Chapter 11
Working Group Proposal #13: Impairment
The Bankruptcy Code imposes numerous hurdles to the confirmation of a plan of
reorganization to ensure that the plan has sufficiently involved the parties in interest. The plan
proponent’s requirement to negotiate with the holders of claims and interests depends on
whether the claims or interests are "impaired," for only impaired classes are entitled
to vote on the plan. [ FN: 11 U.S.C.
§1126(f) provides that "a class that is not impaired under a plan, and each holder of a claim
or interest of such class, are conclusively presumed to have accepted the plan, and solicitation of
acceptances with respect to such class from the holders of claims or interests of such class is not
required. "] Impairment is construed broadly so that holders of claims and
interests that are affected by the plan can participate in negotiations and voting. All classes are
impaired except to the extent that the proposed treatment under the plan "unimpairs"
them pursuant to the options set forth in section 1124.
a) Definition of Impairment
The Code formerly offered three types of treatment under a plan that would
"unimpair" a class of claims or interests: (1) the plan could leave the holders’
rights unaltered; (2) the plan could reverse the acceleration of the maturity of a debt pursuant to
the delineated rules; or (3) the plan could pay the holders’ allowed claims in full in cash on
the effective date of the plan or could pay interest holders the greater of the redemption price or a
fixed liquidation preference. Because the allowed claim excludes unaccrued interest, [ FN: See 11 U.S.C.
§502(b)(2).] option (3) does not require payment of postpetition
interest. The Bankruptcy Reform Act of 1994 eliminated option (3) due to concerns that even a
liquidation-solvent debtor could deny postpetition interest to unsecured creditors that were
unimpaired under option (3), since the "best interest of creditors" test only applied to
impaired classes, and the bankruptcy court in In re New Valley Corp. had just held that
the judicially-crafted "solvent debtor rule," which authorized postpetition interest
payment to creditors before any surplus is paid to or retained by the debtor, did not survive
enactment of the Bankruptcy Code of 1978. [
FN: In re New Valley Corp., 168 B.R. 73, 77 (Bankr. D.N.J. 1994) (solvent
debtor rule did not survive enactment of Bankruptcy Code of 1978). But seeIn re Shaffer
Furniture Co., 68 B.R. 827 (Bankr. E.D. Pa. 1987) (court requiring solvent debtor to pay
postpetition interest before permitting debtor to retain interest in estate); accordIn re
David Green Property Mgt., 164 B.R. 92, 97 (Bankr. W.D. Mo. 1994) (payment of postpetition
interest not prohibited by Code, thus is within court's discretion and depends on equities of
case);In re San Joaquin Estates Inc., 64 B.R. 534, 536 (Bankr. 9th Cir. 1986) (award of
postpetition interest allowed within court discretion when debtor is solvent), citing Matter of
Walsh Construction Inc., 669 F.2d 1325, 1330 (9th Cir.1982) (interest award within court
discretion).]
While it is relatively undisputed that unsecured creditors should not be precluded from
receiving interest from a liquidation-solvent debtor, eliminating subsection (3) of section 1124
didnot address the underlying issue because the Bankruptcy Code still does not provide specific
authorization for a solvent debtor to pay postpetition interest to unsecured creditors, whether or
not the claims are unimpaired. At the same time, the elimination of subsection (3) had several
unintended and undesirable consequences.
The Recommendation
Section 1124 should be amended to re-introduce former subsection (3) to read as
follows:
(3) provides that, on the effective date of the plan, the holder of such
claim or interest receives, on account of such claim or interest, cash equal to -
(A) with respect to a claim, the allowed amount of such claim; or
(B) with respect to an interest, if applicable, the greater of -
(i) any fixed liquidation preference to which the terms
of any security representing such interest entitle the holder of such interest; or
(ii) any fixed price at which the debtor, under the terms
of such security, may redeem such security from such holder.
Reasons for the Change
Treating a class of claims as impaired when the allowed claims will be paid up front and in
full is somewhat odd even in a system that employs a liberal notion of "impairment."
Congress further broadened the definition of impairment in this manner to enfranchise cashed-out
unsecured creditors so that under section 1129(a)(7), the plan could be confirmed only if it paid
postpetition interest to dissenting impaired creditors that would have received postpetition interest
had the debtor liquidated under chapter 7. [
FN: H.R. REP. NO. 835, supra note 20, at 47 - 48, reprinted in 1994 U.S.C.C.A.N. at
3356 - 57.]
