Sea Trail Corporation

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
WILMINGTON DIVISION
IN RE:
SEA TRAIL CORPORATION
DEBTOR
CASE NO.
11-07370-8-SWH
ORDER CONFIRMING PLAN
This case came before the court for a hearing on confirmation of the debtor’s First Amended
Plan of Reorganization on September 20, 2012, in Raleigh, North Carolina. 	Objections to
confirmation were filed by the Bankruptcy Administrator and the Unsecured Creditor’s Committee
(the “Committee”). Upon the conclusion of the hearing, the court took the matter under advisement.
On September 24, 2012, the court entered a separate order notifying the parties of its ruling
confirming the Plan. This order sets out the bases for the court’s decision.
BACKGROUND
The debtor filed a petition for relief under Chapter 11 of the United States Bankruptcy Code
(the “Code”) on September 27, 2011. The debtor owns and operates a vacation and residential resort
in Sunset Beach, North Carolina, known as the Sea Trail Golf Resort and Conference Center. On
January 16, 2012, Waccamaw Bank (the “Bank”), the primary secured creditor of the debtor, filed
a motion for relief from stay, or in the alternative, for adequate protection. When the petition was
SO ORDERED.
SIGNED this 23 day of October, 2012.
________________________________________
Stephani W. Humrickhouse
United States Bankruptcy Judge
____________________________________________________________
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filed, the Bank held senior liens on the vast majority of the debtor’s real estate, including the
debtor’s golf courses, convention center buildings, developed residential lots and undeveloped real
estate. The debtor, the Bank and the Committee agreed to terms regarding the Bank’s stay motion,
which terms were incorporated into an Agreed Order Allowing Relief from the Automatic Stay and
Adequate Protection to Waccamaw Bank (the “Agreed Order”) entered on February 16, 2012.
Pursuant to the Agreed Order, the Bank released a portion of its collateral from its lien for
the benefit of the debtor and unsecured creditors.1 The collateral released is identified in the Agreed
Order as the “Carve-Out Property.” The Carve-Out Property consists of 19.53 acres of undeveloped
real estate identified as Tract 16, a five acre sewer facility abutting Tract 16, 180 sewer taps, a sewer
service agreement, and $31,472.42 of proceeds from the sale of the debtor’s property known as
390 Magnolia Drive SW.
On January 26, 2012, the debtor filed its initial plan of reorganization. On March 13, 2012,
the Bank and the Committee objected to the plan on various grounds. On May 22, 2012, the debtor
filed its First Amended Plan of Reorganization (the “Plan”), which is 	before the court for
confirmation. The Plan establishes sixteen classes:
(1) administrative claims; (2) ad valorem tax claims; (3) other tax claims; (4) the
secured claims of Waccamaw Bank; (5) the secured claim of John & Frances
Williams; (6) the lease agreements with Agricredit Acceptance, LLC; (7) all
executory contracts and leases not separately classified; (8) the sewer service
agreement with Brunswick County; (9) the lease agreements with DeLage Landen
1 The Agreed Order also provides that the automatic stay shall be lifted as to the Bank if the
debtor’s reorganization plan is not confirmed on or before April 30, 2012. Upon the lifting of the
stay, the Bank has sole discretion to proceed with a foreclosure sale against its collateral. The Bank
also waives its unsecured deficiency claim, unless a plan is not confirmed or the debtor’s case is
converted to a Chapter 7 liquidation. The debtor’s plan was not confirmed by the deadline and the
stay has been lifted. However, the Bank has not proceeded with foreclosure and has agreed to waive
its deficiency claim in conjunction with confirmation of the Plan.
2
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Financial; (10) the investment advisory agreement with The Plasencia Group, Inc.;
(11) the lifetime golf membership agreements; (12) the claims asserted by the Master
Association; (13) the general unsecured claims of less than $1,000; (14) the general
unsecured claims greater than $1,000; (15) the general unsecured claims arising from
shareholder loans; and (16) the equity interests of the debtor’s shareholders.
Objections to the Plan were filed by the Bankruptcy Administrator and the Committee. The
Bankruptcy Administrator contends that the treatment of Class 1 violates Section 1123(a)(4) of the
Code because members within that class are treated differently, i.e., the payment of the claims of
some members of that class are guaranteed by the Bank, while others are not. The Bankruptcy
Administrator 	also 	cites 	her 	concerns 	that 	the 	absolute 	priority 	rule 	set 	forth 	in
Section 1129(b)(2)(B) of the Code must be satisfied if the unsecured class objects to the Plan.
