 A Federal Judicial Center Orientation Series for United States Bankruptcy Judges Chapter 11 Reorganization Confirming a Plan the Hard Way with George M. Treister, Attorney at Law, Los Angeles, California Suppose it's not possible to achieve such a fully consensual plan under section 1129A In other words, all the requirements are met except that one or more impaired classes has not accepted the plan. If all requirements have been met except the one in section 1129A8 it's possible to confirm the plan the hard way. This is known as cram down. I emphasize that confirmation is not possible at all unless all of the 12 other requirements have been met. We'll discuss cram down in two steps. First, we'll give an explanation of the concept. Then we'll explain how the concepts apply to creditors and equity interests. Cram down may be hard to understand until you've grappled with it for a while but we'd like to take a few minutes to talk about it now because it often provides the impetus for a consensual confirmation. Even after a brief explanation it probably is going to be apparent why parties normally want to negotiate reasonably so they can confirm the easy way and avoid the difficulties of cram down. To satisfy section 1129B's cram down standards the plan with respect to each non-accepting impaired class must be fair and equitable and cannot discriminate unfairly. What's it mean to be fair and equitable? A considerable body of case law over the years has construed and refined the meaning of the fair and equitable rule. This rule is sometimes referred to as the absolute priority rule. It's been established that senior classes must be fully compensated under the plan before junior classes can share. A senior class is one whose legal rights have priority over a junior class as a result of contractual entitlements or applicable law. For example, in the most simplistic terms creditors are senior by law to stockholders. Preferred stockholders are senior to common stockholders. And among the creditor classes one or more of them may have seniority or be subordinated to the others. As I just said, any impaired senior class that has not accepted the plan must be fully compensated before a junior class may receive any reorganization value. Moreover senior classes can't be overcompensated. Overcompensation would give reorganization value to seniors that fairly and equitably belongs to the junior class. Now how is crammed down applied under the code so that a plan may be confirmed despite the class's opposition? For a class of unsecured claims a plan is fair and equitable if it provides the members of the class with consideration having a present value as of the plan's effective date of not less than the full allowed amounts of the claims in that class. In other words, the consideration fully compensates the impaired non-accepting unsecured creditor class. Let's say that the plan provides that the class is to be compensated with the debtor's notes which will be issued in the principal amount of the allowed claims in that class. The notes must bear a market rate of interest so that the deferred payments will meet the present value requirement. Or suppose the consideration to be distributed to the class is to consist at least to some extent of the stock of the reorganized debtor. To determine the value of that stock the court's going to have to determine the going concern or reorganization value of the reorganized company. This is an exercise that's difficult to predict to say the least. Alternatively, if the unsecured creditor class is not to be fully compensated then under the fair and equitable requirement no junior class, namely stockholders may receive anything under the plan. The fair and equitable rule applies similarly in the case of ownership interest. In the case of a secured creditor class the fair and equitable rule is complied with as a general proposition if the secured creditor retains its lien on the collateral or on the proceeds of the collateral if it's sold and receives under the plan deferred cash payments that have a present value as of the plan's effective date equal to the allowed amount of the secured claim. In other words, the lien remains on the collateral and there must be a stream of future cash payments having a present value equal to the allowed amount of the secured claim. And typically that involves paying a market rate of interest on the deferred installments. The practical effect of the fair and equitable rule in the case of cramming down a secured claim is that the payment period of the secured obligation may be restructured. As a matter of fact, any of the terms of the secured claim may be rewritten as long as the present value of the stream of payments is assured by the appropriate interest rate. There's an alternative provision of fair and equitable that relates to a secured claim. This provision is intended as a reservoir of judicial power to permit other kinds of fair and equitable treatment of secured creditor classes. It enables the cram down of any planned provision on a secured class that assures the realization by that class of the quote indubitable equivalent of the claim. Now I've been referring to secured claims. Let's recall the provisions of section 506A. When a claim is under secured, or in other words, only partially secured, the allowed amount of the secured claim is ordinarily the value of the collateral. Any deficiency is defined as an unsecured claim. The secured and unsecured components go into different classes. For cram down of the secured claim class, the present value of the stream of future payments must be not less than the allowed amount of the secured claim as determined under section 506A. The code contains a special option for undersecured creditors whose claims exceed the value of the collateral. Normally, an undersecured claim would be bifurcated into secured and unsecured components, which would then go into separate classes. However, that kind of creditor may make an election provided by section 1111b, which prevents the planned proponent from stripping down the allowed amount of the secured claim to the value of the collateral. This section 1111b election is a very convoluted provision. It results in the undersecured creditors bringing up its unsecured claim and its potential ability to veto the plan by voting in the unsecured creditor class to reject the plan. But even when the fair and equitable rule is painted with broad brushstrokes, it's readily apparent why parties would normally want to negotiate reasonably to the end that they can confirm the plan the easy way. Seniors are motivated to give up reorganization values to juniors to achieve a consensual plan so as to avoid the time, the expense, and the risks involved in testing the fair and equitable rule. Juniors are motivated to make only reasonable demands because application of the absolute priority rule may result in their receiving nothing under the plan if the reorganization value is determined by the court in a litigation context turns out to be too low.