A new perspective on unfair discrimination in Chapter 11

American Bankruptcy Law Journal

Volumn 72, Issue 2, 1998, Pages 227-262

  Markell, Bruce A ^a,b  

^a INDIANA UNIVERSITY   (United States)

^b Ancel and Dunlap ^*  (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 0347135221     PISSN: 00279048     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (156)

1. In this Article, the use of Arabic numerals with a chapter designation denotes a chapter of the current Bankruptcy Code (title 11, U.S.C., "the Code"). The use of Roman numerals in the same context denotes a chapter of the Bankruptcy Act of 1898 ("the Act").
2. Under the Bankruptcy Code, a plan proponent may confirm a Chapter 11 plan of reorganization without the consent of all impaired classes only "if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan." 11 U.S.C. § 1129(b)(1) (1994) (emphasis added).
3. The uncertain state of the law is demonstrated by Denise Polivy's article appearing in this issue of The Journal. See Denise R. Polivy, Unfair Discrimination in Chapter 11: A Comprehensive Compilation of Current Case Law, 72 AM. BANKR. L.J. 191 (1998). See also Corestates Bank v. United Chem. Techs., Inc., 202 B.R. 33, 47 n.12 (E.D. Pa. 1996) (court notes there are only a "few" cases on the subject, and several of these cases arguably did not involve genuine issues of unfair discrimination). See infra note 56.
4. By 1915 over one-half of all railroad debt securities had been in default at one time or another. WILLIAM Z. RIPLEY, RAILROADS: FINANCE & ORGANIZATION 374 (1915).
5. Writers during this time seemed to embrace a fairly constant estimate that about one in seven railroads were in receivership at any one time during the later part of the nineteenth century and continuing through the early part of this century. Paul D. Cravath, Reorganization of Corporations, in 1 SOME LEGAL PHASES OF CORPORATE FINANCING, REORGANIZATION AND REGULATION 153, 154 (1917);
6. John Franklin Crowell, Railway Receiverships in the United States, 7 YALE REV. 319, 319 (1898).
7. I have previously explored this history in Bruce A. Markell, Owners, Auctions, and Absolute Priority in Bankruptcy Reorganizations, 44 STAN. L. REV. 69, 74-84 (1991).
8. As of 1906, there were over $18 billion of railroad securities outstanding, which included both debt and equity securities. RIPLEY, supra note 4, at 62-63.
9. Of the $18 billion in railroad securities, it was estimated that approximately one-half, or $9 billion, was debt secured by railroad properties. Id. at 63, 105-20.
10. See Markell, supra note 5, at 75.
11. Id. at 75-76. See also 2 ARTHUR STONE DEWING, THE FINANCIAL POLICY OF CORPORATIONS 1238-54 (5th ed. 1953).
12. See Markell, supra note 5, at 75-83.
13. Id.
14. 77 A. 1054 (N.J. Ch. 1910).
15. The lack of notice to Ring was essential to the court's opinion. "[A] foreclosure could properly have been utilisable to cut off the interests of any of the bondholders of the old company who, being fully advised of the proposed reorganization, chose to trust to the results of a sale in foreclosure rather than to join in the reorganization scheme. But to serve this last purpose I am clearly of the opinion that such bondholders, before they can be considered as having been cut off, must have been fully notified of all relevant facts." Id. at 1059.
16. See, e.g., Southern Pac. Co. v. Bogert, 250 U.S. 483 (1919); Fearon v. Bankers' Trust Co., 238 F. 83 (3d Cir. 1916); Investment Registry, Ltd. v. Chicago & M.E.R. Co., 212 F. 594 (7th Cir. 1913).
17. Indeed, Justice Douglas was later to trace the origins of unfair discrimination to the fundamental rule of equality of distribution to creditors. See infra note 33.
18. See, for example, Eagleson v. Pacific Timber Co., 270 F. 1008, 1011 (D. Del. 1920), in which the court set aside a corporate reorganization that included: (i) a share for share exchange of common stock; (ii) a purchase of new preferred stock at ten dollars per share; and (iii) a requirement that those holding both common and preferred stock would have to purchase preferred stock before being allowed to exchange their common stock. The court stated the rationale of the decision as follows: As the holders of more than half of the common stock . . . had none or practically no preferred stock, while many persons, including the plaintiff and the interveners, held substantially equal amounts of preferred and common stock, it is manifest that the plan of reorganization was for the benefit of the majority, to the detriment of the minority, and consequently unfair and fraudulent. Id.
19. See, e.g., Investment Registry, 212 F. at 605, 608 (dealing with a situation in which controlling bondholders paid off, at a premium, certain dissident bondholders so that they would not bid at a foreclosure sale). In that case, the court refused to confirm the sale (and subsequent reorganization) and stated a general rule for syndicate sales of large enterprises involving dissenting bondholders: When such a controversy is on, the chancellor in our opinion not only has the right but owes the duty of being vigilant to see, on the one hand, that a dissenter be not permitted to create a maneuvering value in his bonds by opposing confirmation, and, on the other, that the majority does not use its power, unique in sales of this class, to oppress a helpless minority. Id. at 610. See also In re M. & H. Gordon, 245 F. 905, 906 (S.D.N.Y. 1917) (confirmation of composition plan denied where debtor agreed to pay the accounting and investigative expenses of a particular creditor in order to obtain that creditor's vote in favor of the plan); In re Weintrob, 240 F. 532, 534 (E.D.N.C. 1917) (confirmation of twenty-five percent composition plan denied where the favorable vote of one claim, necessary for the confirmation, was obtained by purchasing the claim at face value).
