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When 100 cents on the dollar is not enough: present value analysis and Chapter 11.

The primary purpose of a Chapter 11 case is the negotiation between a debtor and its creditors of a plan of reorganization which restructures the debtor's finances and provides the basis for repaying creditors. However, Chapter 11 plans are notorious for repaying unsecured creditors something less than the face amount of aims. Plans feature a variety of payment terms; for example, plans are proposed that provide for unsecured creditors to exchange a part or all of their claims for equity in the reorganized debtor; for unsecured creditors to exchange a part or all of their claims for a note in the reorganized debtor; for a combination of the first and second options; or, simply for claims to be paid in part or full, immediately or over time.

The Ninth Circuit Court of Appeals, in In re Perez (30 F.3d, 1209, 1994), recently faced the issue of whether a plan that proposed to pay unsecured creditors 100 cents on the dollar over five and one-half years, without interest, was confirmable. The Perez court applied a basic principle of modern finance, present value analysis, to Chapter 11 and held that as the plan did not compensate certain unsecured creditors for the lost time value of their money, it did not pay their claims in full. The debtor, who held a junior interest, proposed to retain property which rendered the plan unconfirmable.

The Disclosure Statement

A debtor has the exclusive right to file a plan of reorganization during the first 120 days after the bankruptcy filing (although this may be terminated by parties in interest upon a showing of "cause"), and upon the filing of a plan, this "exclusivity period" is extended for an additional 60 days for voting purposes. Prior to any vote on a plan, a debtor proposing a plan must first obtain bankruptcy court approval of a disclosure statement. The purpose of the disclosure statement is to provide impaired creditors with adequate information as to their treatment under a plan so they may make an informed decision when they cast their votes.

The Plan of Reorganization

A plan of reorganization is the vehicle by which a debtor discharges its pre-petition obligations and provides the method for repayment of its obligations. Generally, the hallmark of the plan process is flexibility, and creditors can agree to any treatment of their claims. A plan segregates creditors' claims into classes and describes how such creditor classes are to be treated. The plan must state whether the creditor class is impaired or unimpaired. A class is impaired if the plan alters its legal rights (e.g., creditors within the class will not be paid according to the terms of their respective agreements with the debtor).

Voting to accept or reject a plan is limited only to those creditors impaired under the plan. An impaired creditor class is deemed to have accepted the plan if the plan is approved by at least two-thirds in dollar amount and one-half in number of voting creditors in that class. Those creditors in an accepting creditor class that reject the plan are protected by what is called the "best interests of creditors' test" which requires that rejecting creditors receive as much under the Chapter 11 plan as they would in a Chapter 7 liquidation.

A plan may be confirmed by one of two methods. The most common method is by consent, e.g., all impaired creditor classes vote to accept the plan. Another method is by "cramdown," wherein at least one impaired creditor class votes to accept the plan, the plan does not discriminate unfairly and is fair and equitable as to each impaired creditor class that rejects the plan. In other words, the cramdown provides for confirmation of a plan notwithstanding its rejection by one or more impaired creditor classes.

Cramdown and Unsecured Creditors

A cramdown plan meets the fair and equitable test in one of two situations. First, a cramdown plan is fair and equitable if an unsecured creditor class receives property with a present value equal to the full amount of its claims as of the effective date of the plan. Present value analysis is employed where a plan dictates payment on claims over time. The rationale supporting present value analysis is that a dollar received today is more valuable than a dollar received six months from today as a dollar received today can be invested and earn interest. Where a plan provides for a creditor class to be paid over time, the claims are discounted to present value to determine whether the deferred payments actually result in full payments to the creditor class.

The discount rate is determined by courts who use the interest rate a debtor would pay as a borrower of a like amount on like terms in the commercial loan market as a benchmark.

Second, a cramdown plan is fair and equitable if no junior creditor class or shareholder class retains or receives anything where a senior creditor class rejects the plan and is not being paid in full, the so-called "absolute priority rule."

The Perez Case Facts

A creditor (the Creditor) obtained an unsecured judgment against Perez (the Debtor), who responded by filing a personal Chapter 11 bankruptcy. The Debtor's plan classified the Creditor's claim with other unsecured creditors. Because the Creditor's claim was so large, he controlled the vote of his class. The Creditor voted to reject the plan, which caused the class to reject the plan. The Creditor objected to his treatment under the plan. While the plan stated that it offered 100 cents on the dollar for his claim, the Creditor complained that because the plan provided for deferred payments on his claim (payment over 67 months without interest), it did not actually result in full payment. The Ninth Circuit discounted the payment stream the Creditor was to receive in the future to present value and found the Creditor was not compensated for the lost time value of his money. Since under the proposed plan the Creditor was not actually offered 100 cents on the dollar, yet provided that the Debtor would retain certain property, the Ninth Circuit found the absolute priority rule was violated. As a result, confirmation of the plan was denied.

Objections of Unsecured Creditors

The plan process has built-in protections for an unsecured creditor class that rejects a plan. The Ninth Circuit opinion makes clear a cramdown plan is not confirmable unless the objecting unsecured creditor class is paid in full as of the effective date of the plan, in present value dollars, in a case where junior creditors or shareholders receive or retain anything. In other words, objecting unsecured creditor classes whose claims are to be paid over time are entitled to market-rate interest in such situations.

Scott E. Blakeley is an attorney in the Los Angeles office of Bronson, Bronson & McKinnon, practicing exclusively in bankruptcy and creditors' rights law.
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Author:Blakeley, Scott E.
Publication:Business Credit
Date:Apr 1, 1995
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