However, even with this well-intentioned amendment, chapter 11 still does not expressly
authorize the payment of postpetition interest, even from liquidation-solvent debtors. Section
502(b)(2) unambiguously excludes unmatured interest from the calculation of the allowed claim,
whether or not the class of claims is impaired.
At the same time, the elimination of the third method of unimpairment had unanticipated
consequences. Holders of claims that will be paid in full on the effective date of the plan
understandably lack any strong interest in being active participants in the case. Classes in this
category often are comprised of administrative convenience claims, voluminous claims of a small
dollar amount. Thus, with little or no resulting benefit to creditors, the attendant administrative
costs of sending disclosure packages and solicitation materials to the multitude of creditors
withvery small claims increases the overall costs of the reorganization for everyone. [ FN: See memorandum from Luc A. Despins and
Dennis F. Dunne to Elizabeth I. Holland, National Bankruptcy Review Commission, Re:
Proposed Amendment to 11 U.S.C. Section 1124 at 3 (April 30, 1997).]
At the same time, by leaving an even larger number of creditor classes impaired without
specifying if and when such creditors are entitled to postpetition interest, the amendment gives
substantial leverage to dissenting unsecured creditors who otherwise would be relatively satisfied
with their treatment. A handful of claims can block plans with nuisance complaints by demanding
postpetition interest.
The 1994 amendment also eviscerated any vestigal function of section 1129(a)(10), which
requires as a predicate to confirmation that at least one impaired class accept the plan; if
cashed-out creditors are considered impaired, most debtors are nearly guaranteed to have at least
one impaired class accept the plan. This issue is discussed in greater detail in section (c) of this
proposal.
Because the 1994 amendment to section 1124 did not resolve the issue it was designed to
address, and because the change yielded undesirable consequences, this proposal recommends the
reintroduction of subsection (3) of section 1124 while it directly addresses Congress’
postpetition interest concern in another fashion, which is discussed in the next section of this
proposal.
Competing Consideration
Some people might argue that more classes of creditors should be impaired to
increase creditor involvement. However, creditors that will be cashed out on the effective date of
the plan are unlikely to have strong impetus to be highly involved in the case. Leaving these
creditors impaired goes beyond even the broad notion of impairment that underlies the chapter 11
negotiation process and may dilute the power of creditors that are asked to accept significantly
adverse treatment under the plan.
b) Postpetition Interest For Unsecured Classes of Claims
As stated above, section 1124(3) was eliminated in 1994 in an effort to enable holders of
fully-paid claims to vote on a plan of reorganization so that they could receive postpetition
interest in the rare instance that they would have received interest in a chapter 7 liquidation under
section 726(a)(5). However, section 502(b)(2) excludes unaccrued interest from the allowed
claim, and chapter 11 contains no other express authorization for a liquidation solvent debtor to
pay postpetition interest to unsecured creditors. Although some courts have determined that they
have discretion to grant postpetition interest in appropriate cases, particularly when the debtor
issolvent, [ FN: "Although there are no
provisions comparable to section 726(a) in chapter 11, courts apply the distribution priorities
under section 726(a) to chapter 11 cases. "In re Frontier Properties Inc., 979 F.2d 1358
(9th Cir. 1992). See, e.g.,In re Shaffer Furniture Co., 68 B.R. 827 (Bankr. E.D. Pa.
1987) (court requiring solvent debtor to pay postpetition interest before permitting debtor to
retain interest in estate); accordIn re David Green Property Mgt., 164 B.R. 92, 97 (Bankr.
W.D. Mo. 1994) (payment of postpetition interest not prohibited by Code, thus is within court's
discretion and depends on equities of case);In re San Joaquin Estates Inc., 64 B.R. 534,
536 (Bankr. 9th Cir. 1986) (award of postpetition interest allowed within court discretion when
debtor is solvent).] others believe that section 1129(a)(1) requires a plan to
comport with the provisions of Title 11 and arguably precludes payment of postpetition interest.
When Congress and many parties involved in the bankruptcy system believe that the Code should
not preclude a liquidation-solvent debtor from paying postpetition interest to unsecured creditors,
there is no reason for this ambiguity to remain.
The Recommendation
Section 1123(b) should be amended to establish that a plan may provide for the payment
of postpetition interest on claims at the legal rate if such interest would have been
distributed under section 726(a)(5) if the debtor were liquidated in chapter 7 of Title 11.