20. See, e.g., Swanson v. Barclay Park Corp. (In re Barclay Park Corp.), 90 F.2d 595 (2d Cir. 1937) (holding that a plan which allocated equity interests in an insolvent debtor to existing equity holders violated the unfair discrimination provision of § 77B of the Bankruptcy Act).
21. Act of March 3, 1933, ch. 204, § 77(g), 47 Stat. 1467, 1479.
22. Act of May 24, 1934, ch. 345, § 80(e), 48 Stat. 798.
23. Act of June 7, 1934, ch. 424, § 77B, 48 Stat. 911, 912.
24. Id. § 77B(f)(1).
25. Act of Aug. 27, 1935, ch. 774, § 77(e)(1), 49 Stat. 911, 918.
26. The 1934 provisions were held unconstitutional in Ashton v. Cameron County Water Improvement District, 298 U.S. 513 (1936).
27. The 1937 provisions regarding municipal arrangements were initially placed in Chapter X of the 1898 Act. Act of Aug. 16, 1937, ch. 657, 50 Stat. 654. The Chandler Act moved them to Chapter IX in 1938. Act of June 22, 1938, ch. 575, § 3(a), 52 Stat. 840, 939.
28. Act of Aug. 16, 1937, ch. 657, § 83(e), 50 Stat. 654.
29. Act of June 22, 1938, ch. 575, 52 Stat. 840.
30. S. REP. NO. 75-1916, at 35-36 (1938) (Senate Report No. 1916 accompanied H.R. 8046, which was the bill ultimately enacted). See also ANALYSIS of H.R. 12889, 74TH CONG. 78 n.2 (Comm. Print 1936) [hereinafter ANALYSIS OF H.R. 12889].
31. Congress dropped the "fair and equitable" requirement from Chapter XI and Chapter XII arrangements in 1952, without adding back in any notions of unfair discrimination. See Act of July 7, 1952, ch. 579, § 35, 66 Stat. 420, 433.
32. See, e.g., ANALYSIS OF H.R. 12889, supra note 28, at 78 n.2 (stating the position of the National Bankruptcy Conference that confirmation standard be simply that the plan be "equitable," on the grounds that "[e]quitable' would include 'fair', and would also prevent unfair discrimination in favor of any class of creditors or stockholders."); THOMAS FINLETTER, THE LAW OF BANKRUPTCY REORGANIZATION 461-72 (1939); 2 JOHN GERDES, CORPORATE REORGANIZATIONS § 1080 (1936); Note, Classification of Claims in Debtor Proceedings, 49 YALE L.J. 881 (1940).
33. 311 U.S. 138 (1940).
34. 326 U.S. 536 (1946).
35. As stated by the Court: Beyond that is the question of unfair discrimination to which we have adverted. Compositions under Ch. IX, like compositions under the old s. 12, 11 U.S.C.A. s. 30, envisage equality of treatment of creditors. Under that section and its antecedents, a composition would not be confirmed where one creditor was obtaining some special favor or inducement not accorded the others, whether that consideration moved from the debtor or from another . . . . That rule of compositions is but part of the general rule of 'equality between creditors' (Clarke v. Rogers, 228 U.S. 534, 548, 33 S. Ct. 587, 591, 57 L.Ed. 953) applicable in all bankruptcy proceedings. That principle has been imbedded by Congress in Ch. IX by the express provision against unfair discrimination. Avon Park, 311 U.S. at 147.
36. Id.
37. Id. at 148.
38. 326 U.S. 536 (1946).
39. This analysis assumes that the four percent face rate on the bonds represented what today would be called a market rate of interest. If the four percent rate represented an above-market rate of return, there would have been a benefit to the RFC in addition to simple repayment of its costs in purchasing the old bonds. The Court recognized this possibility, but found no evidence to support it: "The Reconstruction Finance Corporation receives new and refunding bonds in the face amount of its cash advances. It is, of course, possible that 52.521 cents in cash may not be as advantageous an offer as 52.521 cents in new and refunding bonds. But there is no showing that it is not." Id. at 543.
40. Id.
41. Id.
42. Id.
43. H.R. REP. NO. 94-686, at 33 (1975).
44. Id.
45. 1 COMM'N ON THE BANKR. LAWS OF THE U.S., REPORT OF THE COMMISSION ON THE BANKRUPTCY LAWS OF THE UNITED STATES, H.R. DOC. NO. 93-137, at 255 (1973).
46. id. at 269.
47. See H.R. 8200, 95th Cong. § 1129(b)(2)(B)(iv) (1977).
48. It only appeared in paragraph (2) relating to unsecured claims, and was absent from paragraph (1) relating to secured claims and paragraph (3) relating to equity interests. See id.
49. The requirement of the House bill that a plan not 'discriminate unfairly' with respect to a class is included for clarity; the language in the House report interpreting that requirement, in context of subordinated debentures, applies equally under the requirements of section 1129(b)(1) of the House amendment." 124 CONG. REC. 32,407 (1978) (statement of Rep. Edwards); id. at 34,006 (statement of Sen. DeConcini).
50. H.R. REP. NO. 95-595, at 417 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6373.
51. See supra text accompanying note 41.
52. H.R. REP. NO. 95-595, at 414-18 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6370-74. Indeed, the lack of further guidance is surprising given the review of unfair discrimination in the context of the 1976 revisions to municipal arrangements. See supra text accompanying note 41.
53. The floor managers of the bill that became the Code confirmed the applicability of the House Report's examples, even though the bill reported on by the House was different from the bill ultimately adopted. "[T]he language in the House report interpreting that requirement, in context of subordinated debentures, applies equally under the requirements of section 1129(b)(1) of the House amendment." 124 CONG. REC. 32,407 (1978) (statement of Rep. Edwards); id. at 34,006 (statement of Sen. DeConcini).
