The Indubitable Equivalent and Giving Debt for Dirt Can a Debtor Force a Secured Creditor to Take Less than All of Its Collateral in Satisfaction of its Debt

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Feb 2003

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The provisions of 11 U.S.C. §1129(b) are some of the most frequently litigated provisions of the
Bankruptcy Code. Indeed, the common name for §1129(b) is the "cramdown" provision, which applies
when a class of claims has not accepted a proposed plan, and the debtor is attempting to force such class to
accept a certain treatment. Thus, a dispute exists and litigation ensues.

The adversarial nature of §1129(b) is not the only reason for dispute, as §1129(b)'s various provisions are
necessarily fact-intensive to allow confirmation of a plan over the objection of a class of claims as long as
that class is not unfairly discriminated against and the treatment afforded that class is fair and equitable.
See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §1129(b)(1)</a>.

Since "fair and equitable" is a subjective phrase, Congress attempted to give it meaning in §1129(b)(2).
For example, a plan that provides for the sale of collateral with liens attaching to the proceeds of such sale,
or the retention of liens by the secured creditor with deferred cash payments that will equal at least the
amount of the debtors' interest in that collateral, is fair and equitable. See 11 U.S.C. §1129(b)(2)(A)(i) and
(ii). Unfortunately, Congress also attempted to give meaning to "fair and equitable" with that confounded
phrase: indubitable equivalent.

<h3>Indubitable Equivalent</h3>

Section 1129(b)(2)(A)(iii) provides that a plan is fair and equitable, with respect to a class of secured
claims, if the plan provides for the realization by such holders of the indubitable equivalent of such claims.
Section 1129(b)(2)(A)(iii)'s "indubitable equivalent" phrase appears to have originated from the Second
Circuit's opinion in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7… re Murel Holding Corp., 75 F.2d 941 (2d Cir. 193</a>5). In Murel Holding, the
Second Circuit noted that "a creditor who fears the safety of his principal will scarcely be content with
[interest]; he wishes to get his money or at least the property." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…; at 942.</a> The Second Circuit concluded
that there was no reason to deprive a creditor of property "unless by a substitute of the most indubitable
equivalence." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…; However, indubitable equivalence is not further discussed in Murel Holding, and
although Murel Holding's concepts on the treatment of secured classes of claims is embodied in
§1129(b)(2)(A), Murel Holding does not address the meaning of "a substitute of the most indubitable
equivalence."

Nonetheless, the indubitable equivalent of a secured claim is often asserted to be the transfer of collateral to
the secured creditor—i.e., debt for dirt. Indubitable equivalent does not mean that a secured creditor can be
forced to take property in full satisfaction of its claim and either release other collateral or be forced to
waive its entitlement to an unsecured claim. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re Hardy Machinery, 1994 WL 722084, at *1 (Bankr.
N.D. Ala. 1994)</a>. Indeed, a plan that proposes to surrender collateral, together with unencumbered personal
property, to a secured creditor in satisfaction of its debt does not provide the indubitable equivalent. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… re
B.W. Alpha Inc., 89 B.R. 592, 594-95 (Bankr. N.D. Tex. 1988), aff'd., 100 B.R. 831</a>. In fact, the B.W.
Alpha court stated that "[i]n order to be the indubitable equivalent, the property must produce a cash flow
or be capable of being sold within a reasonable time so that the creditor can realize cash... Shifting the
burden of sale to the bank cannot be considered the indubitable equivalent of the bank's claim." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 596</a>.

However, when a proposed plan provides for both the surrender of all of a secured creditor's collateral and
the allowance of any deficiency as an unsecured claim, such a plan could satisfy the indubitable equivalent
test. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Jim Beck Inc., 207 B.R. 1010, 1012 (Bankr. W.D. Va. 1997)</a>; see, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6… re Coral Petro.
Inc., 60 B.R. 377, 381 (Bankr. S.D. Tex. 1986)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re Pennave Properties Assocs., 165 B.R. 793, 795
(E.D. Pa. 1994)</a>.

