Restructuring

Real estate lenders should be aware of a recent decision, In re RAMZ Real Estate Co., LLC, in which the United States Bankruptcy Court for the Southern District of New York held that a class of claims consisting solely of a secured tax claim was impaired for purposes of voting on a debtor’s chapter 11 plan where the plan provided for the full payment of the tax claim but allowed for the payment of postpetition interest at less than the statutorily provided interest rate, and that such impairment was not artificial for purposes of satisfying the requirements of section 1129(b) of the Bankruptcy Code.
Background
In RAMZ Real Estate, the debtor owned two pieces of commercial real property in upstate New York. One of the properties, a mixed-use building located in Kingston, New York, was encumbered by a first mortgage in favor of Community Preservation Corporation in the amount of $744,000. The debtor commenced its chapter 11 case after Community Preservation brought a foreclosure action in state court. Approximately eight months after the commencement of the chapter 11 case, the court entered an order valuing the Kingston property at $485,000, significantly less than the outstanding mortgage debt.
When the debtor eventually filed its chapter 11 plan, the plan provided for the treatment of seven classes of claims – three of which were impaired under the plan. Class 3 consisted of the secured portion of Community Preservation’s claim. Community Preservation’s deficiency claim was unsecured and classified under the plan, pursuant to section 506(a) of the Bankruptcy Code, along with the debtor’s other unsecured claim in Class 6. Community Preservation did not elect to have its entire claim treated as secured pursuant to section 1111(b)(2) of the Bankruptcy Code. The debtor’s plan provided for a distribution of approximately ten (10%) percent to the holders of claims in Class 6 over the course of sixty months. Finally, Class 4 consisted solely of a secured property tax claim held by the Ulster County, New York.
Class 7, which was unimpaired under the plan, contained the interests of the Debtor’s sole existing equity holder. Pursuant to the plan, the debtor’s existing equity holder was to retain 100% of his ownership interest although he would not receive any dividends or payments under the plan. The other classes of claims treated under the debtor’s plan consisted of claims that were either paid in full and expunged by prior order or unimpaired and, thus, not entitled to vote under the plan.
Community Preservation voted to reject the debtor’s plan both for its Class 3 secured claim and its Class 6 unsecured claim. As Community Preservation controlled the vote of Class 3 and Class 6, both of those classes rejected the plan leaving Class 4, comprised of Ulster County’s tax claim, as the only impaired class of creditors voting to accept the debtor’s plan.
Community Preservation filed an objection to confirmation of the debtor’s plan arguing, among other things, that the plan contained classes that were artificially impaired and the plan violated the absolute priority rule.
For a chapter 11 plan to be confirmable it must meet the requirements of section 1129 of the Bankruptcy Code. Section 1129(a)(8) requires that each impaired class of claims accept the plan. If this is not possible, section 1129(a)(10) permits a plan to be “crammed down” over the objection of every other class of creditors pursuant to section 1129(b) so long as at least one class of impaired claims held by non-insider creditors has accepted the plan.   In order to cram down a chapter 11 plan, the plan must meet all of the statutory requirements provided in section 1129(b) of the Bankruptcy Code, in addition to those provided in section 1129(a).
Analysis
Artificial Impairment
Community Preservation first argued that the debtor’s chapter 11 plan could not be confirmed because Ulster County’s claim was not impaired for purposes of section 1129 where it was receiving payment in full over five years at 9% interest. Community Preservation further argued that any impairment of Ulster’s claim was “artificial” and manufactured solely to obtain approval by at least one impaired class of creditors.
Section 1124 of the Bankruptcy Code provides, in relevant part, that a claim is impaired unless the plan “leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest….” Where a section of the Bankruptcy Code alters a creditor’s claim, that claim is not considered “impaired” by the plan, as it is not the plan, but instead the Bankruptcy Code, that alters its treatment. Section 1129(a)(9)(C)(iii) and (D) permit unsecured and secured tax priority claims, respectively, to be paid regular installment payments “of a total value, as of the effective date of the plan, equal to the allowed amount of such claim.” Section 511 of the Bankruptcy Code provides that the rate of interest to be paid on tax claims is to be determined under applicable nonbankruptcy law.
