Recently, we've been seeing debtors try to confirm cram down plans of reorganization that are unfavorable to the secured creditor by "gerrymandering" the class of unsecured claims. The typical situation finds the secured creditor holding an undersecured loan. Under Section 506(a) of the Bankruptcy Code, the secured creditor's claim is automatically bifurcated into a secured claim in an amount equal to the value of the collateral and an unsecured claim for the balance of the debt.
Here's an example taken from a recent case that Ben Young, the author of this important article, and I handled. Our litigation partners, Joe Demko and Matt Kenefick, won a long, hard-fought jury trial in a fraudulent transfer case. Joe and Matt were victorious on appeal and perfected a judgment lien. The judgment debtor filed a Chapter 11 case, too late to avoid the judgment lien, and scheduled its co-judgment debtors as unsecured creditors. Our client's claim was larger than the value of the collateral, so our client had both an secured claim and an unsecured claim.
The judgment debtor filed a plan of reorganization that treated our client very unfairly and sought to cram down that plan on our client. To succeed, the judgment debtor needed one class of her impaired creditors to vote for her proposed plan of reorganization. Let's break down what this means:
• A plan of reorganization is supposed to treat substantially similar creditors alike. As a practical matter, that means that each secured claim is usually placed in its own class, and all unsecured claims are usually lumped together in one unsecured class.
• A debtor may obtain confirmation of its plan despite the negative vote of a class of creditors as long as at least one class of impaired creditors votes for its plan, and the plan itself meets certain other tests.
• A class of claims accepts the plan if creditors holding more than two-thirds in amount and more than one-half in number of the claims in the class vote for the plan, not counting the votes of any insiders.
In our case, the judgment debtor knew that our client's unsecured claim was more than one-third of all unsecured claims. It also knew that our client would not vote for her plan. The judgment debtor's clever solution was to argue that our client's unsecured claim was not "substantially similar" to the other unsecured claims, and that the other claims should be placed in their own class. Since the other claimants were her co-judgment debtors and were friendly, the debtor figured it could get their votes and confirm the plan. Ultimately, Ben, Joe and Matt were able to negotiate a settlement that paid our client's judgment in full.
It is against this backdrop that Ben's article on "gerrymandering" claims should be read. Workout professionals should be aware of this tactic and be able to recognize and respond to it.
Continue reading "Can a Plan of Reorganization Separately Classify a Claim That Is Personally Guaranteed?" »