Michael Parker is a partner with Fulbright &
Jaworski L.L.P. in the firm’s San Antonio office and
is certified in business and consumer bankruptcy
by the Texas Board of Legal Specialization. He
was a co-founder of and is a past president of the
TMA Central Texas Chapter. Parker can be reached
at firstname.lastname@example.org and 210-270-7162.
Special thanks to the
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a cram down plan, however, some
case law has staunchly prohibited the
“artificial impairment” of a (typically
small, insignificant) class of trade
creditors to create such an impaired,
consenting class. These cases conclude
that allowing a debtor who can otherwise
economically pay in full a class of
creditors to manufacture the artifice
of an impaired, consenting class of
creditors for purposes of cramming
down a plan of reorganization
would violate the good faith
proscription of §1129(a)( 3).
that may find its way to the U.S.
Supreme Court. Second, because the
conservative 5th Circuit is not known
for its debtor-friendly opinions, its
strict statutory interpretation bodes
well for those in favor of the allowance
of artificial impairment of claims.
Village stands for the
proposition that artificial
impairment is not a per se
violation of the good faith
proscription of §1129(a)( 3).
Rather, Village found that when
a debtor’s plan pursues a legitimate
and honest reorganizational purpose
to preserve the debtor’s undisputed
equity, nothing in the cram down
provision of §1129(a)( 10) prohibits
artificial impairment of claims.
Third, the court’s analysis separates the
cram down requirements of §1129(a)( 10)
from the good faith examination of
§1129(a)( 3). A plan proposing artificial
impairment can still be defeated as
lacking in good faith—not because of
the artificial impairment, but rather
because of the debtor’s motivation
in seeking the reorganization.
Finally, the 5th Circuit’s statutory
analysis, recognizing the absence of
language distinguishing artificial from
economic impairment, eliminates
a debtor’s motivation as a factor
in the “impairment” of claims and
provides some clarity in 5th Circuit
jurisprudence on the subject. J
The 5th Circuit made clear that “a
debtor’s methods for achieving
literal compliance with §1129(a)
( 10)” do not “enjoy a free pass
from scrutiny” under §1129(a)( 3)
(the good faith test). Moreover, the
court suggested that “an inference
of bad faith might be stronger
where a debtor creates an impaired
accepting class out of whole cloth by
incurring debt with a related party,”
but ultimately proclaimed that artificial
impairment for a proper purpose
does not per se violate §1129(a)( 3).
The appellate court said it would
leave to the bankruptcy court the task
of dealing with such “chicanery.”
The 5th Circuit’s ruling is important
for several reasons. First, as noted
earlier, it adds weight to a debate
1 All sections references are to Title
11 of the United States Code.
2 Although, the 3rd U.S. Circuit Court of
Appeals subsequently cited Windsor with
approval, the 5th Circuit found that the 3rd
Circuit’s approval of Windsor does not adopt
Windsor’s reasoning with respect to its
conclusion prohibiting artificial impairment.
3 The 5th Circuit cited to Matter of Sun
Country Development, Inc., 764 F.2d 406
(5th Cir. 1986)(rejecting the concept of
artificial impairment altogether) and Matter
of Sandy Ridge Development Corp., 881
F.2d 1346 (5th Cir. 1989) (voicing concern
with artificial impairment in single asset
reorganizations). The 5th Circuit also rejected
the noteholder’s argument that Greystone
created an extrastatutory policy against voting
manipulation (of which artificial impairment
would be the next logical extension). Op. at 11.
4 It is rare for the 5th Circuit, which is generally
considered to be a conservative court, to agree
with the 9th Circuit, which is considered to be
a liberal court, making the 5th Circuit opinion
all that much stronger for those favoring
the allowance of artificial impairment.