[Today’s post is from Braden Copeland, a Mercer 3L. He joined us as a Summer Associate in 2021. We’re delighted that he’ll come on as an Associate after he graduates this Spring. I asked him to look for a confirmation-related Subchapter V opinion and write something up for the blog. I’m thrilled to have the help. P.S. A too-early-in-the-year plan confirmation trial delayed our New Year’s post, but it’s still coming! – Dave]
I’m not prejudging it but I think the Trustee’s objection is an uphill battle simply because it sounds almost like he is arguing the 1111(b) election itself is not fair and equitable, which of course there is a reason it exists. But perhaps it is the application of the election and the facts and circumstances of this case that is not fair and equitable and whether or not we can go down that path.
— Judge Thomas Saladino, United States Bankruptcy Court for the District of Nebraska, as heard in a status teleconference on September 22, 2021.
Well, the court went down that path.
But, first, let me back up…
I initially encountered 11 U.S.C. § 1111(b) during my third day on the job as an intern for Judge Austin Carter (Bankr. M.D. Ga.) (the Stone & Baxter alum who taught Dave much of what he knows about day-to-day Chapter 11 practice).
I had no idea what I was reading. Zero. I also had no idea how making an 1111(b) election might be strategically advantageous, or work in the context of a larger case given voting considerations, cramdown maneuvering, and the like. What should someone considering 1111(b) really be thinking about when it comes to their position in the case, and the leverage they may or may not have?
I asked Judge Carter about it and he laughed. He advised me to consider sending that volume of Collier back where it came from and to turn to other, more scrutable research issues. He added that the Code section is a complicated piece of Chapter 11 that can take years to appreciate. Courts wrestle with understanding and applying it; seasoned practitioners struggle to grasp its nuances; and, most of all, it’s not really a Code section that arises often enough to make it well-understood.
Echoing that sentiment—from over 1,000 miles away and more than a year later—this is from Judge Saladino when quizzing creditor’s counsel during a hearing last July:
Have you talked to [debtor’s counsel] about what is needed to be in the plan to address your 1111(b) election? And I’m saying that because, as far as I’m concerned, 1111(b) elections are probably the most complicated aspect of the bankruptcy code, perhaps next to some tax provisions. And I can’t claim that I completely comprehend every aspect of it.
That’s the essence of it. Plainly, the operation of 1111(b) is complicated. So, it surprised me to find it as the centerstage issue in a Subchapter V confirmation opinion that came down Thanksgiving week.
1111(b) Surfaces in a Nebraska Subchapter V Case
Judge Saladino made his 1111(b) observations in In re Topp’s Mech., 2021 Bankr. LEXIS 3235, 2021 WL 5496560 (Bankr. D. Neb. Nov. 23, 2021).
The setup is simple. The debtor, Topp’s Mechanical, Inc., is a Nebraska-based mechanical contractor that specializes in fabrication and installation of specialized steel, stainless steel, and carbon piping and chemical storage systems.
During 2020, Topp’s began to struggle financially and, eventually, filed its Chapter 11 case on January 15, 2021. It elected Subchapter V treatment. Its largest creditor was American Exchange Bank. AEB’s total claim, secured by real and personal property, was $3.8 million, with an estimated deficiency of $1.6 million.
On April 1, AEB elected to have its entire claim treated as a secured claim under 1111(b). Two weeks later, Topp’s filed its first plan of reorganization. It did not address AEB’s 1111(b) election.
On April 29, AEB objected to the plan on numerous grounds, including feasibility and valuation. The Subchapter V Trustee, James A. Overcash (a perfectly ironic last name), also objected, arguing that the plan was not fair and equitable to the unsecured creditors and not feasible.
On June 7, Topp’s filed its first amended plan. AEB objected again on the same grounds. It also noted how the debtor had failed to address its 1111(b) election. Trustee Overcash also objected, but limited his objection to his “fair and equitable” argument.
Was the Plan Fair and Equitable or Not?
On July 21, 2021, Judge Saladino denied confirmation.
On the subject of what it might take to get a plan confirmed, he focused on 1111(b).
The Trustee voiced his concern that the economics of the 1111(b) election discriminated against and were not fair and equitable to the class of unsecured creditors who had not consented to the plan. However, Judge Saladino sounded skeptical. If the court granted the Trustee’s objection, then wouldn’t AEB’s 1111(b) election, which it had the right to make, be nullified?
