As a result of the meltdown of the financial markets, lenders are severely constricting new credit facilities and refusing to renew expiring facilities. The Bankruptcy Code's chapter 11 provides a powerful mechanism for an otherwise viable business to restructure and extend its outstanding debt and in many cases, reduce interest rates on loan facilities.
The modification of an existing credit facility in a bankruptcy case over the objection of a lender is typically accomplished through a "cramdown plan." "Cramdown" means, simply, obtaining confirmation of a chapter 11 plan of reorganization over the objection of one or more dissenting classes of creditors. Often, the objecting creditor is the pre-petition lender holding a loan that the debtor seeks to modify. This technique has been used in countless bankruptcy cases to save businesses large and small.
"Cramdown plans" are governed by section 1129(b) of the Bankruptcy Code, which allows confirmation of a plan if "the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan" despite objections from creditors and other parties. Thus, the debtor must convince the bankruptcy court that the proposed plan is fair and equitable despite objections. So long as the plan provides that a secured lender will retain its lien and receive deferred cash payments equal to the present value of the collateral securing the loan, the judge may find the plan fair and equitable. Generally, this means that payments must be made at a market rate of interest, which may be substantially less than is required under the loan documents.
Where a secured creditor has a claim that exceeds the value of its collateral, a successful "cramdown" can result in both the reduction of the loan balance secured by the collateral, and a reduction in the interest rate to be paid. The unsecured portion of the loan, or deficiency balance, is paid in "bankruptcy dollars," often a few cents on the dollar, like most claims in a bankruptcy case.
A reorganization plan may not discriminate "unfairly" against similarly situated creditors (those with equal priority). Thus, some discrimination with respect to similarly situated creditors is permitted, so long as such discrimination is not "unfair" and there is a reasonable basis for discriminating. Courts also consider whether the disparate treatment has been proposed in good faith, and whether the degree of discrimination is directly related to rationale for the discrimination. For example, while the bankruptcy court would almost certainly find that a debtor's proposal to pay one unsecured class 90% in one year, and another unsecured class 30% over 10 years simply to obtain acceptance by the class being paid 90%, was unfair discrimination, the court might well find that a debtor's proposal to pay two unsecured classes of claims on slightly different terms was appropriate.
Whether discrimination among classes of claims is unfair is important, because the debtor must obtain acceptance by at least one class of creditors whose claims are impaired (i.e., not paid in full) in order to obtain confirmation of its plan.
Most often, a lender will reject a plan that proposes to reduce its secured loan balance to the value of the collateral and lower the interest rate. The debtor will therefore typically need at least one other impaired class to vote in favor of the plan or the plan will not be confirmed. The voting requirements of the Bankruptcy Code require at least one-half in number and two-thirds in dollar amount in order to have acceptance. Thus, a single creditor can block acceptance of a plan if it controls more than one-third of the amount of claims voting in a class. For this reason, debtors often attempt to place a junior lender's unsecured deficiency claim in a separate class from other unsecured claims, where the deficiency claim could control the outcome of voting if placed in the unsecured class. Debtors must be careful to avoid "artificially impairing" a class of claims or gerrymandering the voting with unnecessary classes, which is not permitted.
The Bankruptcy Code also requires that a "cramdown plan" be "fair and equitable." With respect to secured claims, a debtor has three alternative ways in which to establish that the plan is fair and equitable. First, a plan is fair and equitable where the secured creditor retains the liens securing its claims to the extent of the allowed amount of such claims and receives deferred cash payments totaling at least the value, as of the effective date of the plan, of such holder's interest in the property. This effectively means that the debtor can write a new loan and that the debtor is required to pay such claims with interest, but only to the extent of the value of the property as compared to the secured creditor's lien. Thus, a creditor will have its claim bifurcated into secured and unsecured portions. Only the secured portion of the claim receives interest payments. The appropriate rate of interest is often disputed and is determined by the bankruptcy court. Second, the debtor may provide the secured creditor with the "indubitable equivalent" of its claim. Indubitable equivalence means a lack of any reasonable doubt that the secured creditor will receive the payments to which it is entitled. This can take many forms, including the return of collateral, substitute collateral and payments of property and cash. Finally, in the case of the sale of the subject property free and clear of liens, the liens of the secured creditor must attach to the proceeds of the sale. The secured creditor is then entitled to treatment of its claims either through periodic payments or the indubitable equivalent of its claim.
We can expect to see the volume of chapter 11 cases continue to increase over the next several months. A business looking to restructure its debts may wish to investigate these options and others in further detail.