54. H.R. REP. NO. 95-595, at 416 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6372.
55. See In re MCorp Fin., Inc., 160 B.R. 941, 960 (S.D. Tex. 1993). Indeed, the court in MCorp seemed to believe that there would be no unfair discrimination if there was sharing that skipped nonbankruptcy priorities. "The seniors may share their proceeds with creditors junior to the juniors, as long as the juniors continue to receive at least as much as what they would without the sharing." Id.
56. H.R. REP. NO. 95-595, at 417 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6373.
57. Id.
58. Often, creditors with different liquidation priorities will look at the treatment being offered to other classes and complain that their treatment is different. A secured creditor will think another secured class of claims is receiving more favorable terms, or that unsecured claims are being paid first. See In re McCall, No. 93-00632, 1997 WL 428580 (Bankr. D.D.C., May 27, 1997); Jack Friedman, What Courts Do To Secured Creditors in Chapter 11 Cram Down, 14 CARDOZO L. REV. 1495, 1502-04 (1993). While these types of claims can be and are raised under the "fair and equitable" requirement, they are not unfair discrimination claims. Unfair discrimination works only among claimants of equal nonbankruptcy priority. Prudential Ins. Co. of Am. v. Monnier (In re Monnier Bros.), 755 F.2d 1336 (8th Cir. 1985) (secured creditor's complaint that other secured classes of claims were being paid earlier did not give rise to an unfair discrimination claim); Mutual Life Ins. Co. v. Patrician St. Joseph Partners Ltd. Partnership (In re Patrician St. Joseph Partners Ltd. Partnership), 169 B.R. 669 (D. Ariz. 1994) (stretch-out of real estate secured loan on reasonable terms not unfairly discriminatory). Similarly, if a debtor improperly classifies claims, the appropriate objection is under § 1129(a)(1), not that the plan unfairly discriminates as to the improperly classified claim. In re Treasure Bay Corp., 212 B.R. 520 (Bankr. S.D. Miss. 1997). But see Aetna Realty Investors, Inc. v. Monarch Beach Venture, Ltd. (In re Monarch Beach Venture, Ltd.), 166 B.R. 428 (C.D. Cal. 1993) (case remanded in order for bankruptcy court to determine whether higher rates of interest to be paid to junior lienors discriminated unfairly against senior lender); In re The Landing Assocs., Ltd., 157 B.R. 791, 822 (Bankr. W.D. Tex. 1993).
59. As the Supreme Court has indicated, "The normal rule of statutory construction is that if Congress intends for legislation to change the interpretation of a judicially created concept, it makes that intent specific. The Court has followed this rule with particular care in construing the scope of bankruptcy codifications." Midlantic Nat'l Bank v. New Jersey Dept. of Environmental Protection, 474 U.S. 494, 501 (1986) (citation omitted). See also Pennsylvania Dept. of Pub. Welfare v. Davenport, 495 U.S. 552, 569-79 (1990) (Blackmun, J., dissenting).
60. See also 11 U.S.C. § 1123(a)(4) (1994), which requires all members of a class to receive identical treatment under the plan.
61. See supra text accompanying notes 50-55. See generally Polivy, supra note 3.
62. In Steelcase Inc. v. Johnston (In re Johnston), 21 F.3d 323, 328 (9th Cir. 1994), the Ninth Circuit upheld a plan provision that delayed payment of a large disputed claim and created different reserve requirements for different claims, noting that all claims were to be paid in full. See also In re Bouy, Hall & Howard & Assocs., 141 B.R. 784, 793 (Bankr. S.D. Ga. 1992) (permissible to separately classify and pay an unsecured creditor before payment in cash to the secured creditor since the unsecured creditor was a necessary franchisor and had agreed to accept payments over a thirty-six month period in order to cure a default in the franchise agreement).
63. Johnston, 21 F.3d at 328; Granada Wines, Inc. v. New England Teamsters & Trucking Indus. Pension Fund, 748 F.2d 42, 46 (1st Cir. 1984) (pension fund claim and other general unsecured claims must be treated alike); In re Crosscreek Apartments, Ltd., 213 B.R. 521, 537-38 (Bankr. E.D. Tenn. 1997) (unfairness arises from disparity in present value of recovery, not from proposal to pay trade debt within six months and a lender's deficiency claim within ten years); In re 222 Liberty Assocs., 108 B.R. 971, 990-91 (Bankr. E.D. Pa. 1990) ("Generally speaking, [the prohibition of unfair discrimination] ensures that a dissenting class will receive relative value equal to the value given to all other similarly situated classes.") (quoting In re Johns-Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1987), aff'd, 78 B.R. 407 (S.D.N.Y. 1987), and aff'd sub nom., Kane v. Johns-Manville Corp., 843 F.2d 636 (2d Cir. 1988)); In re Sherwood Square Assocs., 107 B.R. 872, 879 (Bankr. D. Md. 1989) (approving plan that paid general unsecureds 66.6 percent of claims in cash on confirmation and lender's deficiency claim at 66.6 percent rate, over a fifteen year period, upon a finding that an appropriate interest rate was employed).
64. For example, see In re Jersey City Medical Center, 817 F.2d 1055, 1057, 1061 (3d Cir. 1987), where the court affirmed a plan that classified physicians' claims separately from medical malpractice and general unsecured claims - and paid them at a substantially higher rate - even though each class had the same nonbankruptcy priority. Note, however, that the payments were to come from different sources. See also In re Kliegl Bros. Universal Elec. Stage Lighting Co., Inc., 149 B.R. 306, 308 (Bankr. E.D.N.Y. 1992) (better treatment of unsecured claim of union justified on the basis that "the Debtor's ability to continue to operate a union shop is absolutely critical to its ability to function successfully in its industry"); In re Richard Buick, Inc., 126 B.R. 840 (Bankr. E.D. Pa. 1991) (priority treatment of vendor claims justified based on testimony that vendor would not deal with reorganized debtor unless claims paid in full); In re Rochem, Ltd., 58 B.R. 641, 643 (Bankr. D.N.J. 1985) (separate classification of unliquidated and disputed tort claimant upheld when plan gives tort claimant $50,000 with respect to unliquidated $35,000,000 tort claim and would, over thirty-six months, pay unsecured trade creditors a dividend of fifty percent of their claims of approximately $171,000).