Finally, the Bankruptcy Administrator contends that the Plan unfairly discriminates against the
Class 14 creditors because Class 15 creditors receive more advantageous treatment under the Plan,
and that by virtue of the “junior” status of Class 15, such treatment may also violate the absolute
priority rule.
The Committee also objected to the treatment of the unsecured classes, stating that the Plan
“offers different treatment to like claims and fails to subordinate inside claims, instead giving them
preferential treatment, all in violation of Sections 1122, 1123 and 1129.” The Committee argues that
such treatment also violates “the doctrine of equitable subordination and the absolute priority rule.”
Prior to the confirmation hearing, the debtor submitted a Summary of Ballots and then a
Supplement to Summary of Ballots. The ballot reports indicate that there were no ballots cast in
Classes 1, 7, 10 and 11; 2 that Classes 2, 3, 6, and 8 were given unimpaired treatment and thus
2 Class 7 claims are treated in Classes 13 and 14; the Class 10 creditor has asserted no claim;
although the ballot report shows no ballots cast, in fact accepting ballots were cast and Class 11 will
be treated as an accepting class.
3
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deemed accepting classes;3 that Classes 4, 9, 12, 13, 14 and 15 accepted the Plan; that the Class 5
claim of John and Frances Williams was noted as “No claims”; and that the Class 16 Shareholder
Class is deemed as a rejecting class because those interests are extinguished under the Plan.
The Class 1 Administrative Claims class was not provided unimpaired treatment and not all
members of that class agreed to the payment of their claims in any manner but in full on the
Effective Date. However, during the hearing, and as an aid to confirmation, the Bank agreed to
guarantee the payment of all administrative claimants on the Effective Date, thus obviating the
objections to the treatment of Class 1 Administrative Claims and satisfying the Section 1129
requirements as to that class.
The ballot report indicates that Class 14 accepted the Plan with three ballots accepting and
two rejecting. However, objections were pending as to two additional claims. If those additional
claims were allowed to vote, and even one voted to reject the Plan, Class 14 would be a rejecting
class. Rather than have the court either estimate those claims or hold hearings on the objections to
claims 	prior 	to 	confirmation, 	the 	debtor 	agreed 	to 	proceed 	at 	confirmation 	pursuant 	to
Section 1129(b), as if the class had rejected.4
Class 14 is an impaired class and consists of all allowed general unsecured claims, except
for certain unsecured claims arising from loans made to the debtor by the debtor’s shareholders.
Class 14 contains approximately fifty-one creditors, most of which are unsecured trade creditors.
3 Although the court does not agree that Class 2 has been afforded unimpaired treatment, that
class has affirmatively accepted the Plan.
4 There was one additional ballot cast by Himmelsbach Communications, Inc. which was not
counted for the purpose of confirmation because it was late-filed and no motion to excuse the late
filing was submitted. 	The parties agreed to allow the claim of Dana Connelly for distribution
purposes only and to continue the hearing on the claim of Dennis Crocker.
4
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The total amount of claims in Class 14 is approximately $711,861.37. 	Under the Plan, each
claimholder in Class 14 will exclusively receive the proceeds from the sale of all 180 sewer taps,
as well as any proceeds from avoidance actions, until each claimholder has recovered 50% of its
claims. Once each claimholder in Class 14 has received 50% of its claims, the net proceeds from
the sale of any remaining sewer taps and avoidance actions will be divided evenly between
Classes 14 and 15. 5 Class 15 is also impaired and consists of all allowed unsecured claims arising
from the shareholder loans. This class contains only eight creditors, but the total amount of claims
is approximately $4,764,580.41. 	This class will receive title to Tract 16, an assignment by the
debtor of the sewer service agreement, and 50% of any remaining proceeds from the sewer taps and
avoidance actions after Class 14 has recovered 50% of its allowed claims. Finally, Class 16 is an
impaired class and consists of the debtor’s twelve shareholders. The Plan provides that Class 16 will
not receive any distributions from the debtor on account of their equity interests unless and until all
senior classes of claims have been paid in full.
