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The center focus of a Chapter 11 bankruptcy is the reorganization plan for the business filer’s debts. A majority of the creditors generally must approve the plan, followed by court confirmation.
However, there are times when one or more classes of creditors won’t accept the plan. Bankruptcy law gives the filer a solution, called cramdown provisions, to move the case ahead.
Cramdown and Making a Rejected Plan Work
The filer must ask the court to use the cramdown laws, and meet almost all other Chapter 11 rules to get the plan confirmed by the court. It’s the filer’s job to show the plan is fair, equitable and not discriminatory to the objecting class of creditors.
Normally, all classes of creditors must approve the plan. When cramdown rules apply, the filer doesn’t have to meet this requirement.
The Plan and the Unfair Discrimination Rule
In a cramdown case, creditors taking less than they’re owed or rejecting the plan are called “impaired creditors.” The filer must show the plan does not unfairly discriminate against this group.
The plan must give creditors at least the amount they would be paid in a Chapter 7 liquidation case. The unfair discrimination test looks at the amount over the liquidation value, also called reorganization surplus. There can be discrimination in how the plan pays out this excess amount, but it can’t be unfair.
Courts differ on the factors that make up the unfair discrimination test. A commonly used test states that a plan may be unfairly discriminatory if there are two or more creditors of the same class and one creditor receives a much lower recovery than other creditors in that class. Regardless of the test used, most cases tend to look at whether or not the differences in how creditors are treated are justified.
One example is discrimination based on timing of payment to creditors. A plan may propose the same payment for a trade creditor and a someone with a judgment from lawsuit, but the trade creditor is paid first. This discriminates, but isn’t unfair. It makes sense to pay those creditors that support the filer’s ongoing business operations first.
The Fair and Equitable Rule
Next, the filer must show the plan is fair and equitable to the impaired class. The fair and equitable rule has two main parts, the absolute priority rule and the rule that no creditor be paid more than what it’s owed.
The absolute priority rule generally means that senior creditors must be paid full value before junior creditors receive anything. The second part speaks for itself and requires that no creditor be paid a “premium” over the allowed amount of its claim.
It’s good to keep in mind that problems do come up in bankruptcy cases, but the law gives solutions, too. It’s all part of getting your business finances back on track and getting the fresh financial start bankruptcy provides.
Questions for Your Attorney
- Will my case take longer if cramdown is needed?
- If my cramdown plan is accepted, what happens if I can’t meet the terms of the plan?
- What are the options if I ask for a cramdown and the court refuses?