A chapter 11 cramdown plan must be “fair and equitable” to each dissenting impaired class. The Bankruptcy Code does not fully define the term “fair and equitable,” however. Restructuring practitioners often use the term as casual shorthand for a plan that fulfills the requirements of section 1129(b)(2) of the Bankruptcy Code. But section 1129(b)(2) does not contain an exhaustive list. Rather, “the condition that a plan be fair and equitable” merely “includes” the requirements of section 1129(b)(2), and the word “includes” is open ended. This raises the question: what other substantive requirements must a cramdown plan satisfy to be considered “fair and equitable” to dissenting impaired classes?
Courts interpreting section 1129(b) have developed a number of substantive components of the “fair and equitable” requirement that do not exist in the text of the Bankruptcy Code. Some of these components are well settled. For example, no one disputes the absolute priority rule’s corollary that no creditor can be paid more than the value of its claim. Perhaps the most-discussed “fair and equitable” component is the “new value” corollary to the absolute priority rule. But other components of the “fair and equitable” requirement are less well known and less well settled.
One relatively unsettled “fair and equitable” component is known as the prohibition on “undue risk shifting”—the concept that a plan may allocate so much of the post-effective-date risk of the debtor’s reorganization to a secured creditor class that the plan is literally either unfair or inequitable to that class. Undue risk shifting may render a plan unconfirmable under section 1129(b)(1) even if the plan complies with section 1129(b)(2). The concept originated in cases long predating Till v. SCS Credit Corp., and it applied particularly to chapter 11 plans involving negative-amortization provisions. In re D & F Construction Inc. is perhaps the classic discussion of undue risk shifting. But, post-Till, courts continue to deny confirmation of plans that unduly shift the risk of the debtor’s reorganization to other parties. In re Premiere Hospitality Group, Inc., a recent decision from the United States Bankruptcy Court for the Eastern District of North Carolina, illustrates how courts apply this common-law cramdown requirement.
In Premiere Hospitality Group, the debtor, a hotel operator, sought to cram down its chapter 11 plan on its secured creditor class. That class consisted only of the claim of BB&T Bank. BB&T held a claim for $2.05 million (plus postpetition interest and attorneys’ fees) secured by a $2.4 million leasehold interest in the hotel property. Under the debtor’s plan, BB&T would have retained its lien and received a new $2.05 million debt obligation with the following characteristics:
- interest at 4.75% per annum;
- a 10-year maturity; and
- a 30-year amortization schedule with a balloon payment at maturity.
BB&T objected on eleven separate grounds, including that the plan was not fair and equitable because the loan terms were substantively unreasonable to BB&T. At the confirmation hearing, the evidence showed that (i) the debtor would have been unable to obtain a loan in the market; (ii) a 6.25–6.5% interest rate would have been more reasonable; and (iii) a 20-year amortization schedule would have been more reasonable.
The Court’s Analysis
The court denied confirmation, explaining that the requirements of section 1129(b)(2) “are not exclusive. Even if a plan meets the standards of [section] 1129(b)(2), it can still be considered not ‘fair and equitable’ and, therefore, nonconfirmable. . . . [T]he plan must literally be fair and equitable.” The court held that the Premiere Hospitality Group debtor’s plan was not fair and equitable because, regardless of the requirements of section 1129(b)(2), the debtor’s treatment of BB&T’s secured claim allocated too much post-confirmation risk to BB&T for it to be “literally” fair and equitable under section 1129(b)(1). In particular, the court found that the “lengthy period of amortization” was “not a reasonable market term for a loan of this nature” and that “the ten (10) year balloon [was] not reasonable and [was] inconsistent with the market terms for loans of similar businesses.”
Other Courts May Apply the Same Legal Standard
Undue risk shifting is not a universal concept, but courts across jurisdictions have adopted it. For example, at least one bankruptcy court in the District of Delaware has denied confirmation of a plan based on undue risk shifting. Courts in the Southern District of New York do not appear to have adopted the prohibition on undue risk shifting, but one bankruptcy court has noted that the requirements of section 1129(b)(2)(A) are a “minimum” standard for treating a secured creditor class fairly and equitably. At least three bankruptcy court decisions from the Eastern District of New York have relied on the prohibition on undue risk shifting to deny confirmation of chapter 11 plans and to allow a secured creditor to foreclose on its collateral. The bankruptcy court for the District of New Jersey has expressly stated, “To be confirmed, a plan may not treat a dissenting class unfairly, and must not unduly shift the risk of reorganization.”
Premiere Hospitality Group and cases like it demonstrate that courts continue to deny confirmation of cramdown plans that involve undue risk shifting, regardless of whether those plans appear to comply technically with the express language of section 1129(b)(2).