Reasons for the Change
This change would authorize the payment of postpetition interest in a chapter 11 plan to
creditors that would have received such interest if the debtor liquidated in chapter 7. Like section
726(a)(5), the recommendation calls for the legal rate of interest. The application of this provision
would not be limited to creditors whose debt instruments contractually entitled them to interest,
and thus the recommendation furthers the policy of providing equal treatment to creditors with
similar priority and preventing discrimination against involuntary unsecured creditors.
This amendment would complement and work in tandem with the section 1129(a)(7)
"best interest test" for dissenting impaired creditors who would be entitled to
postpetition interest if the debtor liquidated in chapter 7. The recommended language would
permit payment of postpetition interest to unimpaired creditors in the case of a
liquidation-solvent debtor. The proposal would not statutorily require payment in this context
because such a requirement could increase litigation in an overly-broad group of cases over the
question of whether a debtor is solvent and could grant too much leverage to creditors that
already are receiving reasonable treatment under the plan. However, the amendment would
provide a statutory basis for a postpetition interest request and is consistent with the discretionary
approach taken by somecourts under the Code [
FN: See infra, note 6.] as well as under the Bankruptcy Act of
1898. [ FN: See 7 Collier on Bankruptcy
¶ 1124.LH[2] at 1124-23 (15 th rev. ed. 1996).] A
liquidation-solvent debtor that refused to pay postpetition interest to unimpaired unsecured
creditors also might be challenged on good faith grounds under section 1129(a)(3), an approach
suggested by the court in the New Valley decision. [ FN: 168 B.R. at 81 (whether good faith provision
required payment of postpetition interest to unimpaired creditors would be factual determination
to be addressed at confirmation hearing).] This amendment could bolster
such an argument.
Most bankruptcy practitioners, regardless of their clientele, seem to agree that
liquidation-solvent debtors should be authorized to pay postpetition interest on the allowed claims
of unsecured creditors, whether or not those claims are impaired. Liquidation-solvent debtors are
relatively rare, and thus enabling amendments should be made cautiously so as not to upset the
negotiation process in the majority of cases.
Competing Consideration
Some might argue that giving unsecured creditors interest prefers interest claims over other
types of claims that are limited by section 502(b), such as lease rejection claims of landlords
[ FN: 11 U.S.C. §502(b)(6) (limiting
damage claim of lessor resulting from termination of lease of real
property).] and certain damage claims of employees. [ FN: 11 U.S.C. §502(b)(7) (limiting damage
claim for termination of employment contract).]
c) Section 1129(a)(10)
The chapter 11 negotiation and plan confirmation process empowers creditors through the
concept of impairment. Chapter 11 is premised on a broad notion of impairment to entail the
participation of all classes of claims affected by the plan. Classes can be impaired in an infinite
number of ways: the plan proponent can delay distribution for thirty days after plan confirmation,
[ FN: In re Hotel Assoc. of Tucson,
165 B.R. 470, 475 (Bankr. 9 th Cir. 1994)(rejecting creditor ’s argument that debtor
"artificially " impaired class by delaying payment 30 days when debtor had sufficient cash to pay
class on effective date).] pay a class of claims all but $75 of their claims,
[ FN: SeeIn re Witt, 60 B.R. 556
(Bankr. N.D. Ohio 1986).] and, at least in the
9th Circuit, enhance the treatment of a class of
claims. [ FN: L&J Anaheim Assocs. v.
Kawasaki Leasing Int'l Inc. , 995 F.2d 940 (9th Cir. 1993).] By relying on
the broadest concept of impairment, the Code almost guarantees that numerous classes in most
reorganization cases are technicallyimpaired so that the claim or interest holders can participate
and vote. [ FN: "Impairment, for the most
part, is not a device to permit or justify the alteration of rights. It is a measuring rod to determine
who may vote, dissent, and invoke the protection of Section 1129(b). " In re Barrington
Oaks, 15 B.R. 952, 959 n. 19 (Bankr. D. Utah 1981) (explaining chapter 11 plan negotiation
under Bankruptcy Code of 1978).] The fact that many of these holders
ultimately are satisfied with the treatment offered by the plan should come as little surprise.