65. Crosscreek Apartments, 213 B.R. at 537-38 (unfair discrimination to pay trade debt in full in cash within six months while providing that lender's unsecured deficiency would be paid in full, without interest, over ten years out of excess cash flow; court assumed that without payment of interest, lender's present value recovery would approximate only one-half of its allowed claim); In re Barney and Carey Co., 170 B.R. 17, 26-27 (Bankr. D. Mass. 1994) (unfair discrimination to pay in full deficiency claims guaranteed by insiders while paying trade creditors only fifteen percent of their claims). See also In re Aztec Co., 107 B.R. 585, 589-91 (Bankr. M.D. Tenn. 1989) (unfair discrimination to pay insider unsecured claims in full while paying nonrecourse deficiency claim three percent); In re ARN LTD. Ltd. Partnership, 140 B.R. 5, 13 (Bankr. D.D.C. 1992) (disallowing proposed zero payment to tenants and stating "[t]hat the debtor views the claimants as disgruntled tenants who are a nuisance to the debtor's reorganization efforts is simply not a basis for such discrimination, and no showing has been made that the plan could not succeed were the [tenants] accorded the same treatment as [other unsecured creditors]."). Cf. In re Cranberry Hill Assocs. Ltd. Partnership, 150 B.R. 289, 291 (Bankr. D. Mass. 1993) (cannot pay trade creditors in full on confirmation in cash, while purporting to pay deficiency in full over nine years without interest, and then only if property is sold; lack of interest and uncertainty of payment makes present value of payments less than 100 percent, and discrimination resulting therefrom is unfair).
66. See, for example, In re Jersey City Medical Center, 817 F.2d at 1057, which affirmed the confirmation of a plan that: (i) separately classified physicians' claims, medical malpractice claims and general unsecured claims, even though each class had the same priority; and (ii) paid 100 percent of the physicians' claims, but only thirty percent of the claims of the other classes. It may have been significant that the payments were to come from different sources. See also In re Sacred Heart Hosp., 182 B.R. 413, 421 n.8 (Bankr. E.D. Pa. 1995) (permissible to separately classify and provide different treatment for unsecured claims that have recourse to insurance from unsecured claims that do not have such recourse). Similar treatment has been held unfair discrimination when a portion of the payment is to come from insiders of the debtor. See 222 Liberty Assocs., 108 B.R. at 990-91 (court will not confirm proposal to pay unsecured classes two percent under plan, and then general partner would pay creditors with recourse in full over time).
67. See, e.g., Mason v. Paradise Irrigation Dist., 326 U.S. 536 (1946), discussed supra notes 36-40 and accompanying text.
68. Compare In re HRC Joint Venture, 187 B.R. 202, 204, 212 (Bankr. S.D. Ohio 1995) (joint proponent of plan, the City of Cincinnati, received more favorable treatment on its deficiency claim than did senior lender; differences in contributions - the city had waived part of its claim - noted and used as a basis for sustaining discrimination), with In re Shadow Bay Apartments, Ltd., 157 B.R. 363, 366 (Bankr. S.D. Ohio 1993) (alleged waiver of administrative claim insufficient to justify retention of one general partner's interest, when another general partner was required to make a cash contribution in order to retain its interest).
69. See In re Woodbrook Assocs., 19 F.3d 312, 321 (7th Cir. 1994) ("The meager 5% distribution, if any, on [the noninsider claims], given the full payment of [the insider claims], clearly suggests from our perspective, as it did from the perspective of the courts below, that this plan was the 'three dollar bill."); In re Aztec, 107 B.R. at 589 (unfair discrimination to pay insider unsecured claims in full while paying nonrecourse deficiency claim three percent). See also Barney and Carey Co., 170 B.R. at 26-27 (unfair discrimination to pay lenders' deficiency claims in full and trade creditors fifteen percent when insiders had guaranteed full amount of lenders' debt).
70. See Brinkley v. Chase Manhattan Mortgage & Realty Trust (In re LeBlanc), 622 F.2d 872, 879 (5th Cir. 1980) (upholding a secured creditor's Chapter XII plan that paid unsecured claims of trade creditors forty percent and paid unsecured insider claims nothing; court notes different status of trade creditors); In re 11,111, Inc., 117 B.R. 471, 478 (Bankr. D. Minn. 1990) (same rationale applied to a creditor's Chapter 11 plan). But see ARN LTD., 140 B.R. at 13 ("Separate classification on the basis of the insider or equity holder status of the creditor does not alone warrant unequal treatment unless equitable subordination principles apply.").
71. Before beginning an analysis of any "tests," however, it should be kept in mind that it is the rare case that turns solely on "unfair discrimination." Given the plethora of confirmation requirements, discussions of unfair discrimination are typically short, and appear to be added to already good reasons to grant or deny confirmation. Thus, they may not be as sharply drawn as they might if looked at as the sole reasons for denying or granting confirmation.
72. Kenneth N. Klee, All You Ever Wanted to Know About Cram Down Under the New Bankruptcy Code, 53 AM. BANKR. L.J. 133, 142 (1979). Professor Klee's article was cited by the court in In re Mortgage Investment Co., 111 B.R. 604, 614 (Bankr. W.D. Tex. 1990).
