Article courtesy of Kevin P. Braun of Morgan, Lewis & Bockius LLP
Debtor’s proposed plan of reorganization failed to satisfy the “best interests of creditors” test and Bankruptcy Code cramdown requirements due to plan’s proposed modifications to secured lender’s note, including paying secured lender less than the full amount of it’s claim while paying other secured lenders’ claims in full; plan also unfairly discriminated against such lender and failed to treat such lender’s impaired class as fair and equitable.
In re CE Electrical Contractors, LLC, 2022 WL 1420094 (May 4, 2022)
In March 2021, CE Electrical Contractors, LLC (“Debtor”) field a voluntary petition under Chapter 11 of the Bankruptcy Code. People’s United Bank, N.A. (“Senior Secured Lender”), as Debtor’s senior, fully secured lender, subsequently filed a Proof of Claim (“the Claim”) relating to a secured loan made by Senior Secured Lender to Debtor in an amount over $80,000 with a variable 5.25% interest rate. In February 2022, Debtor filed its Fourth Amended Plan of Reorganization (the “Plan”). Senior Secured Lender voted to reject the Plan and filed an objection to the Plan on the grounds that the Plan impaired Senior Secured Lender’s Claim in several ways, including converting Senior Secured Lender’s note from a demand note into a term loan, lowering the interest rate to a fixed 4% interest rate, eliminating the annual loan charge and default interest and modifying the terms of a non-debtor guaranty. Senior Secured Lender argued that the Plan failed to satisfy the cramdown requirements of the Bankruptcy Code and the “best interests of creditors” test due to its unfair discrimination against Senior Secured Lender and failure to treat Senior Secured Lender’s impaired class as fair and equitable. Further, Senior Secured Lender objected to the Plan’s temporary injunction in favor of Debtor’s principal, Paul Calafiore (“Calafiore”), relating to several personal guaranties over $3 million on loans for Debtor.
The Bankruptcy Court analyzed Senior Secured Lender’s objections to the Plans under the standards for confirmation of a Chapter 11 plan set forth in the Bankruptcy Code. For a plan to be confirmed, either “(1) it is approved by two-thirds in amount and more than one half in number of each impaired class” or “(2) at least one impaired class approves the plan…and the debtor fulfills the cramdown requirements of [Section] 1129(b) [of the Bankruptcy Code] to enable confirmation notwithstanding the plan’s rejection by one or more impaired classes.” The cramdown requirements provide that (1) “the plan proponent must show that all mandatory confirmation requirements have been satisfied, except for the requirement that all impaired classes have accepted the plan,” (2) “the plan does not discriminate unfairly against any impaired, non-consenting class” and (3) “the plan is fair and equitable.” Further, a Chapter 11 plan must satisfy the “best interests of creditors” test in order to be confirmed. Under the “best interests of creditors” test, a holder of an impaired claim must either accept the plan or receive an amount under the plan that is not less than the amount that such holder would receive in a Chapter 7 liquidation.
The Bankruptcy Court reasoned that since Senior Secured Lender objected to the Plan, the Plan could only be confirmed under the cramdown requirements of the Bankruptcy Code. The Bankruptcy Court agreed with Senior Secured Lender that Debtor could not fulfill the cramdown provisions because the Plan’s proposed modifications of the note unfairly discriminated against Senior Secured Lender and failed to treat its impaired class as fair and equitable. By examining the Plan’s “unfair discrimination” under the “Markell Test” (which approach is generally followed by the courts in the Sixth Circuit), the Bankruptcy Court explained that a rebuttable presumption of unfair discrimination arises when there is “(1) [a] dissenting class; (2) another class of the same priority; and (3) a difference in the plan’s treatment of the two classes” that causes the dissenting class to receive a “materially lower percentage recovery” or “an allocation under the plan of materially greater risk.” The Bankruptcy Court found that the Markell Test was satisfied because (1) Senior Secured Lender dissented to the Plan, (2) other secured creditors existed in different classes, and (3) the Plan proposed to pay such other secured creditors but not Senior Secured Lender in full and also extend the payment of Senior Secured Lender’s Claim longer than the payment of such other secured creditors’ claims. Therefore, the Bankruptcy Court concluded that the Plan unfairly discriminated against Senior Secured Lender. Additionally, the Bankruptcy Court agreed with Senior Secured Lender’s argument that the Plan failed to satisfy the “best interest of creditors” test because the Plan proposed to eliminate the annual loan charge and default interest and therefore pay Senior Secured Lender less than the full value of its secured claim, which it would receive under a Chapter 7 liquidation. Since the Plan proposed to pay Senior Secured Lender less than the full value, the Bankruptcy Court concluded that the Plan did not treat Senior Secured Lender fairly and equitably.
With respect to the Plan’s various proposed modifications to Senior Secured Lender’s note, the Bankruptcy Court made the following conclusions. In determining the appropriate cramdown rate of interest, the Bankruptcy Court held that since no efficient market rate existed, the adjusted rate would be “the current, fixed prime rate plus 2,” which addressed the market cost of funds and a risk adjustment for the restructured secured loan. Regarding the Plan’s proposed modification to the non-debtor guaranty, the Bankruptcy Court rejected the Plan’s proposals, noting that such modification would be unfair and Debtor failed to present authority for modifying the terms of such guaranty. Additionally, the Bankruptcy Court rejected Debtor’s proposed elimination of the annual loan charge, which the Bankruptcy Court found was reasonable given Senior Secured Lender’s monitoring and oversight of the restructured Debtor, and rather than eliminating default interest, the Bankruptcy Court equitably adjusted the default rate postconfirmation to 10%. Finally, the Bankruptcy Court found that Senior Secured Lender’s note could be converted from a demand note to a term loan because forcing Debtor to pay the full balance would threaten Debtor’s reorganization efforts. As reflected in the Bankruptcy Court’s decision, while the Bankruptcy Court found certain modifications to Senior Secured Lender’s note to be fair, the Bankruptcy Court concluded that the Plan failed to satisfy the “best interests of creditors” test and the cramdown requirements of the Bankruptcy Code.