Thus, trading debt for dirt is not as simple to satisfy as it is to say, and where property is given in
exchange for a secured claim, a court must carefully consider such a proposal and take into account the
value of the secured claim and the collateral, whether such is over or undersecured.

<h3>Oversecured Claims</h3>

The common theme in confirmed "debt for dirt" cases is a guarantee of payment and proper valuation,
particularly when the creditor is oversecured. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3… re Wieberg, 31 B.R. 782, 785 (Bankr. E.D. Mo. 1983)</a> (where the court denied confirmation of a plan that proposed, in full satisfaction of a secured creditor's
claim, to transfer to the secured creditor cash and several tracts of land subject to the secured creditor's lien
because a deficiency claim of more than $300,000 would remain with little chance of payment thereon);
see, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7… re Walat Farms Inc., 70 B.R. 330, 334-36 (Bankr. E.D. Mich. 1987)</a> (where the court denied
confirmation of a plan that proposed the surrender of approximately 400 acres to the secured creditor in
exchange for discharge of the mortgage, thereby stripping the secured creditor's lien on the remaining
secured acreage, because of doubts over valuation).

Thus, when a creditor is oversecured, a debtor cannot merely return a portion of collateral without other
relief or a demonstration of value, as such collateral may not yield enough funds to reach the level of
indubitable equivalence. When a debtor demonstrates sufficient value to satisfy a secured creditor's claim,
then a partial surrender of collateral "can provide an oversecured creditor with the 'indubitable equivalent'
of its claim." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re May, 174 B.R. 832, 836-40 (S.D. Ga. 1994)</a>; see, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re Atlanta Southern
Business Park Ltd., 173 B.R. 444, 449 (Bankr. N.D. Ga. 1994)</a>.

Atlanta Southern further addressed the very practical concern of oversecured creditors that the debtor not
shift the risk of loss, or reduce the equity cushion to otherwise expose such creditor to further loss.
Specifically, the Atlanta Southern court held that although a "safety net" (i.e., lien retention on remaining
collateral) is not "an absolute necessity under the indubitable equivalent approach...[t]hat is not to say that
lien retention may not be necessary under some circumstances...[including] where...the value of the
property has not been clearly established..." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 451</a>. In valuing collateral, Atlanta Southern focused on
valuation at the time of confirmation instead of disposition. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… B.R. at 450</a>. Relying on
valuation at the time of confirmation instead of disposition does not give a secured creditor its indubitable
equivalent if the market for the surrendered collateral is declining. A declining market for inventory, for
example, is not uncommon and may encourage a debtor to unload its less desirable inventory. Thus,
focusing on collateral's value at confirmation is similar to granting a claim in the amount of the principal
due without providing for post-confirmation interest. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re Park Forest Develop. Corp., 197 B.R. 388,
397 (Bankr. N.D. Ga. 1996)</a>.

In Park Forest, the debtors proposed to convey two of three pieces of collateral to the secured creditor,
with a corresponding credit toward the debt. The debtors further proposed to either pay any deficiency in
cash or convey the third piece of property to the creditor. The court denied confirmation and held "[a]t any
valuation hearing, the court would consider all issues bearing value, including the costs of maintaining,
marketing and selling the properties during a disposal period, and the marketing efforts undertaken by
debtors since these chapter 11 cases were filed." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 397.</a>

In taking into account all considerations of value, including market forces affecting liquidation value, the
Park Forest court provides a more accurate method of insuring that an oversecured creditor receives the
indubitable equivalent of its claim. When a claim is undersecured, however, the valuation consideration
differs.