73. 115 F.3d 650, 656-57 (9th Cir. 1997).
74. 107 B.R. 585 (Bankr. M.D. Tenn. 1989).
75. Id. at 590. See also 11,111, Inc., 117 B.R. at 478; In re Buttonwood Partners, Ltd., 111 B.R 57, 63 (Bankr. S.D.N.Y. 1990); In re Rochem, Ltd., 58 B.R. 641, 643 (Bankr. D.N.J. 1985); 1 KEITH M. LUNDIN, CHAPTER 13 BANKRUPTCY § 4.61, at 4-132 to 4-133 (2d ed. 1994 & Supp. 1996) (collecting Chapter 13 cases).
76. See In re 203 N. LaSalle St. Ltd. Partnership, 190 B.R. 567, 585 (Bankr. N.D. Ill. 1995), aff'd, 195 B.R. 692 (N.D. Ill. 1996), aff'd, 126 F.3d 955 (7th Cir. 1997), cert. granted, 118 S. Ct. 1674 (May 4, 1998); In re Brown, 152 B.R. 232, 235-37 (Bankr. N.D. Ill.), rev'd on other grounds sub nom., McCullough v. Brown, 162 B.R. 506 (N.D. Ill. 1993); In re Furlow, 70 B.R. 973, 977-78 (Bankr. E.D. Pa. 1987) (criticizing four-part test and stating that appropriate test is that "different treatment is permissible if and only if the debtor is able to prove a reasonable basis for the degree of discrimination contemplated by the Plan"). See also In re 222 Liberty Assocs., 108 B.R. 971, 991-92 (Bankr. E.D. Pa. 1990). Indeed, Judge Lundin himself has stated that the Chapter 13 cases in this area are "ridiculously complicated." 1 LUNDIN, supra note 73, § 4.81, at 4-178.
77. Improper classification is a basis for objecting to confirmation under § 1129(a)(1). Section 1129(a)(1) tests whether the plan complies with the provisions of title 11, which includes classification under § 1122. See 7 LAWRENCE P. KING ET AL., COLLIER ON BANKRUPTCY, ¶ 1129-03[1], at 1129-25 (15th ed. rev. 1998).
78. See, e.g., Aetna Cas. and Surety Co. v. U.S. Bankruptcy Court (In re Chateaugay Corp.), 89 F.3d 942, 949 (2d Cir. 1996); Boston Post Rd. Ltd. Partnership v. Federal Deposit Ins. Corp. (In re Boston Post Rd. Ltd. Partnership), 21 F.3d 477, 483 (2d Cir. 1994); Phoenix Mut. Life Ins. Co. v. Greystone III Joint Venture (In re Greystone III Joint Venture), 995 F.2d 1274, 1279 (5th Cir. 1991); In re Kliegl Bros. Universal Elec. Stage Lighting Co., Inc., 149 B.R. 306 (Bankr. E.D.N.Y. 1992). One bankruptcy court noted that "separate classification for valid business reasons is uniformly accepted." In re SM 104 Ltd., 160 B.R. 202, 217 n.32 (Bankr. S.D. Fla. 1993).
79. See NAT'L BANKR. REV. COMM'N, BANKRUPTCY: THE NEXT TWENTY YEARS § 2.4.16 (1997). The NBRC Report contains an exhaustive survey of the current state of the law on classification. Id. at 567-89. Obviously, unfair discrimination issues recede into virtual nothingness if courts do not permit separate classification of creditors having the same nonbankruptcy priority, and this Article assumes that some form of intra-class division is appropriate and in force.
80. See 11 U.S.C. § 1129(a)(3) (1994) (plan must be proposed in good faith).
81. Cf. 203 N. LaSalle St., 190 B.R. at 585-86 ("First, any discrimination must be supported by a legally acceptable rationale . . . . Second, the extent of the discrimination must be necessary in light of the rationale.").
82. Judge Lundin in Aztec was explicit in his reliance. See In re Aztec Co., 107 B.R. 585, 589 (Bankr. M.D. Tenn. 1989). In Ambanc, the Ninth Circuit relied on Chapter 11 precedent from the Ninth Circuit Bankruptcy Appellate Panel, which in turn relied on Chapter 13 cases. Liberty Nat'l Enters. v. Ambanc La Mesa Ltd. Partnership (In re Ambanc La Mesa Ltd. Partnership), 115 F.3d 650, 656 (9th Cir. 1997) (citing AMFAC Distribution Corp. v. Wolff (In re Wolff), 22 B.R. 510 (B.A.P. 9th Cir. 1982)). Wolff in turn was a business Chapter 13 case. Id. at 511.
83. Section 1322(b)(1) provides that a plan may "designate a class or classes of unsecured claims, as provided in section 1122 of this title, but may not discriminate unfairly against any class so designated 11 U.S.C. § 1322(b)(1). See generally LUNDIN, supra note 73, §§ 4.59-4.81.
84. See 11 U.S.C. § 1325(b)(1).
85. See 8 KING ET AL., supra note 75, at ¶ 1301.LH.
86. Although secured creditors typically comprise their own class, a class of secured creditors can exist in which each member of the class holds bonds or other securities secured by an indivisible interest in some collateral. Unfair discrimination issues could arise if the plan classifies some bondholders separately from the main body, and then proposes to treat that class differently.
87. See supra text accompanying notes 15-18.
88. See 7 KING ET AL., supra note 75, at ¶ 1129.04[4].
89. See supra text accompanying notes 12-42.
90. Professor Countryman's exact words were: Obtain a large piece of stone. Take a hammer and chisel and knock off everything that doesn't look like an elephant." Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 MINN. L. REV. 439, 460 n.85 (1973).
