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Tuesday, April 29, 2014

Castleton Plaza II

Earlier this year, I wrote a series of posts on the flawed understanding behind the extension to chapter 11 cases of Till v SCS Credit Corp.’s “prime plus-” interest rate formula for cram-ups of secured creditors in chapter 13 cases.   In one of those posts, I focused on a recent case, In re Castleton Plaza, as a particularly egregious example of the way the extension of Till to chapter 11 leads to absurd departures from sound financial analysis, decades of precedent and common sense.  At the time I wrote those posts, Castleton Plaza was on remand to the bankruptcy court after the Seventh Circuit, acting with remarkable alacrity, had vacated the order confirming the debtor’s cram-up plan because the plan’s sale of the equity in the reorganized debtor to the existing equity owner had not been subject to competitive bidding.

When I attended the ABI Caribbean Insolvency Forum in San Juan, P.R., back in February, a panel of lawyers from Indiana, where the case had taken place, delivered a presentation about it, and forecast that the debtor would lose on remand, but would appeal the result.  At the time of the conference, the bankruptcy court had sub judice a revised plan and the secured creditor’s motion to dismiss the case, which the court ultimately granted on February 11, 2014.  Whereupon, the debtor did, indeed, appeal directly, with leave, to the Seventh Circuit earlier this month (Case No. 14-1735).  Briefs are to be completed by early June.  Per order of the bankruptcy court, the secured creditor’s exercise of rights is stayed pending resolution of the appeal.

Reading the debtor’s notice of appeal and its argument against dismissal in the bankruptcy court, I thought it would be interesting, as sort of a post-script to the Till posts earlier this year, to examine the position being taken by the debtor, which depend on the extension of Till to chapter 11, although there are other fallacies as well.

The debtor’s revised plan was remarkable for its brazenness.   Notwithstanding the emphasis in Judge Easterbrook’s opinion on the need for an auction where a debtor proposes to sell new equity to an existing equity holder, the revised plan did not contemplate one.  Rather, the debtor revised the treatment of the secured creditor, the claim of which had been bifurcated under the original plan, with the deficiency being discharged at less than par, to provide that it was now fully secured (I discuss later on that this is more a matter of the debtor’s “ipse dixit” than actual economic fact).  The revised plan further proposed a repayment of the secured claim over 10 years on a 30-year amortization schedule with a “fixed market rate of seven percent” (quoting the revised plan).

The debtor then argued, first, that Judge Easterbrook’s opinion was merely an application of the absolute priority doctrine, but the absolute priority doctrine can only be invoked by a dissenting class of unsecured creditors; since the objecting creditor was fully secured, it could therefore not be heard to complain about the continuing lack of an auction.  

Second, the debtor argued, its proposed treatment of the secured claim was “payment in full” because it complied with Till; further, it argued (in one of the most ridiculous arguments I can recall seeing), because a Till-compliant cram-up is within a debtor’s legal rights,  then being crammed-up in accordance with Till is within the “legal, equitable and contractual rights to which such claim or interest entitles the holder of such claim or interest” and, presto, the secured creditor was actually “unimpaired” within the meaning of section 1124, and thus deemed to accept the plan.

The second argument is obviously wrong, regardless what one thinks of Till-in-chapter-11 in that it misreads the word “and” in § 1124(a)’s litany of “legal, equitable and contractual rights”  to mean “or”.  Unimpairment requires that all three kinds of rights be left “unaltered”, not merely one subset of them.  The secured creditor’s debt had come due by its terms and thus the creditor has, but for the automatic stay, a host of contractual, legal and equitable rights to pursue outside of bankruptcy court that the plan, by substituting an extended payout and discharging the terms of the old debt, “alters”.   Also, fairly obviously, to conclude that a cram-down/up leaves a creditor class “unimpaired” would eliminate the role of

The first argument is more competent, also I think it is also wrong, because the “cramdown” section of the Bankruptcy Code, § 1129(b)(2), does not contain the “only if there is a dissenting unsecured creditor class” logic that the debtor reads into it.  Rather, it says the bankruptcy court shall confirm the plan “if the plan … is fair and equitable with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”  The secured claim is such a class under the revised plan, so clearly gets to invoke the “fair and equitable” standard.   The only question is whether the content of that standard is 100% different for different classes, or do overlaps exist.    

The Code then specifies that the “fair and equitable” standard “includes” – which is statutorily defined to be non-limiting – certain criteria which differ by class, but by virtue of the word “includes”, courts can impose additional requirements, and it is clear from Judge Easterbrook’s opinion that it was not tied to the deficiency claim that the original plan would have imposed on the mortgage holder.  And that makes perfect sense as a matter of economic substance because these small to midsize commercial real estate cases are generally all battles between the mortgage holder and the equity holder; there is rarely any unsecured debt to speak of.   In Castleton Plaza, it seems pretty clear that any unsecured debt that existed in the case was consciously created by the debtor’s strategic non-payment of certain trade creditors whose loyalty it could count on (subject to designation of their votes under § 1126 (e)).

But, suppose you disagree with my position on that last issue, and instead believe there are no “cram-up” criteria for secured creditors outside of the ones explicitly specified in § 1129(b)(2)(A)(i).  Then you must confront the “Till in chapter 11” issue.  The proceedings below, it is clear, never proved by way of evidence that the proposed repayment actually delivered to the secured creditor a “value, as of the effective date of the plan, of at least the value of the holder’s interest in the estate’s interest in such property…”, i.e., the foreclosure value of the collateral here.   There was no evidentiary hearing on that issue.  Rather, the debtor simply contended a payout formula compliant with Till delivers that value as a matter of law.  

The plan uses the phrase “fixed market rate of interest”, and thus one might wonder if in fact the repayment terms could be supported by expert evidence, and thus dodge the Till issue, but that phrase is frankly absurd and misleading.  The value of the collateral that was referenced in the proceedings before the bankruptcy judge earlier this year, $8.2 million, is only about 90% of the principal amount of the note to be issued under the plan to the secured creditor (approximately $9.1 million).  There is no credible “market rate of interest” for a 10-year note with a 110% loan-to-value ratio and a 30-year amortization; if there were, the debtor would have found a lender willing to provide it and dispensed with the multi-year cram-up battle.  Thus, to obtain confirmation, the debtor would ultimately have to argue for a rule of law that a note complying with Till satisfies § 1129(b)(2)(A)(i)[1].  As I explained in my posts earlier this year, I think that would be an error of law, not a rule of law, and it will be interesting to see if the Seventh Circuit seizes on the chance to explain why Till should not be applied in chapter 11 cases.

[1]           Technically speaking, the proposed rate of interest is 375 bps above the prime rate, so slightly more than the conventional Till range of 100-300 bps, but that does not seem to affect the analysis as the LTV ratio is still too high for the note to be equal in value to the secured creditor’s claim.