Bankruptcy Court Affirms Availability of 1111(b) Election in Subchapter V Cases

October 12, 2020

Introduction

In In re VP Williams Trans, LLC,[1] Judge Michael Wiles of the United States Bankruptcy Court for the Southern District of New York confirmed that a secured creditor may make an election under section 1111(b) of the United States Bankruptcy Code (the “Bankruptcy Code”) in a proceeding under subchapter V of the Bankruptcy Code for small business debtors. Judge Wiles’s decision appears to be the first decision on this issue in this Circuit since subchapter V of the Bankruptcy Code came into effect this year.

In VP Williams, the secured creditor, DePalma Acquisition I, LLC (“DePalma”), had made an election under section 1111(b) to have its entire claim treated as secured. The debtor objected, contending that (1) the value of DePalma’s collateral was “insignificant” and thus DePalma could not utilize an 1111(b) election, (2) DePalma’s 1111(b) election was not timely, and (3) DePalma could not utilize the 1111(b) election because its previously filed proof of claim treated its claim as partly secured and partly unsecured. The debtor also argued that denying DePalma the ability to utilize an 1111(b) election was consistent with Congress’s goal of furthering reorganizations for small business debtors under subchapter V.

The decision followed the debtor’s objection to a secured creditor’s section 1111(b) election, and the secured creditor’s response to the objection. The Court held that (i) collateral value is not “inconsequential” when the collateral is vital to the plan; (ii) a section 1111(b) election is timely when it is made before any action is taken to solicit votes on a proposed plan of reorganization and before any other steps are taken in contemplation of confirmation, and where the Court is not asked to and does not fix a deadline; and (iii) a section 1111(b) election will not be barred by a prior proof of claim being filed. The decision specified that section 1111(b) does not give way or have a different application in a subchapter V case.

Section 1111(b)

Section 1111(b) of the Bankruptcy Code is a protection available to secured creditors who believe that a plan of reorganization undervalues their collateral. Section 506(a) of the Bankruptcy Code provides that a secured creditor’s claim is secured to the extent of the value of its collateral, and if its claim exceeds the value of the collateral, the excess portion is treated as an unsecured claim. Illustratively, assume a lender has made a secured claim of $10,000 and the collateral declines in value and is only worth $5,000. Under section 506(a), the secured creditor would have a secured claim of $5,000 and an unsecured deficiency claim of $5,000. Section 1111(b) allows a secured creditor to avoid that result by treating its entire claim as secured. When an 1111(b) election is made, the debtor’s plan of reorganization must provide the secured creditor with payments in the amount of its total claim, and such payments must have a present value equal to the secured portion of its claim. To return to our example, if the secured creditor makes the 1111(b) election, the debtor’s plan of reorganization must provide the secured creditor with total payments of $10,000, and the present value of such payments must be at least $5,000.

Subchapter V of the Bankruptcy Code

Subchapter V of the Bankruptcy Code became effective in February 2020. Subchapter V is intended to make it easier for small businesses to reorganize under chapter 11 of the Bankruptcy Code. To be eligible to file a bankruptcy petition under subchapter V, a debtor must have total debt of less than $7.5 million. To ensure subchapter V cases progress, a debtor is required to file a plan of reorganization within 90 days of filing its petition. A trustee is appointed in all subchapter V cases; the job of the trustee is to help facilitate a consensual plan of reorganization or other resolution of the case. There are two other notable benefits for debtors: under subchapter V, a plan of reorganization can be confirmed even if all classes of creditors oppose the plan; outside of subchapter V, a debtor must obtain the consent of at least one impaired class of creditors to confirm a plan. Perhaps even more importantly, subchapter V provides that the debtor may retain ownership of its business even if creditors are not paid in full under the plan. In all other chapter 11 cases, a debtor would not be entitled to retain ownership unless creditor claims were paid in full or the debtor contributed “new value” under the plan in an amount equal to the value of the retained ownership.

Case Background

On February 19, 2020, VP Williams Trans, LLC (“VP Williams” or the “Debtor”) filed a petition for bankruptcy protection under subchapter V. The Debtor had only one creditor, DePalma, and the Debtor’s only assets were a New York City taxi medallion (the “Medallion”) and the taxi vehicle. The Medallion secured DePalma’s loan to the Debtor. Roughly a month after the petition was filed, the COVID-19 pandemic resulted in New York implementing an order requiring the shutdown of non-essential businesses and the Debtor ceased to operate the taxicab.

On March 30, 2020, DePalma filed its proof of claim in the amount of $576,927.58, of which $200,000 was listed as secured and the balance of $376,927.58 was unsecured. On May 19, 2020, the Debtor filed its chapter 11 plan, which proposed to value DePalma’s secured claim at $125,000 and treat the balance as unsecured. In furtherance of its plan, on July 28, 2020, the Debtor filed a motion under section 506(a) of the Bankruptcy Code seeking to value the Medallion at $125,000.

