In re NNN Parkway 400 26, LLC, 2014 Westlaw 309734 (Bankr. C.D. Cal. 2014)
In re NNN Parkway 400 26, LLC, 2014 Westlaw 309734 (Bankr. C.D. Cal. 2014). A bankruptcy court in California has held that a “new value” Chapter 11 reorganization plan requires a genuine market test of the value of the equity, that the lender’s deficiency claim could not be gerrymandered where the guarantor was insolvent, and that the artificial impairment of a consenting class cannot be the result of abusive conduct.
Facts: A group of Chapter 11 debtors sought confirmation of a plan of reorganization that sought to invoke an exception to the “absolute priority rule” of 11 U.S.C.A. § 1129(b)(2)(B)(ii). That rule requires, in essence, that if the non-consenting unsecured creditors are not paid in full, the equity holders cannot retain anything following the reorganization. Under the plan, the equity holders would retain some interest in the reorganized companies, in exchange for the contribution of some “new value.” In addition, the plan separately classified (or “gerrymandered”) the multimillion dollar deficiency claim of the secured lender. The plan also identified a very small single-creditor class as an “impaired consenting class,” for purposes of plan cramdown. The lender objected to the plan on a variety of grounds, and the court denied confirmation.
Reasoning: The court first explained that under Bank of America Nat. Trust and Sav. Ass’n v. 203 North LaSalle Street Partnership, 526 U.S. 434, 119 S. Ct. 1411, 143 L. Ed. 2d 607 (1999), the plan proponent must show that the proposed “new value” is quantitatively sufficient:
LaSalle requires that the quantum of new value be market tested; otherwise the parties and the court cannot know whether the amount of new value proposed in the debtor’s plan is the most available. And if more (or better) could be gotten elsewhere, then the equity is effectively keeping a form of property or interest in the debtor despite not paying the dissenting creditors in full, by exercising its exclusive "option" to direct/determine the source of the new value. But LaSalle is frustratingly vague as to what exactly a debtor must do to "market test" the interest …
Given that vagueness, the debtors attempted to show that their private marketing efforts had constituted a de facto “market test,” since they had tried to reach out to investors to purchase the equity. The court was unimpressed, noting that "[n]o contact log was kept . . . [n]o advertisements of any kind were undertaken . . . whether in commercial real estate investor-oriented magazines or otherwise.” The court held that the debtors’ marketing program fell far short of the required due diligence:
This court does not hold that in every case an investment banker must be hired, whose fee is tied to success in finding the most money on the best terms. But engagement of such a person with that goal and motivation would help. The court does not hold that advertisements in targeted local and national newspapers are always required, or that they would even be appropriate in every case. But the court does hold that debtors bear the burden of showing that the new money offered is the most and best reasonably obtainable after some "market testing" in order to cram down over the objections of a non-consenting class of unsecured creditors. This probably requires, at a minimum, demonstration of a systematic effort designed to "market test" the deal.
Moving to the issue of claims classification, the debtors argued that the lender’s deficiency claim could be separately classified because the lender held a guarantee, unlike other unsecured creditors, in conformity with the holding in In re Loop 76, LLC, 465 B.R. 525 (9th Cir. BAP 2012). But the court held that the debtor had failed to show that the guarantor was insolvent, thus casting doubt on the basis for gerrymandering:
[S]ince this entire question of separate classification is one addressed to separating reality from façade, it follows that the basis for the distinction must be one that is meaningful. . . . [T]his court holds that a guaranty from an insolvent guarantor provides nothing meaningful and so it becomes a distinction without a difference and cannot alone support separate classification.
Finally, the debtor claimed that it had provided a plausible "impaired consenting class" for purposes of cramdown, since it owed approximately $10,000 to one creditor for the purchase of a truck. The court noted that there was testimony that the truck had been unnecessary, that the debtor had no place to store it, and that its purchase was simply a strategy. The court held that this was a case of impermissible "artificial impairment:"
This smells to the court like a device to create an impaired consenting class. Moreover, the parties apparently agree that there are and have been at all times since the petition hundreds of thousands on deposit [in funds available to the debtors], so it is entirely unclear why this creditor is impaired at all. A doctrine has emerged that "artificial impairment" is a form of gerrymandering and when abusively used is held to be antithetical to the good faith which must be at the center of any reorganization effort.
Comment: This opinion is significant because it adds a healthy dose of common sense to the murky jurisprudence surrounding the cramdown process. First, the court required genuine efforts by the debtors to “market test” their new value plan, going so far as to spell out the investor outreach program that a debtor must undertake. As far as I know, no other reported opinion has provided such detailed guidance.
Second, the court’s rejection of gerrymandering in this case adds an important qualification to the rule in Loop 76, supra: it is not enough to show that the lender holds a guarantee. Instead, the debtor must also show that the guarantor is solvent. Otherwise, there is no good reason to separately classify the lender’s deficiency claim. I do not know whether this “friendly amendment” to the holding in Loop 76 will survive appeal, but I hope that it will. Otherwise, the holding in Loop 76 will create a huge loophole in the cramdown process: many (and perhaps most) lenders hold guarantees, thus setting the stage for routine gerrymandering.
Third, the court’s “reality-based” rejection of “artificial impairment” is refreshing. The court was able to look at the circumstances surrounding the collusive creation of the “impaired consenting class” and to reject the debtors’ transparent gamesmanship. However, I am not sure that the court’s ruling on this point would withstand appeal in light of In re L & J Anaheim Associates, 995 F.2d 940 (9th Cir. 1993), which permitted a creditor that propounded a plan of the organization to “impair” itself by accelerating its own recovery. If the blatantly collusive impairment in that case was sufficient, then I don’t see why the purchase of the truck in this case would not pass muster.
Finally (and pedantically), I am delighted to see that the court capitalized the word “Chapter” in “Chapter 11,” perhaps following the lead of the Ninth Circuit in In re Bellingham Ins. Agency, Inc., 702 F.3d 553 (9th Cir. 2012). I continue to believe that the bankruptcy bar’s ostentatious use of the lower case form is without statutory justification and is nothing more than artificial orthographic impairment.
For a critical discussion of the Loop 76 opinion, see 2012 Comm. Fin. News. 19, When Secured Lender Holds Non-Debtor Guarantees, Lender’s Unsecured Deficiency Claim May Be Separately Classified, Thus Enabling Debtor to Confirm Cramdown Plan Using a Separate Class of Impaired Consenting Unsecured Creditors.
This analysis is from CA State Bar Insolvency Committee e-newsletter