James M. Lawniczak on Separate Classification of Deficiency Claims

James M. Lawniczak on Separate Classification of Deficiency Claims

James M. Lawniczak considers a Ninth Circuit appellate panel decision allowing separate classification of a lender's unsecured deficiency claim in a chapter 11 plan. The decision is part of the continuing conflict between single asset real estate debtors and secured creditors over plan confirmation. The majority view has been that an unsecured deficiency claim must be classified with other unsecured claims.

EXCERPT (note-links to statutes below are accessible by lexis.com subscribers):

In Wells Fargo Bank, N.A. v. Loop 76, LLC (In re Loop 76, LLC), 465 B.R. 525 (B.A.P. 9th Cir. 2012), the Bankruptcy Appellate Panel for the Ninth Circuit considered the circumstances under which a chapter 11 plan proponent can separately classify from other unsecured claims a large unsecured deficiency claim of a secured creditor. The most likely reason why a plan proponent would want separate classification, discussed in more detail below, is to prevent a "no" vote by the secured creditor from overwhelming the unsecured class, thus preventing any class from accepting the plan. This is important because under title 11 of the United States Code, the Bankruptcy Code, a chapter 11 plan of reorganization can be confirmed only if at least one class of impaired creditors has voted in favor of the plan.

The Issues on Appeal

Wells Fargo raised three issues on appeal, only one of which will be discussed here. The first issue-the focus of this Emerging Issues Analysis-was that the plan inappropriately separately classified Wells Fargo's deficiency claim from the other unsecured claims. The second and third issues that Wells Fargo raised but that will not be discussed here were that (2) the alleged impaired secured claim in class 3 was a contrived claim developed by the debtor solely to have an accepting impaired class, and (3) the bankruptcy court's finding that the plan was feasible was incorrect. 465 B.R. at 535.

The Result in Loop on the Claim Classification Issue

The court in Loop noted that there is a two-step process to a decision on whether claims have been properly classified, a process that the court remarked was not always followed by other cases. 465 B.R. at 537. When done correctly, the first question is whether the claims are "substantially similar." If the claims are not similar enough, then separate classification is compelled and the inquiry ends without proceeding to the second step. 465 B.R. at 536.

However, even if the claims are substantially similar so that they can be classified together in the same class, there are circumstances under which a plan proponent has discretion to put them in different classes. Separate classification is permissible when supported by a valid business justification and where the plan proponent is not inappropriately gerrymandering to obtain an accepting class. 465 B.R. at 536-37 (citing Barakat v. Life Ins. Co. of Va. (In re Barakat), 99 F.3d 1520, 1525-26 (9th Cir. 1996)). The Loop court went on to note that the fact that a secured creditor has a section 1111(b) election right is, by itself, insufficient to support separate classification. Id. (citing Barakat, 99 F.3d at 1526).

The court in Loop then went back to discuss the first step in the process- whether the fact that Wells Fargo had obtained and was pursuing guarantees was sufficient to make its unsecured claim substantially different from claims of other unsecured creditors so that it had to be separately classified. The court first rejected Wells Fargo's argument that the focus of the issue had to be how the claim relates to the debtor's assets. 465 B.R. at 540. In doing so, the court rejected the holding of In re AOV Indus., Inc., 792 F.2d 1140, 1151 (D.C. Cir. 1986), which did focus on the nature of the claims involved in holding that the existence of a third-party guaranty did not make the claim substantially dissimilar from other unsecured claims. 465 B.R. at 540, n.10.

Instead, Loop concentrated on the "special circumstance" of the guaranteed claim, a circumstance that did not apply to any other creditor. 465 B.R. at 541. It likened a claim with a guaranty to a claim with collateral, something which all courts agree require a separate class. Id.

After reaching resolution of the "substantially similar" issue, the court in Loop did not then go on to discuss the question of whether the debtor had improperly gerrymandered the structure of the classes in order to obtain a confirmable plan. Although the Loop court did not specifically say why it did not reach the gerrymandering issue, it was apparent from the discussion that the nature of the guaranteed claim compelled separate classification in all cases regardless of the intent of the plan proponent. Because the court had found that the claims were not substantially similar, it affirmed the bankruptcy court's decision approving the separate classification without need to discuss improper gerrymandering.


Loop is another story in the competition between single asset real estate debtors and their secured creditors over whether a chapter 11 plan can be confirmed over the creditor's objection, thus forcing the creditor to remain an involuntary lender. If the premise of Loop is accepted by other courts, the existence and use of a guaranty by the secured lender gives the debtor a leg up in the confirmation process.

Access the full versions of Wells Fargo Bank, N.A. v. Loop 76, LLC (In re Loop 76, LLC), 465 B.R. 525 (B.A.P. 9th Cir. 2012), Barakat v. Life Ins. Co. of Va. (In re Barakat), 99 F.3d 1520 (9th Cir. Cal. 1996) and In re Aov Indus., 792 F.2d 1140 (D.C. Cir. 1986) with your lexis.com ID. Additional fees may be incurred.

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