 363(k) protection. If refinancing is not readily available, the
debtor may want to provide that, in the event of an election, any due-on-sale clause be
eliminated.94 A plan that proposes to surrender property to a recalcitrant secured creditor also
could provide that, in the event of a § 1111(b) election, the property would be deeded to the
electing creditor, but that the other elements of the plan would remain effectual.
CONCLUSION
Careful and innovative thinking about Chapter 11 plan structuring can create
opportunities for plan confirmation in a difficult case. Class impairment, claim classification,
and anticipation of a § 1111(b) may move the debtor or other plan proponent closer to the Holy
Grail. Equally careful analysis of potential artificiality in creating impairment, gerrymandering,
and utilization of rights under § 1111(b) may help a creditor block confirmation of a plan that the
creditor considers to be unfair or not in the creditor’s economic interests. The case law on these
topics continues to evolve and to provide opportunities for strategic practice and the selection of
the best paths to guide clients around obstacles to chapter 11 confirmation.



94

In re Airadigm Communications, Inc., 519 F.3d 640, 646 (7th Cir. 2008) (approving plan which provided for
purchase of treasuries as replacement source of income to cover payment of election claim, with FCC to receive
proceeds from sale and retain lien on licenses, but not be entitled to full payment in event of sale).
26
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