Business Restructuring Review

Modification of Secured Loan under Cram-Down Chapter 11 Plan Warranted Due to Plan Feasibility Threat

Many recent court rulings concerning the treatment of secured creditors under a chapter 11 plan have focused on "cram-up" plans involving reinstatement of secured loans to avoid impairment (and the ability to vote on the plan) or "cram-down" confirmation involving either the sale of the lender's collateral, subject to the lender's right to "credit bid" its claim, and attachment of its lien to the proceeds, or treating the secured claim in a way that provides the lender with the "indubitable equivalent" of its claim.

A ruling recently handed down by the U.S. Bankruptcy Court for the District of New Jersey explores another avenue to confirmation of a plan over the objection of a secured creditor. In In re Ocean View Motel, LLC, 2022 WL 243213 (Bankr. D.N.J. Jan. 25, 2022), the court ruled that a plan could be confirmed over a secured lender's objection even though a new secured note given to the lender eliminated his prepetition contractual right to file a deed in lieu of foreclosure in the event of the debtor's default. According to the court, the terms of the new note, which was secured by collateral valued significantly greater than the amount of the debt, more than satisfied the Bankruptcy Code's minimum requirements for cram-down confirmation, and if not eliminated, the deed in lieu of foreclosure provision threatened the plan's feasibility and the debtor's prospects for a successful reorganization. 

Impairment of Claims Under a Chapter 11 Plan

Creditor claims and equity interests must be placed into classes in a chapter 11 plan and treated in accordance with the Bankruptcy Code's plan confirmation requirements. Such classes of claims or interests may be either "impaired" or "unimpaired" by a chapter 11 plan. The distinction is important because, among other things, only impaired classes have the ability to vote to accept or reject a plan. Under section 1126(f) of the Bankruptcy Code, unimpaired classes of creditors and shareholders are conclusively presumed to have accepted a plan. Classes of creditors or interest holders that receive or retain nothing under a plan are deemed to reject it. See 11 U.S.C. § 1126(g). 

Section 1124 provides that a class of claims is impaired under a plan unless the plan: (i) "leaves unaltered the legal, equitable, and contractual rights" to which each creditor in the class is entitled; or (ii) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates each creditor in the class for resulting losses.

Section 1124 originally included a third option, then section 1124(3), for rendering a claim unimpaired—by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that, in light of this third option, a solvent debtor's chapter 11 plan that paid unsecured claims in full in cash, but without postpetition interest, did not impair the claims. The perceived unfairness of New Valley led Congress to remove this option from section 1124 of the Bankruptcy Code in 1994. Since then, most courts considering the issue have held that, if an unsecured claim is paid in full in cash with postpetition interest at an appropriate rate, the claim is unimpaired under section 1124. See, e.g., In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 205–07 (3d Cir. 2003).

Cram-Down Confirmation Requirements

If a class of creditors does not agree to impairment of the claims in the class under the plan and votes to reject it, the plan can be confirmed only if it satisfies the "cram-down" requirements of section 1129(b) of the Bankruptcy Code. Among those requirements are the mandates that, with respect to dissenting classes of creditors, the plan must be "fair and equitable," and the plan must not "discriminate unfairly." 11 U.S.C. § 1129(b)(1).

Fair and Equitable Treatment of Secured Creditors. With respect to a dissenting class of secured claims, section 1129(b)(2)(A) provides that a plan is "fair and equitable" if the plan provides for: (i) the secured claimants' retention of their liens and receipt of deferred cash payments equal to at least the value, as of the plan effective date, of their secured claims; (ii) the sale, subject to the creditors' right to "credit bid" their claims under section 363(k), of the collateral free and clear of all liens, with attachment of the creditors' liens to the sale proceeds and treatment of the liens under option (i) or (iii); or (iii) the realization by the secured creditors of the "indubitable equivalent" of their claims.

