Subchapter V of chapter 11 does not prescribe when a “cramdown” plan must have a five-year duration as opposed to three years.

In terms of the duration of a plan, Bankruptcy Judge Shad M. Robinson of Austin, Texas, concluded that the bankruptcy court has “broad discretion” in deciding whether a plan satisfies the “fair and equitable” requirement contained in Section 1191(b) and (c)(2)(A). His May 24 decision could be read to mean that a debtor must proffer detailed evidence about the income and expenses of the business to establish that the plan is fair and equitable and how long the plan must run.

The debtor was a small medical clinic in a small town in west Texas. The clinic had been in operation about five years before filing a chapter 11 petition and electing treatment under Subchapter V. Annual income was slightly above $1 million a year. The debtor was an LLC owned by a couple who were the managers and were employed by the business.

The secured bank creditor had a bifurcated claim with about $55,000 secured and $280,000 unsecured. Including the bank’s unsecured claim, there were some $475,000 unsecured claims.

The debtor proposed a three-year plan that would have paid unsecured creditors an estimated 8.2% of their claims. The three years of payments to unsecured creditors would have totaled about $39,000. From the total, the bank would have recovered $23,000 on its allowed, unsecured claim.

Neither the U.S. Trustee nor the Subchapter V trustee objected to confirmation. However, the bank voted its secured and unsecured claims against the plan. Because the bank was the only creditor in the secured class, the lack of acceptance by all classes invoked the so-called cramdown requirements for confirmation.

The bank contended that the plan was not proposed in good faith as required by Section 1129(a)(3) and was not fair and equitable under Section 1191(b) and (c)(2)(A).

Good Faith

As Judge Robinson explained, Section 1191(b) directs the court to confirm a cramdown plan if other requirements have been met and “if the proposed subchapter V 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 subchapter V plan.”

The objection to confirmation raised two issues. Was the plan proposed in good faith under Section 1129(a)(3) and did the devotion of the debtor’s disposable income for three years satisfy the fair and equitable test under Section 1191(b) and (c)(2)(A)?

The bank argued that the plan was not filed in good faith because the debtor could pay more were it a five-year plan. Applying a totality of the circumstances test, Judge Robinson found good faith.

To find good faith, Judge Robinson saw the plan as a “legitimate attempt” to reorganize and confirm a plan that would pay creditors more than liquidation. He also found that the plan was proposed with “honest and good intentions” coupled with “fundamental fairness” in dealing with creditors. He therefore overruled the bank’s contention that the plan was not proposed in good faith.

Good Faith Doesn’t Equal ‘Fair and Equitable’

Nonetheless, Judge Robinson said that a finding of good faith “is not outcome determinative” with regard to the fair and equitable test under Section 1191(b) and (c) because “‘good faith’ under § 1129(a)(3) and ‘fair and equitable’ under § 1191(b) and (c) are separate and distinct confirmation requirements that must be satisfied.” He therefore addressed the question of “whether the proposed three-year payment period under the Plan is fair and equitable.”

Judge Robinson began his analysis by noting that “Congress provided no guidance or standards on how the bankruptcy court should fix the duration of a plan under 11 U.S.C. § 1191(c)(2)(A).” However, he accepted the idea that a three-year plan is the “default” period under Section 1191(c) but disagreed with the notion “that a three-year term is generally more reasonable than a five-year term absent ‘unusual circumstances.’”

With no rules specified in Subchapter V, Judge Robinson held that “Congress intended to leave to the sound discretion of the bankruptcy courts the sole authority to fix the plan payment period in subchapter V cases.” He observed that “the relevant statutes governing the applicable period for plan payments under other sections of the Code are so dissimilar to subchapter V that they do not provide any helpful guidance in determining the appropriate time period for fixing plan payments under § 1191(c)(2)(A).”

In exercising discretion, Judge Robinson said,

[T]he bankruptcy court should give appropriate deference to the debtor’s business judgment and proposed period of payments in its subchapter V plan. Furthermore, this Court agrees that a baseline plan payment period of three years is consistent with the intent of Congress to create a quick, efficient reorganization process that would allow the debtor to obtain a discharge as soon as possible.

When there is no objection to the duration of the plan, Judge Robinson said it would be “uncommon” for the bankruptcy court to raise the issue sua sponte. When there is an objection to duration, he said that “the debtor’s proposed period of plan payments is no longer given the same deference and the bankruptcy court is tasked with fixing the applicable period of plan payments in a subchapter V case.”

Analyzing the debtor’s projected income and expenses, Judge Robinson observed that the debtor was creating a $32,000 capital reserve over the course of a three-year plan that would be paying unsecured creditors $39,000. He said that the capital reserve might be reasonable, but “the Court does not have sufficient evidence to make that determination.” Similarly, the debtor had not provided sufficient evidence to show whether the salaries to be paid to the debtor’s owners were “fair market.”

Overall, Judge Robinson said that evidence provided by the debtor was “insufficient . . . for the Court to determine whether the three-year plan payment period is fair and equitable under § 1191(b) and (c)(2)(A).”  Similarly, he was given “insufficient evidence . . . for the Court to ‘fix’ a longer plan payment period not to exceed five years under § 1191(c)(2)(A).”

Concluding the opinion, Judge Robinson said that the three-year plan “may very well be” fair and equitable, but he found “that the Debtor has not met its burden to show by a preponderance of the evidence that the proposed three-year period of plan payments is fair and equitable.”  He also found “insufficient evidence for the Court determine if it should fix a plan payment period longer than three years but not exceeding five years.”

In sum, Judge Robinson overruled the objection about lack of good faith but sustained the objection about failure to establish “fair and equitable.” He denied confirmation of the plan but allowed the debtor three weeks to avoid dismissal by filing an amended plan.