The debtor’s evidence primarily consisted of the testimony of Matthew Smith. Mr. Smith
originally served as a consultant and advisor to the debtor before becoming its chief liquidating
officer on February 7, 2012. Mr. Smith first explained the rationale for separately classifying the
unsecured trade creditor claims and the shareholder loan claims. 	According to Mr. Smith, the
unsecured trade creditors and shareholders had somewhat conflicting interests in the recovery of
their claims. Mr. Smith testified that in his opinion trade creditors generally prefer that assets be
5 The Plan also provides that Class 14 is to receive the remaining amount of proceeds from
the sale of the property located at 390 Magnolia Drive SW–$31,472.42–after the convenience class
of unsecured creditors recovers 35% of its claims.
5
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liquidated expeditiously to achieve a swift recovery of their claims. In contrast, the shareholders
were primarily interested in retaining assets for a longer duration in an effort to maximize their
recovery.
Mr. Smith testified it was the debtor’s position that the assets given to Classes 14 and 15
were appropriate given their differing interests. When the Plan was drafted, Mr. Smith and the
debtor proceeded on the premise that the sewer taps were more liquid than Tract 16, and they felt
that the taps were suitable for the interests and needs of the unsecured trade creditors because their
liquidity would allow for a quicker recovery of their claims. Tract 16 was thought to be less liquid
as a piece of undeveloped real estate, but with greater potential to increase in value than the sewer
taps over the long term. Since the shareholders were in a position financially to delay the recovery
of their claims, and had expressed a desire to delay recovery in order to allow the assets distributed
to them under the Plan to increase in value, Mr. Smith recommended that the debtor allocate to
Class 15 the tract of undeveloped real estate.
The debtor introduced Exhibits 1 - 4 to illustrate through the testimony of Mr. Smith how
much each class would likely recover as a percentage of their allowed claims under the Plan.6 The
creditors within Class 14 could potentially receive as much as 77% and as little as 22% of their
claims, depending on whether the disputed claims within Class 14 were allowed.7 The creditors
6 The Exhibits set forth different scenarios dependent upon whether or not the disputed
claims within Class 14 are allowed: one where neither of the two remaining disputed claims were
allowed, one where both disputed claims were allowed, and then a scenario where one but not the
other disputed claim was allowed. 	See fn. 4.
7 These percentages were based on Mr. Smith’s assumptions that the sewer taps would sell
for as low as $2,000 or potentially as high as $4,000, with $4,000 being the retail value of one sewer
tap.
6
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within Class 15 could potentially recover as much as 9% of their claims and as little as 5% of their
claims.8 Thus, according to Mr. Smith, under every possible scenario the Class 14 creditors would
likely recover a greater percentage of their claims than the Class 15 creditors would recover.
Mr. Smith also considered the possible recoveries if Classes 14 and 15 were consolidated with the
assets and claims being combined into a single class. Mr. Smith testified that if this were to occur,
all general unsecured creditors–the total number of creditors currently in Classes 14 and 15–would
likely receive as much as 18% and as little as 10% on their claims. Therefore, the Class 14 creditors
would more likely recover a greater percentage of their claims under the existing Plan than under
a scenario where Classes 14 and 15 are combined.
However, the cross examination of Mr. Smith called into question the continuing validity
of some of the assumptions made by the debtor regarding the liquidity of the sewer taps. Mr. Smith
admitted that after evaluating the marketability of the sewer taps and determining that they would
be the preferable source of funds for payment to Class 14 creditors, he learned that the sewer taps
could only be sold in conjunction with lots sales in Sea Trail.9 This limitation would affect both the
price and timing of sales. As a result, Class 14 would potentially receive as low as 10% of their
claims from the sale of sewer taps.10 However that percentage recovery would yield the Class 14
8 The percentages in Class 15 were based on a valuation of Tract 16 of $244,125, which was
taken from the most recent appraisal conducted by the Bank, and on assumptions that Class 15
would share in the net proceeds from the sale of the sewer taps after Class 14 recovered 50% of their
allowed claims.
9 The individual sale of sewer taps was only one of three possible sales approaches
contemplated by the debtor. A bulk sale to the proposed purchaser of the debtor’s primary assets
or to a separate investor were the other two means mentioned by the debtor.
10 This scenario assumed that the sewer taps sold for only $2,000, as opposed to their $4,000
retail value, and that all disputed claims in Class 14 were allowed, which would dilute the recovery
for each creditor’s claims, thus presenting a worse case scenario for Class 14 claims.
7
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creditors approximately 1% higher than that to be received by Class 15 creditors under the present
plan and was roughly equivalent to what the Class 14 creditors would receive if both classes were
combined.
