Authored by Tye C. Hancock, Joseph E. Bain, and Evelyn Breithaupt
Recently, in the case of In re Village at Camp Bowie, I, L.P., 710 F.3d 239 (5th Cir. 2013), the Fifth Circuit announced a rule that provides greater flexibility to debtors seeking to successfully emerge from Chapter 11. Under Chapter 11 of the Bankruptcy Code, a plan of reorganization cannot be confirmed unless at least one “impaired” class claims has voted to accept the plan. 11 U.S.C. § 112 (a)(10). Generally, a class of claims is impaired under a plan of reorganization if its members’ rights under applicable non-bankruptcy law are altered in any respect. In many cases, debtors will attempt to intentionally alter (in a non-material way) the rights of a “friendly” class in order to obtain the necessary vote of acceptance from the “impaired” class of creditors. In Village at Camp Bowie, I, L.P., the Fifth Circuit upheld this method of “artificial” impairment as compliant with the plain language of the Bankruptcy Code.
The debtor, Village at Camp Bowie I, LLC (the “Village”), owned real estate in Fort Worth, Texas. Western Real Estate Equities, LLC (“Western”) acquired the debtor’s secured debt “with an eye toward displacing the Village as owner of the underlying real estate.”
The Village filed Chapter 11 bankruptcy to avoid Western’s scheduled foreclosure. The Village eventually filed a plan of reorganization that provided for two impaired voting classes: Western and unsecured trade creditors. The trade creditors were minimally impaired: they would be paid in full three months after the effective date of the plan, even though the Village had enough cash to pay them in full upon confirmation. Western voted against the plan and filed a plan objection. However, the trade creditor class voted in favor of the plan.
At the confirmation hearing, Western contended that the plan could not be confirmed because it did not satisfy Section 1129(a)(10), which requires acceptance of the plan by at least one impaired class of claims. Western contended that the trade creditors were “artificially” impaired and that “artificial impairment” violates Chapter 11’s good faith requirement under Section 1129(a)(3).
The bankruptcy court confirmed the plan validating the concept of artificial impairment under the Bankruptcy Code. Western appealed.
Fifth Circuit’s Ruling
The Fifth Circuit agreed with the Bankruptcy Court and held that acceptance of a plan by an artificially impaired class satisfies Section 1129(a)(10). Section 1124 of the Code defines impairment, stating that a class of claims is impaired under a plan unless the plan “leaves unaltered the legal, equitable, and contractual rights” of the claimants. This definition, at least in the Fifth Circuit, does not distinguish between economically motivated and discretionary impairment of claims.
In so ruling, the Fifth Circuit chose a side in a split among the circuits. In In re Windsor on the River Associates, Ltd., 7 F.3d 127 (1993), the Eighth Circuit held that “a claim is not impaired … if the alteration of the rights in question arises solely from the debtor's exercise of discretion.” However, the Ninth Circuit, in In re L&J Anaheim Associates, 995 F.2d 940 (1993), held that § 1129(a)(10) does not distinguish between discretionary and economically driven impairment.
Reasoning that “the Bankruptcy Code must be read literally,” the Fifth Circuit followed the Ninth Circuit’s reasoning, holding that “impairment” has the same definition under either Section 1124 or Section 1129(a)(10). The court rejected any inquiry into the debtor’s motive for the impairment, and noted that the anti-gerrymandering principle set forth in In re Greystone III Joint Venture, 995 F.2d 1274 (5th Cir. 1991), does not override the plain language of Section 1129(a)(10).
- The flexibility granted to the plan proponent by the Fifth Circuit in Camp Bowie brings renewed emphasis on the ability to proffer a reorganization plan over the objection of a secured lender. Under Bankruptcy Code § 1121, only the Debtor can offer a plan during the first 120 days of a bankruptcy case, which the Court can extend up to 18 months “for cause.”
- Although the Fifth Circuit dismissed the good faith arguments advanced in Camp Bowie, the court expressly did not “suggest that a debtor's methods for achieving literal compliance with § 1129(a)(10) enjoy a free pass from scrutiny under § 1129(a)(3)[’s]” good faith requirement. In particular, “[a]n inference of bad faith might be stronger where a debtor creates an impaired accepting class out of whole cloth by incurring a debt with a related party, particularly if there is evidence that the lending transaction is a sham.”
- Accurate collateral valuation is critical to thetreatment of a secured creditor in Chapter 11.
- In appropriate circumstances, secured creditors should consider purchasing a blocking position in another class of claims in order to defeat confirmation of an unfavorable plan.