The bankruptcy court held that because Ulster was receiving only 9% interest instead of the 12% interest that it was entitled to receive under New York Real Property Tax Law, the claim was impaired for purposes of voting on the debtor’s chapter 11 plan. In so holding, the court distinguished the treatment of Ulster’s claim from the treatment of a similar tax claim at issue in In re Bryson Properties, XCIII, where the Fourth Circuit noted that priority tax claimants, which receive preferential treatment under the Code, were generally not an impaired class that could accept a plan and bind other truly impaired creditors to a cram down. Unlike the tax claim in Bryson Properties, which was paid what it was entitled under the Bankruptcy Code, the court found that Ulster was not receiving the full rate of interest as provided by applicable nonbankruptcy law and, accordingly, its claim was impaired.
The court went on to find that the debtor had legitimate business purposes for impairing Ulster’s claim and, therefore, its claim was not “artificially impaired.” The court agreed with the debtor that the lowering of the interest rate from 12% to 9%, which reduced the debtor’s monthly payments and allowed the debtor to remain within its budget, constituted a legitimate business purpose. Interestingly, the court found that the difference in the interest rates of 3% was not de minimis, especially “in light of the current financial situations that many government entities have faced in the last several years.” The court further noted that Ulster could have demanded to be paid the full 12% interest and yet, it chose to accept the plan. Although the court did not weigh too far into a discussion of the debtor’s possible motivations for impairing Ulster’s claim, the court appeared to indicate that such an examination may be irrelevant when it stated that “nothing in the Code prevents a debtor from negotiating a plan in order to gain acceptance and nothing requires a debtor to employ effort in creating unimpaired classes.”
The New Value Exception and the Absolute Priority Rule
Community Preservation next argued that the debtor’s plan could not be confirmed because the plan violated the absolute priority rule, as the holders of unsecured claims in Class 6, including Community Preservation’s deficiency claim, were not receiving payment in full while existing equity in Class 7 was retaining 100% ownership of the debtor.
Pursuant to section 1129(b)(1) of the Bankruptcy Code, the objection of a rejecting creditor may be overridden only “if 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.” As to a dissenting class of impaired unsecured creditors, a plan may be found to be “fair and equitable” under section 1129(b)(2)(B) only if the allowed value of the claim is paid in full or, in the alternative, if “the holder of any claim or interest that is junior to the claims of such [impaired unsecured] class will not receive or retain under the plan on account of such junior claim or interest any property.” This is known as the absolute priority rule.
Despite previously ruling that Ulster’s claim was not artificially impaired, the court found that the plan violated the absolute priority rule and, therefore, could not be confirmed under section 1129. In so holding, the court rejected the debtor’s assertion that the absolute priority rule had been satisfied where existing equity was providing new value to the debtor in the form of a $15,000 contribution. A debtor relying on the so-called “new value exception” must show that the capital contribution by old equity is: (i) new; (ii) substantial; (iii) money or money’s worth; (iv) necessary for a successful reorganization; and (v) reasonably equivalent to the property that old equity is retaining or receiving.
Following the precedent established by the Supreme Court in Bank of Am. Nat’l Trust & Sav. Assoc. v. 203 N. La Salle St. P’ship, the RAMZ court found that there was no possibility but to deny confirmation of the debtor’s plan. As the debtor had not provided for a competing plan nor was there any evidence that any other parties were given the opportunity to bid on the equity interests, the debtor had failed to demonstrate that the new money contribution of existing equity was “necessary for a successful reorganization.” Although the court was sympathetic to the debtor, the court stated that it would not “substitute its judgment for that of the creditors, which are entitled to vote on a plan.”
Conclusion
Even though the RAMZ court, ultimately, did not find artificial impairment, it does not mean that every other chapter 11 plan is out of the woods. In light of this decision, as well as the Fifth Circuit’s decision last year in In re Village at Camp Bowie I, L.P., secured creditors should proceed with caution and understand that a plan that artificially impairs creditors may ultimately not be confirmed.