Editor’s Note: ABI hosted a webinar entitled “The 1111(b) Election: Advanced Mathematics and Strategies” in June. Visit ABI’s Distance Learning site at cle.abi.org to purchase recordings of this webinar.
Until a month ago, I thought I fully understood the § 1111(b) election — or at least understood it better than many bankruptcy attorneys. Then I suddenly realized that my entire understanding may or may not be correct. I have always believed that the § 1111(b) election requires the debtor to make payments at the present value[1] while also paying at least the total amount of the full allowed claim over the life of the loan.[2] My understanding of § 1111(b) is based on presentations by experts in the field,[3] and on the information in Colliers.[4]
However, a crafty attorney recently filed an appellate brief that made me look at the issue a little more closely. The attorney mentioned a “single purpose theory” vs. a “dual purpose theory.” Both theories deal with how interest payments are applied when calculating the repayment terms of an election. After researching the issue at length, I confirmed my original understanding but still feel a little uneasy about the election.
The Election in General
Section 1111(b)(2) simply states that “[i]f such an election is made, then notwithstanding section 506(a) of this title, such [a] claim is a secured claim to the extent that such claim is allowed.” This means exactly what it says: A debtor cannot bifurcate an undersecured claim.
As previously stated, once the § 1111(b) election is made, the debtor has to meet two different burdens: the debtor has to make sure that (1) the payments maintain the present value of the collateral and (2) the aggregate total of the payments over time is at a minimum the allowed claim amount. I do not believe anyone disputes those burdens, but the real question is what happens to the interest payments.
The full language of § 1111 lays out how to make the election and when an election cannot be made. I will not spend time on these issues because great attorneys have already written articles that touch on those issues. Rather, I will focus on the application of interest payments once the election has been properly made.
Dual-Purpose Theory
Simply stated, the dual-purpose theory allows the interest payments that have been made by the debtor to serve two purposes. The first purpose is making sure that the payment amount maintains the present value of the collateral, while the second purpose is making sure that the aggregate total of all payments is at least the full allowed claim amount.
Hon. John E. Waites of the U.S. Bankruptcy Court for the District of South Carolina recently examined both theories in depth in In re Pamplico Highway Development LLC.[5] He stated that “the Court believes that the majority view is the better-reasoned approach and concludes that interest payments may serve a dual purpose.”[6] The dual-purpose theory has also been discussed and followed by the Sixth[7] and Ninth[8] Circuit Bankruptcy Appellate Panels and in many other courts nationwide.
Single-Purpose Theory
The single-purpose theory holds that the interest payments made by the debtor must maintain the present value of the collateral that cannot count toward the aggregate total amount of the claim payments. This means that the creditor can exclude the interest payments when calculating the total amount paid by the debtor.
The leading cases in support of the single-purpose theory are from New York.[9] Francis G. Conrad, a former bankruptcy judge for the Southern District of New York, detailed the history of the § 1111(b) election and found that at confirmation, the debtor must pay an electing creditor the present value equal to the value of the true secured claim, plus an amount equal to the unsecured portion of the debt as valued at confirmation without regard to the present value.[10]
Arguments Supporting Each Theory
The argument in favor of the single-purpose theory is that if the debtor paid the full value of the collateral upon confirmation, it would still owe the remaining amount of the claim. By forcing the creditor to count the interest payments toward the full amount of the claim, the court is actually hurting the creditor because the money is worth more presently than over time.
Similarly, the argument supporting the dual-purpose theory is that creditors are in fact receiving interest, the difference in the amount of the actual claim and the value of the collateral. If the collateral is worth $1 million but the claim is for $2 million, then when the election is made the creditor is already receiving $1 million in interest. If the present-value interest payments were not applied to satisfy the full amount of the claim, creditors would arguably be receiving interest on top of interest.
Further Thoughts
As stated by Hon. Joel Pelofsky in In re Southern Missouri Towing Service Inc.,[11] “the debtor does not have to pay the whole secured claim in the same manner as if it were fully collateralized. If that were not so, every holder of an undersecured claim would make the election.” This quote brings up a very interesting point: If the creditor was allowed to exclude the interest payments when calculating the amount paid toward the full claim amount, there appears to be no downside to the election. The creditor would not only receive the exact same treatment as if it failed to make the election — the value of the collateral with interest — it would also receive the added benefit of being paid well over its full allowed claim amount.
Example
As a general example, Big Bank holds a total allowed claim of $10,746,136 and the value of the collateral is $5,380,000. The court determines that there is no current market for financing and applies In re Till[12] for interest. The court determines that 5.25 percent is the appropriate interest rate and that the 25-year amortization is also appropriate with a balloon payment for the remaining balance at the end. Prior to the disclosure statement hearing, Big Bank makes the § 1111(b) election. Table 1 (see attachment) sets forth how the election would work under the dual- and single-purpose theories. Clearly, the interest payments make a significant difference and may ultimately make or break the feasibility requirement under § 1129.[13]
Conclusion
Chapter 11 practitioners should be very familiar with every aspect of the § 1111(b) election. It can make or break a case for debtors and creditors alike.
[1] Also referred to as the “net present value test.”
[2] Also referred to as the “allowed claim test.”
[3] Franklind Davis Lea (Tactical Financial Consulting, LLC; Alpharetta, Ga.) led presentations at the Alexander L. Paskay Seminar on Bankruptcy Law and Practice and ABI’s Annual Spring Meeting in early 2014. Materials from this session can be found here. Recordings from this conference are available for purchase at cle.abi.org.
[4] 7 Collier on Bankruptcy § 1111.03 (Alan N. Resnick and Henry J. Somers eds., 16th ed., 2009).
[5] In re Pamplico Highway Development LLC, 468 B.R. 793 (Bankr. D.S.C. 2012).
[6] Id. at 791.
[7] In re Brice Road Developments LLC, 392 B.R. 274 (B.A.P. 6th Cir. 2008).
[8] First Fed. Bank of Cal. v. Weinstein, 227 B.R. 284 (B.A.P. 9th Cir. 1998).
[9] In re 680 Fifth Ave. Assocs., 156 B.R. 726 (Bankr. S.D.N.Y. 1993), and In re 266 Washington Assocs., 141 B.R. 275 (Bankr. E.D.N.Y. 1992).
[10] 680 Fifth Ave. Assocs. at 733.
[11] In re Southern Missouri Towing Service Inc., 35 B.R. 313, 314 (Bankr. W.D. Mo. 1983).
[12] Till v. SCS Credit Corp., 541 U.S. 465 (2004).
[13] 11 U.S.C. § 1129(a)(11).