S.D.N.Y. Explores Impairment of a Secured Creditor Retaining its Collateral

An essential element to any cramdown plan is the presence of at least one impaired accepting class.  Even when a plan proponent purports to satisfy this requirement, objecting parties will often challenge the plan’s classification scheme or whether a particular class is truly impaired.  A recent decision from the Southern District of New York, In re Ashley River Consulting, LLC, serves as a reminder that when a secured creditor is retaining its collateral under a plan, the secured creditor’s agreement to accept less than it is entitled to – by making a contribution to other creditors – can render the secured creditor impaired and provide the impaired accepting class necessary for cramdown if that secured creditor votes to accept the plan. 
Background
In 2003, debtor Emerald Investments, LLC, entered into a joint venture with Kriti Ripley, LLC for the purpose of developing a marina and condominiums in Charleston, South Carolina.  The joint venture could be characterized as anything but smooth sailing.  In a saga spanning over nine years relating to, among other issues, accusations of diversion and misappropriation of the joint venture’s funds by Emerald, Kriti eventually obtained a money judgment and lien over Emerald’s membership interests in the joint venture.
On the eve of a scheduled foreclosure of Emerald’s membership interests, Emerald commenced its chapter 11 case.  Emerald’s principal was eventually replaced by a chapter 11 trustee following a finding of misconduct.  After an attempt to market and sell the marina property only yielded a single qualifying bid, which was far below the price that would have provided for any recovery to unsecured creditors, the trustee filed a chapter 11 plan with the support of Kriti that provided for Emerald’s membership interests to be turned over to Kriti.  Following Kriti’s 1111(b)(2) election, the proposed plan classified Kriti’s entire claim as a secured claim in its own class.  Ultimately, the plan’s only accepting class was the class with Kriti’s secured claim.
The Plan Objections
Emerald’s principal, joined by the debtors’ largest unsecured creditor (holding a claim for unpaid legal services) objected to the plan.  In addition to challenging the plan’s classification scheme, the objectors challenged whether the plan had an impaired accepting class.  Relying on In re 183 Lorraine Street Associates, where the court noted that a plan would leave a claim unimpaired where the plan proposed to give the secured creditor its collateral, the objectors asserted that Kriti’s claim was unimpaired because its collateral, Emerald’s membership interests, was being turned over to Kriti pursuant to the plan.  The objectors went on to assert that the plan puts Kriti in the same place it would have been as if the debtors never filed for chapter 11 because, but for the debtors’ chapter 11 filing, Kriti would have continued his foreclosure on Emerald’s membership interests.
Section 1129
Section 1129(a) of the Bankruptcy Code contains the confirmation requirements for a chapter 11 plan.  In particular, section 1129(a)(10) requires that, 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.  Essentially, cramdown of a plan is not permitted unless it is shown that at least one class that is harmed by the plan favors the plan.  As the court noted, section 1129 serves as a “statutory gatekeeper barring access to cramdown where there is absent even one impaired accepting class.”
Analysis
Although the Court agreed with the objectors that In re 183 Lorraine Street Associates stands for the proposition that a secured creditor retaining its collateral under a plan is typically unimpaired, the Court found that the objectors failed to appreciate that the Lorraine court actually concluded that a secured creditor retaining its collateral under a plan would in fact be impaired if the secured creditor was receiving less than it was entitled to (in that case the secured creditor received its collateral less a $5,000 deposit for the benefit of unsecured creditors).  Here, even though Kriti was retaining its collateral – Emerald’s membership interests – pursuant to the plan, Kriti had also agreed to pay the administrative claims of the chapter 11 cases, which were estimated to exceed $90,000.  Under the plan, Kriti was to receive less than it was entitled to because it was funding the administrative claims of the chapter 11 cases.
Accordingly, the court concluded that because Kriti’s claim was impaired as a result of paying the administrative expenses and because Kriti voted in favor of the plan causing the class to accept the Plan, the Plan had an impaired accepting class and could be confirmed over the objections of any non-accepting classes.
Conclusion 
As the objectors in In re Ashley River Consulting, LLC quickly learned, a contribution for the benefit of other creditors can in fact render a secured creditor, who typically would be unimpaired because it was retaining its collateral under the plan, impaired.  The decision leaves one wondering how significant the contribution must be before a court would question whether such contribution was merely an attempt to manufacture an impaired accepting class to facilitate cramdown.
Kevin Bostel is an Associate at Weil Gotshal & Manges, LLP in New York.