Plan Accordingly: After Finding “Artificial” Impairment, Court Finds Plan Proposed In Bad Faith

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Contributed by Adam Lavine

Recently, in In re Swartville LLC, No. 11-08676, 2012 WL 3564171 (Bankr. E.D.N.C. Aug. 17, 2012), the United States Bankruptcy Court for the Eastern District of North Carolina denied confirmation of Swartville’s chapter 11 plan after finding that the plan had not been proposed in “good faith.”  The bankruptcy court’s decision reminds debtors that, although they “can and should” take advantage of the Bankruptcy Code’s protections, they might run afoul of one of the Bankruptcy Code’s good faith requirements if they attempt to “distort the [Bankruptcy Code’s] carefully balanced provisions through overreaching.”

Swartville was a single asset real estate case involving a two-party dispute between the debtor, Swartville, LLC, and its secured lender, T.D. Bank, N.A.  To confirm its chapter 11 plan, the debtor attempted to “cram down” T.D. Bank pursuant to section 1129(b)(2) of the Bankruptcy Code.  Under section 1129(a)(10) of the Bankruptcy Code, if a plan contains an impaired class of creditors, the plan, nonetheless, may be confirmed (notwithstanding the rejection of the plan by a class of creditors) if at least one impaired class of creditors has accepted the plan – assuming that certain other provisions of the Bankruptcy Code have been satisfied.  Assuming the debtor is able to satisfy section 1129(a)(10), then, as to the other impaired, but rejecting classes, the plan may be confirmed if the debtor can meet the cram down requirements set forth in section 1129(b)(2).  The cram down requirements differ depending on whether the class sought to be “crammed down” is comprised of secured or unsecured creditors.

Swartville’s plan attempted to cram down its only major creditor, T.D. Bank.  T.D. Bank objected to confirmation arguing, among other things, that the plan failed to meet the initial requirements set forth in section 1129(a)(10) – namely that the plan lacked at least one impaired, accepting class.  Swartville purported to have obtained the acceptance of class 7, which consisted of claims totaling $8,901 that would be paid in full 60 days after the effective date.  T.D. Bank, however, stated that the impairment was “artificial” because the creditors at issue would be paid in full just a short time after confirmation.  In other words, T.D. Bank argued the class was not “impaired” as such term is used in section 1124 of the Bankruptcy Code and that, as a result, class 7 did not qualify as an impaired accepting class for purposes of even reaching the cramdown analysis.

In analyzing whether to confirm the Swartville plan, the Bankruptcy Court noted that “two divergent approaches have emerged with respect to the application of the Bankruptcy Code’s impairment standard to a class of claims that is only nominally impaired.”  On one hand, some courts engage in an analysis to determine whether a nominally impaired class truly qualifies as “impaired” for purposes of section 1129(a)(10) – the cramdown provision.  On the other hand, some courts “tackle the artificial impairment issue by considering it as part of the good faith analysis required by section 1129(a)(3).”

The reason some courts analyze nominal impairment under section 1129(a)(3), which requires plans to have been filed in good faith, is because the Bankruptcy Code’s definition of impairment is broad.  Rather than contradict Congress’s broad definition of impairment, such courts prefer to address artificial impairment, which they view as an abuse of the Bankruptcy Code, by denying confirmation on the grounds that the plan has not been proposed in good faith.  Persuaded by this approach, the bankruptcy court analyzed class 7’s nominal impairment under the good faith analysis required by section 1129(a)(3).

In holding that Swartville failed to propose its plan in good faith, the bankruptcy court pointed to two main factors as the underpinnings for its decision.  First, the court found compelling the fact that the case was essentially a two-party dispute where the debtor was attempting to cramdown its only major creditor (which held over 1.6 million in claims) on the basis that a class holding a mere $8,901 in claims had accepted the plan.  Second, and perhaps more importantly, the court determined that the debtor failed to submit any evidence to justify the proposed 60-day delay in paying the claims in class 7. Accordingly, the court was left with the “inescapable conclusion” that the impairment to class 7 was “indicative of bad faith.”

Swartville should serve as a reminder to plan proponents that, even though a plan may meet the technical requirements of the Bankruptcy Code, a bankruptcy court may look beyond them and find bad faith nonetheless.