United States: First Impressions: The Sixth Circuit Weighs In On Artificial Impairment Under A Chapter 11 Plan

One of the prerequisites to confirmation of any chapter 11 plan is that at least one "impaired" class of creditors must vote in favor of the plan. This requirement reflects the basic (but not universally accepted) principle that a plan may not be imposed on a dissident body of stakeholders of which no class has given approval. However, it is sometimes an invitation to creative machinations designed to muster the requisite votes for confirmation of the plan.

"Strategic" classification can entail, among other things, "manufacturing" an impaired class even though the impairment is immaterial. For example, the plan could pay creditor claims nearly, but not entirely, in full or modify the rights of the creditors in the class in some incidental way—in either case, with such minimal effect that creditors are still willing to vote to accept the plan despite slight impairment of their claims. Sometimes referred to as "artificial impairment," this practice is controversial.

So much so, in fact, that there is a split among the federal circuit courts of appeal concerning its legitimacy. In Village Green I, GP v. Federal National Mortgage Association (In re Village Green I, GP), 2016 BL 20874 (6th Cir. Jan. 27, 2016), the Sixth Circuit weighed in on this debate as a matter of first impression. It joined the Fifth and Ninth Circuits in ruling that artificial impairment does not preclude a plan from satisfying the impaired class acceptance requirement, but instead is relevant in determining whether the debtor has proposed a chapter 11 plan in good faith.


Only impaired classes of creditors are entitled to vote on a chapter 11 plan. Holders of claims that are not impaired by a plan are deemed to accept it. Section 1124 of the Bankruptcy Code provides that a class of claims is impaired under a plan unless the plan provides the following treatment for each claimant in the class: (1) "leaves unaltered the legal, equitable, and contractual rights" to which the claimant is entitled; or (2) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates the claimant for resulting losses.

Section 1124 is derived from section 107 of chapter X of the former Bankruptcy Act of 1898 (repealed in 1978), which provided that "creditors" or "any class thereof" would be "affected" for purposes of a plan—and therefore entitled to vote—"only if their or its interest shall be materially and adversely affected thereby." The legislative history indicates that when section 1124 was enacted as part of the present-day Bankruptcy Code in 1978, floor leaders for the final version of the bill stated that the provision "defines the new concept of 'impairment' of claims or interests; the concept differs significantly from the concept of 'materially and adversely affected' under the Bankruptcy Act." 124 Cong. Rec. H11,103 (daily ed. Sept. 28, 1978); 124 Cong. Rec. S17,419‒17,420 (daily ed. Oct. 6, 1978).

Section 1124 originally included a third option for rendering a claim unimpaired—by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that a solvent debtor's chapter 11 plan which paid unsecured claims in full in cash, but without postpetition interest, did not impair the claims. Due to the perceived unfairness of New Valley, Congress removed the "cash out" option from section 1124 in 1994.

Impaired Class Acceptance as a Condition to Cramdown

Even if all impaired classes of creditors do not vote to accept a chapter 11 plan, the plan may still be confirmed under the Bankruptcy Code's nonconsensual, or "cramdown," provisions. Among those is the requirement in section 1129(a)(10) for at least one impaired class to vote to accept the plan (without counting insider votes).

This requirement operates as one of several statutory gatekeepers to cramdown. Although there is some disagreement on this point, section 1129(a)(10) is supposedly premised on the policy that, before compelling creditors to bear the consequences associated with cramdown, at least one class whose members are not being paid in full (or whose claims are otherwise impaired) should be willing to go along with the chapter 11 plan. Compare In re Windsor on the River Assocs., Ltd., 7 F.3d 127, 131 (8th Cir. 1993) (interpreting legislative history to suggest that the purpose of section 1129(a)(10) "is to provide some indicia of support by affected creditors and prevent confirmation where such support is lacking") with Final Report and Recommendations of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 (December 8, 2014) (the "ABI Commission Report") p. 258 (recommending removal of section 1129(a)(10) from the Bankruptcy Code and stating that "[a]lthough some courts and commentators suggest that section 1129(a)(10) was intended to ensure that a plan had some creditor support, neither the legislative history nor the Bankruptcy Code indicate[s] such a purpose") (citations omitted).

Artificial Impairment

Courts disagree whether section 1129(a)(10) draws a distinction between "artificial" and "economically driven" impairment. For example, in Windsor, the Eighth Circuit ruled that "a claim is not impaired [for purposes of section 1129(a)(10)] if the alteration of the rights in question arises solely from the debtor's exercise of discretion." According to this approach, section 1129(a)(10) recognizes impairment only to the extent that it is caused by economic "need."

