Citations
- 707 F.3d 821
Full opinion text
EASTERBROOK, Chief Judge.
Creditors in bankruptcy are entitled to full payment before equity investors can receive anything. 11 U.S.C. § 1129(b)(2)(B)(ii). This is the absolute-priority rule. Equity investors sometimes contend that the value they receive from the debtor in bankruptcy is on account of new (post-bankruptcy) investments rather than their old ones. The Supreme Court held in Bank of America National Trust & Savings Ass’n v. 203 North LaSalle Street Partnership, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999), that competition is the way to tell whether a new investment makes the senior creditors (and the estate as a whole) better off. A plan of reorganization that includes a new investment must allow other potential investors to bid. In this competition, creditors can bid the value of their loans. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, — U.S. -, 132 S.Ct. 2065, 182 L.Ed.2d 967 (2012). The process protects creditors against plans that would give competing claimants too much for their new investments and thus dilute the creditors’ interests.
This appeal presents the question whether an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an “insider,” as 11 U.S.C. § 101(31) defines that term. The bankruptcy judge answered yes; our answer is no. Competition is essential whenever a plan of reorganization leaves an objecting creditor unpaid yet distributes an equity interest to an insider.
The material facts are simple. Castle-ton Plaza, the debtor, owns a shopping center in Indiana. George Broadbent owns 98% of Castletoris equity directly and the other 2% indirectly. EL-SNPR Notes Holdings is its only secured lender. The note carries interest of 8.37% and has several features, such as lockboxes for tenants’ rents and approval rights for major leases, designed for additional security. The note matured in September 2010, and Castleton did not pay. Instead it commenced a bankruptcy proceeding. About a year later Castleton proposed a plan of reorganization under which $300,000 of EL-SNPR’s roughly $10 million secured debt would be paid now and the balance written down to roughly $8.2 million, with the difference treated as unsecured. The $8.2 million secured loan would be extended for 30 years, with little to be paid until 2021, and the rate of interest cut to 6.25%, exceptionally low for credit representing 97% of the estimated value of the borrower’s assets. All of the note’s extra security features, such as the rental lockbox and approval rights, would be abolished.
Unpaid creditors normally receive the equity in a reorganized business. Castle-ton proposed a plan that cut the creditors out of any equity interest. Since the plan pays EL-SNPR less than its contractual entitlement, § 1129(b)(2)(B)(ii) provides that George Broadbent cannot retain any equity interest on account of his old investment — and 203 North LaSalle requires an auction before he could receive equity on account of a new investment. The proposed plan of reorganization nominally left George empty-handed. But it provided that 100% of the equity in the reorganized Castleton would go to Mary Clare Broad-bent, George’s wife, who would invest $75,000. Mary Clare owns all of the equity in The Broadbent Company, Inc., which runs Castleton under a management contract. George is the CEO of The Broad-bent Company and receives an annual salary of $500,000 for his services. The plan of reorganization provides that the management contract between Castleton and The Broadbent Company would be continued.
EL-SNPR believes that Castleton’s assets have been undervalued — see 2011 Bankr.LEXIS 3804 (Bankr.S.D.Ind. Sept. 30, 2011) (estimating the real estate’s value at $8.25 million)' — and that, given the dramatic decrease in the amount Castleton owes on the loan, the equity in the reorganized business will be worth more than $75,000. Cf. In re River East Plaza, LLC, 669 F.3d 826 (7th Cir.2012). It offered $600,000 for the equity and promised to pay all other creditors 100