In re Deming Hospitality, LLC

• Decision Date: 05 April 2013
• Docket Number: No. 11-12-13377 TA,11-12-13377 TA
• Parties: In re: DEMING HOSPITALITY, LLC, Debtor.
• Court: U.S. Bankruptcy Court — District of New Mexico

In re: DEMING HOSPITALITY, LLC, Debtor.

No. 11-12-13377 TA

UNITED STATES BANKRUPTCY COURT DISTRICT OF NEW MEXICO

Entered on docket: April 5, 2013

MEMORANDUM OPINION

This opinion addresses the argument of the State Bank of Texas ("SBT") and the United States Small Business Administration ("SBA") that the debtor's Amended Disclosure Statement, filed March 1, 2013, doc. 95 (the "Disclosure Statement") should not be approved because the Debtor's reorganization plan (the "Plan") is facially unconfirmable. The alleged defects in the plan are:

1. The separate classification of SBA's deficiency claim violates 11 U.S.C. § 1122(a);

2. The disparate treatment of SBA's deficiency claim violates § 1129(b)(1)'s prohibition against unfair discrimination;

3. The general unsecured claims are "artificially impaired;"

4. The classification and/or voting rights of Choice Hotels International, Inc. ("Choice Hotels") and New Mexico Taxation and Revenue ("TRD") are improper; and

5. The Plan violates the absolute priority rule.

At a hearing held February 20, 2013, the Court set a briefing schedule on the Plan's alleged facial unconfirmability. SBT and SBA filed briefs, Debtor responded, and a hearing was held March 11, 2013.

I. THE PLAN

Debtor's Plan, filed January 7, 2013, provides for eight classes of claims: Four classes of secured claims (SBT, SBA, TRD, and Luna County); a class for Choice Hotels; a class for non-priority unsecured claims other than the SBA's deficiency claim; a class for SBA's deficiency claim; and an equity class. The Plan provides, in pertinent part:

1. Class 2 Secured (SBA): SBA has a junior lien on Debtor's real and personal property, securing a debt of about $1,500,000. SBA's claim is treated as wholly unsecured and reclassified as a Class 7 unsecured claim. SBA's lien is stripped;

2. Class 4 Secured (TRD): TRD has a junior lien on Debtor's real and personal property, securing unpaid gross receipts tax debt of about $27,800. TRD's claim is treated as wholly unsecured, and therefore as an unsecured priority tax claim;

3. Class 5 (Choice Hotels): Choice Hotels is the franchisor under a certain Licensing Agreement, an executory contract with a $67,000 pre-petition arrearage. Debtor proposes to assume the contract and pay Choice Hotels $50,000 in full satisfaction of the arrearage;

4. Class 6 (General Unsecured Claims): General unsecured claims are to be paid 75% of their claim amounts within 30 days of the effective date;

5. Class 7 (SBA Deficiency Claim): SBA is to be paid $25,000 on its $1,500,000 deficiency claim, within 30 days of the effective date; and

6. Class 8 (Equity Interests): Equity interests would retain their equity, in exchange for investing $150,000 of "new value" into the Debtor.

SBA and SBT stated in their briefs and in open court that they would vote to reject, and would object to, the Plan.

II. THE COURT HAS DISCRETION TO DISAPPROVE THE DISCLOSURE STATEMENT IF THE PLAN IS UNCONFIRMABLE ON ITS FACE

It is within the Court's discretion to deny approval of a disclosure statement if the accompanying plan is unconfirmable on its face. See In re American Capital Equipment, LLC, 688 F.3d 145, 154 (3d Cir. 2012) (citing Norton Bankr. Law Practice, the court stated that "[i]t appears to be within the discretion of the bankruptcy court to withhold approval of a disclosure statement ifthe accompanying plan is unconfirmable"); Alexander Properties, LLC v. Patapsco Bank, 883 F. Supp. 2d 552, 554, 560 (D. Md. 2012) (bankruptcy court correctly declined to approve debtor's disclosure statement because the plan was not confirmable); In re Arnold, 471 B.R. 578, 585 (Bankr. C.D. Cal. 2012) (appropriate to deny approval of disclosure statement where plan is un-confirmable on its face); In re GSC, Inc., 453 B.R. 132, 157, n. 27 (Bankr. S.D.N.Y. 2011), citing In re Quigley Co., Inc., 377 B.R. 110, 115 (Bankr. S.D.N.Y. 2007) (same); In re Main St. AC, Inc., 234 B.R. 771, 775 (Bankr. N.D. Cal. 1999) (same).

III. CLASSIFICATION OF SBA'S DEFICIENCY CLAIM

SBT and SBA argue that the separate classification of SBA's deficiency claim from other unsecured claims violates § 1122(a).¹

There is no controlling Tenth Circuit law on whether substantially similar claims may be separately classified. As stated in In re City of Colorado Springs Spring Creek General Imp. Dist., 187 B.R. 683, 687 (Bankr. D. Colo. 1995) ("Spring Creek"):

The express language of § 1122(a) imposes only one requirement—that claims in a given class be substantially similar to each other. There is no requirement that all substantially similar claims be placed in the same class nor is there a prohibition against classifying substantially similar claims separately. Almost all courts interpreting § 1122(a) recognize that it does not prohibit separate classification of similar claims, yet many courts, including seven Circuit Courts of Appeal, have augmented § 1122(a) to impose restrictions on a plan proponent's ability to separate similar claims.FN3

