Five related Debtors – a Holding Company that owned two Mezzanine Debtors that, in turn, owned two Operating Debtors – filed bankruptcy. The Operating Debtors each owned and operated resorts. The five cases were jointly administered but not substantively consolidated. [1]
By the time of plan confirmation, a single Lender owned both a loan secured by the Mezzanine Debtors’ interests in the Operating Debtors and a loan to the Operating Debtors secured by the resorts. The five Debtors filed a joint Chapter 11 reorganization plan under which a third-party investor would acquire the Operating Debtors, thereby extinguishing the Mezzanine Debtors’ ownership interest in the Operating Debtors. The Lender was under-secured and made an election to have its entire claim treated as secured under 11 U.S.C. § 1111(b)(2). The proposed plan termed out the Lender’s loans. The restructured loan under the proposed plan had a “due on sale” clause with a ten-year exception.
The Lender was the only creditor class for the Mezzanine Debtors, and voted against the Plan. The Lender also objected to confirmation on two grounds. First, it argued that the ten-year exception to the due-on-sale clause would deprive the Lender of the full benefit of its election under Section 1111(b)(2). Second, the Lender argued that, as it was the only class in the Mezzanine Debtors’ bankruptcy cases and voted against the plan, the plan violated the confirmation requirement of Section 1129(a)(10),[2] which requires that if a class is impaired under the plan, at least one impaired class accept the plan. Several other impaired classes for the Holding Company debtor and the Operating Debtors voted to approve the plan. The bankruptcy court overruled the Lender’s objections and approved the plan.
The Ninth Circuit affirmed the bankruptcy court’s decision. As to the ten-year exception to the due-on-sale clause, the appellate court found nothing in the language of Section 1111(b)(2) that disallowed the exception. And nothing in Section 1123, which describes what a Chapter 11 plan must contain, required inclusion of a due-on-sale clause in the plan.
As to the requirements of Section 1129(a)(10), the appellate court held that because there was an accepting impaired class in a case of one of the related Debtors, there was an accepting impaired class “under the plan” within the meaning of Section 1129(a)(10). The cases were not substantively consolidated, as is allowed in the Ninth Circuit, but Section 1129(a)(10) was satisfied by the acceptance of an impaired class in a different bankruptcy case under the joint plan. The Lender argued on appeal that the joint plan was actually a substantive consolidation, but it did not make that argument in the bankruptcy court below, and the Ninth Circuit did not consider it.
Judge Friedland’s concurring opinion indicates that if the Lender had objected to plan confirmation on the basis that the plan attempted substantive consolidation, the results on appeal could have been different. Judge Friedland acknowledge the Lender’s argument that it was “unfairly deprived of the ability to object effectively to reorganization of the Mezzanine Debtors, despite being their only creditor. While Lender’s concern is not unfounded, I believe any unfairness resulted not from the interpretation of § 1129 that Lender challenged in this appeal, but instead from the fact that this particular reorganization treated the five Debtor entities as if they had been substantively consolidated—something Lender did not object to in the bankruptcy court.” In re Transwest, Opinion at pg. 15.
The practice point here: when opposing a joint plan in a Chapter 11 reorganization, it is important to consider objecting to the de facto substantive consolidation under the joint plan in order to preserve a secured creditor’s cram-down rights under 11 U.S.C. § 1129(a)(10).