91. See 11 U.S.C. §§ 1129(a)(4) & (5) (1994).
92. See id. § 1129(a)(7).
93. See id. § 1129(b)(1).
94. See 7 KING ET AL., supra note 75, at ¶ 1129.04.
95. See 11 U.S.C. § 1129(a)(7) (best interests test); id. § 1129(a)(11) (feasibility); id. § 1129(a)(3) (good faith); id. § 1123(a)(4) (requiring that all members of every class receive equal treatment).
96. See id. § 1129(a)(10).
97. American United Mut. Life Ins. Co. v. City of Avon Park, 311 U.S. 138, 147 (1940).
98. Thus, assuming a ten percent interest rate, a present payment of only thirty-nine dollars would be worth $100 in ten years. The Bankruptcy Code imports present value analysis by requiring the plan, to be confirmed under § 1129(b) to return to each dissenting class "deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan." 11 U.S.C. § 1129(b)(2)(A)(i)(II) (emphasis added) (secured claims). See id. § 1129(b)(2)(B)(i) (unsecured claims); id. § 1129(b)(2)(C)(i) (interests).
99. See 7 KING ET AL., supra note 75, at ¶ 1129.06[1].
100. The priorities are contained in 11 U.S.C. § 507(a)(2)- (9).
101. See 7 KING ET AL., supra note 75, at ¶ 1122.03[4][b].
102. There is a subtle form of discrimination tolerated by this usage. The Code disallows certain otherwise valid nonbankruptcy claims to further fairness and reorganization. See 11 U.S.C. § 502(b)(3)-(8). Since a plan typically only provides for distributions with respect to allowed claims, the holders of such claims will have the amount of their otherwise valid nonbankruptcy claims reduced before any discrimination inquiry begins.
103. American United Mut. Life Ins. Co. v. City of Avon Park, 311 U.S. 138, 147 (1940).
104. See supra text accompanying notes 12-18.
105. See supra text accompanying notes 60-61.
106. See supra text accompanying note 63.
107. Steelcase Inc. v. Johnston (In re Johnston), 21 F.3d 323, 328 (9th Cir. 1994); Teamsters Nat'l Freight Indus. Negotiating Comm. v. U.S. Truck Co., Inc (In re U.S. Truck Co.), 800 F.2d 581 (6th Cir. 1986); In re 222 Liberty Assocs., 108 B.R. 971, 990-91 (Bankr. E.D. Pa. 1990) ("Generally speaking, [the prohibition of unfair discrimination] ensures that a dissenting class will receive relative value equal to the value given to all other similarly situated classes.") (quoting In re Johns-Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1987), aff'd, 78 B.R. 407 (S.D.N.Y. 1987), and aff'd sub nom., Kane v. Johns-Manville Corp., 843 F.2d 636 (2d Cir. 1988)); In re Sherwood Square Assocs., 107 B.R. 872, 879 (Bankr. D. Md. 1989) (confirming plan where general unsecureds paid 66.6 percent of claims in cash on confirmation and lender's deficiency claim also paid at 66.6 percent rate, but over fifteen year period).
108. American United, 311 U.S. at 147.
109. See 11 U.S.C. § 544(a) (1994).
110. See id. § 547.
111. See id. § 726(b).
112. See id. § 1122(b).
113. See id. § 547(c)(2).
114. See Russell A. Eisenberg & Francis F. Gecker, The Doctrine of Necessity and Its Parameters, 73 MARQ. L. REV. 1 (1989).
115. This assumes, of course, that relevant law permits separate classes for claims that have the same nonbankruptcy priority. See supra notes 75-76.
116. For a good explanation of value in the corporate reorganization context, see Peter V. Pantaleo & Barry W. Ridings, Reorganization Value, 51 BUS. LAW. 419 (1996).
117. As stated by the Third Circuit in In re Penn Central Transportation Co., 596 F.2d 1102, 1115-16 (3d Cir. 1979): That argument [that market value should not be used] has considerable force when the securities in issue represent equity in, or long term interest bearing obligations of, a reorganized debtor. In such cases, the market value of the security will depend upon the investing public's perception of the future prospects of the enterprise. That perception may well be unduly distorted by the recently concluded reorganization and the prospect of lean years for the enterprise in the immediate future. Use of a substitute "reorganization value" may under the circumstances be the only fair means of determining the value of the securities distributed. See also In re New York, New Haven and Hartford R.R. Co., 4 B.R. 758, 792 (D. Conn. 1980) ("The stigma of bankruptcy alone is a factor that will seriously depress the market value of a company's securities."); In re Missouri Pacific R.R. Co., 39 F. Supp. 436, 445-46 (E.D. Mo. 1941).
118. See 11 U.S.C. § 1129(a)(11).
119. See 7 KING ET AL., supra note 75, at ¶ 1129.03 [11].
120. See supra text accompanying notes 71-73.
121. Plans clearly can be and are compared by creditors. But that is a different inquiry than the inquiry courts conduct to see if the plan is minimally acceptable - that is, whether the plan is fair and equitable and whether it avoids unfair discrimination. These judicial inquiries examine whether the proposed plan meets a minimum set of requirements, not whether tinkering will produce a "better" plan. Each creditor and equity holder formulates its own normative judgment as to which of two plans is better; the Code, however, does not provide for the court to make that sort of normative judgment at the confirmation stage, providing instead for a comparative inquiry - the plan proposed is compared to the minimum Code requirements, and the court either confirms or denies confirmation based upon this examination and comparison. Only after there are two confirmable plans does the Code provide a normative standard for a judge to use in selecting between or among plans. See 11 U.S.C. § 1129(c).
