Pursuant to the provisions of Chapter 11 bankruptcy for the reorganization of a failing business, the debtor is generally allowed the first opportunity to propose a plan of reorganization. The Bankruptcy Court will only confirm a Chapter 11 plan if the plan designates classes of claims and interests, a sufficient majority of which must ultimately vote to accept the plan. The designation of classes of claims and interests in a plan of reorganization can involve grouping creditors with similar economic interests together, for the aforementioned voting purposes.
Acceptance of the Plan of Reorganization
A class of voters accepts a plan if the creditors that vote to accept the plan:
- Hold at least two-thirds in dollar amount of the allowed claims in the class, and
- Hold more than one-half in number of the allowed claims in the class
The Classification of Similar Claims and Interests
The classes of claims and interests that will either vote to accept or object to a debtor's plan of reorganization are created by the debtor. In designating classes of claims and interests, the debtor is limited by two requirements:
- The plan must provide the same treatment for each claim or interest of a particular class; i.e., treat everyone the same, and
- The plan may place a claim or interest in a particular class only if such claim or interest is "substantially similar" to the other claims of interests of such class
"Substantially similar" claims or interests are those claims or interests which are similar in legal character, or those that share similar economic interests with respect to the debtor's assets. By grouping people with similar economic interests together as one class, the court can be confident that the plan is satisfactory when a sufficient majority of claimants in a group votes to accept the plan.
Limitations on "Gerrymandering"
As worded, the Bankruptcy Code does not require the classification of substantially similar claims. Rather, the Code prohibits the classification of claims that are not substantially similar. This distinction suggests that the debtor does not have to put two claims together just because they are substantially similar. In fact, the debtor seems to have some discretion to place claims in separate classes, even though the claims might appear to be substantially similar. Such discretion can be important if, in fact, it allows the debtor to strategically place plan supporters into a class with plan opponents, such that the plan supporters outvote the plan opponents to ultimately gain class acceptance.
However, the Code appears to have been drafted to limit such "gerrymandering," or the artificial creation of classes of claims for the purpose of ensuring the confirmation of the plan. Specifically, under Section 1129(a)(10) of the Code, if there is an impaired class of claims under the plan (claims that are not going to be paid completely), the court cannot confirm a plan unless at least one class of impaired claims has accepted the plan, not counting the votes of insiders. Depending on the status of the debtor, an "insider" can include a relative, general partner, director or officer of the debtor.
"Cramdown" Confirmation
In addition, when not all classes have consented to accept a plan, Section 1129(b) allows the court to confirm the plan only if it: (1) does not discriminate unfairly, and (2) is fair and equitable with respect to each impaired class that has not accepted the plan. Taking the anti-insider and cramdown provisions together, it appears that the intention of the Code, together with case law on the issue, is to prevent the debtor from "gerrymandering" votes in favor of the plan.
