United States: Cramdown Plan Of Reorganization: "Dirt-For-Debt"

Last Updated: September 23 2013
Article by Vicki Harding

In re Investors Lending Group, LLC, 489 B.R. 307 (Bankr. S.D. Ga. 2013) –

The treatment of a bank's claim under a Chapter 11 plan of reorganization became the last issue that required resolution in order to confirm the proposed plan.  The bank's debt was secured by 12 separate pieces of property with an aggregate value in excess of its debt.  After the creditors' committee filed a competing plan, the debtor and committee submitted a joint plan that proposed to surrender 5 of the 12 parcels to the bank in full satisfaction of its claim.  The bank objected, arguing that this treatment did not provide the bank with the "indubitable equivalent" of its claim, as required for cramdown purposes.

Initially the debtor had proposed to retain all 12 parcels subject to the bank's lien, with the bank debt restructured to provide 5.25% interest with amortization over 20 years.  Release prices for each parcel were to be set at 60% of the scheduled values as of the petition date.  The bank objected to the debtor's valuation of the parcels as being too low (i.e. it should receive more in connection with release of a parcel).  It argued that replacement or fair market value should be used because the debtor intended to retain possession.

This particular dispute was overtaken by events when the debtor and committee proposed their joint plan, which switched to partial "dirt-for-debt" treatment – meaning that the debtor would surrender some of the parcels in full satisfaction of the bank's debt.  This time the bank objected to the proposed valuation of the surrendered properties on the basis that it was too high  (i.e. the actual value of surrendered properties was lower, so that the parcels were insufficient to pay the bank's claim in full).

So, the bank retained its own appraiser and proposed new, lower values.  Although the debtor and committee believed that they could support higher numbers, they accepted the bank's values in order to avoid further litigation.  Using the bank's lower values, the plan was modified to increase the number of surrendered properties from 5 to 7 out of the 12 properties.

After all of the other objections to confirmation were resolved, the bank continued to object to use of its own values in forcing it to accept surrender of only a portion of its collateral in full satisfaction of its debt.  As of the hearing, bank was owed ~$714,000.  Based on the bank's values as accepted by the debtor and committee, the value of the 12 properties was $940,000, and the value of the 7 properties to be surrendered was $752,000.  (The debtor planned to retain the remaining 5 parcels with a value of $188,000.)  The bank objected that (1) $8,000 was an insufficient equity cushion, and (2) the values should be revisited and reduced to liquidation values or should include carrying costs not included in the bank's appraisal.

This dispute was taking place in the context of a cramdown fight.  A cramdown plan must be "fair and equitable," which includes requirements specifically applicable to secured creditors.  (See discussion in RadLAX: Supreme Court Speaks On Credit Bidding.)  Under Section 1129(b)(2)(A) of the Bankruptcy Code, one alternative is to provide the secured creditor the "indubitable equivalent" of its claim.  The court started by noting that if a claim is oversecured, the indubitable equivalent is its face value.  Consistent with this concept, the court had previously sanctioned partial surrender of collateral in full satisfaction of a claim as providing the indubitable equivalent of the claim.

The court concluded that where the debtor proposes to surrender property, a foreclosure or liquidation type value is appropriate.  However, in this case it found that the bank was estopped from arguing that the value it proposed and consented to was not a foreclosure value.  On the other hand, the court also agreed that precedent suggested that the court should take a conservative approach.

So, although the bank was bound by the values it agreed to, the court made adjustments to reflect that in a sale of the surrendered parcels the lender would be able to recover only the net amount after paying a typical realtor's commission and closing costs.  Consequently, the court approved reducing the values for each of the parcels by 8%.

The court concluded by determining that confirmation would be denied unless the debtor offered to surrender property with agreed values totaling $810,000 (i.e. so that the total value would still be sufficient after deducting 8%).  The court invited the debtor and committee to file an amended plan as suggested, advising that the plan could then be confirmed without further notice or hearing.  Not surprisingly, the debtor and committee immediately filed plan amendments, and an order confirming the plan was entered within a couple of weeks.

In the proper circumstances – such as a debtor with inventory of real estate and an oversecured creditor – a dirt-for-debt plan could be a very attractive option.  Of course, the devil is in the details, which in this case includes valuation of the real estate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Vicki Harding
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