Are You Ready for the Next Downturn? Ninth Circuit “Cramdown” Cases Affecting Real Estate Lenders
Plan Approval in a Multi-Debtor, Single-Plan Context
In In re Transwest Resort Properties, Inc., the Ninth Circuit addressed the Chapter 11 reorganization plan approval process where a single plan was proposed for multiple affiliated debtor entities whose cases were being administered jointly. Generally, for "cramdown" plans, the Bankruptcy Code requires that at least one class of impaired creditors vote in favor of a plan for it to be approved. In Transwest, a mezzanine lender who was the sole creditor for two of the five debtor entities and whose loan would be extinguished under the single, jointly administered plan, argued that impaired class approval had to occur on a per debtor basis, and that since it was the only impaired class member for two of the debtors, its votes against the plan in those debtor cases barred confirmation (as there were no impaired classes of creditors in those cases voting in favor of the plan). The bankruptcy court, the district court, and the Ninth Circuit rejected that position, holding instead that impaired class approval applied on a per plan basis, and that the votes of the impaired class of creditors of the other three debtors established consent from an impaired class across all debtors, and supported plan confirmation. The Ninth Circuit is the first circuit-level court to address this issue, and the lower bankruptcy courts remain split on the issue.
Lenders, particularly mezzanine lenders, who lend to one or more isolated borrowing entities within a corporate group of debtor entities may not have the voting control in the plan confirmation process they assume exists to block "cramdown", and should factor that reality into their risk assessments.
"Cramdown" Value = Replacement Value (even if it's less than foreclosure value)
In In re Sunnyslope Housing Limited Partnership, the Ninth Circuit, in an en banc opinion, addressed how a secured creditor's interest should be valued in the context of a "cramdown," i.e. where the debtor seeks to retain and use creditor's collateral in the reorganization plan and the value of that collateral is to be determined based on the proposed use of the property. Valuation of the property in the "cramdown" context was critical to how much the secured creditor would recover under the proposed plan, given that amount of its secured claim would be determined by the value of the property. The Sunnyslope case presented a highly unusual circumstance where the foreclosure value of the apartment complex collateral was significantly higher than its replacement or use value due to the existence of low-income housing covenants that would be extinguished in a prospective foreclosure.
Despite the higher foreclosure value supported by the secured creditor, the Ninth Circuit affirmed application of the replacement value standard for determining the secured creditor's present value of its claim under the plan. In doing so, the Ninth Circuit affirmed prior precedent holding that only a property’s replacement value – to be determined in light of its “proposed disposition or use” – could be utilized for determining the amount of a secured claim in the cramdown context. In applying its replacement value standard in Sunnyslope, the Ninth Circuit confirmed that the highest and best use of collateral may not dictate the value of a creditor’s secured claim, even where the replacement value, as determined by the collateral’s anticipated use or disposition, is lower than its foreclosure value.
Lenders facing a potential "cramdown" of its secured claim, based on present value of its claim against real property, should carefully analyze the potential difference between a property's foreclosure value and its replacement value and adjust expectations accordingly.