Bowie Cuts to the Heart of Artificial Impairment

Written by: Robert DeMarco
Fifth Circuit Clarifies Position on Artificial Impairment of Classes
The Fifth Circuit Court of Appeals recently clarified its position on class treatment in a single asset real estate bankruptcy case [In re Village at Camp Bowie I, L.P., 710 F.3d 239 (5th Cir. 2013)].  Village at Camp Bowie I, L.P. [“VCB”], filed for relief under chapter 11 of the Bankruptcy Code on August 10, 2010; the day before a scheduled foreclosure sale.  As of the petition date, VCB owed approximately $32 million to Western Real Estate Equities, LLC [“Western”] secured by real property located in west Fort Worth, Texas [the “Property”] and less than $60,000.00 to various unsecured trade creditors.
Western filed a motion for relief from stay on August 10, 2010, which motion the Bankruptcy Court took under advisement, but did not lift the stay as there was significant equity in the Property.  The Debtor eventually filed its plan of reorganization on November 29, 2010.  Subsequently, a second amended plan was filed, which plan designated only two voting, impaired classes, one consisting of Western’s secured claim and the other consisting of the unsecured trade claims.
The second amended plan tendered Western a secured note in the amount of its secured claim with interest accruing at 5.84% per annum with a balloon payment due in five years.  The unsecured creditors were to be paid in full over three months from the effective date of the plan
Western objected to confirmation on the basis of artificial impairment [11 U.S.C. § 1129(a)(10)].  Western argued that the class of unsecured trade creditors were artificially impaired as the impairment was minimal –roughly $900.00 in foregone interest over a three month period.  Alternatively, Western contends the plan was not filed in good faith [11 U.S.C. § 1129(a)(3)].
The Fifth Circuit acknowledged a split between the Eighth and Ninth Circuits regarding the question of whether § 1129(a)(10) distinguishes between artificial and economically driven impairment.  The Court expressly rejected the Eight Circuit’s position and joined with the Ninth Circuit in holding that § 1129(a)(10) does not distinguish between discretionary and economically driven impairment.  Judge Higginbotham, writing for the Court explained that the Eighth Circuit’s treatment of the issue was inconsistent with § 1123(b)(1) “which provides that a plan proponent “may impair or leave unimpaired any class of claims,” and does not contain any indication that impairment must be driven by economic motives.”  In re Village at Camp Bowie I, L.P., 710 F.3d 239, 245 (5th Cir. 2013).  Judge Higginbotham was critical of the Eighth Circuit’s conclusion that condoning artificial would reduce § 1129(a)(10) to a nullity, stating that “this logic sets the cart before the horse, resting on the unsupported assumption that Congress intended § 1129(a)(10) to implicitly mandate a materiality requirement and motive inquiry [and] ignores the determinative role § 1129(a)(10) plays in the typical single-asset bankruptcy, in which the debtor has negative equity and the secured creditor receives a deficiency claim that allows it to control the vote of the unsecured class.”  Id. at 246.
Western, however, contended that statutory construction was not the real issue directing the Court to its decision in Matter of Greystone III, Joint Venture, 995 F.2d 1274 (5th Cir. 1991).  The Fifth Circuit, in Greystone, held that a plan proponent cannot gerrymander creditor classes solely for purposes of obtaining the impaired accepting class necessary to satisfy § 1129(a)(10).  The Court countered explaining that Western ignores the fact that the anti-gerrymandering principle resolved an ambiguity in § 1122 and was not a broad statement intended to “ride roughshod over affirmative language in the Bankruptcy Code to enforce some Platonic ideal of a fair voting process.”  Camp Bowie, 710 F.3d at 247.  “A plan proponent’s motives and methods for achieving compliance with the voting requirement of § 1129(a)(10) must be scrutinized, if at all, under the rubric of § 1129(a)(3), which imposes on a plan proponent a duty to propose its plan “in good faith and not by any means forbidden by law.”  Id. (citations omitted).
The Court concluded that the second amended plan was proposed with the legitimate and honest purpose of reorganizing and had a reasonable chance of success.  As such, the plan was proposed in good faith.
This recent opinion further emphasizes the importance that valuation can play in bankruptcy.  This is especially so in the case of a single asset real estate case.
Lastly, while this case does present certain challenges to secured lenders in the single asset real estate case scenario, such secured lenders are not without recourse.  A lender might consider: (a) purchasing the unsecured trade debt so as to control the unsecured creditor class; or (b) propose a competing plan that pays unsecured creditors in full on the effective date, so as to leave that class unimpaired.
DATED:  June 25, 2013