Bankruptcy Code Section 1129(b)(2)(A) Does Not Authorize Confirmation of "Cramdown" Plans

In its June 28, 2011 opinion, the Seventh Circuit Court of Appeals held that Bankruptcy Code § 1129(b)(2)(A) does not authorize confirmation of a debtor’s Chapter 11 plan over the objection of a secured creditor where the debtor seeks to sell assets free and clear of that creditors’ liens, unless that creditor is provided the opportunity to “credit bid” the amount of its liens at the asset sale.

In re River Road Hotel Partners, LLC, 2011 WL 2547615 (7th Cir. 2011). The decision is significant in that its ruling is contrary to the 3rd Circuit’s recent opinion in In re Philadelphia Newspapers, 599 F.3d 298 (3d Cir. 2010) which held that a plan proposing to sell a debtor’s encumbered assets free and clear of liens in an auction where credit bidding would not be allowed could qualify as “fair and equitable” under § 1129(b)(2)(A)(iii).

The Court stated that by granting secured creditors the right to credit bid, the Bankruptcy Code ensures that their liens will not be extinguished for less than face value without their consent and that this protection is important since there are a number of factors that create substantial risk that assets sold in bankruptcy auctions will be undervalued. While the right to credit bid has always been required in a sale pursuant to Bankruptcy Code § 363, this decision ensures that a debtor cannot sidestep the requirement by selling assets outside of § 363.

In River Road Hotels, the Debtors developed a hotel in Chicago for which they received over $155 million in construction loans from certain construction lenders (the “Lenders”). In the Plan, the Debtors sought to sell substantially all of their assets free and clear of the Lenders’ liens with the proceeds to be distributed to creditors according to the priority rules set forth in the Bankruptcy Code. In connection with the Plan, the Debtors filed a motion requesting approval of proposed procedures for conducting the asset sale. The Lenders objected to the proposed bid procedures because the Lenders’ interests were impaired under the Plan without their approval and yet the Plan did not provide Lenders’ the opportunity to bid the amount of their liens at the asset auction as required under § 1129(b)(2)(A)(ii). The Debtors argued that while the Plan did not comply with § 1129(b)(2)(A)(ii)’s requirements, it is still confirmable under § 1129(b)(2)(A)(iii), consistent with the Philadelphia Newspapers decision, because it provides Lenders the “indubitable equivalent” of their claims. Therefore, the issue addressed by the Seventh Circuit concerned the proper interpretation of § 1129(b)(2)(A) and its subsections.

Plans that are confirmed under § 1129(b) are often referred to as cramdown plans because they have been “crammed down” the throats of objecting creditors. Section 1129(b)(1) requires a plan must be “fair and equitable” with respect to each class of impaired creditors that have not otherwise accepted the plan. Section 1129(b)(2)(A) defines what constitutes “fair and equitable” treatment in the secured creditor context. In River Road Hotels, the Seventh Circuit found that the first two subsections of § 1129(b)(2)(A) set forth the specific conditions that a plan seeking to sell encumbered assets in particular manners must meet. Subsection (i) sets forth the requirements that apply to plans where the debtor seeks to retain possession of or sell an encumbered asset with the liens attached. Subsection (ii) sets forth requirements that apply to plans that seek to sell an encumbered asset free and clear of liens. Meanwhile, subsection (iii) states that a plan must provide for the realization by secured creditors of the indubitable equivalent of their claims. According to the Debtors, a plan satisfying this general requirement—the indubitable equivalence standard—should be granted “fair and equitable” status.

In rejecting the Debtors’ interpretation of § 1129(b)(2)(A)(iii), the Court held that under the Debtors’ interpretation, plans could qualify for treatment under subsection (iii) even if they seek to dispose of encumbered assets in the ways discussed in subsections (i) and (ii), but fail to meet those subsections’ requirements. Instead, the Court held that the proper interpretation is that plans can only qualify as “fair and equitable” under subsection (iii) if they propose disposing assets in ways that are not described in subsections (i) and (ii). Because the Debtors’ suggested reading of subsection (iii) would nullify subsections (i) and (ii) and ignore protections for secured creditors recognized in other Bankruptcy Code provisions, the Court rejected the Debtors’ interpretation and held that the Bankruptcy Code requires cramdown plans that contemplate selling encumbered assets free and clear of liens at an auction satisfy the requirements set forth in subsection (ii) and in particular, that such secured creditors be allowed the opportunity to credit bid the amount of their secured claim at the auction.