Mary Grace Diehl, U.S. Bankruptcy Court Judge.
This case presents two issues of first impression in the Eleventh Circuit: (1) whether separate classification of unsecured claimants is permissible in a Chapter 11 plan of reorganization in order to create an impaired, consenting class as required by 11 U.S.C. § 1129(a)(10); and, (2) whether the absolute priority rule is
The Court has considered the briefs as filed along with the record in connection with this matter and upon review of same, finds and concludes that Debtors' plan impermissibly classifies the unsecured deficiency claim of Auto-Owners and further, that the plan violates the absolute priority rule. Therefore, confirmation will be denied.
To confirm Debtors' plan, the Court must determine that both the plan and its Debtor-proponents have fully complied with the requirements of Section 1129 of the Bankruptcy Code. See 11 U.S.C. § 1129. Under Section 1129(a)(1), the plan must comply with "applicable provisions" of the Code including Sections 1122 and 1123. In particular, Section 1122(a) governs the classification of claims, and while it does not require that all substantially similar claims be placed in the same class, it does require that all claims or interests placed in a specific class be "substantially similar." Debtors' plan treats the holders of general unsecured claims through three sub-classes, to wit; Class 2(a) "Small Claims," Class 2(b) "[Other] General Unsecured Claims," and, Class 2(c) "Special unsecured claim (deficiency claim)." Class 2(c) consists solely of the unsecured claim of Auto-Owners in the amount of $1,146,716.70.
Objectors contend that Debtors have failed to justify the separate classification of the claim of Auto-Owners in Class 2(c) from other unsecured claims in Class 2(b). In support of the proposed classification, Debtors observe that holders of large unsecured deficiency claims like Auto-Owners can effectively control a class of unsecured claims and block confirmation of a plan.
Here, Debtors contend that separate classification of Auto-Owners' unsecured claim is warranted because the claim is not substantially similar to other unsecured claims given its legal character as a business debt, whereas the other claims are consumer debt. Further, Debtors argue that unlike the holders of those claims in Class 2(b), Auto-Owners benefits from certain guaranties, which may be taken into account under Section 1122(a). Regarding the latter contention and citing the decision of Wells Fargo Bank, N.A. v. Loop 76, LLC (In re Loop 76, LLC), 465 B.R. 525 (9th Cir. BAP 2012), Debtors assert that these guaranties distinguish the nature of Auto-Owner's claim as compared to other claimants in relation to the Debtors, and properly serve as grounds for separately classifying the claim. In Loop 76, the court determined that for purposes of examining the substantial similarity of claims under Section 1122(a), such analysis is not restricted to how the claim relates "to the assets of the debtor." 465 B.R. at 540, discussing Steelease, Inc. v. Johnston (In re Johnston), 21 F.3d 323 (9th Cir.1994). As that court reasoned, it is appropriate to consider whether a creditor has access to means of possible recovery beyond a debtor's assets in regard to a proposed classification, as these sources could be an important, distinguishing feature when compared to the rights of other claimholders. 465 B.R. at 541.
In response, Auto-Owners emphasizes that a number of circuit courts have held that a plan proponent must provide a legitimate reason for separately classifying similar claims, and it maintains Debtors have failed to do so through their proffered distinctions.
Applying this rule with respect to an examination of alleged dissimilarity, the Court agrees with the Objectors that Debtors have not adequately explained how claims placed in Class 2(b) are consumer debt as opposed to business debt.
The Court is also unpersuaded by Debtors' contention that Auto-Owners' right of recourse against non-debtor guaranties for satisfying its claim in this matter establishes a sufficient legal difference to support separation of its claim from those of other unsecured creditors. This is particularly so because the treatment of the two sub-classes is identical. Objectors argue that the existence of third-party sources for repaying a claim is simply not relevant to the issue of classification. Relying on the rationale that it is the nature of those claims as asserted against a debtor's assets that is properly considered — not the nature of other claims or interests a claimant may hold, they insist this Court's inquiry is similarly constrained. See In re AOV Indus., Inc., 792 F.2d 1140 (D.C.Cir.1986); see also In re 18 RVC, LLC, 485 B.R. 492 (Bankr.E.D.N.Y.2012).
