This is the next (long overdue) post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In this post, we’ll switch to Section F of the Report regarding “Plan Voting and Confirmation Issues.” Subsection 1, the focus of this post, addresses “Class Acceptance Generally and for Cramdown Purposes.”
Overview of Plan Voting
Generally, “impaired” creditors may vote to accept or reject a Chapter 11 plan. Although the concept of impairment is beyond the scope of this post, impairment is measured by the impact of the plan on a creditor, not the impact of the bankruptcy case on the creditor. Under Section 1122 of the Bankruptcy Code, a plan proponent may designate different voting classes, with each class to only contain claims or interests that are similarly-situated. Classification is critical and, thus, subject to manipulation because (i) it can determine whether a class accepts a plan under Section 1126(c) (i.e., at least 2/3 of the amount and more than 1/2 of the number of claims votes to accept) and (ii) cramdown under Section 1129(b) requires at least one accepting impaired class. The Commission refers to the “one-half number of allowed claims” requirement as the “numerosity” requirement. The Commission points out that the “original purpose of classification was to provide equal treatment for similarly situated creditors.” Similarly, the original purpose of the dollar amount and numerosity requirements was to protect minority claimants and interest holders.
Rethinking the Numerosity Requirement
Ultimately, the Commission recommends that a “one creditor, one vote” rule should replace the numerosity requirement in Section 1126(c), particularly given the “anecdotal evidence” that it has “served, at best, a nominal role in determining class support for a plan.” Although the Commission discussed various alternatives to the numerosity requirement, it concluded that the “one creditor, one vote” rule is the “most democratic” and is “less susceptible to abuse” than the numerosity requirement. However, the Commission recognizes that identifying the “one creditor” may present issues too. As a solution, it suggests that “affiliated entities under common investment management” should be treated as a single creditor while “expressly recognizing the different capacities (e.g., indenture trustee and lender) in which a single creditor may hold claims.”
Rethinking the “One Impaired Accepting Class” Requirement
The Commission also recommends eliminating Section 1129(a)(10) (i.e., the requirement that at least one accepting impaired class is necessary for cramdown). Specifically, the Commission weighed the potential utility of the rule (playing a “gating role” for confirmation) against the potential for abuse (buying claims to control voting and “artificial impairment”). On the one hand, the Commission points out that strategic claims buying can permit a single creditor to block cramdown by making it impossible for a plan proponent to satisfy Section 1129(a)(10). Indeed, even the prospect of claims buying will keep debtors’ lawyers up at night, especially in cases that hinge on the votes of minor or just a few claims. On the other hand, the Commission points out that “artificial impairment” can position a plan proponent to satisfy Section 1129(a)(10) when it might not otherwise satisfy it.
The Commission mostly focuses on artificial impairment. In short, the artificial impairment debate boils down to 2 views: (i) a claim is impaired by a plan even if the plan only makes “minor changes in the terms of the creditor’s claim or repayment rights” and (ii) a claim is impaired by a plan only if the plan makes “meaningful economic changes to the debt.” The Commission cites the Fifth and Ninth Circuits as sanctioning “artificial or minor impairment” as sufficient to satisfy Section 1129(a)(10). See W. Real Estate Equities, L.L.C. v. Vill. at Camp Bowie I, L.P. (In re Vill. at Camp Bowie I, L.P.), 710 F.3d 239 (5th Cir. 2013) (to hold otherwise would be to “shoehorn a motive inquiry and materiality requirement into section 1129(a)(10)” that does not exist). Reed Smith published a good article on Bowie and artificial impairment in the ABI Journal.
Although the Commission “acknowledged the potential gating role served by section 1129(a)(10),” it “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.” Therefore, the Commission concludes that Section 1129(a)(10) should also be eliminated from the Bankruptcy Code.
On the one hand, the numerosity requirement rarely presents a confirmation obstacle in our cases. However, we recently had a case with 115 separate mortgages spread over 8 creditors. Therefore, if we had been forced to litigate confirmation, then the “one creditor, one vote” rule could have been interesting. On the other hand, the issues of artificial impairment and “gerrymandering” (a forbidden term in our parts) come up often or, at least, litigious creditors are prone to raise them. Although eliminating Section 1129(a)(10) might very well make cramdown something more than a myth for our debtors, the Commission’s discussion of why Section 1129(a)(10) should be eliminated is a little short on details and justification.
Overall, the numerosity and “one impaired accepting class” requirements arguably provide just enough of a gating feature to fuel the “Let’s Make a Deal” approach that makes consensual plans possible. Indeed, debtors and creditors need to be scared of not being able to cramdown and of being crammed down, respectively.
In our next post, we’ll discuss the Commission’s recommendations regarding “Assignment of Voting Rights.”