At the close of evidence and arguments, the court took the matter under advisement to decide
the following issues: (1) whether the debtor’s disclosure statement contained adequate information;
(2) whether the separate classification of Classes 14 and 15 was proper under the Code; (3) whether
the disparate treatment between Classes 14 and 15 unfairly discriminated against Class 14;
and (4) whether the Plan was fair and equitable with respect to Class 14.
DISCUSSION
Section 1129 of the Code sets out the requirements for confirmation of a Chapter 11 plan.
Pursuant to this section, for a plan to be confirmed the plan and the plan’s proponent must comply
with “the applicable provisions of this title.” 	11 U.S.C. § 1129(a)(1)–(2). 	The “applicable
provisions” include Section 1122 of the Code, which governs the classification of claims within a
plan, as well as Section 1125 regarding the disclosure statement. 	See In re Cajun Elec. Power
Coop., Inc., 150 F.3d 503, 513 n.3 (5th Cir. 1998), cert. denied, 526 U.S. 1144, 119 S. Ct. 2019
(1999) (presuming that Sections 1129(a)(1) and (a)(2) require compliance with Section 1125);
Mickey’s Enters., Inc. v. Saturday Sales, Inc. (In re Mickey’s Enters., Inc.), 165 B.R. 188, 193
(Bankr. W.D. Tex. 1994) (“In order to confirm a plan the court must find that the plan and its
proponent have complied with the applicable provisions of Title 11. One of those applicable
provisions is § 1125 which requires disclosure of ‘adequate information.’”); see also In re Greate
Bay Hotel & Casino, Inc., 251 B.R. 213, 223 (Bankr. D.N.J. 2000) (stating that the “applicable
8
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provisions” include Section 1122); In re Aspen Limousine Serv., Inc., 193 B.R. 325, 340 (D. Colo.
1996) (providing that Section 1129(a)(1) requires compliance with Section 1122).
In addition to complying with the “applicable provisions” of Title 11, the proposed plan must
also be accepted by all impaired classes of claims. 11 U.S.C. § 1129(a)(8). A plan that has rejecting
impaired classes, however, may be confirmed over their rejection if the plan “does not discriminate
unfairly, and is fair and equitable, with respect to” those classes. 11 U.S.C. § 1129(b)(1). This is
commonly referred to as the “cram down” provision, and it requires a court to separately analyze
whether the plan unfairly discriminates against any impaired rejecting classes and whether the plan
is fair and equitable to those classes.
The proponent of the plan “has the burden of establishing by a preponderance of the evidence
that the plan complies with the statutory requirements for confirmation of Section 1129(a).” In re
Swartville, LLC, 2012 Bankr. LEXIS 3809 (Bankr. E.D.N.C. 2012); In re Atrium High Point Ltd.
P’ship, 189 B.R. 599, 609 (Bankr. M.D.N.C. 1995). If the case is nonconsensual, the proponent of
the plan also has the burden of showing by a preponderance of the evidence that the requirements
of Section 1129(b)(1) are met. In re Smith, 357 B.R. 60, 66 (Bankr. M.D.N.C. 2006); In re Dow
Corning Corp., 244 B.R. 696, 700 (Bankr. E.D. Mich. 1999), aff’d, 255 B.R. 445 (E.D. Mich. 2000).
As expressed in the order entered on September 24, 2012, the court finds that the disclosure
statement contains adequate information, that the separate classification of Classes 14 and 15 is
proper, and that the Plan does not unfairly discriminate, and is fair and equitable to, Class 14.
9
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I. 	Disclosure Statement
In order to solicit acceptances of a plan, the debtor must furnish all holders of claims or
interests with the plan or a summary of the plan accompanied by a written disclosure statement.
11 U.S.C. § 1125(b). 	This disclosure statement must contain “adequate information,” which is
defined in Section 1125(a)(1) as:
[I]nformation of a kind, and in sufficient detail, as far as is reasonably practicable in
light of the nature and history of the debtor and the condition of the debtor’s books
and 	records, 	including 	a 	discussion 	of 	the 	potential 	material 	Federal 	tax
consequences of the plan to the debtor, any successor to the debtor, and a
hypothetical investor typical of the holders of claims or interests in the case, that
would enable such a hypothetical investor of the relevant class to make an informed
judgment about the plan, but adequate information need not include such information
about any other possible or proposed plan and in determining whether a disclosure
statement provides adequate information, the court shall consider the complexity of
the case, the benefit of additional information to creditors and other parties in
interest, and the cost of providing additional information.
