The 1111b Election
1111b is a unique feature of a chapter 11 case that invites strategy plays by both debtor and creditors.
Section 1111(b) election: A partially secured creditor may claim to have her claim in a Chapter 11 case treated as secured to the full extent that the claim is allowed even though, under section 506(a), it otherwise would be considered secured only up to the value of the collateral. Bankruptcy Code §1111(b)(2);
(1) Example: Debtor owes $500,000 to Creditor, pursuant to a non-recourse loan secured by a first mortgage on commercial real property, which has a fair market value of $400,000. Creditor's claim is classified in a separate class from the other claims in the case, and Creditor's lawyer makes the election, under section 1111(b), to have her entire $500,000 claim treated as secured. Subsequently, bankruptcy Debtor defaults on payments to Creditor under the confirmed reorganization plan, at a time when commercial real property has appreciated in value to $500,000. In this instance, the effect of the election will be to enable Creditor to recover the full amount of her claim.
(a) Compare: Assume the same facts as above, except that Creditor's lawyer does not make the section 1111(b) election. Following Debtor's default, lawyer for a third party bidder pays $500,000 for commercial real property at the foreclosure sale. Since Creditor's allowed secured claim was $400,000, the surplus of $100,000 will go to the bankruptcy Debtor's estate. Creditor's recovery will be limited lo $400,000, plus whatever percentage she is entitled lo under the plan on her unsecured claim for a deficiency within the bankruptcy plan.
(2) Exceptions: The section 1111(b) election cannot be made under either of the following circumstances:
(a) If the creditor's interest in the property is of inconsequential value.
and in the case of a low priority junior lien would be or minimal recovery at foreclosure ; or
(b) The creditor has recourse and the collateral is sold under section 363.
(3) Waiver of deficiency claim: if the section 1111(b) election is made, the secured party forfeits her unsecured claim for any deficiency and also loses the opportunity to affect the decision of the unsecured class to accept or reject the plan of reorganization. Bankruptcy Code §1111(b)(2); Bankruptcy Rule 3018(d); In re Southern Missouri Towing Service, Inc., 35 Bankruptcy 313 (Bankruptcy Wisconsin). Mo. 1988
(a) Example: Assume the same facts as in the first example above, except that the value of the property has depreciated to $300,000 at the time of the bankruptcy Debtor's default after confirmation. Because Creditor's lawyer made the section 1111(b) election, she loses her unsecured claim for a deficiency and her recovery will be only $300,000.
(4) Preventing a cash out: The section 1111(b) election of the bankruptcy code sometimes is invoked where the plan proposes no payment to the unsecured creditors, and the electing creditor desires to avert a cash out for the value of her collateral.
(5) Cram down: Where a secured creditor making the section 1111(b) election rejects the proposed Chapter 11 plan, confirmation can be obtained under the bankruptcy Code's "cram down" provisions if the plan (in addition to providing for the creditor's retention of her lien) proposes to pay the electing creditor deferred cash payments (i) which equal at least the full dollar amount of her allowed claim (without interest), and (ii) which have a present value, as of the effective date of the plan, of at least the value of the collateral.
(a) Example: Creditor's lawyer loans Debtor $500,000, secured by a first mortgage on property, which has a value of $600,000. The bankruptcy Debtor defaults and then files a Chapter 11 petition. The property has depreciated and is worth $400,000, and Creditor makes the section 1111(b) election. The proposed plan provides for Creditor to retain her lien on the property and to receive deferred cash payments on her claim. Creditor rejects the plan. For the plan to be confirmed over Creditor's rejection, the proposed payments must total at least $500,000 and must have a present value, as of the effective date of the plan, of at least $400,000. Bankruptcy Code §1129(b)(2)(A)(1);
(6) Time of election:
The section 1111 (b) election may be exercised at any time before the end of the hearing on the disclosure statement or within a later time set by the court. Bankruptcy Rule 3014
ABOUT THE AUTHOR: Charles Andersen
Mr. Andersen is admitted to practice in the states of California, New York, Pennsylvania, and Connecticut and focus his practice on bankruptcy.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.