Chapter 11

     A debtor who is not eligible for relief under Chapter 13 of the Bankruptcy Code may seek to reorganize under Chapter 11. A Chapter 11 plan of reorganization, often proposed months (sometimes years) after the filing of a Chapter 11 petition, following the debtor's negotiation with its creditors and shareholders, or with committees representing creditors and shareholders, is typically considerably more complex than a Chapter 13 plan. Unlike a Chapter 13 plan, a Chapter 11 plan must, with certain exceptions, be approved by requisite majorities of votes of the debtor's creditors and shareholders. Once confirmed, the Chapter 11 plan redefines and replaces the pre-petition legal relationship between the debtor, its creditors, and its shareholders.

     We focus in these materials on the treatment afforded the allowed secured claim in Chapter 11. As in Chapter 13, the allowed secured claim is guaranteed the following minimum treatment: (1) if the secured claim is to be paid over time, the secured creditor must receive on account of that claim a stream of payments totaling an amount that will have the same value to the secured creditor as would a lump sum payment of the allowed secured claim at the time the plan is confirmed by the bankruptcy court; and (2) the secured creditor must retain a lien to secure the stream of payments. See Bankr. Code 1129(a)(8) and 1129(b)(1) and (2)(A). Because the debtor may be able to force this treatment on the secured creditor even if the secured creditor votes against the plan, this feature of Chapter 11 is colloquially referred to as "cram down."

     To illustrate, suppose that an airline company files a Chapter 11. Among its debts is a $10,000,000 obligation to a bank secured by a security interest in a group of airplanes owned by the debtor. If the airplanes are worth $8,000,000 and if the bank is not secured by any other collateral, the bank has an allowed secured claim in the amount of $8,000,000 and an allowed unsecured claim in the amount of $2,000,000 (just as in our case of a consumer debtor and her automobile, but with a few zeroes added). Even though the debt to the bank may be in default and may have been accelerated, the plan may propose to pay the bank $8,000,000, on account of the allowed secured claim, over a period of years not to exceed the useful life of the airplanes, with suitable interest to assure the bank present value, as of confirmation of the plan, of $8,000,000. The plan will also propose to secure the promise to pay $8,000,000 with a lien on the airplanes or with a lien on other appropriate collateral. If the plan may otherwise be confirmed (pursuant to requirements we don't explore here), the bank will be forced to accept this new relationship with the airline company even if the bank casts its vote against the plan.

     The debtor will also need to propose some payment of allowed unsecured claims, including the bank's $2,000,000 claim. Here the bank has more power because its vote against the plan may preclude the plan from receiving the requisite majority of votes from holders of unsecured claims. The proponent of the plan may not "cram down" the plan on the holders of unsecured claims unless the plan also proposes to wipe out the interests of existing shareholders or requires existing shareholders, as a condition to retaining ownership interests, to contribute new value to the venture, both of which alternatives the shareholders would like to avoid. Thus, the threatened negative vote of enough unsecured creditors can hold the plan hostage to negotiations in which the holders of unsecured claims seek the best possible repayment terms as a condition to a vote in favor of the plan.

     In some cases, particularly those involving real estate in a cyclical market, the treatment described above for an undersecured creditor may prove unfair. Consider the following possibility. A real estate developer files Chapter 11. The developer owes bank $10,000,000, secured by a first deed of trust on real property valued at $8,000,000. Assume no other liens on the property. Suppose the developer treats the bank here in the same manner described in the case of the airline that filed Chapter 11 and suppose that holders of unsecured creditors vote in favor of a plan that promises to pay them 50% of their claims. Suppose, as well, that shortly after the plan is confirmed, a dramatic rise in real estate values increases the value of the developer's real property to $12,000,000. In that case, the developer might well sell the real property. Because the bank's lien on the real property secures only an $8,000,000 debt, the developer will reap $4,000,000 from the proceeds of the sale. In other words, the benefit of the appreciation in the real property will accrue exclusively to the developer and the bank will end up with at most $9,000,000.

     If, at the time the plan is proposed, the bank foresees the foregoing scenario as a realistic possibility, it can alter the result by making an "1111(b) election." It is virtually impossible to understand this election by reading the statute, but try. Start with Bankr. Code 1111(b)(2). The language of that section tells us that if our lender in the preceding paragraph so elects, the debtor must treat the lender as having an allowed secured claim of $10,000,000 even though the real property is worth only $8,000,000. If, following confirmation, the debtor sells the property for $12,000,000, the lender, whose lien secures a $10,000,000 allowed secured claim, will reap the first $10,000,000. This sounds pretty good until one considers the cost.

     By making this election, the lender sacrifices any unsecured claim, because it has elected to be treated as fully secured. It therefore also sacrifices its vote as an unsecured creditor and its corresponding power to influence the amount of payments to unsecured creditors. Of course this won't matter if the confirmed plan promises (and the debtor completes) payment to the lender of a stream of payments with a value, as of confirmation, of $10,000,000. But the plan need not promise that much. It need only promise to pay a stream of payments totaling at least $10,000,000 with a value, as of confirmation, of $8,000,000. See Bankr. Code 1129(b)(2)(A)(i)(II). If the debtor does not sell the real property, but completes payments under the plan, the lender will end up with a stream of payments having a value, as of confirmation, of $8,000,000. This is $1,000,000 less than it would have received had it not made the election and the debtor had made a 50% payout to holders of unsecured claims. The lender must thus decide whether the potential benefits of the election are justified by the sacrifice.

     There is a further complication. We know from our study of the state system that undersecured creditors will be denied a deficiency in some circumstances, either by their contract with the debtor (the agreement is explicitly "non-recourse") or by applicable state anti-deficiency law (e.g. Cal. Code Civ. Pro. 580b). Consider once more our lender with a first lien on real property worth $8,000,000 to secure a $10,000,000 debt. If the lender is without recourse, either by virtue of its contract with the debtor or by virtue of applicable state anti-deficiency law, then, under the Bankruptcy Code, we would think that our lender has an allowed secured claim of $8,000,000, but no unsecured claim. If this were true, the strategic debtor might well be tempted to file Chapter 11 and emerge with a plan to pay the lender a steam of payments having a value, as of confirmation, of $8,000,000 but no obligation to pay the balance of the debt. The Bankruptcy Code forecloses this strategy by providing, in Bankr. Code 1111(b)(1)(A), that the non-recourse lender will be deemed to have recourse (and thus have an allowed unsecured claim, in our example, of $2,000,000), unless it makes the 1111(b) election.