Law School Case Brief
Kham & Nate's Shoes No. 2, Inc. v. First Bank of Whiting - 908 F.2d 1351 (7th Cir. 1990)
A plan of reorganization may be confirmed only if each class of impaired creditors votes to accept it. There is one exception to the requirement of approval: 11 U.S.C.S. § 1129(b)(1) provides that a "fair and equitable" plan may be crammed down the throats of objecting creditors. Under 11 U.S.C.S. § 1129(b)(2)(B)(ii), a plan treats unsecured creditors fairly and equitably if the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property. This is the "absolute priority rule." An objection to the plan may be overridden only if every class lower in priority is wiped out. Priority is "absolute" in the sense that every cent of each class comes ahead of the first dollar of any junior class.
Debtor Kham & Nate's Shoes No. 2, Inc., ran four retail shoe stores in Chicago. It has been in bankruptcy since 1984, operating as a debtor in possession. Defendant First Bank of Whiting (“Bank”), one of Kham & Nate's creditors, appealed from the order confirming its plan of reorganization. This order not only reduced the Bank's secured claim to unsecured status, but also allowed Khamolaw Beard and Nathaniel Parker, the debtor's principals, to retain their equity interests despite the firm's inability to pay its creditors in full. The bankruptcy judge subordinated the Bank's claims after finding that it behaved "inequitably", and he allowed Beard and Parker to retain their interests on the theory that their guarantees of new loans to be made as part of the reorganization are "new value". The Bank appealed, contending that it was within the rights of a creditor bank to look after its own interests and that guarantees to repay new loans did not constitute "new value." The Bank challenged the court's jurisdiction.
In a case involving a bankruptcy debtor in possession, were defendant Bank’s contentions that it was within the rights of a creditor bank to look after its own interests and that guarantees to repay new loans did not constitute "new value" meritorious?
After finding that it had jurisdiction over orders confirming reorganization plans, the appellate court then determined that equitable subordination was inappropriate because the Bank acted properly by exercising its contractual privilege to advance its interests. Because contracts gave creditors priority over shareholders, any reorganization plan had to do the same, under the absolute priority doctrine, absent new value added; therefore, the reorganization plan should not have been confirmed.
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