Many courts have applied Windsor to deny confirmation of a chapter 11 plan impairing the de minimis claims of some creditors for the purpose of contriving a class to accept the plan. See, e.g., In re Combustion Engineering, Inc., 391 F.3d 190, 243‒44 (3d Cir. 2003); In re All Land Investments, LLC, 468 B.R. 676, 690 (Bankr. D. Del. 2012); In re Daly, 167 B.R. 734, 737 (Bankr. D. Mass. 1994); see also In re Deming Hospitality, LLC, 2013 BL 93045, *6 (Bankr. D.N.M. Apr. 5, 2013) (stating that "[i]f there is no economic justification for failing to pay Class 6 in full after confirmation rather than the proposed 75%, then the impairment of the class likely would be 'artificial' and impermissible"); In re Swartville, LLC, 2012 BL 211034, *2 (Bankr. E.D.N.C. Aug. 17, 2012) ("artificial impairment" refers to a scenario where a debtor "deliberately impairs a de minimis claim solely for the purpose of achieving a forced confirmation over the objection of a creditor"). These courts have reasoned that allowing manipulation of this kind undermines the policy of consensual reorganization expressed in section 1129(a)(10).

Other courts, including the Fifth and Ninth Circuits, have concluded that artificial impairment does not violate section 1129(a)(10). In L & J Anaheim Assocs. v. Kawasaki Leasing Intl., Inc. (In re L & J Anaheim Assocs.), 995 F.2d 940 (9th Cir. 1993), the Ninth Circuit ruled that section 1129(a)(10) does not distinguish between discretionary and economically driven impairment. According to the court, "[T]he plain language of section 1124 says that a creditor's claim is 'impaired' unless its rights are left 'unaltered' by the plan," and "[t]here is no suggestion here that only alterations of a particular kind or degree can constitute impairment." Accord In re Greate Bay Hotel & Casino, Inc., 251 B.R. 213 (Bankr. D.N.J. 2000); In re Duval Manor Assocs., 191 B.R. 622 (Bankr. E.D. Pa. 1996). In Western Real Estate Equities, LLC v. Village at Camp Bowie I, LP (In re Village at Camp Bowie I, LP), 710 F.3d 239, 245 (5th Cir. 2013), the Fifth Circuit joined the Ninth Circuit in holding that section 1129(a)(10) "does not distinguish between discretionary and economically-driven impairment" and that "any alteration of a creditor's rights, no matter how minor, constitutes impairment" (citations and internal quotation marks omitted).

However, most courts taking this approach have concluded that artificial impairment is relevant to the issue of whether the debtor proposed its chapter 11 plan in good faith. Section 1129(a)(3) of the Bankruptcy Code provides that a plan may be confirmed only if "proposed in good faith and not by any means forbidden by law." Even if artificial impairment is not impermissible per se, these courts have held, proposing a contrived impaired class may constitute bad faith. See Camp Bowie, 710 F.3d at 247; FNMA v. Village Green I, GP, 483 B.R. 807 (W.D. Tenn. 2012) (refusing to reject artificial impairment outright but holding that, under either section 1129(a)(3) or 1129(a)(10), the debtor must demonstrate some economic justification for delaying payment to de minimis creditors); In re The Beare Co., 177 B.R. 886 (Bankr. W.D. Tenn. 1994).

The Sixth Circuit had an opportunity to examine the concept of artificial impairment in Village Green.

Village Green

Village Green I, GP (the "debtor") purchased an apartment complex in Memphis, Tennessee, in 2005 with secured financing provided by the Federal National Mortgage Association ("FNMA"). FNMA commenced a foreclosure proceeding after the debtor defaulted on the mortgage in December 2009. The debtor filed for chapter 11 protection in April 2010 in the Western District of Tennessee to halt the foreclosure proceeding.

At the time of the bankruptcy filing, the apartment complex—the debtor's only asset—was valued at $5.4 million. FNMA was owed $8.6 million. Apart from FNMA, the debtor's only creditors were its former accountant and lawyer, who were owed approximately $740 and $1,600, respectively, on an unsecured basis.

The debtor's proposed chapter 11 plan classified FNMA's secured claim into one class, while creating two separate classes of unsecured claims. The first class of unsecured claims contained FNMA's deficiency claim (approximately $3.2 million). The other unsecured class contained the claims of the lawyer and the accountant, which totaled approximately $2,340.

Under the plan, FNMA was to receive deferred cash payments in respect of its $5.4 million secured claim for 10 years, secured by a mortgage on the property with slightly modified terms. At the expiration of the 10-year period, FNMA would receive a balloon payment from the proceeds of a mortgage refinancing. With respect to FNMA's unsecured deficiency claim, the plan proposed to pay FNMA deferred cash payments for 10 years, with any remaining balance to be paid from the proceeds of the mortgage refinancing. The separately classified unsecured claims of the lawyer and the accountant were to be paid in full, but in two equal installments 30 and 60 days after the plan's effective date.

Prior to voting on the plan, FNMA offered to acquire the claims of the lawyer and the accountant at 100 cents on the dollar, payable immediately. The lawyer and the accountant rejected the offer.

FNMA voted to reject the plan with respect to its secured and unsecured claims. The lawyer and the accountant voted in favor of the plan.

