In re Village Green I, GP, ___F.3d___, 2016 Westlaw 325163 (6th Cir. 2016)
The Sixth Circuit has held that a cramdown plan of reorganization was not propounded in good faith due to the artificial impairment of small claims held by two creditors who were closely connected to the Chapter 11 debtor, especially since the debtor had sufficient funds on hand to pay those creditors in full immediately.
This is a circuit split issue: 9th Circuit and 6th Circuit are split on the issue of "artificial impairment." See, e.g., In re L & J Anaheim Associates, 995 F.2d 940 (9th Cir. 1993), holding that the definition of "impairment" under § 1124 did not necessarily mean "harmed." The Ninth Circuit reasoned that under § 1124(1), an unimpaired claim is one that is "unaltered." Therefore, any alteration, no matter how trivial, is sufficient to constitute impairment. The Village Green court conceded the issue of impairment but focused instead on the “bad faith” prong of the analysis. Perhaps the Supreme Court will ultimately resolve this question.
Facts and reasoning in Village Green: A partnership owned an apartment complex that was substantially "underwater" on its mortgage. It filed a Chapter 11 petition and eventually sought confirmation of a "cramdown" plan. Under 11 U.S.C.A. §1129(a)(10), a plan may be confirmed over the objections of most of the creditors (“crammed down”) if there is at least one impaired consenting class of creditors. Under the proposed plan, the debtor’s accountant and attorney were owed $2,400 but would not be immediately "cashed out" for 60 days, even though the debtor had sufficient cash to do so. By contrast, the plan proposed to pay its secured creditor over a 10 year span of time.
The debtor contended that those two creditors (its attorney and its accountant) constituted an "impaired consenting class," thus satisfying the cramdown requirements. After considerable litigation, the bankruptcy court eventually lifted the automatic stay and dismissed the bankruptcy case on the ground that it had not been filed in good faith. The district court affirmed, and so did the circuit court.
The court first agreed that the minor delay in payment to the debtor’s accountant and attorney meant that they were technically "impaired" for purposes of §1124(1). However, the court went on to hold that the plan had been propounded in bad faith, in violation of §1129(a)(3), since the debtor had ample funds to pay the "impaired creditors" immediately: "[T]hat the minor claimants ([the debtor’s] former lawyer and accountant) are closely allied with [the debtor] only compounds the appearance that impairment of their claims had more to do with circumventing the purposes of § 1129(a)(10) than with rationing dollars."