Pratt's Journal of Bankruptcy Law
"Does the Presence of Guarantees Justify Separate Classification of a Lender’s Deficiency Claim in a Chapter 11 Case?"
A "cramdown" plan of reorganization in a Chapter 11 commercial real estate case typically involves an attempt by a property owner to force an undersecured mortgage lender to accept a "new note" for a reduced principal amount, equivalent to the value of the mortgaged property, with modified terms including an extended maturity and a "market" rate of interest. As explained in more detail below, mortgage lenders, which are often the overwhelmingly largest creditor in these cases, have been relatively successful in blocking these plans by using their deficiency claim to control the unsecured creditor class and cause it to vote against plan approval. If a debtor cannot get approval of a plan of reorganization, the case will typically be dismissed and the mortgage lender will be able to exercise its right to foreclose under applicable state law.
In a recent decision, In re Loop 76, LLC, the Bankruptcy Appellate Panel of the Ninth Circuit upheld a Bankruptcy Court determination that a secured lender's unsecured deficiency claim could be separately classified from the claims of other unsecured creditors, paving the way for confirmation of a cramdown plan of reorganization over the lender's opposition. Rejecting the lender's argument that its borrower – a single asset real estate debtor – had "gerrymandered" an accepting impaired class in order to confirm its plan, the court focused on the lender's access to third party guarantees to support an evidentiary conclusion that its claim was not "substantially similar" to other unsecured creditors, such that separate classification was appropriate without any inquiry into the debtor's motivation for doing so.