In order to confirm a chapter 11 plan of reorganization, a debtor must satisfy all the provisions of §1129(a) of the Bankruptcy Code, except for §1129(a)(8). Section (a)(8) requires that each class of creditors either (i) accepts the proposed plan or (ii) is unimpaired under the proposed plan. When a debtor fails to meet 1129(a)(8), the debtor can “cram down” a dissenting unimpaired secured creditor pursuant to 1129(b), but only if the plan is “fair and equitable” with respect to that creditor.
A debtor’s plan of reorganization is “fair and equitable” if the plan provides the holder of a secured claim with the indubitable equivalent of its claim. When the collateral at issue is real property, this type of plan is often referred to as a “Dirt-for-Debt” plan. Essentially, a “Dirt-for-Debt” plan allows a debtor to force the surrender of real property on a secured creditor in satisfaction of the secured creditor’s claim.
Courts apply a two-step analysis to determine whether a creditor is receiving the indubitable equivalent of its claim. First, the court determines the value of the property based on its highest and best use. Second, the court determines whether surrendering the collateral, at its court-determined value, provides the secured creditor with the indubitable equivalent of its claim. In analyzing the second prong, courts look at such factors as the expense the lender will undertake trying to market and sell the property, the status of the real estate market, and the length of time it may take to sell the property.
The Middle District recently evaluated a “Dirt-for-Debt” plan in In re Sugarleaf Timber, LLC (“Sugarleaf”). In Sugarleaf, the Debtor owned approximately 7,060 acres of real property. Debtor funded the purchase by borrowing roughly $30,000,000 from Farm Credit of North America, ACA (“Farm Credit”). Debtor executed three promissory notes in favor of Farm Credit, each of which was secured by the property. Farm Credit filed a proof of claim for roughly $26,000,000 and Debtor’s plan proposed to satisfy Farm Credit’s claim in full by surrendering the collateral to Farm Credit.
First, the Court determined the value of the collateral to be $30,330,000. In reaching its valuation, the Court reviewed several appraisals and concluded the highest and best use of the property was for mixed-use development. The Court relied on several factors, including site preparations made to the property and the property’s location in the path of economic and transportation growth. Second, the Court found that an equity cushion of more than $4 million was significant enough to offset the risks and uncertainties associated with forcing Farm Credit to accept the collateral in place of payment. Thus, the Court concluded that a forced surrender of the property constituted the indubitable equivalent of Farm Credit’s claim.
The significance of “Dirt-for-Debt” plans is that they shift the risk of developing, marketing and selling real property from the debtor to the lender. This creates significant challenges for lenders, who may lack experience in the area of holding and selling real property. Furthermore, “Dirt-for-Debt” plans shift the risk that the surrendered property may not sell on the open market for the amount of the lender’s claim, thus, leaving the lender with an uncollectable deficiency.
Farm Credit has appealed the Bankruptcy Court’s decision. We will provide an update pending the outcome of the appeal.