Whether a disclosure statement contains adequate information is determined by the court on
a case by case basis. In re Radco Props., Inc., 402 B.R. 666, 682 (Bankr. E.D.N.C. 2009) (citing In
re A.H. Robins, Co., 880 F.2d 694, 696 (4th Cir. 1989). In any case, however, a proper disclosure
statement should be “clear and succinct.” 	Radco Props., 402 B.R. at 682. 	Courts have also
acknowledged the underlying purpose of a disclosure statement, which is to provide creditors with
enough information to “determine what distribution or other assets they will receive and also what
risks they will face.” In re Constr. Supervision Servs., Inc., No. 12-00569-8-RDD, 2012 Bankr.
LEXIS 4564 at *4 (Bankr. E.D.N.C. October 1, 2012) (citing Nelson v. Dalkon Shield Claimants
Trust (In re A.H. Robins Co.), 216 B.R. 175, 180 (Bankr. E.D. Va. 1997)). 	Accordingly, the
statement should “provide the creditors with an accurate basis for determining their position and
their ability to make an informed decision with regard to the acceptance or rejection of the [p]lan.”
10
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In re Newkirk, No. 11-05896-8-RDD, 2012 Bankr. LEXIS 977 at *8-9 (Bankr. E.D.N.C. March 9,
2012) (quoting In re Hendrix-Barnhill Co., Inc., No. 11-01974-8-RDD, 2011 Bankr. LEXIS 4521
at *9 (Bankr. E.D.N.C. Oct. 27, 2011)).
The disclosure statement supplied by the debtors in the instant case contains adequate
information as required by Section 1125(b). Among much other information, it provides a detailed
summary of the history and business structure of the debtor, the events and actions taken by the
debtor leading up to and during the bankruptcy, the circumstances surrounding the Agreed Order,
the terms of the Agreed Order, the legal issues relating to acceptance or rejection of the Plan, the
legal issues relating to confirmation of the Plan, and the potential federal tax consequences of the
Plan to the debtor. More importantly, however, the statement incorporates the Plan itself and thus
explains the proposed treatment for each class, including a detailed description of the assets that
each class is to receive under the Plan. 	All of these provisions were written in a clear,
understandable and succinct fashion so that the parties, all of whom were relatively sophisticated
individuals or entities, could make an informed decision as to whether they should accept or reject
the Plan. 	Therefore, the debtor’s disclosure statement complies with Section 1125(b) and is
approved.
II. 	Classification
Section 1122 of the Code provides little guidance as to how claims are to be classified. In
re Draiman, 450 B.R. 777, 790 (Bankr. N.D. Ill. 2011) (citing In re Nat’l/Northway Ltd. P’Ship,
279 B.R. 17, 25 (Bankr. D. Mass. 2002)). Specifically, Section 1122(a) “does not expressly require
that all substantially similar claims be placed in the same class, nor does it expressly prohibit
substantially similar claims from being classified separately.” In re SM 104 Ltd., 160 B.R. 202, 216
11
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(Bankr. S.D. Fla. 1993); Draiman, 450 B.R. at 790. The Fourth Circuit has stated, however, that
Section 1122 prohibits the separate classification of claims if “the plan unfairly creates too many
or too few classes, if the classifications are designed to manipulate class voting, or if the
classification scheme violates the basic priority rights. . . .” In re Bryson Properties, XVIII, 961 F.2d
496, 502 (1992); see also In re Somerset Props. SPE, LLC, 2012 Bankr. LEXIS 3867, at *6 (Bankr.
E.D.N.C. 2012) (“[I]t is well-established that separate classification may not be created with the sole
intent to achieve cram-down. . . .”).
Although a classification scheme designed to manipulate voting is specifically prohibited,
the debtor is still afforded some degree of flexibility in proposing a plan and has “considerable
discretion to classify claims and interests according to the facts and circumstances of the case.”
Bryson, 961 F.2d at 502; Somerset, 2012 Bankr. LEXIS 3867, at *8. 	A debtor may, therefore,
separately classify claims as long as it is for a legitimate purpose other than to manipulate voting.
Bryson, 961 F.2d at 502; see also Somerset, 2012 Bankr. LEXIS 3867, at *11-12 (“If a plan
proponent can articulate legitimate differences among otherwise substantially similar claims . . . then
separate classification may be proper.”) (citing In re Simon, 2008 Bankr. LEXIS 2787, at *2 (E.D.