This Court recognizes that the holding in Loop 76 allowing for consideration of a guaranty has been criticized. The grounds of such critiques, however, generally focus on the failure to take into account additional factors such as the collectability of the guaranty, the existence of any nondebtor collateral, and presence of litigation that could affect that creditor's rights. See In re 4
Having concluded that confirmation must be denied on grounds of classification, the Court will also address the alternative argument contesting confirmation of the plan as offered by Objectors. Because the plan fails to satisfy Section 1129(a)(8) with respect to Auto-Owners, Debtors must show that the plan does not "discriminate unfairly" and is "fair and equitable" with respect to such impaired class that has not accepted the plan. See 11 U.S.C. § 1129(b)(1). Under the fair and equitable test, a debtor must satisfy the "absolute priority rule" by providing for such dissenting class in full before a junior class, often an equity owner, receives or retains any property under the plan. For a class of unsecured claims, this test is codified in Section 1129(b)(2)(B)(ii).
Objectors argue that Debtors' cramdown plan violates the rule because they propose to retain their interest in prepetition business activities, rental properties, and other assets, while holders of unsecured claims will only receive a percentage of what they are owed. Debtors assert, however, that there is an issue in the case law regarding whether and to what extent this rule survived passage of BAPCPA with respect to debtors in Chapter 11 who are individuals. Specifically, the question centers on the proper treatment of a class of unsecured claims under Section 1129(b)(2)(B)(ii) and the interaction between the definition of property of the estate in Section 541 and Section 1115(a).
While a junior claimant may not retain any interest under a plan when holders of unsecured claims are not paid in full, Section 1129(b)(2)(B)(ii) provides an exception in reference to Section 1115.
A competing line of authority, followed by four circuit courts of appeal, holds that the absolute priority rule still applies in a Chapter 11 case where the debtor is an individual. Construing the phrase "included in the estate" under Section 1129(b)(2)(B)(ii) to provide at most a limited exception to the rule, these courts conclude more narrowly that such a debtor can retain only post-petition property as added to the estate by Section 1115(a).
Debtors assert that adoption of the narrow view will only increase the difficulty in confirming a plan of reorganization for individuals under Chapter 11. Objectors note that such arguments have been made and dismissed in other cases, and here, they similarly insist Debtors can still negotiate with their creditors or pay them more on their claims. Not only have Debtors failed to undertake such efforts in this case, they have also offered no valuation of their income-producing properties. Accord Maharaj, 681 F.3d at 575. As other courts have observed, however, several amendments to Chapter 11 under BAPCPA bear similarity to provisions in Chapter 13, which contains no absolute priority rule. Further, a narrow view of the exception would render any practical application of Section 1115 problematic given the added requirements of Section 1129(a)(15)(B) whereby debtors must commit five years of projected disposable income to their plans. See O'Neal, 490 B.R. at 850-51; see also Friedman, 466 B.R. at 483; accord In re Lucarelli, 517 B.R. 42, 52 (Bankr.D.Conn.2014).
This Court appreciates the practical issues created in adopting the narrow approach and finding that Debtors must comply with the absolute priority rule in their plan. The assessment of such concerns as expressed in decisions like Lucarelli is instructive. This Court also does not take lightly the prospect of a debtor attempting to reorganize, but otherwise effectively forced to liquidate a prepetition business interest that is a primary source of future income. Accord Ice House America, 751 F.3d at 739-40. Nevertheless, upon review of the argument and authority presented and the statutory language at hand, the Court concludes that the absolute priority
Based upon the above reasoning, the Court concludes that Objectors' position opposing confirmation on this basis is, therefore, also well-taken. As submitted, Debtors' plan is not confirmable because Auto-Owners, as an unsecured claimholder, is not receiving fair and equitable treatment under Section 1129(b)(2)(B)(ii). This holding follows inasmuch as Auto-Owners is not being paid in full on its claim and has not accepted the plan, while Debtors propose retaining their prepetition interests in property of the estate as defined in Section 541 beyond that described in Section 1115(a) and referenced in Section 1129(b)(2)(B)(ii), in violation of the absolute priority rule.
Accordingly, in view of the above discussion and the findings and conclusions as set forth herein regarding both grounds for objection as asserted by the Objectors, it is
The Clerk shall serve a copy of this Order upon Debtors, counsel for Debtors, counsel for Auto-Owners Insurance Company, the United States Trustee, and all creditors and parties in interest herein.
11 U.S.C. § 1129(b)(2)(B)(ii) (emphasis supplied).