It is in this context that an anomalous provision appears: section 1129(a)(10) requires that at
least one impaired class vote in favor of the plan as a condition of plan confirmation, [ FN: 11 U.S.C. §1129(a)(10) provides "[i]f a
class of claims is impaired under the plan, at least one class of claims that is impaired under the
plan has accepted the plan, determined without including any acceptance of the plan by an insider.
"] a requirement that should have little effect in most cases when such a
wide range of classes of claims are deemed impaired. However, in attempts to prevent the
potential confirmation of a plan, dissenting classes of creditors often seek to revoke the power
that the Code has given to other creditors and challenge the impairment of an accepting class,
alleging that the treatment was altered "artificially." This argument should bear little
weight in a statutory scheme that employs a broad and un-conditioned concept of impairment, but
it has been the source of a great deal of litigation, cost, and delay by disgruntled creditors who
question the right or the choice of their fellow creditor classes to vote in favor of the plan. In
other cases, creditors challenge the plan proponent’s classification of claims and allege that
the plan proponent classified claims improperly to construct an impaired accepting class, even
though the Bankruptcy Code imposes no express restrictions on the ability of a plan proponent to
separately classify similar claims. This issue has provoked a tremendous amount of litigation as
well.
While Congress’ removal of subsection (3) of section 1124 to impair fully-paid
creditors did not accomplish its intended goal, it had an unintended salutary effect on section
1129(a)(10):
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." [ FN: In re Atlanta Stewart Partners, 193
B.R. 79, 82 (Bankr. N.D. Ga. 1996).]
To the extent that section 1129(a)(10) is "functionally repealed" [ FN: See, e.g., Linda J. Rusch, Unintended
Consequences of Unthinking Tinkering: The 1994 Amendment and the chapter 11 Process, " 69
Am. Bankr. L. J. 349, 392 (1995) (change in section 1124 "functionally repealed " section
1129(a)(10)).] at present by the 1994 amendment to section 1124, the
same result can be accomplished directly by re-introducing section 1124(3), as suggested in part
(a) of this proposal, and eliminating section 1129(a)(10). This would reduce cost and delay and
re-establish the equilibrium in chapter 11 without lessening the substantive protection for
dissenting creditors in the confirmation and cramdown standards. As Chief Judge Kahn notes in
the aforementioned quote, it also would permit the parties to "focus on the heart of the
plan" and the fundamental issues in plan confirmation.
The Recommendation
Section 1129(a)(10) of the Bankruptcy Code should be eliminated.
Reasons for the Change
In addition to the voting process, the various confirmation requirements offer creditors both
procedural and substantive protections to ensure fair treatment of dissenting classes of impaired
creditors, particularly in the context of a non-consensual plan. Section 1129(b) mandates that the
plan treat each objecting impaired class fairly and equitably and not discriminate unfairly against
such classes; each of these standards has multiple components. [ FN: 11 U.S.C. §1129(b)(1). The Court of
Appeals for the 9th Circuit recently held that discrimination
between classes must satisfy four criteria to be considered fair under 11 U.S.C. §1129(b):
(1) the discrimination must be supported by a reasonable basis; (2) the debtor could not confirm
or consummate the Plan without the discrimination; (3) the discrimination is proposed in good
faith; and (4) the degree of the discrimination is directly related to the basis or rationale for the
discrimination. In re Ambanc La Mesa Limited Partnership, 95-16872, 1997 WL 277183
(9th Cir. May 28, 1997).] Individual creditor interests are protected in the
confirmation process as well: all plans must have been proposed in good faith and must provide
each individual impaired and dissenting creditor with at least as much as they would have received
in a chapter 7 liquidation. [ FN: 11 U.S.C.
§1129(a)(3), (a)(7).] These provisions are wholly consistent with
the notion of involving impaired creditors in the negotiation and confirmation process to reach
mutually satisfactory solutions while providing baseline protection for the dissenters.
