Unfair Discrimination: Emerging Trend Creates New Means of Contesting Confirmation
by: Douglas E. Wedge
Moore & Van Allen PLLC; Charleston, S.C.
Section 1129(b) of the Bankruptcy Code is known as the “cramdown” provision.1 If a chapter 11 reorganization plan satisfies all of the confirmation requirements set forth in §1129(a), except for obtaining the acceptance of all classes or having unimpaired classes under the plan, a debtor can confirm a plan provided it does not discriminate unfairly among each class of claims or interests that is impaired and has not accepted the plan. The Code does not define “unfair discrimination,” but two tests have been developed to harness this concept and ensure that creditors are treated fairly. This concept is as important as the constituency of general unsecured creditors in a given case and can represent widely varying types of claims – trade creditors that provided goods and services to the debtor, personal-injury claimants seeking damages from the debtor and undersecured creditors whose collateral has left them exposed with an unsecured claim, to name a few. This note describes these tests and reports that the Delaware District Court opted to use the emerging rebuttable presumption analysis as its test in a recent confirmation hearing.
The traditional test consists of four factors that courts analyze to determine whether a plan unfairly discriminates among classes of creditors. The four factors are (1) whether the discrimination is supported by a reasonable basis, (2) whether the debtor could consummate the plan without the discrimination, (3) whether the discrimination is proposed in good faith and (4) the relationship between the discrimination and its basis or rationale.2 The traditional test has met some criticism as some of its factors overlap with each other and/or with the confirmation requirements set forth in §1129(a). Nonetheless, the traditional test’s essential inquiry is whether the proposed discrimination has a reasonable basis and is necessary for reorganization.
An alternative to the traditional test has emerged – the rebuttable-presumption test. Under this analysis, a rebuttable presumption of unfair discrimination arises when there is (1) a dissenting class, (2) another class of the same priority and (3) a difference in the plan’s treatment of the two classes that results in either (a) a materially lower percentage recovery for the dissenting class (measured in terms of the net present value of all payments) or (b) regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in connection with its proposed distribution.3 If there is an allegation of a materially lower percentage recovery, the presumption of unfair discrimination can be rebutted by showing that, outside of bankruptcy, the dissenting class would similarly receive less than the class receiving a greater recovery or that the alleged preferred class had infused new value into the reorganization that offset its gain. First proposed by Hon. Bruce Markell in a law review article,4 the new approach has been praised because it focuses less on the reasonableness of the discrimination and more on the extent of and level of risk presented by the plan’s discrimination.5
Faced with allegations of personal injury claimants receiving a substantially greater distribution than other general unsecured creditors, the court in Armstrong World Industries chose to apply Judge Markell’s rebuttable-presumption test. Both the debtor and the objecting creditor constituency, the unsecured creditors’ committee, agreed that the rebuttable presumption test should be used rather than the traditional four-factor test. Moreover, the Delaware District Court’s application of the rebuttable-presumption test is not an anomaly as courts have used this approach rather than the four-factor analysis.6
Trade creditors can obtain some level of comfort knowing that with the rebuttable-presumption approach emerging, they can have some added flexibility in making the unfair-discrimination argument in objecting to confirmation. With two competing approaches, creditors can examine each test and evaluate which one best suits a particular case. In some instances, it may make sense to rely on the traditional test and attack the lack of a reasonable basis in a debtor’s creating separate classes and providing different treatment for each, when ostensibly, both are similarly situated general unsecured creditors. On the other hand, where debtors advance a cogent, well-reasoned explanation as to the creation of separate classes and their inconsistent treatment, creditors can opt to play a different hand and criticize the inconsistencies in distribution between the separate classes as a means to challenge confirmation.
1 Further references to the Bankruptcy Code shall be by section number only.
2 See In re Armstrong World Industries, Case No. 00-4471, slip op. at 21 (D. Del. Aug. 14, 2006); see generally 3 Henry J. Sommer and Lawrence P. King, eds., Collier Bankruptcy Manual 1129.04[3][a] (3d ed. rev. 2006).
3 See In re Armstrong World Industries, Case No. 00-4471, slip op. at 22 (D. Del. Aug. 14, 2006) (citing In re Dow Corning Corp., 244 B.R. 696, 702 (Bankr. E.D. Mich. 1999)).
4 See Markell, Bruce A., “A New Perspective on Unfair Discrimination in Chapter 11,” 72 Am. Bankr. L. J. 227 (1998).
5 See 3 Sommer, Henry J., and King, Lawrence P., eds., Collier Bankruptcy Manual 1129[3][a] (3d ed. rev. 2006).
6 See, e.g., In the Matter of Greate Bay Hotel & Casino Inc., 251 B.R. 213 (Bankr. D. N.J. 2000); In re Dow Corning Corp., 244 B.R. 696 (Bankr. E.D. Mich. 1999).