Lenders Beware -- Fifth Circuit has lowered the bar for cramdown plan confirmation

In a recent Fifth Circuit decision, Western Real Estate Equities, LLC v. Village at Camp Bowie I, L.P., No. 12-10271 (5th Cir. 2013), the court held that the acceptance vote from a minimally and “artificially impaired” class of claims meets the 11 U.S.C. § 1129(a)(10) requirement for the confirmation of a non-consensual “cramdown” chapter 11 plan.

Camp Bowie involved a single asset real estate debtor, Village at Camp Bowie I, L.P. (“Debtor”), who filed a Chapter 11 petition that stayed the nonjudicial foreclosure sale of its property scheduled for the following day. As of the petition date, Debtor owed Western Real Estate Equities, LLC (“Western”) approximately $32 million secured by a lien on Debtor’s real property and approximately $59,000 to thirty-eight unsecured trade creditors (“Unsecured Creditors”). Debtor filed a plan of reorganization designating two impaired creditor classes consisting of Western and the Unsecured Creditors. Under Debtor’s plan, (1) Western would receive a new five year note for the secured claim amount and interest, with a balloon payment of the remaining principal and accrued interest due at maturity; (2) the Unsecured Creditors would be paid in full within three months from the effective date without interest; and (3) Debtor’s pre-petition owners and related parties would make a capital infusion of $1,500,000 for newly issued preferred equity. Unsurprisingly, the Unsecured Creditors voted for the plan, whereas Western voted against the plan.

In objecting to the plan, Western argued that the plan did not receive the vote “of at least one class of claims that is impaired under the plan” required under § 1129(a)(10). This was, Western argued, because the Unsecured Creditors’ claims were “artificially impaired” and thus an inadequately impaired class to meet the voting requirement of an impaired class. Western argued that Debtor minimally and “artificially impaired” Unsecured Creditors’ claims by delaying payment for three months instead of paying them in full at plan confirmation, which Debtor had sufficient cash flow to do. In the alternative, Western argued that such “artificial impairment” violated the good faith requirement of § 1129(a)(3).

The bankruptcy court rejected Western’s objections and confirmed the plan, which the Fifth Circuit affirmed on appeal. While reviewing for “clear error,” the Fifth Circuit held “that § 1129(a)(10) does not distinguish between discretionary and economically driven impairment.” The court explained that this was because the plain meaning of impairment under § 1124 contains no “motive inquiry” or “materiality requirement.” The court reasoned that impairment is not required to be driven by economic motives and can be discretionary, which was the case here. Further, the court found that the three month delay in full payment to Unsecured Creditors without interest sufficiently impaired their claims because the Bankruptcy Code does not recognize a distinction between de minimis and material impairments.

Moreover, the court held that artificial impairment does not constitute bad faith as a matter of law. Rather, the court stated that a debtor’s artificial impairment would be one factor in the totality of circumstances analysis for a finding of good faith. Because Debtor “proposed a feasible cramdown plan for the legitimate purpose of reorganizing its debts, continuing its real estate venture, and preserving its non-trivial equity in its properties,” the court held that the good faith requirement was met.

While the impact of Camp Bowie upon the restructuring community remains to be seen, there exist two clear takeways. First, debtors have greater leeway when designing an impaired class of creditors for the purpose of a cramdown plan of reorganization, which is particularly helpful in the context of single asset real estate cases. Second, secured lenders and distressed real estate investors can no longer rely upon the expectation that a de minimis impairment of claims is enough to block a cramdown plan of reorganization, but must employ more robust planning strategies to protect against a cramdown plan.