In the midst of these meaningful creditor safeguards is section 1129(a)(10). A late addition to
the Bankruptcy Reform Act of 1978, section 1129(a)(10) was enacted as a reaction to a single
asset real estate case under chapter XII of the Bankruptcy Act of 1898 in which the court
confirmed a cramdown plan that was supported by no classes of materially and adverselyaffected
creditors. [ FN: "It is widely known that the
requirement was designed to ameliorate a perceived harshness inherent in the cramdown
provisions available under the Code in the wake of the decision inIn re Pine Gate
Associates. " In re Duval Manor Assoc., 191 B.R. 622, 628 (Bankr. E.D. Pa. 1996),
citingIn re Pine Gate Associates, 2 Bankr. Ct. Dec. 1478 (N.D.Ga.1976) (permitting
cramdown of chapter XII plan over objection of undersecured mortgage lender that was paid
economic value of lien). " The language of the original provision that became section 1129(a)(10)
apparently was provided by the National Association of Real Estate Investment
Trusts.] However, no longer are the parameters defined by the
Bankruptcy Act’s "material" and "adverse" standard, which
permitted creditor participation only if the creditor would be affected negatively by the plan and
thus fostered uncertainty over whether the value of a creditor's interest would be diminished by a
plan: [ FN: Section 107 of the Bankruptcy
Act of 1898 provided that "creditors" or "any class thereof" was "affected" for purposes of a plan
"only if their or its interest shall be materially and adversely affected thereby." 11 U.S.C.
§507 (Repealed 1978).] under the Code, treatment that is neither
materially different nor adverse can render classes of claims impaired. [ FN: "Impairment under section 1124 has generally
come to mean in its most basic form any alteration of the holder's legal, equitable, or contractual
rights, unless payment in cash of the allowed amount of the claim is made on the effective date of
the plan. " In re Block Shim Development Co., 118 B.R. 450 (N.D. Tex.) (interpreting
pre-1994 impairment definition), aff ’d, 939 F.2d 289 (5th Cir. 1990).
] As such, section 1129(a)(10) provides a procedural roadblock to
cramdown that is premised on a standard that is inapplicable in chapter 11. [ FN: Originally, it was not even clear if the requisite
accepting class of creditors had to be impaired at all, which created a split in the case law.
SeeIn re Victory Construction Co., 42 B.R. 145, 152 (Bankr. C.D. Cal. 1984)
(Discussing case law split and absurdities of various interpretations of provision). Congress
settled this question in the Bankruptcy Amendments and Federal Judgeship Act of 1984 by
amending the provision to clarify that a plan of reorganization had to be approved by at least one
class of impaired creditors. SeeIn re Sun Country Development, 764 F.2d 406, 408 n. 3
(5th Cir. 1985) (because section 1129(a)(10) was clarified, court need not consider whether
unimpaired class accepting plan would have satisfied provision).]
Dissatisfied with this provision’s shortcomings, objecting creditors have attempted to
read more into the requirement and the definition of impairment than what the plain language of
the Code provides. The provision does not on its face preclude a plan proponent from
"intentionally" impairing a friendly class to satisfy the requirement of section
1129(a)(10), and the definition of impairment was intentionally broadened to include less affected
creditors. However, some creditors have sought to limit the ability of other creditors to fill the
role of an impaired accepting class. In response, many courts have responded that any change in
treatment, including a beneficial or nominal change, constitutes impairment under a literal reading
of section 1124. [ FN: L&J Anaheim Assocs.
v. Kawasaki Leasing Int'l Inc., 995 F.2d 940 (9th Cir. 1993) (any alteration of rights, including
abrogation of secured creditor's rights and remedies under Uniform Commercial Code, constituted
impairment in chapter 11); In re Beare, 177 B.R. 886, 889 (Bankr. W.D. Tenn. 1994)
(acceptance of plan by class impaired by delay in payment for 60 -120 days satisfies section
1129(a)(10));In re 7 th Street & Beardsley Partnership, 181 B.R. 426, 431 (Bankr.
D. Ariz. 1994) (Section 1129(a)(10) is a technical requirement for confirmation. It is an obligation
for the proponent of a Plan to fulfill; it is not a substantive right of objecting creditors
").] They have reasoned that "[t]his statute literally allows any
impairment to qualify, and does not specify a degree of impairment in terms of the magnitude of
the impairment or of the claim. Where there is no ambiguity in the statute, federal courts normally
will not interpose equitable qualifications that the legislature has not explicitly put in the
statute." [ FN: In re
Beauchesne, 209 B.R. 266, 275 (Bankr. D. N.H. 1997) ( "the application of the absolute priority
rule is the real protection for the secured creditor, rather than reading "artificial impairment" or a
minimal impairment requirement into section 1129(a)(10) ").] This
approach comports with the Supreme Court’s mandate that courts read the Bankruptcy
Code literally and not "impose their own gloss on unambiguous statutory language."
[ FN: John R. Clemency & John A.