The Bankruptcy Code does not define "indubitable equivalent," but courts interpreting the term have defined it as, among other things, "the unquestionable value of a lender's secured interest in the collateral." In re Philadelphia Newspapers, LLC, 599 F.3d 298, 310 (3d Cir. 2010); accord In re Sparks, 171 B.R. 860, 866 (Bankr. N.D. Ill. 1994) (a plan provides the indubitable equivalent of a claim to the creditor where it "(1) provides the creditor with the present value of its claim, and (2) insures the safety of its principle [sic]"); see generally Collier on Bankruptcy ("Collier") ¶¶ 361.03([4] and 1129.04[2][c][i] (16th ed. 2022) (discussing the derivation of the concept from In re Murel Holding Corp., 75 F.2d 941 (2d Cir. 1935), and explaining that "abandonment, or unqualified transfer of the collateral, to the secured creditor," substitute collateral, and the retention of liens with modified loan terms have been deemed to provide the "indubitable equivalent"). See, e.g., In re River East Plaza, LLC, 669 F.3d 826 (7th Cir. 2012) (30-year U.S. Treasury bonds substituted as collateral for an undersecured mortgage loan were not the indubitable equivalent of the mortgage because the bonds carried a different "risk profile" and they impermissibly stretched out the time period over which the lender would be paid); In re LightSquared Inc., 513 B.R. 56 (Bankr. S.D.N.Y. 2014) (a chapter 11 plan that would provide a first-lien secured creditor with a note secured by a third-priority lien on existing and new collateral did not provide the secured creditor with the indubitable equivalent, where there was enormous disagreement as to valuation and unresolved regulatory hurdles); In re Colony Beach & Tennis Club, Inc., 508 B.R. 468 (Bankr. M.D. Fla. 2014) (a chapter 11 plan under which the collateral securing the claims of an undersecured lender that elected to have its claim treated as fully secured would be sold free and clear of liens in exchange for receiving either payment in an unspecified amount in one year or the right to have its collateral transferred back to it did not provide the indubitable equivalent of its claim), aff'd, 2015 WL 3689075 (M.D. Fla. June 12, 2015); In re DBSD N. Am., Inc., 419 B.R. 179 (Bankr. S.D.N.Y. 2009) (a chapter 11 plan under which a first-lien creditor would receive an amended loan facility secured by a first lien on substantially all of the debtor's assets, but eliminated or loosened certain covenants and included less restrictive cross-default provisions, provided the first-lien creditor with the indubitable equivalent of its claim), aff'd, 2010 WL 1223109 (S.D.N.Y. Mar. 24, 2010), aff'd in part, rev'd in part on other grounds, 634 F.3d 79 (2d Cir. 2011).

No Unfair Discrimination. The Bankruptcy Code does not define "unfair discrimination," and "[c]ourts have struggled to give the unfair discrimination test an objective standard." Collier at ¶ 1129.03[a]. Nevertheless, most courts agree that the purpose underlying the requirement is "to ensure that a dissenting class will receive relative value equal to the value given to all other similarly situated classes." In re LightSquared Inc., 513 B.R. 56, 99 (Bankr. S.D.N.Y. 2014); accord In re SunEdison, Inc., 575 B.R. 220 (Bankr. S.D.N.Y. 2017); In re 20 Bayard Views, LLC, 445 B.R. 83 (Bankr. E.D.N.Y. 2011); In re Johns-Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1986), aff'd, 78 B.R. 407 (S.D.N.Y. 1987), aff'd, 843 F.2d 636 (2d Cir. 1988).


Courts have historically relied on a number of tests to determine whether a plan discriminates unfairly. Several courts have adopted some form of the unfair discrimination test ("Markell test") articulated by Bruce A. Markell in his article A New Perspective on Unfair Discrimination in Chapter 11, 72 Am. Bankr. L.J. 227, 249 (1998). See, e.g., In re Armstrong World Indus., Inc., 348 B.R. 111 (D. Del. 2006); In re Quay Corp., Inc., 372 B.R. 378 (Bankr. N.D. Ill. 2007); In re Exide Techs., 303 B.R. 48 (Bankr. D. Del. 2003). The Markell test was first applied by a bankruptcy court in In re Dow Corning Corp., 244 B.R. 705 (Bankr. E.D. Mich. 1999), aff'd in relevant part, 255 B.R. 445 (E.D. Mich. 2000), aff'd in part and remanded, 280 F.3d 648 (6th Cir. 2002). Under the Markell test, a rebuttable presumption that a plan unfairly discriminates will arise when the following elements exist:

(1) a dissenting class; (2) another class of the same priority; and (3) a difference in the plan's treatment of the two classes that results in either (a) a materially lower percentage recovery for the dissenting class (measured in terms of the net present value of all payments), or (b) regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution.

Id. at 710. The burden then lies with the plan proponent to rebut the presumption by demonstrating that "outside of bankruptcy, the dissenting class would similarly receive less than the class receiving a greater recovery, or that the alleged preferred class had infused new value into the reorganization which offset its gain." Id.

Ocean View

Ocean View Motel, LLC ("OVM") owns a hotel in Wildwood, New Jersey. OVM's principals were originally Mark Jones ("Jones") and Harry Falterbauer ("Falterbauer"), who together owned several other properties in the vicinity. In 2015, Jones bought out Falterbauer's interest in the company, agreeing to pay the purchase price over time under a series of loan agreements. The loans, which were made by Falterbauer to both Jones and OVM, were secured by a junior mortgage on the hotel.

After Jones and OVM defaulted on the loans in the fall of 2018, Falterbauer sued to foreclose on the hotel. The parties settled the litigation in 2019 under an agreement among Jones, OVM, and Falterbauer whereby Falterbauer acquired the senior mortgage debt, OVM executed a new $1.5 million promissory note in Falterbauer's favor, and OVM and Jones agreed to give Falterbauer a signed deed in lieu of foreclosure authorizing Falterbauer to take possession of the hotel upon default.