FN3. The Second, Third, Fourth, Fifth, Sixth, Eighth and Eleventh Circuit Courts of Appeal have imposed such restrictions. See, e.g., Boston Post Road Ltd. Partnership v. F.D.I.C. (In re Post Road Ltd. Partnership), 21 F.3d 477, 483 (2nd Cir.1994); John Hancock Mut. Life Ins. Co. v. Route 37 BusinessPark Assoc., 987 F.2d 154, 159-60 (3d Cir.1993); Lumber Exch. Bldg. Ltd. Partnership v. Mutual Life Ins. Co. (In re Lumber Exch. Bldg. Ltd. Partnership), 968 F.2d 647, 649 (8th Cir.1992); Travelers Ins. Co. v. Bryson Properties, XVIII (In re Bryson Properties, XVIII), 961 F.2d 496, 502 (4th Cir.1992); Phoenix Mut. Life Ins. Co. v. Greystone III Joint Venture (Matter of Greystone III Joint Venture), 995 F.2d 1274, 1278-1279 (5th Cir.1991); Olympia & York Florida Equity Corp. v. Bank of N.Y. (In re Hollywell Corp.), 913 F.2d 873, 880 (11th Cir.1990); Teamsters Nat'l Freight Indus. Negotiating Committee v. U.S. Truck Co. (In re U.S. Truck Co.), 800 F.2d 581, 586 (6th Cir.1986).

The main judicial gloss on § 1122(a) is that the subsection prohibits a debtor from separately classifying similar claims to "gerrymander" a consenting class:

When objections to classification under § 1122(a) arise, courts are usually presented with allegations that the plan proponent separately classified similar claims only to ensure acceptance by at least one class of impaired claims as required by § 1129(a)(10). Such manipulation is viewed as an abuse of Chapter 11. In the oft cited case of Phoenix Mut. Life Ins. Co. v. Greystone III Joint Venture (Matter of Greystone III Joint Venture), 995 F.2d 1274 (5th Cir. 1991), the Fifth Circuit held that "one clear rule" has emerged from the otherwise muddled § 1122 case law: "[T]hou shalt not classify similar claims differently in order to gerrymander an affirmative vote on a reorganization plan". Greystone, 995 F.2d at 1279.

Spring Creek, 187 B.R. at 687-88. See also In re SunCruz Casinos, LLC, 298 B.R. 833, 837 (Bankr. S.D. Fla. 2003) (collecting 19 cases); In Dean, 166 B.R. at 953.

If a creditor objects to the classification scheme on gerrymandering grounds, most courts require the plan proponent to justify the classification. See In re Dean, 166 B.R. at 949 (Bankr. D.N.M. 1994) (debtor must demonstrate reasons apart from gerrymandering to separately classify); In re Barakat, 99 F.3d 1520, 1526 (9th Cir. 1996), cert. denied, 520 U.S. 1143 (1997) (business or economic justification required); In re Tucson Self-Storage, Inc., 166 B.R. 892, 898 (9th Cir. BAP 1994) (placed justification burden on debtor); In re Heritage Organization, LLC, 375 B.R. 230, 303 (Bankr. N.D. Tex. 2007) (discussing when separate classification justified). See alsoSpring Creek, 187 B.R. at 683, n. 4 (collecting cases).

A few courts have been reluctant to read anti-gerrymandering (or other) restrictions into § 1122(a). See, e.g., Spring Creek, 187 B.R. at 689; In re ZRM-Oklahoma Partnership, 156 B.R. 67, 70 (Bankr. W.D. Okla. 1993); Principal Mut. Life Ins. Co. v. Baldwin Park Towne Center, Ltd. (In re Baldwin Park Towne Center, Ltd.), 171 B.R. 374, 377 (Bankr. C.D. Calif. 1994); In re Dow Corning Corp., 244 B.R. 634, 650 (Bankr. E.D. Mich. 1999), aff'd, 255 B.R. 445 (E.D. Mich. 2000) (citing ZRM-Oklahoma). These courts argue that the restrictions imposed are not found in the language of § 1122(a), which is plain and unambiguous. They also argue that reading such restrictions into § 1122(a) is unnecessary, given the safeguards found in § 1129, e.g. the prohibition against "unfair discrimination" in § 1129(b), the "fair and equitable" requirement of § 1129(b), and the "good faith" requirement of § 1129(a)(3).

The Court will adopt the "one clear rule" against gerrymandering to satisfy § 1129(a)(10), whether the source of the rule is § 1122(a) or § 1129. Since the plan proponent has the burden of proving compliance with § 1129 in any event,² the Court will place the burden on the plan proponent to justify any separate classification of substantially similar claims, if a party in interest objects on gerrymandering grounds.

If the plan proponent carries its burden of showing that substantially similar claims were not separately classified to gerrymander a consenting class of impaired claims, the Court will make no further inquiry into whether the separate classification of similar claims violates § 1122(a); anyremaining confirmation issues would be addressed under § 1129.

Analyzing separate classification objections in this way protects creditors from gerrymandering and/or other improper classification attempts, while not taking undue liberties with the text of § 1122(a).

Using the foregoing framework, the Court concludes that the Plan is not facially uncon-firmable because it classifies SBA's deficiency claim separately. Debtor has the burden of showing that SBA's deficiency claim was not separately classified to gerrymander a consenting class or for some other improper purpose, and should be given the opportunity to do so. It could well...