<h3>Undersecured Claims</h3>

When a creditor is undersecured, valuation of the surrendered property determines the amount of the
creditor's unsecured claim. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… re Sandy Ridge Develop. Corp., 881 F.2d 1346, 1353-54 (5th Cir. 1989)</a>. In
fact, when a creditor is undersecured, "common sense" states "that property is the indubitable equivalent of
itself..." (i.e., by definition, "a secured claim equals the value of" the property). <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…; at 1350.</a>

Similarly, the Ninth Circuit has held that "the value of the secured portion of an undersecured creditor's
claim is by definition equal to the value of the collateral securing it. Therefore, a creditor necessarily
receives the indubitable equivalent of its secured claim when it receives the collateral securing that claim,
regardless of how the court values the collateral. "...[I]n contrast, the amount of collateral deemed to be the
indubitable equivalent of [the oversecured creditor's] claim depends entirely on the court's valuation of the
collateral." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… re Arnold & Baker Farms, 85 F.3d 1415, 1423 (9th Cir. 1996)</a>.

While valuation is less important for undersecured creditors, an undersecured claim is not satisfied by a
surrender of collateral alone, nor is a partial surrender prohibited. In fact, courts have confirmed plans that
provide for only a partial surrender of collateral based on the provision for cash payments to satisfy any
deficiency in the value of the property surrendered, and the retention of liens in the remaining property
until the claim is paid in full. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re Simons, 113 B.R. 942, 947 (Bankr. W.D. Tex. 1990)</a>.

Such additional value/consideration does not necessarily require strict cash equivalence, as even securities
may suffice. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re San Felipe @ Voss Ltd., 115 B.R. 526, 529 (S.D. Tex. 1990)</a>. In San Felipe, the
debtor's plan proposed to satisfy a secured claim by giving the secured creditor cash, various securities of a
non-debtor entity and a limited guaranty. The court confirmed the plan and held that there was sufficient
margin between the "payment package" and the allowed secured claim based on its examination of "(1)
whether the substituted security is completely compensatory and (2) the likelihood that the secured
creditor will be paid." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 529</a>; see, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Sunflower Racing Inc., 219 B.R. 587, 602-03 (Bankr. D.
Kan. 1998)</a> (where the court denied confirmation of a plan that substituted a letter of credit for a secured
creditor's lien based on ambiguities in the proposed letter of credit accommodations); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… re Future Energy
Corp., 83 B.R. 470, 496 (Bankr. S.D. Ohio 1988)</a> (where the court denied confirmation of a plan that
proposed to substitute securities for collateral because of the questionable value of stock with no
established market).

Consequently, when determining whether the proposed treatment of a class of undersecured claims gives
the indubitable equivalent of such claims, the ultimate issue is whether or not the substitute collateral is
the equivalent of the amount of the undersecured claim, as opposed to the original collateral. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… re
Mulberry Phosphates Inc., 149 B.R. 702, 710-12 (Bankr. M.D. Fla. 1993)</a>.

<h3>Conclusion</h3>

When attempting to determine whether a secured creditor is realizing the indubitable equivalent of its
claim, one important concept must be kept in mind: Is the proposed treatment fair and equitable? After all,
the phrase "indubitable equivalent" is a method of treating an impaired secured creditor fairly and
equitably.

It is not fair and equitable to surrender to an oversecured creditor only part of its collateral when such
collateral may not satisfy the oversecured creditor's claim. Section 1129(b) simply does not contemplate
shifting the risk of loss to an oversecured creditor. An oversecured creditor must be paid in full to be
treated fairly and equitably. Thus, if a proposed plan shifts the risk of loss, then the plan does not provide
for the indubitable equivalent and is not fair and equitable. Similarly, surrendering collateral to an
undersecured creditor, without providing for an unsecured claim for any deficiency, is not fair and
equitable. In other words, the "debt for dirt" concept does not allow a debtor to give a secured creditor less
value than it would if paying the creditor in cash. Thus, a good rule of thumb, though general, is that if a
plan proposes greater risk of loss than allowing the creditor to foreclose, then the plan is not fair and
equitable.

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Saturday, February 1, 2003 - 12:00

Bankruptcy Rule

2003