Similar to pizza ingredients, artificial impairment of creditors results in artificial confirmation of the Chapter 11 plan. In Village Green I, GP v. Fannie Mae (In re Village Green I, GP), the Sixth Circuit affirmed the decision to vacate the confirmation order a second time. The debtor had three creditors: its lender, its former lawyer, and its former accountant. The debtor's only collateral, an apartment building, partially secured the lender's claim ($3.2MM unsecured). The debtor proposed paying the two minor claims in full over 60 days while cramming down the lender. The plan provided for $2 million in principal payments over ten years while releasing the debtor from its obligation to maintain and insure the collateral adequately. In the first appeal, the district court remanded for a determination as to whether the debtor had proposed the plan in good faith. On remand, the bankruptcy court found good faith but the district court again vacated and remanded the case. The bankruptcy court dismissed the case and the debtor appealed.
The Sixth Circuit addressed two issues with the confirmation of the plan. In order to impair any class of creditors, under Â§ 1129(a)(10), at least one class must accept its proposed impairment. Section 1124 defines impairment but only asks if the creditor's rights have been altered, not if the alteration appears contrived. The Sixth joins the Fifth and Ninth Circuit in requiring the artificial nature of the impairment to be tested under Â§ 1129(a)(3). Only the Eighth Circuit makes a distinction on whether the impairment is economically driven or an exercise of discretion. But when the Sixth tested whether "the plan has been proposed in good faith," it noted that the debtor had ample cash flow to satisfy the minor claims. Further, the closely allied "impaired" creditors compounded the appearance of circumvention. Finally, the lender had offered to pay the minor claims in full. The artifice employed by the debtor to "impair" a class showed the lack of good faith.
Artificial impairment occurs most often in single asset real estate (SARE) cases because the debtor must deal with the controlling lender. SARE cases also provide opportunity for the lender to control the class of other creditors through claim buying. But after Village Green, maybe debtors will attempt to disguise the artificial impairment better or make the cramdown a little more palatable.