404 Beware the Unsecured Guaranty in Your Borrower’s Chapter 11 Strategy
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Beware the Unsecured Guaranty in Your Borrower’s Chapter 11 Strategy

When an Unsecured Guaranty Becomes a Problem

Most often, having a third party guaranty obligated to you as additional security for the repayment of a loan is a good thing.  However, a bankruptcy context can have the effect of skewing conventions, depending on your perspective, so that what was once thought to be a good position can turn out to be a disadvantage, and vice versa.  Such can be the case when a Chapter 11 debtor sets out to seek plan confirmation. 

Consider for a moment that you are an under-secured mortgage holder and your borrower has filed a Chapter 11 bankruptcy petition.  Your loan is secured up to the value of the property and you have Guarantors, other than the debtor, who may be liable for the unsecured portion of the loan.

The simple existence of a non-debtor Guarantor can have the unfortunate result of putting you at a distinct disadvantage when it comes time to vote for or against a proposed Chapter 11 plan of reorganization, resulting in confirmation of a plan over your objections, and an eventual cram-down of your unsecured claim.

How can this happen?  An astute debtor who follows the bankruptcy rules precisely will group creditors into classes under a plan of reorganization.  The rules require debtors to group similarly-situated creditors.  The creditor classes then have a say-so in the approval of a proposed plan — each class may vote for it or against it. 

In this situation, the fact that you have a non-debtor guaranty obligated for the unsecured portion of the debt means that your situation is different from the other unsecured creditors who have no guaranty.  Thus, you may be placed in a different class from the other unsecured creditors.  If you are excluded from the class containing the other unsecured creditors, then no matter the size of your comparative unsecured loans, you cannot control the vote of the other unsecured class.

Generally, if any class of impaired creditors accepts a plan, the plan can be approved and can “cram down” other creditors.

This is the scenario that was affirmed by the Ninth Circuit in Wells Fargo Bank, N.A. v. Loop 76, LLC, et al. (In re Loop 76, LLC), _____ B.R. ______ (9th Cir. BAP February 23, 2012).  The appellate court concluded that the debtor correctly classified the unsecured creditor with a guaranty separately from the other unsecured creditors.  

What is a creditor in this situation to do?  One strategy would be for the creditor to acquire all of the unsecured claims and proceed to control the vote.  Another strategy would be to demonstrate to the court through competent evidence that the guaranty has no value — a daunting task fraught with legal complications of its own — in order to be properly classified with the other unsecured creditors.  We will be watching to see whether the high court will hear the issue and find that it is patently unfair to allow a debtor to control the vote of the unsecured non-priority creditors in this manner.

Now is the time to prepare to protect your rights as a creditor by developing a relationship with an experienced business litigation and transactional law firm before adversity arises. 

Glass & Goldberg provides high quality and cost-effective legal services and advice for clients in all aspects of business litigation and transactional law.  Call us at (818) 888-2220, email us at info@glassgoldberg.com, or visit us on the web at www.glassgoldberg.com to learn more about the firm and sign up for future newsletters.

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