Va. 2008)); 	In re Orchards Vill. Invs., 2010 Bankr. LEXIS 48, at *18 (Bankr. D. Or. 2010)
(“Similar claims generally are placed in the same class unless there are legitimate business or other
reasons for separate classification.”).
In the instant case, the debtor, through the testimony of Mr. Smith, has satisfied its burden
of showing a legitimate reason for separately classifying Classes 14 and 15. 	The two classes of
unsecured creditors have different, and somewhat contradictory, interests. Generally speaking, trade
creditors are accustomed to short-term lending processes with an expectation of being repaid within
12
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a relatively short time period. 	See, e.g., Bruce A. Markell, A New Perspective on Unfair
Discrimination in Chapter 11, 72 Am. Bankr. L.J. 227 (1998) (stating that “[t]rade creditors have
short-term maturities” and they “understand the risk of selling goods on short-term credit. . . .”); see
also In re Greate Bay Hotel & Casino, Inc., 251 B.R. 213, 232 (Bankr. D.N.J. 2000) (agreeing with
Professor Markell’s analysis of trade creditor expectations regarding short-term credit). 	The
shareholders in the instant case have expressed a willingness to accept property pursuant to the Plan
which may have to be held for some time to maximize its value for distribution. Such a position is
somewhat inconsistent with the presumed wishes and expectations of the general unsecured trade
creditor class. 	Thus there are certainly legitimate differences between the two classes of
claimholders which justify separate classification.
The Committee and the Bankruptcy Administrator argue that the purported reason for the
separate classification–to provide a quicker recovery for trade creditors while allowing the
shareholder creditors to retain assets for a longer duration–is negated by the possibility that the
sewer taps are not as liquid as once thought to be. Regardless of the actual liquidity of the assets,
however, the fact of the matter is that Classes 14 and 15 still have inconsistent interests. Creating
two separate classes enables the debtor to satisfy, or at least attempt to satisfy, the different interests
at play by providing each class with distinct treatment that is intended to be suitable for the needs
and expectations of the creditors within their respective class. 	The suggested alternative, i.e.,
combining the two classes into a single class, may result in internal conflict among members of such
combined class because those creditors would most likely disagree as to the timing and methods for
liquidating the assets. See 11 U.S.C. § 1123(a)(4) (requiring a plan to provide the same treatment
for each claim in a particular class); see also In re New Jersey Medical Center, 817 F.2d 1055, 1061
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(3d Cir. 1987) (“Section 1123(a)(4) only requires equality of treatment of claims . . . placed in the
same class”). 	Separate classification, therefore, increases the likelihood for a successful
reorganization, and the debtor is given the flexibility under the Code to separately classify similar
claims for this purpose. Cf. In re Deep River Warehouse, Inc., 2005 Bankr. LEXIS 1793, at *15
(Bankr. M.D.N.C. 2005) ([I]t must be observed that, in the Fourth Circuit, the separate classification
of even substantially similar claims is permissible if the debtor can offer any reason ‘which will
withstand scrutiny,’ which means not ‘for the purpose of manipulating voting.’” (quoting Bryson,
961 F.2d at 502).
III. 	1129(b)(1) Unfair Discrimination
Courts have developed different tests for determining whether a reorganization plan unfairly
discriminates against a class in violation of Section 1129(b)(1). See 7 Alan N. Resnick & Henry J.
Sommer, Collier on Bankruptcy ¶ 1129.03[3][a] (16th ed. rev. 2012) (describing the various tests).
These tests range from a rigid, mechanical approach in which almost any form of discriminatory
treatment violates Section 1129(b)(1) to a broad, flexible one in which the outcome depends heavily
on the facts and circumstances of each case. 	See Denise R. Polivyal, Unfair Discrimination in
Chapter 11: A Comprehensive Compilation of Current Case Law, 72 Am. Bankr. L.J. 191, 199-203
(1998) (providing overview of different approaches to unfair discrimination analysis).
