On March 9, 2012, the US Bankruptcy Court for the District of Delaware held in In re All Land Investments, LLC that artificial impairment of a class cannot be used to meet the requirements for a cramdown plan of reorganization (cramdown plan) under section 1129(a)(10) of the Bankruptcy Code.

The main issue before the Court was whether a court may confirm a cramdown plan of reorganization if it was only approved by an artificially impaired class. Under section 1129 of the Bankruptcy Code, a court may confirm a cramdown plan if it:

(See Practice Note, Chapter 11 Plan Process: Overview: Confirmation of a Plan: Cramdown Plans.)

The Bankruptcy Code does not address the degree to which an impaired class' rights must be affected to meet the requirements of this section and whether that impairment must be actual or can be artificial. This issue was addressed in In re Combustion Engineering, Inc. which defined artificial impairment as occurring when a plan imposes an insignificant or de minimis impairment on a class of claims to qualify those claims as impaired under section 1124 of the Bankruptcy Code for the purposes of meeting the voting requirements for a cramdown plan (391 F. 3d 190 (3d Cir. 2004)). Courts are split over whether artificial impairment can be used to meet the cramdown requirement that one impaired class approves a plan.

All Land Investments, LLC (the Debtor) was created specifically to purchase real property that would be developed into a single family residential subdivision. The Debtor received two secured loans from RBS Citizens, N.A. (Citizens). The Debtor filed for relief under Chapter 11 of the Bankruptcy Code and identified as impaired under their amended plan of liquidation (the amended plan):

Citizens' deficiency claims under the amended plan would be treated as Class 5 claims. Classes 1, 3 and 5 (except Citizens and one other Class 5 creditor, whose claims were later purchased by another Class 5 creditor) voted to accept the amended plan. Citizens filed an objection to confirmation, arguing that the amended plan did not meet the cramdown requirements of section 1129(a)(10) of the Bankruptcy Code, which requires the plan to be approved by at least one impaired class, because Classes 1 and 3 were only artificially impaired and Citizens' unsecured claims controlled Class 5.

The Debtor argued that the amended plan did meet the cramdown requirement because it was approved by Classes 1 and 3, and that Citizens' valuation of the collateral was incorrect, making it a non-controlling member of Class 5.

The Court, applying the reasoning in a line of cases, including In re Combustion Engineering, held that allowing a debtor to use artificial impairment to show that an impaired class had approved a plan would "distort the meaning and purpose of section 1129(a)(10)" and render it null. The Court held that the votes of Classes 1 and 3 should not count in the cramdown analysis because they would be paid in full under the amended plan and the Debtor did not provide evidence of a valid business purpose for impairing these claims in the amended plan.

The Court, therefore, focused its cramdown analysis on Class 5, which included Citizens' deficiency claim. Although there was an issue as to how this deficiency claim should be valued, the Court found that Citizens' claim controlled the Class 5 vote. Because Class 5, the only truly impaired class, rejected the amended plan, confirmation of the amended plan was denied.

Although there is a split in the courts on whether artificial impairment will be permitted, debtors and their counsel should not manipulate the confirmation process to obtain the votes necessary for a cramdown. They must be able to show a valid business purpose or other economic justification for the impairment.