Taking the lead from its recent decision in In re River Road Hotel Partners,¹ in In re River East Plaza, LLC,² the Seventh Circuit held that a debtor cannot avoid the lien retention prong of Section 1129(b)(2)(A)(i)³ by transferring an undersecured creditor’s lien to substitute collateral as indubitable equivalence pursuant to Section 1129(b)(2)(A)(iii). Because of the pending Supreme Court review of the Seventh Circuit’s In re River Road decision,⁴ the court skirted the statutory construction question of whether the indubitable equivalent prong of Section 1129(b)(2)(A)(iii) can be used to circumvent the lien retention requirement of Section 1129(b)(2)(A)(i) and focused instead on what was required by the indubitable equivalence standard in a lien substitution context.

After defaulting on its mortgage, the debtor, the owner of a building in Chicago, filed for bankruptcy to thwart the foreclosure sale initiated by its secured lender, LNV. At the time of the filing, the mortgage of $38.3 million was secured solely by the building which the debtor valued at $13.5 million, a value LNV did not dispute. LNV made the election under Section 1111(b) to treat its entire claim as secured (and not bifurcated into a secured claim and unsecured claim), thereby entitling LNV to be paid under the debtor’s plan the full $38.3 million amount of its claim over time, but with a present value equal to $13.5 million.

To satisfy LNV’s claim under the Section 1111(b) test, the debtor’s plan of reorganization sought to replace the lien on the building with a substitute lien on $13.5 million in 30-year treasury bonds. The debtor argued that, at current interest rates, in 30 years, the treasury bonds would grow in value to $38.3 million—thus, LNV would be paid its allowed secured claim in full through a stream of payments that had a present value equal to $13.5 million. The debtor asserted that the substitute collateral and payment stream was the indubitable equivalent of LNV’s secured claim and, as such, the plan, pursuant to Section 1129(b)(2)(A)(iii), could be confirmed over LNV’s objection.

In rejecting the debtor’s position, the Seventh Circuit first distinguished between substitution of collateral in the case of an undersecured creditor versus an oversecured creditor. In the case of an oversecured creditor, the Seventh Circuit noted that substitution of collateral would satisfy the indubitable equivalent test so long as the substitution does not increase the oversecured creditor’s risk of becoming undersecured in the future. In the case of an undersecured creditor, however, the only substitution that could be the indubitable equivalent would be a swap for collateral that is either (a) more valuable or (b) no more volatile in value than the original collateral. But, the Seventh Circuit noted, there is no rational debtor that would make such a substitution because it is akin to making a gift to an undersecured creditor.

Applying that test to the facts before it, the Seventh Circuit concluded that the substitute lien on the treasury bonds was not equivalent to LNV’s retaining its lien on the building. The Seventh Circuit reasoned that if LNV retained its lien on the building and the debtor subsequently defaulted and filed a second bankruptcy, the bankruptcy court would likely permit LNV to foreclose promptly, permitting LNV the benefit of any rise in value. However, if the collateral were substituted, notwithstanding the debtor’s second default, LNV would have to wait until the treasury bonds were due to be paid, during which time, the treasury bonds would be subject to inflationary risks. Thus, according to the Seventh Circuit, while the lien on the building and a substitute lien on treasury bonds may be of a similar value at confirmation, the two types of collateral are subject to very different risk profiles and thus are not the indubitable equivalent.

The In re River East Plaza decision raises a number of issues and questions. First, the opinion is premised upon the view that indubitable equivalence requires preservation of the upside potential in a secured creditor’s collateral if there is a post-confirmation default and rise in value. This view is in direct contrast to the Fifth Circuit’s holding in In re Pacific Lumber Co.,⁵ wherein the Fifth Circuit concluded that the “Bankruptcy Code, however, does not protect a secured creditor’s upside potential; it protects the ‘allowed secured claim.’” Indeed, Section 1129(b)(2)(A)(iii) requires indubitable equivalence of secured creditor’s allowed claim, not its lien. In addition, the Seventh Circuit’s view is at odds with the Supreme Court’s decision in United Savings Assn. of Texas v. Timbers of Inwood Forest Assoc., Ltd.,⁶ which squarely held that the only property right that a secured creditor is entitled to be adequately protected in a chapter 11 case is the decline in value of its collateral.

