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In re Castleton Plaza, LP - 707 F.3d 821 (7th Cir. 2013)


Creditors in bankruptcy are entitled to full payment before equity investors can receive anything. 11 U.S.C.S. § 1129(b)(2)(B)(ii). This is the absolute-priority rule. Equity investors sometimes contend that the value they receive from the debtor in bankruptcy is on account of new (post-bankruptcy) investments rather than their old ones. A plan of reorganization that includes a new investment must allow other potential investors to bid. In this competition, creditors can bid the value of their loans. The process protects creditors against plans that would give competing claimants too much for their new investments and thus dilute the creditors' interests.


Castleton Plaza, the debtor, owns a shopping center in Indiana. George Broadbent owns 98% of Castleton's equity directly and the other 2% indirectly. EL-SNPR Notes Holdings is its only secured lender. The note carried interest of 8.37% and had several features, such as lockboxes for tenants' rents and approval rights for major leases, designed for additional security. The note matured on September 2010 and Castleton did not pay it. Instead it commenced a bankruptcy proceeding. About a year later Castleton proposed a plan of reorganization under which $300,000 of EL-SNPR's roughly $10 million secured debt would be paid now and the balance written down to roughly $8.2 million, with the difference treated as unsecured. The $8.2 million secured loan would be extended for 30 years, with little to be paid until 2021, and the rate of interest cut to 6.25%. All of the note's extra security features, such as the rental lockbox and approval rights, would be abolished. Unpaid creditors normally receive the equity in a reorganized business. In its proposed a plan of reorganization, Castleton provided that 100% of the equity would go to an equity investor's wife, who would invest $375,000.  EL-SNPR offered $600,000 instead. The U.S. Bankruptcy Court refused to condition the plan's acceptance on the wife's making the highest bid in an open competition, as EL-SNPR requested, and approved the plan. EL-SNPR filed an appeal.


Can an equity investor evade the competitive process by arranging for the new value to be contributed by an “insider” without a bid?




The judgment of the bankruptcy court was reversed, and the case was remanded with directions to open the proposed plan of reorganization to competitive bidding. Competition was essential whenever a plan of reorganization left an objecting creditor unpaid yet distributed an equity interest to an insider. The debtor proposed a plan that cut the creditors out of any equity interest. Since the plan paid the secured lender less than its contractual entitlement, 11 U.S.C.S. § 1129(b)(2)(B)(ii) provided that the husband, the equity holder, could not retain any equity interest on account of his old investment, and 203 North LaSalle required an auction before he could receive equity on new investment. The absolute-priority rule applied despite the fact that the wife had not invested directly in the debtor. If, as the debtor and owners insisted, their plan offered creditors the best deal, then they would prevail in the auction. But if, as appellant believed, the bankruptcy judge underestimated the estate's assets, then someone would pay more than $375,000 for the equity in the reorganized firm.

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