The Fourth Circuit has embraced a test that takes a four-part inquiry originally used to assess
fairness under Section 1322(b)(1) of the Code and applies it to Section 1122(b)(1).11 See Ownby
11 There have been numerous tests created for the unfair discrimination analysis, but the four-
part test acknowledged by the Fourth Circuit has been adopted by many courts. See, e.g., In re
Union Fin. Servs. Group, Inc., 303 B.R. 390 (Bankr. E.D. Mo. 2003); In re Am. HomePatient, Inc.,
298 B.R. 152 (Bankr. M.D. Tenn. 2003); In re Aztec Co., 107 Bankr. 585, 590 (Bankr. M.D. Tenn.
1989). Another prevailing test is one that creates a rebuttable presumption that a plan is unfairly
14
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v. Jim Beck, Inc. (In Re Jim Beck, Inc.), 214 B.R. 305, 307 (W.D. Va. 1997), aff’d per curiam,
No. 97-2701, 162 F.3d 1155, 1998 U.S. App. LEXIS 20736 (4th Cir. Aug. 24, 1998) (unpublished
table decision); In re Sutton, 2012 Bankr. LEXIS 752, at *6-7 (Bankr. E.D.N.C. 2012); but see In
re Prosperity Park, LLC, 2011 Bankr. LEXIS 1852, at *9 (Bankr. W.D.N.C. 2011) (applying a
rebuttable presumption test rather than the four-part test). This test consists of the following four
factors:
(1) whether there is a reasonable basis for the discrimination; (2) whether the plan
can be confirmed and consummated without the discrimination; (3) whether the
discrimination is proposed in good faith; and (4) the treatment of the classes
discriminated against.
Jim Beck, 214 B.R. at 307; see also In re Aztec Co., 107 Bankr. 585, 590 (Bankr. M.D. Tenn. 1989).
When applying this test, a court must weigh the four factors by looking at all of the facts and
circumstances of each individual case. As the Fourth Circuit has stated, whether a plan is unfairly
discriminatory requires a “totality of circumstances” type of analysis. Bryson, 961 F.2d at 502 n.9.
Ultimately, the responsibility of the court is to examine the disparate treatment that exists within a
proposed plan, if any, and to determine whether the discrimination is justified under the Code. See
Resnick & Sommer, supra, ¶ 1129.03[3][a].
Regardless of which test courts use to determine whether a plan is unfairly discriminatory,
it is important to clarify that Section 1129(b)(1) permits discriminatory treatment as long as the
discrimination is not unfair. See In re LeBlanc, 622 F.2d 872, 879 (5th Cir. 1980) (“A bankruptcy
court can permit discrimination when the facts of the case justify it.”); In re Renegade Holdings,
Inc., 429 B.R. 502, 521 (Bankr. M.D.N.C. 2010), reh’g granted, 2010 Bankr. LEXIS 2252 (Bankr.
discriminatory if several requirements are satisfied. See In re Dow Corning Corp., 244 B.R. 696,
702 (Bankr. E.D. Mich. 1999).
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M.D.N.C. 2010) (“The prohibition under section 1129(b)(1) is against ‘unfair discrimination’ and
not simply discrimination of any kind.”); In re Crosscreek Apts., 213 B.R. 521, 537 (Bankr. E.D.
Tenn. 1997) (“[D]iscrimination in the treatment of classes is permissible so long as it is not unfair.”);
Aztec, 107 Bankr. at 589 (“Section 1129(b)(1) prohibits only unfair discrimination, not all
discrimination.”). To hold that any degree of disparate treatment among similarly situated classes
violates 	Section 	1129(b)(1) 	would 	“threaten[] 	the 	vitality 	of 	the 	word 	‘unfairly’ 	in
[Section] 1129(b)(1).” Aztec, 107 Bankr. at 589.
Consistent with the Code’s requirement for unfairness, courts often conclude that a plan is
unfairly discriminatory when there is a large discrepancy in the percentage recovery between
similarly situated creditors. See, e.g., In re Tuscon Self-Storage, Inc., 166 B.R. 892 (9th Cir. BAP
1994) (finding unfair discrimination when plan provided 100% recovery for unsecured trade
creditors and 10% to deficiency claim); In re Sentry Operating Co. of Tex., Inc., 264 B.R. 850, 863-
64 (Bankr. S.D. Tex. 2001) (finding unfair discrimination when plan provided for 100% recovery
for one class of unsecured creditors and 1% recovery to another class of unsecured creditors); In re
Barney & Carey Co., 170 B.R. 17 (Bankr. D. Mass. 1994) (finding unfair discrimination when plan
paid deficiency claims 100% over ten years and paid trade creditors only 15% of claims within
ninety days); Aztec, 107 B.R. at 589 (finding unfair discrimination when plan paid insider unsecured
claims in full while paying nonrecourse deficiency claim only 3%). However, courts have been less
likely to find that a plan is unfairly discriminatory when the percentage recovery of claims is
relatively close. See, e.g., Greate Bay Hotel, 251 B.R. at 231-32 (applying rebuttable presumption
test and finding that plan was not unfairly discriminatory even though one class only recovered 76%
of its claims while another similarly situated class recovered 80% of its claims). 	A crucial
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distinction, therefore, between cases in which plans have been determined to be unfairly
discriminatory and those that have not is the magnitude of the difference in the amount of recovery
between similarly-situated classes.