OVM and Jones defaulted again in 2020 but prevented Falterbauer from filing the deed in lieu of foreclosure by obtaining a temporary state court injunction. OVM filed for chapter 11 protection on September 30, 2020, in the District of New Jersey. At that time, the hotel's value was at least $2.1 million.

OVM proposed a chapter 11 plan under which Falterbauer would receive a new note secured by the hotel in the amount of approximately $1.6 million amortized over 20 years at 7% interest. The note provided for default-rate interest but eliminated Falterbauer's remedy of filing a deed in lieu of foreclosure. OVM had no other secured debt. The plan proposed to pay administrative and other priority claims either in full on the effective date or as otherwise agreed by the creditors or permitted under the Bankruptcy Code. The plan would pay general unsecured creditors in full over four years and provided that Jones would retain his ownership interest in OVM.

Only Falterbauer voted to reject the plan and objected to its confirmation. He argued that the plan discriminated unfairly and was not fair and equitable because it eliminated his contractual right to file a deed in lieu of foreclosure, which would force him, at his expense, to start foreclosure proceedings once again in state court upon OVM's likely post-bankruptcy default. OVM countered that Falterbauer's loan was protected by a large equity cushion, that a deed in lieu of foreclosure is not a standard commercial lending practice in New Jersey, and that "the feasibility of the plan would be negatively impacted by the threat of this hostile creditor being able to foreclose upon 30 days' delay in payment." Ocean View, 2022 WL 243213, at *2. 

The Bankruptcy Court's Ruling

In his ruling, U.S. Bankruptcy Judge Andrew Altenburg, Jr. noted that a chapter 11 plan may "modify the rights of holders of secured claims." See 11 U.S.C. § 1123(b)(5). He further explained that, if a secured creditor does not agree to modifications that impair its claim and votes to reject the plan, the plan can be confirmed only if, among other things, the plan does not discriminate unfairly (11 U.S.C. § 1129(b)(1)) and the plan's treatment of the secured claims is "fair and equitable" within the meaning of section 1129(b)(2)(A).

Initially, Judge Altenburg explained that the plan did not unfairly discriminate because "there is no different treatment of similarly situated classes." Id. at *1.

Next, Judge Altenburg found that OVM's plan satisfied the "minimal elements" of subsection 1129(b)(2)(A)(i) because Falterbauer would retain the liens securing his claim and receive deferred cash payments with a present value equal to the amount of the claim. Moreover, he explained, the hotel securing his claim was worth well more than the amount of Falterbauer's claim, the loan would accrue default-rate interest at 12%, and OVM was obligated to pay his attorneys' fees and costs in the event of post-confirmation default. 

Judge Altenburg noted that eliminating certain terms of a loan agreement "is not an unusual event in the plan confirmation process." Id. at *3 (citing In re Am, Trailer & Storage, Inc., 419 B.R. 412, 440-41 (Bankr. W.D. Mo. 2009) (in determining whether modification of loan documents is appropriate, considering: "(1) whether the proposed terms and covenants unduly harm the secured creditor with respect to its collateral position; and (2) whether the inclusion of terms and conditions from the pre-bankruptcy loan documents would unduly impair the debtor's ability to reorganize.")). He agreed with OVM that the feasibility of its plan "would be hampered by the ability of one unfriendly creditor to end [OVM's] operations upon default on his claim only." Id. at *4. Eliminating the deed in lieu provision, he wrote, "contributes to the plan's feasibility, as [it] prevent[s] confirmation from being followed by the liquidation or need for further financial reorganization." Id. (citing 11 U.S.C. § 1129(a)(11)).

Judge Altenburg accordingly overruled Falterbauer's objection and confirmed OVM's chapter 11 plan.


Secured claims can be treated in a variety of ways under a chapter 11 plan. As noted, a secured loan, even if accelerated, can be reinstated under circumstances that would render the secured creditor unimpaired (and therefore deemed to accept the plan). See 11 U.S.C. § 1124. Ocean View is an example of a case where unimpairment was not an option due to the existence of a prepetition loan provision that, if retained, threatened the debtor's prospects for continuing to do business after emerging from bankruptcy, thereby calling into question the feasibility of its chapter 11 plan. Under those circumstances, the bankruptcy court found that the cram-down plan's treatment of the secured creditor's claim was fair and equitable even though it eliminated one of the secured creditors' contractual remedies. In so ruling, the court strove to strike a balance between what it perceived to be protecting the interests of a secured creditor in accordance with the Bankruptcy Code's nonconsensual plan confirmation requirements and affording the debtor a reasonable prospect of successfully reorganizing.

Although the court never had to address the issue, it would have been interesting if it had examined whether the plan's treatment of the secured claim provided the lender with the indubitable equivalent of its claim.

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