Several months ago, we blogged about In re Loop, a decision from the Ninth Circuit B.A.P., Wells Fargo Bank, N.A. v. Loop 76 LLC (In re Loop 76 LLC), 465 B.R. 525 (B.A.P. 9th Cir. 2012), where the court held that a bankruptcy court may “consider the existence of a third-party source for payment, including a guarantor” when determining whether unsecured claims are substantially similar for purposes of plan classification.
In a recent decision by the United States Bankruptcy Court for the Eastern District of New York, In re 18 RVC, LLC, No. 8:12-72378-reg, 2012 Bankr. LEXIS 4991 (Bankr. E.D.N.Y. Oct. 22, 2012), Judge Grossman held that the existence of a personal guarantee for an unsecured claim of a partially secured lender, alone, is insufficient to support separate classification of that claim under section 1122(a) of the Bankruptcy Code as one that is not “substantially similar” to all other unsecured claims. In re 18 RVC, LLC is the first case in New York and outside the Ninth Circuit to decline to follow In re Loop.
In In re 18 RVC, LLC, a chapter 11 single asset real estate case, the debtor filed for bankruptcy protection to prevent a foreclosure proceeding by its largest creditor, New York Community Bank (“NYCB”). The real property at issue was encumbered by a first mortgage lien held by NYCB. NYCB’s loan was personally guaranteed by the debtor’s principal. In October 2012, the debtor filed an amended disclosure statement and plan. The amended plan proposed to bifurcate NYCB’s claim into a secured claim and an unsecured deficiency claim, creating the following classes: (1) NYCB’s secured claim; (2) NYCB’s unsecured deficiency claim; (3) minimal priority tax claims; and (4) miscellaneous unsecured claims.
Section 1129(a)(10) of the Bankruptcy Code provides that “[t]he court shall confirm a plan only if all of the following requirements are met: . . . (10) If a class of claims is impaired under the plan, at least one class of claims that is impaired under the plan has accepted the plan . . . .” Among the four classes proposed by the debtor in its amended plan, only NYCB’s Class 2 unsecured claim and the miscellaneous unsecured Class 4 claims were impaired. Because NYCB made it clear to the debtor that it would not approve the amended plan, confirmation would require acceptance by Class 4 — the class holding the miscellaneous unsecured claims.
Under section 1126(c), “A class of claims has accepted a plan if such plan has been accepted by creditors . . . that hold at least two-thirds in amount and more than one-half in number of the allowed claims of such class held by creditors . . . .” If NYCB’s unsecured claim were classified with the rest of the unsecured claims, leaving only one impaired class, the dollar amount of NYCB’s claim as compared to the rest of the class would preclude the class from approving the plan over NYCB’s objection, preventing confirmation. Separately classifying NYCB’s deficiency claim in Class 2 from all other unsecured claims in Class 4, along with presumed acceptance by Class 4, would ensure that the debtor met the threshold requirement of an “impaired accepting” class and could proceed to attempt to “cram down” the plan over NYCB’s objection.
NYCB objected to the amended disclosure statement on several grounds, one of which was the improper and separate classification of the unsecured portion of its claim in Class 2 from the rest of the unsecured creditors in Class 4. Section 1122(a) of the Bankruptcy Code provides that “a plan may place a claim or an interest in a particular class only if such claim or interest is substantially similar to the other claims or interests of such class.” The debtor’s sole justification for separately classifying NYCB’s unsecured claim from all others was the existence of a personal guarantee by the debtor’s principal.
The court began its discussion with the Second Circuit’s decision in Boston Post Road Limited Partnership v. FDIC (In re Boston Post Road Limited Partnership), where the court held that a secured creditor’s deficiency claim was not “credible proof of any legitimate reason” for classifying that claim differently from other unsecured claims. In Boston Post Road, a single asset real estate case, the debtor classified the FDIC’s unsecured mortgage deficiency separately from unsecured trade claims. The FDIC was the debtor’s largest unsecured creditor. If the FDIC’s deficiency claim were classified together with other unsecured claims, the FDIC could preclude acceptance by that class, much like the NYCB in In re 18 RVC, LLC.
The bankruptcy court, the district court, and the Second Circuit in Boston Post Road held that separately classifying the FDIC’s unsecured mortgage deficiency claim from the unsecured claims of trade creditors solely to create an impaired accepting class was impermissible:
“[A]pproving a plan that aims to disenfranchise the overwhelmingly largest creditor through artificial classification is simply inconsistent with the principles underlying the Bankruptcy Code. A key premise of the Code is that creditors holding greater debt should have a comparably greater voice in reorganization. . . . Debtor fails to persuade that a single-asset debtor should be able to cramdown a plan that is designed to disadvantage its overwhelmingly largest creditor.”
The debtor argued that Boston Post Road does not preclude separate classification, and urged the court to adopt the Ninth Circuit B.A.P.’s recent decision in In re Loop, where the court held that a bankruptcy court may “consider the existence of a third-party source for payment, including a guarantor, when determining whether unsecured claims are substantially similar under section 1122(a).”
Unmoved by the debtor’s argument, the court stated that “[t]he record is barren of any facts that could allow the Court to find that there is any reason for separately classifying this claim other than for the purpose of creating a class of creditors to vote in favor of the Debtor’s proposed plan and cram down the secured lender.” In rendering this decision, the court explained that it was following the majority of case law on point and cited a handful of cases as examples from various jurisdictions to support its holding. Among others, the court cited In re 4th Street East Investors, Inc. (which we blogged about here), the first case to decline to follow In re Loop, finding that the existence of a non-debtor guarantor was an insufficient basis to separately classify unsecured claims. The court also cited In re 500 Fifth Avenue Associates, where the United States Bankruptcy Court for the Southern District of New York held that a right of recourse against the debtor’s general partners did not justify separate classification. The court found recourse and nonrecourse creditors of equal rank and with equal rights within chapter 11, and that “in the absence of a purpose independent of the debtor’s desire to gerrymander an impaired assenting class, they should be classified together.” Of course, these are not the only cases that have addressed the issue. You can find a discussion of In re Reid Park Properties, LLC. here where the court, also, distinguished its facts from In re Loop.
The court concluded by limiting its findings to the facts of the case and characterizing the debtor’s classification of NYCB’s unsecured deficiency claim as “an improper gerrymandering of classes intended to obtain the vote of an impaired class of creditors and not for any other legitimate reason.”
In the context of single asset real estate cases where guarantees are common, Judge Grossman’s stricter standard for determining whether deficiency claims are substantially similar to other unsecured claims weakens a debtor’s ability to cram down. Nonetheless, debtors will likely continue to rely on In re Loop’s more favorable standard, while it appears, at least in New York, that courts will not be so inclined.