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Looking Back at the Oldies (Cases)

posted by Bob Lawless

Sorry for the light blogging the past few days. This is what happens when you have six academics running a blog as an adjunct to their teaching and research and the end-of-the-semester crunch hits. We have not collectively fallen off the face of the Earth, although looking out my window right now makes me wonder. It was snowing when I woke up this morning. Snow in April? Whose idea was that? More to the point, whose idea was it to move from the University of Nevada, Las Vegas back to the Midwest?

Yesterday, I was teaching my Bankruptcy Reorgs class, and I had two of my students arguing a motion to confirm a chapter 11 plan. The question was whether the plan properly classified creditors. For the nonbankruptcy types, a brief digression is in order. Everyone else can skip below the jump . . . meaning that if you are a bankruptcy type you should not be reading these words. Stop it. I mean it. Skip below the jump.

Chapter 11 plans treat creditors by classes, and creditors vote on the plan by class. A class is considered to have accepted a plan if one-half of the number and two-thirds of the dollar amount of the claims in the class vote to accept. And, for the bankruptcy court to confirm a chapter 11 plan, at least one impaired class of claims has to have voted to accept the plan. Thus, the debtor has strong incentives to arrange the classes so there will be a relatively friendly class of creditors who will vote to accept the  plan. The Bankruptcy Code says the debtor cannot place dissimilar claims in the same class, but the Code is not clear on whether there are limits on the debtor's ability to place similar claims in different classes. Can the debtor gerrymander the classes so as to create a class that will vote to accept? It is an ambiguity in the statute or, as such a situation is known to lawyers, it is litigation happy-funtime. Now, we'll get back to stuff those nosy bankruptcy types can read.

In the early and mid-1990s, there was a slew of cases defining the limits on the debtor's ability to classify claims. The Fifth Circuit, in a case called Greystone, said "Thou shalt not gerrymander" (those were actually its words and I'm not making that up), but of course gerrymandering is in he eye of the beholder. Debtors and the creditors who love them still get to fight over what is and is not gerrymandering. Most courts allowed separate classification if there was a legitimate reason to do so. Yesterday, my students argued whether it was enough that the debtor would have a continuing business relationship with some creditors to classify those creditors separately, and the students sitting as judges in the matter voted 6-2 that it was.

What happened to all these cases? Classification was a hot topic back for a while, and like many legal issues died down. My sense is that it was not because the issues were all settled. Although there were lots of precedents to discuss in my class yesterday, there certainly did not seem to be a definitive answer to the problem. What happened, I think, is that single-asset real estate cases went away (more or less). In those cases, the debtor essentially has one major asset in the form of real estate and one major lender. The size of the lender's claim will swamp all of the other claims combined, meaning the lender will control the voting outcome in the classes unless the debtor can gerrymander a separate class that does not include the lender. After the 1994 amendments to the Bankruptcy Code, bankruptcy was much less attractive to single-asset debtors.

I was never a fan of the classification cases. They were always about something else, and the something else was really about harsh treatment against the debtor's sole lender. The courts were trying to get at this "something else" by using the classification rules instead of tackling the harsh treatment head on. Let's relegate these old cases to the trash heap and instead use the bankruptcy concept of unfair discrimination, which requires equal treatment between groups of creditors at the same level of priority.

Oh, yeah, and before he complains, I'll admit that I stole that idea from my good friend Judge Bruce Markell and his article, A New Perspective on Unfair Discrimination in Chapter 11, American Bankruptcy Law Journal, vol. 72, p. 227 (1998). In reaching their decision in class, several of my students expressly relied on Judge Markell's reasoning. For the bankruptcy types who face this issue, I commend the article to you.

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

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