Macdonald | Fernandez LLP


221 Sansome Street
San Francisco, CA 94104
Telephone: (415) 362-0449
Facsimile: (415) 394-5544
914 Thirteenth Street
Modesto, CA 95354
Telephone: (209)549-7949
Facsimile: (209) 236-0172

Chapter 11 Plan Cannot Treat Undersecured Claim as Fully Secured Absent Section 1111(b) Election

In In re Marlow Manor Downtown, LLC, No. AK-14-1122-JuKiKu (9th Cir. B.A.P. Feb. 6, 2015), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") ruled that a chapter 11 plan of reorganization cannot classify an undersecured claim as fully secured unless the creditor itself elects to be treated as fully secured under Bankruptcy Code Section 1111(b)(2).
In Marlow Manor, the debtor proposed a chapter 11 plan treating a partially-secured lienholder, namely AHFC, as fully secured.  This allowed the debtor to classify the deficiency claim separately from general unsecured claims in order to avoid the impact of an unfavorable vote against the plan by AHFC.  The creditor moved for a determination that the classification was improper.  

The bankruptcy court granted the creditor's motion.  The debtor appealed, and the BAP affirmed.
The BAP found that the plan sought to treat AHFC’s unsecured claims as though it had made the Section 1111(b) election although it had not.  The Section 1111(b) election required the debtor to treat a partially-secured claim as fully secured and pay the full amount of the claim under a plan.

The BAP held that, under Bankruptcy Code Section 1122(a), separate classification of AHFC’s deficiency claims was improper because there was nothing to distinguish them from other general unsecured claims.  Specifically, although the existence of a guarantee may justify separate classification, in this case the guarantor was insolvent and not a source of recovery.

This opinion highlights the importance of determining the value of collateral in bankruptcy.  If the value is not estimates, and the debtor and creditor cannot agree on a value, debtors may not be able to neutralize the creditor's objections by simply paying the creditor in full.