The Trustee responded, stating that “I believe [my objection] effectively does that. Whether I have the right to do that I can’t tell you for sure.” With that, the hearing ended. Trustee Overcash had some work to do to justify his objection.
On August 4, 2021, Topp’s filed its second amended plan. It addressed AEB’s 1111(b) election.
While AEB didn’t object, the Trustee again raised the fair and equitable issue.
Mr. Overcash’s beef was that the debtor was proposing to pay AEB $4.27 million over the life of the plan even though its total claim was only $3.76 million. He acknowledged that AEB was entitled to interest as a part of its election, but argued that the interest amount not only exceeded 1111(b), but also, if respected, would be paid at the expense of unsecured creditors to the extent that the excess interest decreased the disposable income available for unsecured creditors.
While the math is a little more complicated, the treatment was certainly lopsided on its face: AEB would receive $122,993.77 over three years compared to $26,019 for unsecured creditors over the same period—creditors whose claims were in excess of $1.8 million.
Counsel for AEB and Topp’s added little to the conversation.
Nevertheless, and as alluded to in the opening quote, Judge Saladino wasn’t buying the Trustee’s argument.
With the “fair and equitable” issue being the sole issue standing in the way of plan confirmation, the parties agreed to brief it.
The Parties Made Their Case. . .
Trustee Overcash focused on the money, citing in his brief a hypothetical from another case—
An example of the application of these [1111(b)] requirements is found in In re Body Transit, Inc., 619 B.R. 816 (E.D. PA 2020) where the court describes the treatment necessary for a creditor where the secured creditor’s claim is $100,000.00, but the value of the collateral is only $30,000.00.
Assuming an appropriate present value interest rate of 6% in this hypothetical, the debtor could file a plan that satisfies § 1129(b)(2)(A)(i)(II) by providing for 60 monthly payments of $580.00. Those payments total $34,800.00, which includes $4,800.00 in interest. If the creditor made a § 1111(b) election, the plan would have to pay at least an additional $65,200.00 on account of the full $100,000.00 allowed secured claim.
See Body Transit, 619 B.R. at 832-833.
Applying the Body Transit math to the Topp’s plan, the Trustee showed how the proposed 1111(b) treatment failed. This table is from the Trustee’s brief:
Referencing the table, the Trustee explained that the difference between the Body Transit and the Topp’s treatments is that, in Body Transit, the interest amount was part of the total claim payout amount such that the $100,000 remained the ceiling for the total amount of the payments.
That was not so in the Topp’s treatment. In Topp’s, the interest amount was added such that the total claim amount of $3,763,611.81 was not the ceiling. Rather, the ceiling was adjusted higher by the amount of the interest ($502,909.17), such that $4,266,520.98 would be the total amount of the payments.
It is that adjustment that the Trustee brought to the attention of the court. It’s hard to tell from the opinions and the briefs how much of the allegedly excess $502,909.17 decreased disposable income but, to the extent that it decreased it dollar-for-dollar, the Trustee argued that it was not permissible under 1111(b) and discriminated against unsecured creditors.
AEB and Topp’s disagreed, arguing that (i) 1111(b) elections are allowed generally, (ii) the election was proper in the Topp’s case, (iii) the calculations were done correctly and were not discriminatory (in an area, they claimed, that even Collier recognizes is not well-settled), and (iv) rejecting the proposed 1111(b) treatment would strip away from AEB “the benefit of the interest component required for secured claims under a plan of reorganization.”
Then it Was Judge Saladino’s Turn
In explaining 1111(b) and recognizing its intersection with Subchapter V, Judge Saladino deserves more credit than he gave himself in the lead-up. He took up the analysis this way:
Subchapter V’s Fair and Equitable Requirement
Initially, he pointed out that the Trustee’s objection arose under 11 U.S.C. § 1191(b), a provision that requires a plan to be fair and equitable to each impaired class that has not accepted the plan. For a non-consenting class of unsecured creditors, that means that a debtor must, under § 1191(c)(2), “apply all of its disposable income for at least a three (3) year period for making payments under the plan and that the value of the plan distributions is not less than the debtor’s disposable income.”
That rule gets to the heart of the Trustee’s objection because, the Trustee contended, the payments to AEB were inflated and, thus, were unfairly and inequitably diminishing the amount of disposable income for unsecured creditors.
Then, Judge Saladino turned to 1111(b), reducing it to this black-letter rule (albeit one he admitted makes the operation of the rule seem simpler than it is):
A partially secured creditor making an election under 1111(b)(2) has waived its unsecured deficiency claim in order to have the entire amount of their debt treated as a secured claim.
