Joe Cotterman 2013-02-01 02:45:12
Bankruptcy 101: THE BOTTOM LINE: WHAT WILL I RECOVER ON MY CLAIM? Introduction The path through a Chapter 11 case presents many twists and turns for debtor and creditor. Throughout, most creditors have their eyes on the prize and remain focused on the bottom-line question, “what will I recover on my claim?” Like the reader who can’t resist looking at the last page of a novel first, many creditors, when receiving a Chapter 11 plan and disclosure statement, flip to those few critical pages that describe distributions to creditors. While distributions can take many forms, this article discusses the most common – monetary payments. This article focuses on some of the more significant provisions of the bankruptcy code that dictate how, and how much, creditors should be paid through a Chapter 11 plan. The means, amount, and timing of creditor distributions required under Chapter 11 varies widely from case to case. For secured creditors, required distributions are closely tied to the value of their collateral. For unsecured creditors, the amount is more closely aligned with the value of the debtors’ property that is not encumbered by liens. For all creditors, the timing of distributions is a practical consideration – how and when will there be sufficient cash generated to make the required distributions? The Statutory Framework One of the statutes most critical to answering the creditor’s distribution question is 11 U.S.C. §1129,1 which dictates the requirements for confirming a Chapter 11 plan. §1129 has a long list of confirmation requirements; the following are those that speak directly to what creditors must receive on their claims. The Best Interest of Creditors Test §1129(a)(7) embodies what is commonly known as the “best interest of creditors test”; for a plan to be confirmed, (7)With respect to each impaired class of claims or interests— (A)each holder of a claim or interest of such class— (i)has accepted the plan; or (ii)will receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date . . . .” §1129(a)(7) references two other aspects of the Chapter 11 process; classification and voting. A detailed discussion of classification and voting is beyond the scope of this article, but in summary, substantially similar claims are classified together – unsecured claims, priority claims, etc. At least one class must vote in the aggregate to accept the plan, but in addition to the vote, the best interest of creditors test is one of the “hard requirements” for confirmation that §1129 imposes. The best interest of creditors test looks to what the creditors will receive under a plan, compared to what they would receive in a hypothetical Chapter 7 liquidation. To pass the test, the present value of distributions under a Chapter 11 plan must at least equal what creditors would receive in a Chapter 7 liquidation. For Unsecured Creditors For unsecured creditors, the best interest of creditors test looks to the present value of plan distributions compared to the liquidation value of the debtor’s unencumbered property. General unsecured creditors do not get first payment priority, so priority claims including administrative expenses,2 as well the value of liens encumbering the debtor’s property, work to reduce the liquidation distribution to unsecured creditors. The bottom line: what is the net value of unencumbered property available to unsecured creditors, and by comparison, how much will those creditors get under the plan? For Secured Creditors For secured creditors, same test, different factors. Generally, secured creditors are entitled to be paid at least the value of their equity in their collateral (i.e., net collateral value after prior liens). If the net collateral value exceeds the amount of their claim, secured creditors are entitled to payment in full, and in some cases, plus interest.3 The foregoing is what the fully secured creditor can expect in a liquidation, and hence, is what they must receive under a Chapter 11 plan. Where the net collateral value is less than the secured creditor’s claim, the deficiency will be bifurcated from the secured claim and treated as an unsecured claim. In that case, each of the two bifurcated claims will be held up to the best interest of creditors test as applicable to secured and unsecured claims, respectively. The 1111(b) Election The “1111(b) election” is a unique tool for the under secured creditor. In short, an under secured creditor can often elect to have its claim treated as though it were entirely secured, rather than bifurcated between secured and unsecured portions. The election preserves future appreciation of the collateral for the secured creditor by preventing a debtor from paying only the depressed present value of the collateral plus little or no distribution on the unsecured deficiency, then reaping the benefits of appreciation later. If the under secured creditor exercises the election, it waives any unsecured deficiency claim, but will receive payments that equal the full face amount of the claim, and which have a present value equal to the present value of the collateral. The Absolute Priority Rule And The New Value Exception Priority claims impact the unsecured creditor in more ways than just reducing the available net liquidation value of the debtor’s property. Under §1129(b)(2)(B), a class of creditors (here, unsecured creditors) may not receive any payment unless all classes with a higher priority are paid in full. This is known as the “absolute priority rule”. Equity holders in a debtor, as a class, are junior to all creditor classes. Accordingly, unsecured creditors should make sure that the plan does not give a debtor’s equity holders payments or other property unless either: i) unsecured, secured, and priority creditors are paid in full; or, ii) equity holders buy back into the debtor through what is known as the “new value exception” to the absolute priority rule. What constitutes a sufficient “new value” contribution is based on the circumstances of the case. Most importantly, unsecured creditors should check to be sure the debtor’s equity holders are not attempting to retain their equity interest for free while paying creditors less than in full. Feasibility Most of the foregoing discussion focuses on how much a creditor might receive through a Chapter 11 plan. What is commonly called “feasibility” focuses more on how and when a creditor can expect that distribution. §1129(a)(11) requires that confirmation of the plan is not likely to be followed by liquidation or the need for further reorganization of the debtor (unless proposed in the plan). This requirement looks to whether the plan is “feasible,” i.e., can the debtor make happen what is proposed in the plan? A plan that proposes large monthly payments from a debtor whose cash flow is already negative isn’t feasible. Conversely, creditors should check to be sure that the plan isn’t “too feasible”, i.e., that the bulk of available net revenue is going to creditor distributions. Insufficient payments from hefty revenue implicate more than feasibility issues, but the feasibility analysis is where those issues may be spotted first, so it’s always an important point to check. CONCLUSION The foregoing issues are only a small part of what creditors need to monitor in assessing a Chapter 11 plan. As noted at the outset, in this article we only focused on a few of the most significant factors and requirements that impact an unsecured creditor’s recovery in a Chapter 11 case. There are many ways to attempt to maximize the creditor’s recovery in a given case that go beyond the scope of this article. The foregoing is meant to provide a few guideposts for assessing that bottom line – or what it should be - in a Chapter 11 plan. Joe Cotterman is a partner with the Andante Law Group of Daniel E. Garrison, PLLC and has over 20 years of corporate restructuring, business bankruptcy, creditor rights, commercial litigation and corporate and real estate transaction experience. He holds an AV “Preeminent” rating, the highest professional designation awarded by Martindale-Hubble, the primary professional rating organization for attorneys and is listed in both Southwest Super Lawyers, a designation limited to the top 5% of attorneys in the southwestern United States, and every year since 2009, in Best Lawyers in America, the oldest and most respected peer-review publication in the legal profession.
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