Mike Markham on Chapter 11 – 6 of 10 – Cramdowns

Now I want to talk about a couple of terms that exist in Chapter 11 cases.  I am sure people have heard the term “cramdown”, but in my experience the word cramdown gets misused, and confused with a “strip down” or “stripping down.”  When you strip down a lien, you are reducing it to the value of the asset.  For example, if you have a $10,000,000 debt on an $8,000,000 piece of real estate, under the Bankruptcy Code that debt gets stripped down to $8,000,000 from a secured perspective and then you have a separate $2,000,000 unsecured deficiency claim.  This stripping down becomes valuable in equipment-type situations, because equipment depreciates very rapidly, unlike real estate that maintains its value somewhat over time.  You can have great fluctuations in real estate depending upon market forces, but equipment – furniture, fixtures, and other “rolling stock,” tends to lose value rapidly.
A cramdown simply means that you are cramming down or forcing the terms of a plan on a creditor.  A cramdown can apply to a secured creditor, an unsecured creditor, or even equity.  Cramdown simply means that you are cramming the plan down over the objection of the creditor.  Now, you can have a plan that has both a strip down and a cramdown, but again, the cramdown just means you are cramming it down over their objection.
So what does that mean for a secured creditor?  You have to pay them the value of their secured claim as part of the plan based upon its net present value, with interest over time.  So if you are doing that over time, it means you have to do that at some interest rate that brings it back to a present value that is one of the terms in the Bankruptcy Code – the indubitable equivalent of their secured claims.  So that relates to the secured claim, meaning that if you strip them down from $10,000,000 to $8,000,000, then you are cramming down the treatment of that $8,000,000, which in a real estate case might be interest at prime plus 2% over 60 months, with a 30-year amortization and a balloon at the end of the 60 months.  That is a very common real estate cramdown plan that can be used with great leverage against secured creditors, as long as you have an impaired class that has voted in favor of your plan.
As mentioned above, one of the prerequisites for utilizing the cramdown provision in Section 1129(b) of the Bankruptcy Code is that you have to have the vote of at least one impaired class.  In other words, you can’t cram down everybody.  That tells you from a strategic perspective is that you’ve got to make a friend or have an ally in your case, and that is something you ought to be thinking about from day one – who is going to be your impaired class that is going to open the door for you to use a cramdown, because if you can’t use a cramdown, then you have no leverage at all and you are probably never going to get your case confirmed. So that is how it works with secured creditors.
You can also cramdown unsecured creditors by having inferior classes, i.e., equity, receive or retain property under the plan.  If you are wiping out equity, cramming down the unsecured is automatic, because they have to take whatever has been offered.  You can run into issues where in a closely held company, equity is getting wiped out but it is getting reissued to the brother or the cousin or the uncle or the father where it is not really getting wiped out, it is getting kept in the family. Those can be interesting issues, but still from a strategic standpoint, even in those mom and pop or closely held cases, the debtor has much more negotiating power if they are wiping out equity.  If equity is unimpaired, meaning that the mom and pop are just going to keep the stock of the company, then if the unsecured creditors vote no, that plan is non-confirmable.  If you know you are going to have a problem with your unsecured creditors, you need to be thinking about wiping out the stock, and if you are going to bring in a family member or a friend to buy that stock, they need to buy it for real value, so have that person put money into the company, which is called new value.  Have them put in new value so that they can get the stock. You’ve wiped it out, they have paid new value.  The value of the stock post confirmation, whatever that might be, that can be a very complicated analysis, depending on the complexity of the entity, but if you have new value coming in, then unsecured creditors are fairly powerless to stop that plan from going forward, unless, of course, there is some other violation.
The primary rule in a plan is that the creditors receive more than they would have gotten in a Chapter 7 liquidation.  In most cases, where the debtor is woefully insolvent and upside down, it is not hard for the plan to provide more, because unsecured creditors would usually get zero in a liquidation, but you can have cases where there is equity over and above the secured debt.  Remember, when you do that analysis, you have to look at the administrative expenses, i.e., the attorney fees or Trustee fees that would come off of the top, what are the priority claims, taxes, employee claims, and then whatever is left would make its way to unsecured creditors, who receive more than they would have received without the Chapter 11.
Now you can even do a cramdown on equity.  You don’t often see that.  Sometimes there is value in equity, but again there is no inferior class to equity unless you have multiple levels of equity.  In more complicated cases you can have A shares, B shares, C shares, common shares that you would apply the rule in that fashion – as long as an inferior class receives nothing, then equity can retain something for the higher class.  As long as you are wiping out common shares, then you can give the holders of the preferred equity interests whatever you want to give them, and they are getting more than they would otherwise get.

Since starting with the Johnson Pope Bokor Ruppel & Burns firm in 1988, Michael’s practice has concentrated on bankruptcy and insolvency related Litigation. Michael has represented corporate and individual debtors, secured creditors, equipment lenders, landlords, creditor’s committees, trustees and petitioning creditors in involuntary bankruptcies.

Michael also has substantial experience in receivership cases.