With that, Judge Saladino offered up the following solid gold Subchapter V nugget.
Protection With a Cost (That a Creditor Avoids in Subchapter V)
As Judge Saladino explains, 1111(b) essentially exists to protect an undersecured creditor from exposure that may be inherent in collateral that has a volatile value.
In other words, 1111(b) can help an undersecured creditor avoid having its secured claim determined when the value of its collateral is depressed only to have the collateral value rebound such that the debtor—after settling unsecured claims for pennies on the dollar—may sell the collateral, pay off the secured portion of the claim, and reap a windfall.
“In effect, [the creditor that has made the 1111(b) election], by retaining its lien as security for its entire claim, holds that collateral hostage from the debtor’s efforts to benefit from that post-confirmation appreciation of collateral until the entire amount of the creditor’s claim is paid.” In re Scrubs Car Wash, Inc., 527 B.R. 453, 456 (Bankr. D. Colo. 2015).
Judge Saladino explains that in a regular Chapter 11 case, 1111(b) protection comes with a cost. A creditor making the election and foregoing its right to call its deficiency unsecured loses its right to participate in the class of unsecured creditors. And influence and participation in that class can be valuable when it comes to blocking confirmation.
In a Subchapter V case, though, 1111(b) protection doesn’t come with that cost because unsecured creditor class consent isn’t required. If consent isn’t required, then having a blocking vote is not as important. So, for the undersecured creditor in a Subchapter V case, here is the solid gold nugget: Since having influence in the class of unsecured creditors can be meaningless in Subchapter V, there may be no downside to making an 1111(b) election provided that, as a threshold matter, its 1111(b) payment calculations are correct and prove that an election makes economic sense.
Ultimately, though, the calculations are what defeated the second plan in Topp’s.
What’s Fair and Equitable?
After taking that brief, worthwhile detour, Judge Saladino turned to the two-part test for determining the proper amount to pay the creditor under 1111(b). Because it’s a small world, Judge Saladino cited, among other cases, Judge Drake’s IPC Atlanta case that we covered extensively in the Judge Drake Series. And Judge Drake simply quoted Judge Barliant (Bankr. N.D. Ill.) for the two-part test, which we’ll block quote again because it’s so simple:
(1) the simple, arithmetic total of the stream of payments must at least equal the total claim, and (2) those payments must have a present value equal to the value of the collateral.
While that is precisely the formula that Topp’s thought it was respecting, Trustee Overcash cried foul and Judge Saladino agreed.
Specifically, the deal Topp’s worked out with AEB was just too rich. It wasn’t too rich because it was paying AEB interest. It also wasn’t too rich, per se, because the interest component reduced disposable income. Rather, it was too rich because it had Topp’s paying interest in excess of the total claim and because at least a portion of that interest diminished disposable income during the three year payout period at the expense of unsecured creditors.
In short, if you look at the chart above, the $502,909.17 should have counted towards satisfying the deficiency of $1,639,916.93 rather than being paid on top of it. It’s really the same issue that Judge Drake encountered in IPC over 27 years ago. And by the time that issue made its way to Topp’s (where it was most dangerous for unsecured creditors) there was a majority approach and Judge Saladino adopted it.
Thus, he rejected the second plan and ordered a third:
Because the debtor’s second amended Chapter 11 plan proposes to pay to American Exchange Bank far more than it is entitled to receive as a result of its election under 11 U.S.C. § 1111(b), there is less money available to pay to unsecured creditors. Accordingly, the plan discriminates unfairly and is not fair and equitable to the class of unsecured creditors. Confirmation is denied and debtor shall file an amended plan.
So, there you have it. I’m wondering now whether we’re about to start encountering undersecured creditors making 1111(b) elections in Subchapter V cases more often. Time will tell. If they do start appearing more frequently, then Topp’s teaches that trustees and judges should study 1111(b) proposals even more carefully in Sub V cases because there is not only a potential for abuse, but unsecured creditors will likely bear that abuse during the three to five years after confirmation. The absolute priority rule, which Subchapter V bypasses, curbs if not eliminates that abuse in regular Chapter 11 cases.
Coda: The 1111(b) Election Gets Withdrawn
AEB heard Judge Saladino loud and clear and, on December 9, 2021, filed a motion to withdraw its 1111(b) election. Thanks to Trustee Overcash, the unsecured creditors now appear set to receive more money. I wonder if any of those lucky recipients of his advocacy will send him something around the holidays next year.