In order to confirm a chapter 11 reorganization plan, a debtor must satisfy all of the provisions of § 1129(a) of the Bankruptcy Code, except for § 1129(a)(8), which requires that each class of creditors either (1) accept the proposed plan or (2) is unimpaired under the proposed plan. When a debtor fails to meet § 1129(a)(8), the debtor can “cram down” a dissenting unimpaired secured creditor pursuant to § 1129(b), but only if the plan is “fair and equitable” with respect to that creditor.
A debtor’s reorganization plan is “fair and equitable” if the plan provides the holder of a secured claim with the indubitable equivalent of its claim.[1] When the collateral at issue is real property, this type of plan is often referred to as a “dirt-for-debt” plan, which essentially allows a debtor to force the surrender of real property on a secured creditor in satisfaction of the secured creditor's claim.
Courts apply a two-step analysis to determine whether a creditor is receiving the indubitable equivalent of its claim. First, the court determines the value of the property based on its highest and best use. Second, the court determines if surrendering the collateral, at its court-determined value, provides the secured creditor with the indubitable equivalent of its claim. In analyzing the second prong, courts look at several factors, including the expense that the lender will undertake trying to market and sell the property, the status of the real estate market, and the length of time that it might take to sell the property.
The Middle District of Florida, Jacksonville Division, recently evaluated a “dirt-for-debt” plan in In re Sugarleaf Timber LLC[2]. In Sugarleaf, the debtor owned approximately 7,060 acres of real property and funded the purchase by borrowing roughly $30 million from Farm Credit of North America ACA. The debtor executed three promissory notes in favor of Farm Credit, each of which was secured by the property. Farm Credit filed a proof of claim for roughly $26 million and the debtor’s plan proposed to satisfy Farm Credit’s claim in full by surrendering the collateral to Farm Credit.
First, the bankruptcy court determined the value of the collateral to be $30,330,000. In reaching its valuation, the court reviewed several appraisals and concluded the highest and best use of the property was as a mixed-use development. The court relied on several factors, including site preparations that were made to the property and the property’s location in the path of economic and transportation growth. Second, the court found that an equity cushion of more than $4 million was significant enough to offset the risks and uncertainties associated with forcing Farm Credit to accept the collateral in place of payment. Thus, the bankruptcy court concluded that a forced surrender of the property constituted the indubitable equivalent of Farm Credit’s claim.
The significance of a “dirt-for-debt” plan is that it shifts the risk of developing, marketing and selling real property from a debtor to a lender. This creates significant challenges for lenders, who may lack experience in the area of holding and selling real property. Furthermore, “dirt-for-debt” plans shift the risk that the surrendered property may not sell on the open market for the amount of the lender’s claim, thus, leaving the lender with an uncollectable deficiency. Farm Credit has appealed the bankruptcy court’s decision and an update will be issued in the newsletter pending the outcome of the appeal.
[1] 11 U.S.C.A. § 1129 (West).
[2] In re Sugarleaf Timber LLC, Case No. 3:11-bk-03352-PMG