The Intersection of the 1111(b) Election and Subchapter V

As subchapter V matters continue to become a meaningful part of an insolvency practice, lawyers and financial advisors should be aware of the nuances that can arise in such matters when they intersect with the more complicated areas of bankruptcy law. The § 1111(b) election within a subchapter V matter falls squarely within this realm, and its application has led some cases into uncharted territory.

The § 1111(b) Election

The § 1111(b) election allows a partially secured/undersecured creditor to waive its unsecured deficiency claim and elect to treat its entire claims as secured. The election can protect a creditor against the undervaluation of the collateral in a market that may be temporarily depressed, and a subsequent sale of that collateral when values rebound, resulting in a financial benefit to the debtor. The election allows the secured creditor to retain a lien on the collateral equal to the full amount of the claim. While the secured creditor that elects § 1111(b) will not participate as an unsecured creditor in the plan process, it retains the benefit of any post confirmation appreciation.

Should the debtor choose to retain the collateral as part of its plan, the debtor must make payments to the secured creditor equal to the amount of its claim, and those payments must have a present value equal to the value of the collateral. The valuation of the collateral and the valuation of the proposed payment stream may require expert testimony, as they could be subject to scrutiny by interested parties.

Absent making the election, an undersecured creditor has a bifurcated claim comprised of the secured claim, which is equal to the value of the collateral as of the petition date, and an unsecured deficiency claim for the balance of the debt. It is entitled to receive (1) the net present value of its collateral on the secured portion of the claim, and (2) its pro rata share of any distributions under the plan on its unsecured claim.

The secured creditor is required to make the election before the conclusion of the hearing on the disclosure statement or within a time as established by the court. [1] The election is not applicable if the secured creditor’s interest in the property is of inconsequential value. [2]

Subchapter V

Subchapter V of the Bankruptcy Code, effective in February 2020, was enacted to make reorganization under chapter 11 easier and more efficient for businesses with debts of less than $7.5 million. [3] The requirements to confirm a plan under subchapter V are more streamlined than a traditional chapter 11. Only the debtor may file a plan of reorganization, which must be filed within 90 days. No separate disclosure statement is required.

A trustee is appointed in subchapter V matters to help facilitate a consensual plan. A plan under subchapter V does have a requirement to be “fair and equitable,” and debtors must apply all net disposable income for at least a three-year period toward making plan payments. Some key benefits of the subchapter V election include plan confirmation even if all classes of creditors oppose the plan, and the debtor may retain ownership of its business, even if all creditors are not paid in full under the plan.

Subchapter V Matters Intersecting with 1111(b) Election

In re Body Transit, Inc. [4]

In In re Body Transit Inc., the debtor sought to reorganize its fitness club business under chapter 11 and elected subchapter V. The debtor’s secured creditor, First Bank, had a claim for $970,000. The debtor valued First Bank’s collateral, which was comprised of fitness equipment, at $30,000 and proposed a plan to pay that amount, with interest, to First Bank. The debtor’s plan projections demonstrated there was no net disposable income available to pay unsecured creditors. First Bank objected to the plan on the grounds that the value of its collateral should be based on the enterprise value and made the § 1111(b) election. The court sided with First Bank and ultimately adopted an enterprise value of $80,000.

The debtor objected to the § 1111(b) election on the grounds that the collateral of $80,000 had “inconsequential value.” The court ruled in favor of the debtor and found that the secured portion of the creditor’s claim was only 8.2% of its total claim, and that the percentage was inconsequential. The court noted that the purpose of Subchapter V can influence what defines inconsequential value, indicating that the decision in a subchapter V matter could be different than in a traditional chapter 11 given the goals of subchapter V.

In re Williams Trans, LLC [5]

In In re VP Williams Trans, LLC, the debtor filed a subchapter V petition on March 30, 2020. The debtor’s only asset was a New York City taxi medallion. The debtor had one creditor, DePalma, which had a claim secured by the value of the tax medallion.

The creditor filed its proof of claim for $576,000, which included a $200,000 secured claim for the value of the medallion. In a motion filed on July 28, 2020, the debtor requested that the court adopt a value for the medallion of $125,000. On Sept. 4, 2020, DePalma filed an election under § 1111(b), and the debtor subsequently objected on the grounds that the value of the collateral was inconsequential, the election was made in an untimely manner, and the election was barred by DePalma’s filing of the proof of claim.

The court sided with the creditor and found that the value of the collateral, which was at least 15.6% of the claim, was not inconsequential and noted that the collateral was the debtor’s most valuable asset, without which the debtor would not be able to reorganize. The court found that there was nothing in § 1111(b) that evidenced Congress’s intent to limit the use of § 1111(b) in a subchapter V case, noting a different perspective from In re Body Transit Inc.

The court also rejected the debtor’s argument on the timeliness of the § 1111(b) election, finding that the absence of a disclosure statement in a subchapter V means that the election may be made by a date fixed by the court. The debtor did not ask the court to fix a date, and the election was made before any action was taken to solicit votes on the plan, which the court found acceptable.

Finally, the court ruled that the filing of the proof of claim did not bar the creditor from subsequently making the § 1111(b) election.

In re Topp’s Mechanical Inc. [6]

In In re Topp’s Mechanical Inc., the debtor, a mechanical contractor based in Nebraska, filed a chapter 11 case on Jan. 15, 2021, and elected subchapter V treatment. Topp’s secured creditor, AEB, which had a claim for $3.8 million secured by real and personal property, made the § 1111(b) election. The debtor ultimately filed a plan that included a proposed payment stream to AEB, and AEB did not object to the plan. However, the subchapter V trustee objected to the plan on the grounds that it was not fair and equitable for the nonaccepting unsecured class, which would be receiving a small payment of approximately $26,000 over a three-year period.

The payment stream that the debtor proposed resulted in payments totaling $4.3 million to AEB that exceeded the claim amount of $3.8 million. The court found that the secured creditor would receive an “excess payment” of approximately $500,000 that was comprised of interest payments that diminished the amount of disposable income that should have been available to the nonaccepting unsecured creditors. The court denied the confirmation on the grounds that the plan discriminated unfairly and was not fair and equitable to the class of unsecured creditors.

Conclusion

The § 1111(b) election is available to secured creditors in subchapter V cases and may be a powerful tool for a creditor to deploy. Professionals advising secured creditors should be aware of the issues surrounding the timing of the election and plan accordingly. Consideration as to whether the collateral value could be deemed to have “inconsequential value” is also important given the different stances courts have taken on this issue. Finally, the role of the subchapter V trustee is to help facilitate a consensual plan, so the impact of the plan on a nonconsenting unsecured creditor class should not be overlooked when evaluating the § 1111(b) election.