The bankruptcy court confirmed the plan. Among other things, the court ruled that: (i) the class consisting of the lawyer and accountant claims was impaired due to the 60-day payment delay; and (ii) because that impaired class voted in favor of the plan, the plan satisfied section 1129(a)(10).

FNMA appealed to the district court, which vacated the confirmation order and remanded the case below for a determination whether the debtor proposed the chapter 11 plan in good faith. The bankruptcy court found that the plan was proposed in good faith, reasoning that the debtor was "economically justified in rationing every dollar" under the plan. However, after the district court again vacated and remanded the ruling, the bankruptcy court ultimately lifted the automatic stay to permit FNMA to continue its foreclosure proceeding and, sua sponte, dismissed the debtor's chapter 11 case. The district court affirmed those rulings, and the debtor appealed to the Sixth Circuit.

The Sixth Circuit's Ruling

Even though the rulings below involved relief from the automatic stay and dismissal of the debtor's chapter 11 case, the Sixth Circuit addressed two different, albeit related, issues on appeal: (i) whether the lawyer and accountant class was impaired for purposes of section 1129(a)(10); and (ii) whether the debtor proposed its chapter 11 plan in good faith, as required by section 1129(a)(3).

Addressing the first issue, the Sixth Circuit joined the Fifth and Ninth Circuits in holding that "Section 1124(1) by its terms asks only whether a plan would alter a claimant's interests, not whether the debtor had bad motives in seeking to alter them." Instead, the court wrote, the debtor's motives "are expressly the business of § 1129(a)(3)." According to the Sixth Circuit, because section 1129(a)(3) expressly requires an inquiry into the debtor's motives in proposing a plan, "there is no reason to graft that inquiry onto the plain terms of § 1124(1)."

The Sixth Circuit faulted the bankruptcy court's good faith finding. In concluding that the debtor's chapter 11 plan was feasible, the Sixth Circuit explained, the bankruptcy court found that the debtor would have more than sufficient cash on the effective date to pay off its minor unsecured claims immediately. Moreover, the Sixth Circuit wrote, the fact that the lawyer and the accountant were closely allied with the debtor "compounds the appearance that impairment of their claims had more to do with circumventing the purposes of § 1129(a)(10) than with rationing dollars." The purported rationale underpinning good faith evaporated completely, the court noted, when the accountant and the lawyer rejected FNMA's offer to pay their claims in full immediately.

Remarking that "the minor claims' impairment was transparently an artifice to circumvent the purposes of § 1129(a)(10)," the Sixth Circuit affirmed the district court's rulings.


With Village Green, three circuits have now staked out the position rejecting any distinction between economically driven and artificial impairment for purposes of section 1129(a)(10). Under this view, if one or more claims are impaired in accordance with the plain meaning of section 1124, regardless of whether the claims are "materially or adversely affected"—a concept from prior law that was rejected in enacting section 1124—a class containing the claims which votes in favor of a plan can satisfy the impaired class acceptance requirement for confirmation of a cramdown chapter 11 plan. Artificial impairment under these authorities, however, is relevant in assessing whether a debtor has proposed its plan in good faith.

Interestingly, at the district court level, the debtor made two arguments that the Sixth Circuit did not consider on appeal. First, the debtor argued that elimination of the cash-out provision in section 1124 in 1994 had the effect of broadening the definition of impairment, thereby undermining the Eighth Circuit's rule in Windsor that artificial impairment and the debtor's "motives in creating the impaired class" are relevant for purposes of section 1129(a)(10). See Village Green I, GP v. FNMA, 523 B.R. 581, 591–92 (W.D. Tenn. 2014), aff'd, 2016 BL 20874 (6th Cir. Jan. 27, 2016). The district court rejected this argument, noting that the debtor "has not persuaded the Court that the 1994 amendments to § 1124 have any bearing on the issue of whether the plan impaired the de minimis claims without justification." Id.

Second, the district court downplayed the debtors' argument that artificial impairment essentially results in "single asset real estate cases [being] judged by a different standard than any other business Chapter 11 case." According to the district court, the debtor "must demonstrate some economic justification for delaying payment to the de minimis creditors," failing which, based on the totality of the circumstances, and thus not a generalized rule for single-asset real estate cases, the debtor will be found not to have proposed its plan in good faith. Id.

Finally, in the ABI Commission Report, the commissioners recommended that acceptance by at least one impaired class should not be required as a condition to confirmation of a chapter 11 plan and that section 1129(a)(10) should be removed from the Bankruptcy Code. The commissioners were skeptical of the policy considerations attributed to the provision, noting that, "given the variation in class composition and the different motives and objectives of creditors, a non-accepting class does not necessarily equate to lack of creditor support for the plan." ABI Commission Report p. 258. The commissioners debated the advantages and disadvantages of the "gating role served by section 1129(a)(10)," but ultimately determined that "the potential delay, cost, gamesmanship, and value destruction attendant to section 1129(a)(10) in all cases significantly outweighed its presumptive gating role." Id. at p. 261.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Mark G. Douglas
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.