Section 1129(a)(10) And Artificial vs. Economic Impairment Of Claims

In a very recent decision, the Fifth Circuit Court of Appeals considered the issue of whether an impaired class of creditors is truly "impaired" when the plan proponent has the economic ability to pay such creditors in full on the effective date but elects not to, thereby permitting the class to vote in favor of confirmation of the proponent's plan. This can be described as "artificial" vs. "economic" impairment.

A brief review of the relevant sections of the Bankruptcy Code helps to frame the issue. Section 1123(b) of the Bankruptcy Code provides that a plan of reorganization "[may] impair or leave unimpaired any class of claims." A claim is impaired if the claimant's legal, equitable or contractual rights are altered.1 Section 1129 of the Bankruptcy Code enumerates the requirements to confirm a chapter 11 plan, including § 1129(a)(10), which provides that if there is at least one class of claims impaired under the plan, in order for such plan to be confirmed, at least one impaired class must accept the plan. Accordingly, where a plan is going to impair a class of claims, it is important for the plan proponent to find at least one impaired class to vote in favor of the plan. The issue then becomes, to what extent can an impaired and accepting class be created by a plan proponent by temporarily delaying payments to creditors within that class?

In re Village at Camp Bowie I L.P.

In In re Village at Camp Bowie I L.P.,2 a mortgage-holder that was owed $32 million appealed the confirmation of a plan that provided for the payment in full, without interest, of a class comprised of 38 unsecured creditors owed $59,398. The plan contemplated that such payments would be made within three months of its effective date. All 38 unsecured creditors in that class voted to accept the plan, while the class controlled by the secured creditor's deficiency claim voted against confirmation. It was undisputed that the debtor had sufficient cash flow to pay the unsecured creditors in full at confirmation. The rejecting secured creditor asserted that the treatment of the unsecured creditors constituted "artificial" impairment violating § 1129(a)(10).

Confirming the plan, the bankruptcy court acknowledged that the unsecured creditors could have been left unimpaired. However, the court rejected the secured creditor's assertion that § 1129(a)(10) distinguishes between artificial and economic impairment. The secured creditor had also asserted that the impairment in the...