The Facts:  A single asset real estate [commercial office building] case comprised of 4 secured liens:  1) 1st Mortgage of $2 Million; 2)  2nd Mortgage of $300,000;  3)  3rd Mortgage of $200,000; and 4) 4th Mortgage of $100,000.  Tenants have defaulted and/or moved out, resulting in lower gross rental income.  Debtor-in-Possession [DIP] wishes to stretch out the loan term and pay less interest due to historically low interest rates.  DIP wishes to keep the property and simply pay lenders less over a longer period of time, thus obtaining a court sanctioned refinance.

Basic Requirements for Confirming a Non-Consensual Plan:  In addition to the requirements necessary to confirm a Consensual plan [one of which is that at least one impaired class accepts the plan], a Non Consensual plan requires the following:  1) The plan does not discriminate unfairly; and 2) The plan is fair and equitable with respect to each class of impaired claims that has not accepted the plan ["absolute priority rule"].

Prong #1:  No Unfair Discrimination

The unfair discrimination rule applies only to those who have not accepted the plan.  For example, the DIP cannot treat a junior secured creditor more favorably than a senior secured creditor.  So, if you are going to negatively amortize the 1st Mortgage, then you'd better do it for the 2nd Mortgage also.

Prong #2:  Fair and Equitable Treatment ["Absolute Priority Rule"]

Next, the plan must be fair and equitable [absolute priority rule] to each class of impaired claims that have not consented to the plan.  This rule says that a non-consenting class of creditors must be compensated in full before any junior class may receive or retain property under the plan.  This rule does not apply to individual Chapter 11 debtors. 

Options for "Fair and Equitable" Treatment of Secured Creditors

There are 3 options for "fair and equitable" treatment of non-consenting, impaired, secured creditor classes: 

Option 1: Secured Creditor retains lien on collateral and receives deferred payments.

Option 2: Sell property and creditor gets lien on proceeds.  Then creditor is treated under Option 1 or 3.

Option 3:  Creditor receives "indubitable equivalent" of its claim. 

Application to Facts

For the DIP that wishes to keep the property, only Option 1 makes sense.  This allows the DIP to make deferred payments as long as they equal the present value of the collateral.  Assuming that the DIP does not wish to strip down the lien to a lower value/amount, this simply means the loan amount is amortized at a rate that compensates the lender for its present value, i.e. a refinanced loan. One of the impaired classes must accept the plan.  In the fact pattern above, the DIP is lucky in that the value of the property has fallen below the total owed on the 1st, 2nd and 3rd Mortgages.  The 4th Mortgage is more than happy to agree to the plan because they feel lucky enough to receive anything at all.

Appropriate Discount Rate

But what is that discount rate ?  The Ninth Circuit has held that the appropriate discount rate must be determined on the basis of the rate of interest which is reasonable in light of the risks involved and on a case-by-case basis.  In re Camino Real Landscape Maintenance Contractors, Inc. (9th Cir. 1987) 818 F2d 1503, 1505; In re Patterson (9th Cir. BAP 1988) 86 BR 226, 227.  Some courts have used the "formula" approach where a "base rate" (e.g. treasury bond rates, prime rate, or other established index) that is adjusted based on factors such as 1) nature of the loan, 2) quality of the collateral; and 3) risk of default.  In re Villa Diablo Assocs. (BC ND 1993) 156 BR 650, 653.  This is most useful when no reliable market data exists for the plan's treatment of the claim, e.g. 100% loan to value ratio.