Harris, "The Fight Over ‘Artificial Impairment ’ Under Section 1129(a)(10): It ’s
Time to Call it Quits, " 14-NOV Am. Bankr. Inst. J. 20, 23 n. 10 (1995); United States v. Ron
Pair Enterprises Inc., 489 U.S. 235 (1989).] In courts that hold that the
statute imposes no impediment to impairing classes, section 1129(a)(10) is relatively meaningless
when even a nominal difference in treatment for a class that is being paid in full is sufficient to
qualify for impaired status. [ FN: SeeIn
re Atlanta Stewart Partners, 193 B.R. 79 (Bankr. N.D. Ga. 1996) (first published case to hold
that elimination of section 1124(3) meant that unsecured class of claims that would be paid in full
is impaired for purposes of section 1129(a)(10)).] Yet, objecting creditors
continue to challenge the breadth of the impairment standard in this context, which yields more
litigation and increases costs.
The litigation is exacerbated by the fact that not all courts read sections 1129(a)(10) and
1124 literally. According to the Court of Appeals for the
8th Circuit and courts that have followed its lead, a class of
claims can be "impaired" under section 1124 but "unimpaired" for
purposes of section 1129(a)(10) if the alteration of rights arises from the plan proponent's exercise
of discretion. [ FN: Windsor on the River
Assocs. Ltd. v. Balcor Real Estate Fin. Inc. (In re Windsor on the River Assocs. Ltd.), 7 F.3d 127
(8th Cir. 1993). See, e.g.,In re W.C. Peeler Co. Inc, 182 B.R. 435 (Bankr. D.S.C. 1995)
(because debtor could have paid impaired accepting class sooner out of income, class not truly
impaired and plan not confirmable);In re Investors Fla. Aggressive Growth Fund Ltd.,
168 B.R. 760, 766 (Bankr. N.D. Fla. 1994)(paying unsecured trade debt in four installments when
debtor had other unencumbered assets is not true impairment for purposes of section 1129(a)(10),
thus plan not confirmable);In re North Washington Center Ltd. Partnership, 165 B.R.
805, 810 (Bankr. D. Md. 1994) (debtor proposed to pay trade creditors 80%, but court decided
that debtor could have paid 100%, thus trade creditors not actually
impaired).] This approach, which not surprisingly is somewhat popular in
single asset real estate cases, potentially gives a secured creditor "veto power"
[ FN: David Gray Carlson, The
Classification Veto in Single - Asset Cases under Bankruptcy Code Section 1129(a)(10), 44
S.C.L. Rev. 565, 614 (1993) ("nowhere is it written that a debtor - in - possession has a duty to
maximize the opportunity for one single creditor to veto the proceedings").
] over plan confirmation in the case of a solvent debtor, even if creditors
that are impaired under section 1124 vote to accept the plan. Under this method of analysis, a
court not only substitutes its judgment for the judgment of the claim holders who voted
affirmatively on the plan, but the court also speculates on alternativemethods of restructuring the
debtor that would unimpair various classes of creditors. [ FN: Other courts have been rather critical of this
approach. "We do not believe it is the bankruptcy court's role to ask whether alternative payment
structures could produce a different scenario in regard to impairment of classes. Denying
confirmation on the basis that another type of plan would produce different results would impede
desired flexibility for plan proponents and create additional complications in the already complex
process of plan confirmation. " In re Hotel Assoc. of Tucson, 165 B.R. 470, 475 (Bankr.
9 th Cir. 1994).] Yet, even these courts might have difficulty
circumventing the 1994 change in the impairment definition; several courts already have held that
by eliminating subsection (3) of 1124, Congress has spoken definitively that a claim paid in full at
confirmation is impaired, and thus paying a claim in full without interest is "actual,"
not "artificial," impairment for purposes of section 1129(a)(10). [ FN: SeeIn re Atlanta Stewart Partners, 193
B.R. 79 (Bankr. N.D. Ga. 1996) (elimination of section 1124(3) meant that unsecured class of
claims paid full allowed claim is impaired for purposes of section 1129(a)(10)); In re Park
Forest Development Corp.,197 B.R. 388 (Bankr. N.D. Ga. 1996) (following Atlanta Stewart
Partners, determining that 1994 amendment deemed claims to be impaired and thus could not be
disqualified as "artificially " impaired).]