122. See supra text accompanying notes 12-42.
123. See 11 U.S.C. § 1129(a)(7).
124. Section 503(b)(3)(D) allows entities not paid by the estate to receive reimbursement of their expenses if they make a "substantial contribution" to the Chapter 11 case. See 11 U.S.C. § 503(b)(3)(D). These expenses may include attorneys' fees. See id. § 503(b)(4). Section 503(b)(3) also permits administrative priority recovery for creditors who recover property for the benefit of the estate, see id. § 503(b)(3)(B), and for creditors who contribute to the prosecution of a criminal case related to the debtor's business or property, see id. § 503(b)(3)(C).
125. 326 U.S. 536 (1946).
126. See supra text accompanying notes 36-40.
127. 326 U.S. at 543.
128. See id. Case v. Los Angeles Lumber Products Co., 308 U.S. 106 (1939) is often cited as the source of new value principles for the fair and equitable requirement of nonconsensual confirmation. See generally Markell, supra note 5.
129. 207 B.R. 764 (Bankr. S.D.N.Y. 1997).
130. Id. at 791.
131. As the court noted, "[m]anagement contracts are a permissible way to effectuate a corporate reorganization." Id. (citations omitted).
132. See Brinkley v. Chase Manhattan Mortgage & Realty Trust (In re LeBlanc), 622 F.2d 872, 879 (5th Cir. 1980) (upholding creditor plan which paid unsecured claims of trade creditors forty percent and unsecured insider claims nothing); In re 11,111, Inc., 117 B.R. 471, 478 (Bankr. D. Minn. 1990) (same). But see In re ARN LTD. Ltd. Partnership, 140 B.R. 5, 13 (Bankr. D.D.C. 1992) ("Separate classification on the basis of the insider or equity holder status of the creditor does not alone warrant unequal treatment unless equitable subordination principles apply.").
133. In re Graphic Communications, Inc., 200 B.R. 143 (Bankr. E.D. Mich. 1996) (unfair discrimination when plan proposed to pay noninsider ten percent and insider 100 percent, with the difference based on an insider guarantee of cash flow deficiencies, estimated at $15,000; the company had revenues of over $440,000 and net income of $39,000 in the seven-month period preceding the bankruptcy).
134. See Steelcase Inc. v. Johnston (In re Johnston), 21 F.3d 323, 328 (9th Cir. 1994); Teamsters Nat'l Freight Indus. Negotiating Comm. v. U.S. Truck Co. (In re U.S. Truck Co.), 800 F.2d 581 (6th Cir. 1986); Granada Wines, Inc. v. New England Teamsters & Trucking Indus. Pension Fund, 748 F.2d 42 (1st Cir. 1984) (pension fund claim and other general unsecured claims must be treated alike); In re 222 Liberty Assocs., 108 B.R. 971, 990-91 (Bankr. E.D. Pa. 1990) ("Generally speaking, [the prohibition of unfair discrimination] ensures that a dissenting class will receive relative value equal to the value given to all other similarly situated classes") (quoting In re Johns-Manville Corp., 68 B.R. 618, 636 (Bankr. S.D.N.Y. 1987), aff'd, 78 B.R. 407 (S.D.N.Y. 1987), and aff'd sub nom., Kane v. Johns-Manville Corp., 843 F.2d 636 (2d Cir. 1988)); In re Sherwood Square Assocs., 107 B.R. 872, 879 (Bankr. D. Md. 1989) (confirming plan where general unsecureds paid 66.6 percent of claims in cash on confirmation and lender's deficiency claim also paid at 66.6 percent rate, but over fifteen year period).
135. See Mason v. Paradise Irrigation Dist., 326 U.S. 536 (1946). See also supra text accompanying notes 127-131.
136. See 11 U.S.C. § 1111(b) (1994).
137. See In re 203 N. LaSalle St. Ltd. Partnership, 126 F.3d 955, 969 (7th Cir. 1997) ("[T]he disparity between [the trade claims and the nonrecourse deficiency claim], with the trade creditors receiving 100 percent and Bank America receiving sixteen percent, is not unfair. Bank America does better than it would have under Chapter 7, and the trade creditors do no worse. Additionally, the plan called for the payment of the bank's unsecured deficiency claim before any insider creditor would be paid. Finally, the bankruptcy court concluded that this discrimination is narrowly tailored to meet the requirements of the 'best interest' test. We believe that this explanation adequately explains the difference in treatment between the two classes of unsecured claims, and the bankruptcy court did not clearly err in refusing to find this discrimination unfair"), cert. granted, 118 S. Ct. 1674 (May 4, 1998). See also In re Woodbrook Assocs., 19 F.3d 312, 317-320 (7th Cir. 1994); Travelers Ins. Co. v. Bryson Properties XVIII (In re Bryson Properties XVIII), 129 B.R. 440, 445 (M.D.N.C. 1991) ("Where legal claims are sufficiently different as to justify a difference in treatment under a reorganization plan, reasonable differences in treatment are permissible."), rev'd on other grounds, 961 F.2d 496 (4th Cir. 1992); In re Rivers End Apartments, Ltd., 167 B.R. 470, 487-88 (Bankr. S.D. Ohio 1994).
138. The Code, for example, limits certain claims for rent. See 11 U.S.C. § 502(b)(6). In the case of an insolvent Chapter 11 lessee whose plan is a joint plan with an affiliated guarantor of that lease, the treatment of such claims could potentially qualify for different treatment. See 4 KING ET AL., supra note 75, at ¶ 502.03[7](f).
