Can a Partial “Dirt for Debt” Plan Satisfy the “Indubitable Equivalent” Cramdown Standard?

on January 17, 2013 ·

Posted in Chapter 11 Plans,Secured Claims

For years, the notion of cramming a secured creditor down with the “indubitable equivalent” of its claim under section 1129(b)(2)(A)(iii) of the Bankruptcy Code seemed nothing more than a theoretical (if little understood) possibility.  As we have discussed in this blog, here and here, it seemed to gain new life with the ultimately unsuccessful attempts by the RadLax and Philadelphia Newspaper debtors to cram down plans that sought to sell encumbered assets free and clear of liens without allowing their secured lenders to credit bid.  Within the past year, courts have rejected other arguments on the indubitable equivalent front, including that the debtor could replace real estate collateral with treasury bonds having a face amount equal to one-third of the mortgage debt or that a debtor could pay interest under the plan according to the terms of the original debt instrument without otherwise complying with reinstatement requirements or demonstrating that such interest provided the lender with the present value of its secured claim.  Debtors have had mixed results in seeking to apply the indubitable equivalent standard to partial “dirt for debt” plans — where a debtor seeks to confirm a plan that conveys less than 100% of a lender’s real estate collateral in full satisfaction of its claim.  The indubitable equivalent argument recently prevailed, however, in In re Investors Lending Group, LLC, in which the United States Bankruptcy Court for the Southern District of Georgia held that a partial “dirt for debt” plan could (with some additional modifications) satisfy the “indubitable equivalent” standard. 

The debtor, Investors Lending Group, LLC, was in the business of granting loans, secured by non-owner occupied and commercial real estate.  The loans issued by the debtor were generally short term loans designed to enable clients to renovate, refinance or construct new projects.  The debtor also owned and leased commercial real estate.  Twelve of its owned properties secured a debt owed by the debtor to the Bank of the Ozarks.  The debtor and its unsecured creditors’ committee filed a joint plan of reorganization that proposed to surrender to the bank five of the twelve properties to the bank in full satisfaction of the bank’s secured claim.  The debtor planned to retain the other seven properties to fund its future operations and pay other creditors.

After the bank objected to the proposed disclosure statement and put forth its own lower valuations of the debtor’s properties, the debtor accepted the bank’s values and incorporated those values into an amended plan under which the debtor would surrender seven of the twelve properties in full satisfaction of the bank’s claim.  The bankruptcy court approved a revised disclosure statement that reflected the bank’s proposed values.

Notwithstanding that the amended plan used the bank’s values, the bank nevertheless objected to the plan and argued that the seven parcels gave it an insufficient equity cushion.  The bank argued that, because the bank would have to sell the parcels to repay its claim, the valuation either should be reduced to a liquidation value or should be reduced by certain carrying and sale expenses not contemplated by the appraisal, such as a typical 6% real estate commission, additional closing costs, maintenance expenses, and repair costs for the properties to be surrendered.

The debtor argued that because the court had approved the property values in the context of approval of the disclosure statement, the bank was precluded from arguing that the court should reduce the approved property values because of anticipated liquidation.  The bank countered that, even though the property values had been approved as part of the disclosure statement approval, the values could still be changed because a plan of reorganization could be modified at any time prior to confirmation.  In the alternative, the bank argued that the court should reduce the proposed surrender values to insure that the bank received the indubitable equivalent of its claim.

In its analysis, the court first noted that it had previously upheld the use of partial “dirt for debt” plans in the cramdown context in full satisfaction of an oversecured creditor’s claim.  The court stated that section 506(a)(1) of the Bankruptcy Code allows courts to establish the value of property and determine whether the property to be surrendered provides the indubitable equivalent of a secured claim. 

Citing upon the U.S. Supreme Court’s decision in Associates Commercial Corp. v. Rash the bankruptcy court concluded that, because Rash holds that replacement, and not foreclosure, value should apply when the debtor proposes to retain collateral, the converse was also true.  In other words, if the proposal before the court was to surrender property in whole or in part, then the foreclosure or liquidation value was the proper standard.  Although that might sound like a complete victory for the bank, because the parties had agreed on the valuations, the court held that it would treat the valuations in the disclosure statement as a realistic liquidation value for the properties.

The court stated, however, that to confirm a partial “dirt for debt” plan, it was obligated to take particular care that a lender forced to accept property in satisfaction of its claim over its objection received the indubitable equivalent of cash.  The court then adjusted the bank’s claim to account for several factors not considered in the valuation, including an 8% discount on account of the typical commissions and expected closing costs that would be borne by the bank.

While the court refused to confirm the debtor’s plan as originally proposed, the court indicated that a partial “dirt for debt” deal could satisfy the “indubitable equivalent” standard for cramdown purposes. 

11 USC Sec. 506
Sec. 506. Determination of secured status
      (a)(1) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor's interest or the amount so subject to setoff is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.
11 USC Sec. 1129
Sec. 1129. Confirmation of plan
    . . . (b) (2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:
    (A) With respect to a class of secured claims, the plan provides –
    . . . (iii) for the realization by such holders of the indubitable equivalent of such claims.
In re Philadelphia Newspapers, 599 F.3d 298 (3d Cir. 2010).
520 U.S. 953 (1997)

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