Overpayment of Secured Creditor Violates Absolute Priority Rule

By: Peter N. Chiaro

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

The United States Bankruptcy Court for the Eastern District of Pennsylvania, in In re Brewery Park Associates, L.P.,[1] recently affirmed that the “absolute priority rule” is violated when a secured creditor receives more than the value of its claim under a chapter 11 plan.  Following the expiration of the debtor’s exclusivity, the Retirement Fund (“TRF”), a secured creditor, proposed its own chapter 11 plan.[2]  After failing to gain approval from all classes of impaired creditors, it sought to cramdown its proposed chapter 11 plan under section 1129(b).[3]  TRF’s plan allowed TRF to obtain a parcel of property that was worth, by its own estimate, between $5 million and $6 million in exchange for a credit bid of $2 million.[4]  Further, because TRF’s secured claim was roughly $5.2 million, TRF’s low credit bid would also give it deficiency claims against the loan guarantors.[5]  The court determined that TRF’s plan would likely overpay TRF’s allowed claim, and therefore the plan could not be confirmed because it was not fair and equitable.[6]

            In order to cramdown a plan of reorganization on an impaired class of creditors, the plan must be, among other things, “fair and equitable.”[7]  In analyzing whether TRF’s plan was “fair and equitable,” the court focused on two key questions: (1) whether any class senior to the dissenting class would receive more than full compensation for its’ claims or interest; and (2) whether members of the dissenting class would receive full compensation for their claims before any junior class would receive any distributions.[8]  Because TRF’s plan made no allotment for payments to junior creditors, the latter requirement was easily satisfied.[9]  The former question was more difficult to answer because the value of the property at issue was subject to uncertainty in the real estate market, the length of time the property would be marketed, and the use of the property.[10]  Because of procedural limitations and certain other restrictions that TRF’s plan would have imposed on competing bidders[11], the court concluded that it was unlikely that any party other than TRF would submit a qualifying bid for the property at issue.  Further, the court reasoned that if TRF were to obtain the property, valued between $5 million and $6 million, in exchange for a $2 million credit bid, and could also maintain claims against the original loan guarantors under state law, the proposed plan would “very probably overpay TRF’s allowed secured claim to the detriment of classes with lower priority.”[12]

This case is important because it provides insight on how courts will interpret the “fair and equitable” requirement with regard to determining whether a creditor has received more than its allowed claim.  Given the current state of commercial real estate—prices are down 47% throughout the country since their peak in 2007[13]—the court’s analysis of property values and the value of a creditor’s claim takes into account the potential for abuse of the cram down requirement.  With prices at a significant bargain today, relative to peak prices, the likelihood that a secured creditor will receive more than its allowed claim is a significant concern moving forward.  The decision in In re Brewery Park Associates, L.P. gives a better understanding of how to apply the “fair and equitable” requirement in an uncertain commercial real estate market.