139. See supra text accompanying notes 12-17.
140. See, e.g., Woodbrook, 19 F.3d at 321 ("The meager 5% distribution, if any, on [the noninsider claims], given the full payment of [the insider claims], clearly suggests from our perspective, as it did from the perspective of the courts below, that this plan was the 'three dollar bill."); In re Aztec Co., 107 B.R. 585, 589 (Bankr. M.D. Tenn. 1989) (unfair discrimination to pay insider unsecured claims in full while paying nonrecourse deficiency claim three percent). If the ultimate recovery is the same, however, different treatment has been upheld, In re Sherwood Square Assocs., 107 B.R. 872, 879 (Bankr. D. Md. 1989) (general unsecureds paid 66.6 percent of claims in cash on confirmation; lender's deficiency claim also paid at 66.6 percent rate, but over fifteen year period), but only upon a proper showing that the deferred payments are truly equivalent in value to the present ones. See also In re Cranberry Hill Assocs. Ltd. Partnership, 150 B.R. 289, 291 (Bankr. D. Mass. 1993) (cannot pay trade creditors in full on confirmation in cash, while purporting to pay deficiency in full over nine years without interest, and then only if property is sold; lack of interest and uncertainty of payment make present value of payments less than 100 percent, and discrimination resulting therefrom is unfair).
141. See, e.g., In re Graphic Communications, Inc., 200 B.R. 143 (Bankr. E.D. Mich. 1996).
142. It could be, for example, that issuing stock to the dissenting class might affect some tax benefits sought by the plan, or that members of the dissenting class are ineligible for the benefits distributed under the plan, as in the unlikely case of distributing ownership interests in a plane registered in the United States when the dissenting class is comprised wholly of non-United States citizens and would otherwise hold a majority interest in the plane.
143. See, e.g., In re Barney and Carey Co., 170 B.R. 17, 26-27 (Bankr. D. Mass. 1994) (unfair discrimination to pay lenders' deficiency claims in full and trade creditors fifteen percent when insiders had guaranteed full amount of lenders' debt); In re 222 Liberty Assocs., 108 B.R. 971, 990-91 (Bankr. E.D. Pa. 1990) (court will not confirm proposal to pay unsecured classes two percent under plan, and then general partner would pay creditors with recourse in full over time).
144. See, e.g., Brinkley v. Chase Manhattan Mortgage & Realty Trust (In re LeBlanc), 622 F.2d 872, 879 (5th Cir. 1980) (upholding plan which paid unsecured claims of trade creditors forty percent and which paid unsecured insider claims nothing); In re 11,111, Inc., 117 B.R. 471, 478 (Bankr. D. Minn. 1990) (same).
145. In re ARN LTD. Ltd. Partnership, 140 B.R. 5, 13 (Bankr. D.D.C. 1992) ("Separate classification on the basis of the insider or equity holder status of the creditor does not alone warrant unequal treatment unless equitable subordination principles apply.").
146. In re Kliegl Bros. Universal Elec. Stage Lighting Co., Inc. 149 B.R. 306, 309 (Bankr. E.D.N.Y. 1992) (better treatment of unsecured claim of union was justified on the basis that "the Debtor's ability to continue to operate a union shop is absolutely critical to its ability to function successfully in its industry."); In re Bouy, Hall & Howard & Assocs., 141 B.R. 784, 793 (Bankr. S.D. Ga. 1992) (permissible to separately classify and pay unsecured creditor before payment in cash to secured creditor since unsecured creditor was necessary franchisor and had agreed to accept cure payments over thirty-six month period); In re Richard Buick, Inc., 126 B.R. 840 (Bankr. E.D. Pa. 1991) (priority treatment of vendor claims justified based on testimony that vendor would not deal with reorganized debtor unless claims paid in full).
147. Section 14 of the Bankruptcy Act discharged "debts," which were in turn limited by § 1(14) to any claims "provable in bankruptcy." Sections 57d and 63d of the Act, however, presumptively did not allow unliquidated or contingent claims to be provable. See 3 JAMES WM. MOORE ET AL., COLLIER ON BANKRUPTCY ¶ 57.15 (14th ed. 1977).
148. Indeed, the plans confirmed in the A.H. Robins and Johns-Manville cases assumed that the plan consideration would pay all tort claims in full. See In re A.H. Robins Co., 880 F.2d 709, 720 (4th Cir. 1989); Note, The Manville Bankruptcy: Treating Mass Tort Claims in Chapter 11 Proceedings, 96 HARV. L. REV. 1121, 1128-33 (1983).
149. In re Rochem, Ltd., 58 B.R. 641, 643 (Bankr. D.N.J. 1985) (separate classification of unliquidated and disputed tort claimant upheld when plan gives tort claimant $50,000 with respect to unliquidated $35,000,000 tort claim and would, over 36 months, pay unsecured trade creditors a dividend of fifty percent of their claims of approximately $171,000). Under the proposed analysis, Rochem can be justified only if the higher payment of trade claims was commensurate with the value of the participation of trade creditors in the reorganization.
150. In re Eagle-Picher Indus., Inc., 203 B.R. 256 (S.D. Ohio 1996) (permissible to separately classify tort claimants, and to provide for different payment scheme to such claimants upon election, when all creditors ultimately to receive the same percentage recovery).
151. Note that issues of unfair discrimination do not enter into consideration of whether equity interests can contribute to the reorganization. That is a question, as I have framed it, of vertical equity, and the province of those cases discussing the new value corollary to the absolute priority rule. See Markell, supra note 5; 7 KING ET AL., supra note 75, at ¶ 1129.04[4] [c].
152. See supra note 64.
153. See 11 U.S.C. § 1129(a)(7) (1994).
154. See id. § 726(a)(4), (5).
155. This assumes that the estate could bring the fund into the estate through its avoiding powers, see, e.g., id. § 548(a)(2), or through rejection and rescission of the contract creating the settlement fund, see id. § 365.
156. See supra text accompanying notes 123-131.