Adams and Reese Partner Tim Anzenberger had his article "The § 1111(b) Election: Overview, Considerations and Unique Issues in Subchapter V" published in the American Bankruptcy Institute (ABI) Secured Credit Newsletter.
Anzenberger is a commercial and bankruptcy litigator, pursuing the interests of financial institutions and other creditors in bankruptcy cases and litigating on their behalf in state and federal courts.
*The article is reprinted below with permission from the American Bankruptcy Institute’s Secured Credit Committee Newsletter, www.abi.org. Copyright © 2023 all rights reserved.
The § 1111(b) Election: Overview, Considerations and Unique Issues in Subchapter V
By Timothy J. Anzenberger
Adams and Reese LLP; Jackson, Miss.
Under § 506(a)(1) of the Bankruptcy Code, a secured creditor’s claim is secured only to the extent of the collateral’s value. Any amount over that value is bifurcated into a separate unsecured claim [1].
Critically, if a secured creditor’s claim is “nonrecourse” against the debtor, the creditor will not have an allowed unsecured claim for any deficiency after bifurcation. As a result, an undersecured creditor holding a nonrecourse claim could lose a significant portion of its claim (that is, any deficiency) in bankruptcy, particularly where the collateral has lost value or has been undervalued during the bankruptcy case.
However, § 1111(b) protects an undersecured creditor’s interests in chapter 11. Section 1111(b)(1)(A) grants an undersecured creditor an allowed claim for any deficiency, whether the claim is recourse or not [2]. Section 1111(b)(2), in turn, allows an undersecured creditor to instead “elect” having its entire claim treated as fully secured by the collateral while waiving any deficiency [3]. If an undersecured creditor makes that election, the creditor is entitled “to receive payments with a face value equal to the amount of its claim, the present value of which must at least equal the value of the collateral.” [4]
The purpose of § 1111(b) is to protect secured creditors from the potential undervaluing of collateral — whether intentionally by the debtor, under current market conditions or otherwise.
For example, before the Bankruptcy Code was enacted, “‘a debtor could file bankruptcy proceedings during a period when real property values were depressed, propose to pay secured [nonrecourse] lenders only to the extent of the then-appraised value of the property, and’ cram down ‘the secured lender class, preserving any future appreciation of the property for the debtor.’” [5] Congress drafted § 1111(b) to remedy that concern.
So why might an undersecured creditor make an election under § 1111(b)?
- The most obvious reason is that a creditor will make the election when a plan proposes little to no recovery to the unsecured class.
- A § 1111(b) election is also wise where the collateral has been undervalued, is inherently difficult to value, or will likely appreciate in value post-confirmation.
- Because a creditor making the election retains its lien on the collateral, a creditor will typically make the election where the debtor is likely to default under the plan.
Yet if a secured creditor is — for whatever reason — more interested in blocking confirmation, that creditor may wish to forgo a § 1111(b) election (as long as, of course, the amount of its deficiency allows the creditor to control the vote of the unsecured class). A creditor may also forgo the election where the plan proposes to pay the creditor’s secured claim over an unacceptable time frame, perhaps over the course of several decades.
Notably, subchapter V poses several issues to creditors contemplating a § 1111(b) election:
- First, declining the election to control the unsecured class and block confirmation is not an available strategy, as subchapter V allows confirmation even if no classes have accepted the plan.
- Second, there is no set deadline for creditors to make a § 1111(b) election in subchapter V. Outside of subchapter V, a secured creditor may make the election at any time before the conclusion of the hearing on the disclosure statement or any later date set by the bankruptcy court [6]. But there is no disclosure statement hearing in subchapter V. Bankruptcy Rule 3017 therefore provides that, in subchapter V, a secured creditor may make its § 1111(b) election not later than a date the court may fix. But what date is that? And what if the bankruptcy court never fixes any such date? In subchapter V, secured creditors should consider filing a motion asking the bankruptcy court to set a deadline, thereby achieving certainty and avoiding any potential waiver of the right to make the election.
- Third, bankruptcy courts have differed as to whether the purposes and policies underlying subchapter V play a role in interpreting the “inconsequential value” exception under § 1111(b)(1)(B)(i). Under that exception, a creditor may not make a § 1111(b) election if the secured creditor’s lien “is of inconsequential value . . . .” But the Bankruptcy Code does not define that phrase. Outside of subchapter V, some courts hold that creditors may make the election as long as the collateral has any value [7]. Other courts compare the value of the lien to the value of the collateral [8]. Yet in In re Body Transit Inc., the bankruptcy court rejected both approaches, interpreting the inconsequential-value exception in light of the purposes and policies underlying subchapter V [9]. The Small Business Reorganization Act (SBRA) was enacted “to broaden the opportunity for small businesses to successfully utilize the benefits of chapter 11 of the Bankruptcy Code.” [10]According to the court, bifurcating severely undersecured claims and prohibiting them from using a § 1111(b) election to block confirmation and compel liquidation promotes the SBRA’s purpose [11]. The court accordingly held that “[t]he correct methodology for determining whether the creditor’s interest in the debtor’s property is inconsequential is by comparing the value of the creditor’s lien position (i.e., the value of its interest in the debtor’s property) to the total amount of its claim.” [12]
Ultimately, secured creditors should not underestimate the leverage that § 1111(b) provides. Not only does § 1111(b) protect secured creditors whose collateral has a depressed value, it serves as a power tool to control the confirmation process and better negotiate plan treatment.
Footnotes
[1] 11 U.S.C. § 506(a)(1).
[2] There are, however, exceptions. Section 1111(b)(1) does not apply if the collateral will be sold under § 363 or through a plan, assuming the secured creditor will have the ability to credit bid the total amount of its claim.
[3] Exceptions also exist to § 1111(b)(2). First, a secured creditor may not make an election if the collateral’s value is “inconsequential.” Second, like § 1111(b)(1), the election is unavailable if the collateral will be sold under § 363 or through a plan, again assuming the secured creditor will have the ability to credit bid the total amount of its claim.
[4] In re Houston Regional Sports Network L.P., 603 B.R. 804, 807 (Bankr. S.D. Tex. 2019) (citing 11 U.S.C. § 1129(b)(2)(A)(i)(II)).
[5] William L. Norton, III, 5 Norton Bankr. L. & Prac. 3d § 102:2 (July 2023 Update) (quoting In re SubMicron Systems Corp., 432 F.3d 448, 460 n.15 (3d Cir. 2006)).
[6] Fed. R. Bankr. P. 3014 and 3017.
[7] E.g., In re Baxley, 72 B.R. 195, 198 (Bankr. D.S.C. 1986).
[8] E.g., In re McGarey, 529 B.R. 277, 284 (D. Ariz. 2015).
[9] 619 B.R. 816 (Bankr. E.D. Pa. 2020).
[10] Id. at 837 (internal quotations omitted).
[11] Id.
[12] Id. at 835; but see In re VP Williams Trans LLC, 2020 WL 5806507, at *6 (Bankr. S.D.N.Y. 2020) (rejecting In re Body Transit Inc. and holding that “[i]f Section 1111(b) was supposed to give way in a subchapter V case, or to have a different application in such a case, that was for Congress to say, and [it] did not do so”).