On September 4, 2020, DePalma filed an election under section 1111(b) of the Bankruptcy Code to have its secured claim be treated as equal to the total amount of its claim, $576,927.58. On September 16, 2020, VP Williams objected to the section 1111(b) election and moved to strike it. The Court heard preliminary argument on the 1111(b) issue in an argument later that same day. In its objection and in oral argument, the Debtor asked the Court to adopt the rationale of In re Body Transit, Inc., a subchapter V case recently decided by the United States Bankruptcy Court for the Eastern District of Pennsylvania.[2] In Body Transit, the court disallowed a secured creditor’s 1111(b) election; the Court found that because the value of the secured creditor’s claim was only 8.4% of the amount of its total claim, the secured portion was “insignificant.” The Court also noted that, in its view, that result was consistent with the Congressional objective of facilitating the reorganization of small business debtors under subchapter V. At the end of the preliminary argument, the Court directed DePalma to respond to the Debtor’s objection. The Court issued its opinion on September 29, 2020.

The VP Williams Trans, LLC Decision

The Court in VP Williams Trans, LLC first analyzed whether the value of the Medallion is “inconsequential.” The Court began with the text of the statute, noting the dictionary definition of “inconsequential” meaning “irrelevant,” “of no significance,” or “unimportant.” The Court noted that the collateral is the Debtor’s most valuable asset, without which the Debtor would not be able to reorganize. The Court concluded that the Medallion was not “irrelevant,” “of no significance,” or “unimportant” and held that the Medallion was not “inconsequential.”

The Court directly addressed the Body Transit decision and declined to follow it. The Court explained that, contrary to the reasoning expressed in Body Transit, nothing in section 1111(b) evidenced Congress’s intent to limit the use of the 1111(b) election in subchapter V cases. The Court noted that section 1111(b) applies in all chapter 11 cases, and if Congress intended to limit its application in a subchapter V case, it could have done so, but it had not. The Court also distinguished Body Transit factually. In Body Transit, the value of the taxi medallion was approximately 8.4% of the amount of the secured creditor’s claim. In VP Williams, the value of the Medallion was at least 15.6% of DePalma’s claim, roughly twice as significant as the value of the collateral in Body Transit.

The Court next considered the Debtor’s claim that DePalma’s section 1111(b) election was untimely. The Debtor argued that in a subchapter V case, the election had to be made before the plan of reorganization was filed. The Court rejected that argument because it is unsupported by the statute. The Court noted that the purpose of section 1111(b) is to allow a secured creditor the chance to protect itself against treatment under a plan it deems improper. Thus, it ruled, it is illogical to require such an election before a plan is filed.

The Court further noted that Fed. R. Bankr. P. 3014 provides that an 1111(b) election may be made by a deadline fixed by the court. The Court noted that it was not asked to set a date, and never did. And the section 1111(b) election was made before any action was taken to solicit votes on the plan and before any other steps were taken in contemplation of confirmation. For those reasons, the Court found the section 1111(b) election was timely.

The Court last addressed whether the section 1111(b) election was barred by the terms of the prior proof of claim DePalma filed. The Court noted that the information DePalma provided about the value of the collateral is information that was required by the official proof of claim form. The statements of the “secured” and “unsecured” portions of the claim were made in accordance with section 506(a) of the Bankruptcy Code. The Court noted that nothing in the rules or the statute suggests that the statements in prior proofs of claim bar creditors from making the section 1111(b) election.

Accordingly, the Court held that the section 1111(b) election was timely, effective, and not waived.

Takeaways

  • The 1111(b) election is fully available to secured creditors in subchapter V cases.
  • Collateral value is not “inconsequential” when the collateral is vital to the plan.
  • A section 1111(b) election is timely when it is made before any action is taken to solicit votes on a proposed plan of reorganization and before any other steps are taken in contemplation of confirmation, and where the Court is not asked to and does not fix a deadline.
  • A section 1111(b) election will not be barred by a prior proof of claim being filed.

Herrick, Feinstein LLP represented DePalma Acquisition I, LLC in this case.


For more information on this alert or other restructuring & bankruptcy matters please contact:

Stephen Selbst at +1 212 592 1405 or [email protected]
Rodger T. Quigley at +1 212 592 1577 or [email protected]

© 2020 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.


[1] Case No. 10-14419 (MEW) (Bankr. S.D.N.Y. Sept. 29, 2020), Decision Denying Debtor’s Objection to Section 1111(b) Election.

[2] Case No. 20-10014 (ELF), 2020 WL 4574907 (Bankr. E.D. Pa. Aug. 7, 2020).