Texas Mineral Liens May Be Modified in a Subchapter V Cramdown Plan

A debtor can confirm a cramdown plan under subchapter V of chapter 11, even though the objecting secured creditors will receive replacement collateral worth less than the collateral originally securing the claims, according to Bankruptcy Judge Eduardo V. Rodriguez. However, the substitute collateral was still worth six times more than the secured claims.

Sitting in Houston, Judge Rodriguez explained why the absolute priority rule does not apply in subchapter V cases. He also found nothing sacrosanct about Texas mineral liens and said they may be modified over the secured creditors’ objections.

By containing all of the requisite findings and statutory references, the 53-page decision by Judge Rodriguez can be used as a template for anyone writing an opinion or order confirming a plan being crammed down on secured creditors under subchapter V.

The Collateral-Switching Plan

Designed for chapter 11 reorganizations to be more streamlined and less costly for small businesses, subchapter V of chapter 11 became effective on February 19. The debt limit for subchapter V was raised to $7.5 million on March 25.

The debtors’ primary assets were leases on about 2,500 acres in Pecos County, Texas, where they drill and produce oil and gas. The debtors filed their petitions under subchapter V on March 3.

The debtors filed plans promising to pay secured and unsecured creditors in full. Several classes of unsecured creditors voted in favor of the plan, but three classes of secured creditors voted against the plan.

The objecting secured creditors had claims totaling about $1.2 million for supplying goods and services. Their claims were secured by Texas mineral liens on all of the leaseholds where they worked. The property subject to the liens was worth about $35 million.

The undisputed testimony showed that the debtors’ assets were worth in excess of $50 million. To provide flexibility so the debtors could develop their assets, the plan took away the secured creditors’ liens on all of the leaseholds and gave them replacement liens on property with a value of $7.4 million. In addition, the secured claims were to remain recourse obligations of the debtors, who would be required to sell assets if the secured claims were not paid within two years.

In his September 30 opinion, Judge Rodriguez marched through the labyrinth of statutory requisites for confirmation of a cramdown plan, showing how subchapter V differs from chapters 11, 12 and 13. He explained, among other things, how the absolute priority rule does not apply in subchapter V, thus allowing the equity holders to retain ownership without making a new value contribution. He explained how Congress gave other protections to creditors in a subchapter V cramdown plan in lieu of the absolute priority rule.

Collateral Switching and the Fair and Equitable Rule

The confirmation objections by the secured creditors focused primarily on losing collateral. They argued that stripping away collateral meant the debtors could not satisfy the “fair and equitable” requirement under Section 1129(b)(2)(A)(iii), as modified and made applicable in subchapter V by Section 1191.

For secured creditors, the “fair and equitable” requirement is satisfied if the plan assures “the realization by such holder of the indubitable equivalent of such claims.” See Sections 1191(c)(1) and 1129(b)(2)(A).

The statute contains an “important distinction,” Judge Rodriguez said, because indubitable equivalent is “tied to” the claim, not to the property securing the claim. He said that the creditors incorrectly focused on their prepetition collateral, not their claims.

With $1.2 million in claims and $35 million in prepetition collateral, the creditors had a coverage ratio of 29 to 1. They argued that the plan must maintain the ratio. Judge Rodriguez said the argument was “without merit” because the plan satisfied the indubitable requirement under Section 1129(b)(2)(A)(iii).

Judge Rodriguez cited the Fifth Circuit for permitting the exchange of collateral to satisfy Section 1129(b)(2)(A)(iii). Although there must be “a high degree of certainty,” the satisfaction of the requirement is subject to the bankruptcy court’s discretion.

Although the plan provides collateral coverage of only 6 to 1, and not 29 to 1, Judge Rodriguez said the plan “provides virtual certainty that the Allowed Claims will be paid in full,” given more than $6 million in excess collateral.

Texas Mineral Liens

The creditors countered by arguing that Texas mineral liens are “sacrosanct” and cannot be modified. For that proposition, Judge Rodriguez said the creditors “offer no authority whatsoever.” Rather, he said, “[n]either the Bankruptcy Code [n]or case law provide statutory mineral liens [with] extra protection.”

Judge Rodriguez said that Section 1123(a)(5)(E) allows a plan to modify “any lien,” including IRS liens. He therefore held that “statutory mineral liens may be modified over objection under Section 1123(a)(5)(E), as long as Section 1129(b)(2)(A) is satisfied.”

In sum, Judge Rodriguez said the plan “more than satisfies the stringent indubitable equivalent standard” by (1) providing a 6 to 1 value-to-debt ratio, (2) continuing the recourse nature of the obligation, and (3) requiring the debtors to sell assets if the debt is not paid within two years.

Judge Rodriguez confirmed the plan.