Second, the opinion argues that treasury bonds are not sufficient to provide the indubitable equivalence of a claim as they are subject to interest rate changes (namely, inflation and a correlating loss in value). This rationale ignores the fact that a rise in interest rates could similarly negatively impact the valuation and pricing of real estate.

Third, the opinion, as with the Seventh Circuit’s prior decision in In re River Road Hotel Partners LLC, effectively “reads out” the indubitable equivalent subsection of 1129(b)(2)(A) thereby rendering the statutory “or” that links Sections 1129(b)(A)(i), (ii) and (iii), meaningless. Recognizing, perhaps, the strained construction of its holding, the Seventh Circuit offers two examples when the indubitable equivalence test might apply: (a) where the creditor is oversecured, or (b) where the creditor is undersecured and the substitute collateral is more valuable than the original collateral. These examples, however, may prove too much. As to the first example, where a secured creditor is oversecured, Section 1111(b) has no practical applicability (there is no concern of bifurcation of the claim) and the suggestion is at odds with the long line of “dirt for debt” cases that apply Section 1129(b)(2)(A)(iii) outside of the Section 1111(b) context and do not require excess collateral coverage. The second example may also not be a valid application as providing excess collateral to a secured creditor may violate the uncodified principle of the absolute priority rule if the secured creditor ultimately receives more than its allowed claim. A creditor may not be paid more than its allowed claim, and Section 1111(b) does not require a debtor to do so.⁷

The Seventh Circuit’s decisions in In re River East Plaza and In re River Road are at odds with the Fifth Circuit’s opinion in In re Pacific Lumber Co. and the Third Circuit’s opinion in In re Philadelphia Newspapers, LLC⁸ in the differing view expressed with regard to the extent to which a secured creditor’s rights can be impaired in a chapter 11 case. As the Supreme Court has granted certiorari in the In re River Road case, its decision may provide guidance to this long-standing debate in chapter 11 cases.

¹651 F.3d 642 (7th Cir. 2011) (holding that any cramdown plan that contemplates a sale of collateral must, pursuant to Section 1129(b)(2)(A)(ii), permit the secured creditor to credit bid, thus blocking debtor’s use of the “indubitable equivalent” alternative to circumvent the secured creditor’s credit bidding rights in a sale plan ).

²2012 WL 169760 (7th Cir. Jan. 19, 2012)
 

³11 U.S.C. § 1129(b) provides that:

(1) . . . if all of the applicable requirements of [Section 1129(a)] other than paragraph (8) [requiring that each class of creditors has either accepted the plan or is unimpaired under the plan] are met with respect to a plan, the court, on request of the proponent of the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.
(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(A) With respect to a class of secured claims, the plan provides—

(i) (I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and

(II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property;

(ii) for the sale, subject to section 363 (k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or
(iii) for the realization by such holders of the indubitable equivalent of such claims.

⁴See RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 845 (2011) (granting certiorari sub nom).
⁵584 F.3d 229, 247 (5th Cir. 2009)
⁶484 U.S. 365, 381 (1988)
⁷See Reconstruction Finance Corp. v. Denver & R.G.W.R. Co., 328 U.S. 495, 530-31 (Senior creditors “are not entitled to more than full payment and they are under a duty to account to the [junior creditors] for any surplus remaining after they have been made whole.”); In re Genesis Health Ventures, Inc., 266 B.R. 591, 612 (Bankr. D. Del. 2001) (“A corollary of the absolute priority rule is that a senior class cannot receive more than full compensation for its claims.”).
⁸599 F.3d 298 (3d Cir. 2010)