Chapter 11 Bankruptcy

One of the significant benefits of a Chapter 11 bankruptcy is that under the Bankruptcy Code, the rights of a secured creditor can be adjusted to more favorable terms for the debtor which can allow the debtor to keep operating its business with lower operating costs. One of the methods available to a debtor and debtor-in-possession in Chapter 11 to lower secured claim payments is by cramming down the secured claim.

Who is a Secured Creditor?

A secured creditor is a creditor that has some kind of collateral that secures its loan. The collateral can be in the form of real estate secured by a Deed of Trust, all assets of the borrower of the loan, which is perfected by a UCC-1 financing statement, a receivables lender, an equipment lender, or statutory liens. For example, if a construction business financed the purchase of an excavator for its business and the loan is secured by the excavator through a UCC-1 financing statement, the secured loan may be adjustable in Chapter 11.

Cramdown in Chapter 11

Pursuant to 11 U.S.C. § 1129, a Court can confirm a Chapter 11 case only if the 16 requirements delineated thereunder are met. Normally, one of these requirements for confirmation of a Chapter 11 plan is that an impaired class of creditors – a creditor whose claim is not paid in full in accordance with the terms of it loan – must accept the Chapter 11 plan. However, 11 U.S.C. § 1129(b) provides an exception to the impaired class requirement: the Court shall confirm a plan as long as “the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.”

In order for a Chapter 11 plan to be considered fair and equitable for a secured claim, the plan must provide 1) that the holders of secured claims retain its lien securing such claims and 2) that the holders of secured claims receive deferred cash payments totaling “at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property…” or the secured creditor must realize the “indubitable equivalent” of its secured claim.

The first part of the analysis is similar to any cramdown – the secured creditor receives the value of the collateral and not necessarily the value of its claim. For example, if the excavator in the above example is worth $100,000 and the loan that is secured by the excavator is $200,000, the secured creditor’s claim can be crammed down to the value of the collateral – $100,000. The remainder of the claim – $100,000 – will be treated as a general unsecured claim.

The second component of 11 U.S.C. § 1129(b) allows a debtor to term out a loan longer than the terms in the security instrument. In the example above, if the original term of the loan is 10 years, the debtor may be able to term it out over 20 years, thus allowing the debtor to keep functioning at lower operating costs.

The next component that can be adjusted is the interest rate that is used to provide the secured creditor with its present value of its claim. In Till v. SCS Credit Corp., 124 S. Ct. 1951 (2004), the Supreme Court adopted the “formula approach” to determine the interest rate to use in a cramdown and stated that the starting point is the prime interest rate plus additional points based upon the risk of the loan. If, for example, the interest rate on a loan is 9% but the prime rate is 5%, lowering the interest rate to 6% would result in savings over the course of the loan.

Chapter 11 can provide a lifeline to a debtor that cannot currently afford its secured claim payments as structured under the terms of the loan documents that govern the claim. If a Chapter 11 debtor, for example, owns a gas station with a commercial mortgage secured by the gas station and can no longer afford the payments, a Chapter 11 may provide an opportunity to term the loan out longer than its original terms, lower the secured portion of the claim, and lower the interest rate paid on the claim. This form of restructuring debt could save the business from failure.

If you have questions about Chapter 11 for your business, please call Steiner Law Group at (410) 670-7060.