Section 1129(a)(10) also has been primarily responsible for engendering litigation over the
formation of the classes themselves. This litigation, and corresponding cost and delay, has taken
place almost exclusively in single asset real estate cases. Deleting section 1129(a)(10) would
complement the Commission’s proposal to clarify the rules of claims classification. The
abundant litigation on section 1129(a)(10) prompted the Commission’s proposal
recommending that a plan proponent can classify substantially similar claims separately if
supported by a "rational business justification." This generally is the standard under
case law and works without much dispute in non-single asset cases. Most circuit courts of appeal
already have suggested or established that gerrymandering to satisfy section 1129(a)(10) is not a
business justification and is improper. [ FN:
See, e.g.,In re Greystone III Joint Venture, 995 F.2d 1274, 1279 (5th Cir.1991), cert.
denied , 506 U.S. 821 (1992);In re Holywell Corp., 913 F.2d 873, 880 (11th
Cir.1990).] The classification debate highlights the ways in which section
1129(a)(10) has diverted the analysis of the confirmation standards; courts expend valuable time
and resources considering these issues and repeatedly parsing the statutory language instead of
focusing on the substantive standards protecting the objecting creditor.
Even if one were not disturbed by the cost and delay produced by excessive litigation, the
retention of section 1129(a)(10) is not desirable because its mechanical operation can yield absurd
results. For example, if a plan impaired only one class, and that class was comprised of only
claims of insiders, a consensual plan could not be confirmed because section 1129(a)(10) excludes
insiders from consideration. To confirm this plan that treats all classes very well, the debtor would
have to impair additional classes, which would not be permissible under the
8th Circuit approach. Thus, even if the broad impairment
standard permits seemingly facile satisfaction of the provision, this does not lead to the conclusion
that the provision is benign and should be retained.
To the extent that a single asset real estate case prompted the last-minute enactment
ofsection 1129(a)(10), a more policy-driven and direct remedy to single asset real estate problems
should provide the final justification for the provision’s repeal. Following the lead of
Congress in the Bankruptcy Reform Act of 1994 and in the Technical Corrections Act of 1997,
the Commission is developing proposals to address single asset real estate cases that are not
well-suited to the bankruptcy process and that have skewed chapter 11 case law in this context,
[ FN: Section 1129(a)(10) creates "an
incentive to manipulate classes and engage in counterproductive gamesmanship since courts have
often made result - oriented decisions in single - asset cases, and allowed this behavior. These
decisions have then created precedents which have been wrongly applied in other contexts
involving complex capital structures. " National Bankruptcy Conference ’s Code Review
Project, Reforming the Bankruptcy Code Final Report, 28 (Rev. ed. 1997). ]
as well as many others. Instead of facilitating the expedient resolution of
single asset cases and ensuring that some adversely affected creditors support the plan, section
1129(a)(10) seems to only prolong single asset real estate cases through litigation over
impairment and classification.
The substantive and economic analysis required in consensual cases and the additional
protections in cramdown cover the same ground as section 1129(a)(10), but in a manner that is
much more protective of creditors’ rights. In cases that truly involve bad faith, a concern
that underlies many opinions discussing section 1129(a)(10), courts should be encouraged to use
more direct means already at their disposal to prevent unfairness -- some of which may be
underutilized such as sections 305 or 1112 -- or substantive standards for confirmation. As an
additional source of protection, the Commission has recommended that exclusivity be lifted
whenever a debtor proposes to confirm a new value plan. Many practitioners, including some who
represent secured lenders, have recognized that the new value/exclusivity proposal would protect
creditors’ interests in the absence of section 1129(a)(10). The elimination of section
1129(a)(10) would ameliorate the excessive litigation over issues that are not germane to the
fundamental questions surrounding the confirmation of a chapter 11 plan.
Competing Considerations
Although most would agree that section 1129(a)(10) serves little function in chapter 11 cases
involving operating businesses, some parties have argued that section 1129(a)(10) is necessary in
single asset real estate cases, especially when the secured creditor buys the claims of all other
creditors and thus controls all classes, whether or not the classes are impaired. However, in cases
that essentially are two-party disputes, a court has more direct means at its disposal to prevent
unfairness. In addition, as previously discussed, the Commission is developing a number of
proposals specifically designed to deal with single asset real estate problems.
Some believe that section 1129(a)(10) serves a symbolic function and thus should not be
removed. However, whatever symbolic function might be served by this provision comes at a high
cost.
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