Section 1122(a) of the Bankruptcy Code provides that “a plan may place a claim … in a particular class only if such claim … is substantially similar to the other claims … of such class.” Among other things, Section 1129(b) provides that to confirm a plan of reorganization the plan must not discriminate unfairly. To determine whether discrimination exists, some courts will examine: (a) whether there is a reasonable basis for the discrimination; (b) whether the plan can be confirmed and consummated without the discrimination; (c) whether the discrimination is proposed in good faith; and, (d) the treatment of the classes discriminated against.

A debtor is required to obtain the consent of at least one class of creditors to confirm its plan under the “cram down” provisions of Section 1129(b). So, when courts address whether the plan unfairly discriminates against certain creditors, the issue is whether or not the debtor has unfairly created a class to accept its plan. In other words, a plan must create classes of creditors holding substantially similar claims and cannot provide a dissenting class a materially lower recovery relative to other equal ranking classes, in order to create an accepting class of creditors who would be receiving more than the dissenting class.

In Consolidated Land Holdings LLC, No. 19-04760 (Bankr. M.D. Fla. Aug. 20, 2021), the debtor had created a class consisting of one unsecured creditor who was scheduled to receive more than the other unsecured creditors who were being treated in another class. The Bankruptcy Court was asked to determine whether the debtor’s plan unfairly discriminated against the remaining unsecured creditors for the purpose of obtaining a consenting class.

For some background, the debtor in Consolidated Land Holdings, created a separate class for a hotel management company holding a $2.5 million claim. The plan provided for the hotel management company to pay $1 million to the estate. In addition, the hotel management company would swap its claim for equity and from the $1 million, it would receive $350,000. The hotel management company would also “consider” an application to manage one of the hotels. The remaining general unsecured creditors were treated through a separate class and would receive 7% of their claims paid over five years. It is also worth noting that the primary lender, who was owed $62 million and held a deficiency claim, was lumped in with the other general unsecured creditors.

The primary lender objected to confirmation of the debtor’s plan, first contending that the plan did not comply with Section 1122(a), which requires placing “substantially similar” claims in the same class. It further contended that but for the hotel manager being separately classified, there would be no accepting class, and thus the plan could not be confirmed.

In terms of whether the debtor could separately classify the hotel manager’s unsecured claim, the court first noted that the debtor had “considerable, but not unlimited, discretion” in classifying claims and that is permitted — provided it’s for a legitimate business reason. That said, quoting from the Fifth Circuit Court of Appeals, separate classification is not permitted if the sole purpose is to “gerrymander an affirmative vote on a reorganization plan.” Phoenix Mutual Life Ins. Co. v. Greystone III Joint Venture (In re Greystone III Joint Venture), 995 F.2d 1274, 1279 (5th Cir. 1991).

The court first found the plan unfairly discriminated against general unsecured creditors as there was no legitimate or logical reason to separately classify them from the hotel manager. It further noted the hotel manager’s commitment to “consider” an application from one of the hotels was “not a legitimate business reason” for separate classification. Finding that there was no reasonable basis of discrimination, the court refused to confirm the plan as there was not at least one consenting class voting in favor of the plan.

As a side note, the primary lender had filed a competing plan that the bankruptcy judge found to be confirmable. It provided for the liquidation of the debtor’s assets with the proceeds being distributed in accordance with the priority provisions of the Bankruptcy Code. The primary lender had a choice under the debtor’s plan to be treated as fully secured, but chose the route of bifurcating its claim of $61,578,860.95. The secured portion of its claim was based on the value of its collateral, i.e., $58,700,000.00. Thus, its unsecured portion was approximately $2.8 million, which allowed the primary lender to basically control the vote of the class consisting of the remaining general unsecured creditors.

Arguably, though a 7% distribution under the debtor’s plan does not appear to be much compared to the 13% distribution to be paid to the hotel management company, it is unknown whether general unsecured creditors will receive 7% under the lender’s liquidation plan since presumably the collateral will be liquidated and there will not be enough to pay any general unsecured claims. Also, presumably, the remaining general unsecured claimants were vendors who now face the uncertainty of whether a new owner will retain their accounts.

About the Author: Bill Siegel

William L. (Bill) Siegel is a Shareholder and Section Head of the Cowles and Thompson Bankruptcy and Creditors’ Rights Practice Group as well as a member of the Corporate and Business Practice Group.