The court will begin its analysis by examining the actual treatment given to the unsecured
trade creditors within Class 14. This factor, while not dispositive, weighs strongly in favor of the
debtor and towards a conclusion that the Plan does not unfairly discriminate against Class 14. The
debtor’s evidence demonstrated that the Class 14 creditors will likely receive a greater percentage
of their claims than the Class 15 creditors. The Class 14 creditors are also likely to receive a greater
percentage of their claims under the present Plan than they would if Classes 14 and 15 were
consolidated into one class. While it is clear that the Plan discriminates between Classes 14 and 15,
it is far from clear how this particular discrimination is at all unfair. As previously stated, most
courts conclude that a plan is unfairly discriminatory when a large discrepancy exists between the
percentage recovery that the similarly-situated classes receive. In the instant case, however, the
discrepancy, if there is any, seems to be slight and could potentially benefit the Class 14 creditors.
Accordingly, the actual treatment given to Class 14 under the Plan, once compared to the alternative
forms of treatment, strongly suggests that the discrimination within the Plan is not unfair.
The discrimination between Classes 14 and 15 is also supported by a reasonable basis. 	As
previously explained, the somewhat inconsistent interests between the two classes will likely affect
the manner in which each class desires to dispose of the assets distributed to it under the Plan. The
inconsistent interests justify classifying the creditors separately as well as providing each class with
different treatment. See Denise R. Polivyal, Unfair Discrimination in Chapter 11: A Comprehensive
Compilation of Current Case Law, 72 Am. Bankr. L.J. 191, 198-99 (explaining how several courts
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have recognized that the reasons justifying separate classification oftentimes justify different
treatment given to each class); see also, e.g., In re Johnston, 21 F.3d 323, 328 (9th Cir. 1994) (stating
that the plan’s classification scheme satisfied the unfair discrimination test because the reasons for
classification were reasonable and nondiscriminatory reasons); In re Rivers End Apartments, 167
B.R. 470, 487 (Bankr. S.D. Ohio 1994) (stating that reasons for separate classification of
nonrecourse deficiency claims and other unsecured claims seem to more appropriately support
reasons for differing treatment).
The evidence also demonstrates that the discrimination between Classes 14 and 15 was
proposed in good faith. Mr. Smith, the debtor’s chief liquidating officer, testified that he and the
debtor genuinely believe that treating the unsecured trade creditors differently from the shareholder
creditors is not only fair to each party, but it also enhances the debtor’s ability to successfully
reorganize. This testimony was corroborated by the evidence indicating that Class 14 is better off
with its current treatment under the Plan than it would be with the suggested alternative forms of
treatment. At the confirmation hearing, the Committee asserted a lack of good faith but did not
produce much, if any, evidence to support these allegations. 	While the cross-examination of
Mr. Smith may have undercut the accuracy of the assumptions regarding Class 14's treatment, it
alone is insufficient to infer a lack of good faith. The assumptions made by the debtor regarding the
liquidity of the sewer taps were made in good faith, even if later found to be less factually sound.
The evidence collectively shows that the discrimination between Classes 14 and 15 was intended
to, and may in fact, benefit both classes and was proposed in good faith.
Finally, although an inquiry into whether the discrimination is necessary for the
reorganization seems to weigh in favor of a conclusion that the Plan is unfairly discriminatory, it is
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certainly not outcome determinative. The debtor has shown that separate classification facilitates
a successful reorganization, but has not established that the Plan would fail if the two classes were
consolidated and given the same treatment. However, simply because the reorganization may be
possible without the proposed discrimination does not necessarily render the Plan unfairly
discriminatory, particularly when the debtor has demonstrated that the Class 14 creditors will likely
be better off with the different treatment than without it. Although the Class 14 and 15 creditors are
similarly situated in that they are all unsecured creditors, there is a significant disparity in the
amount owed to each class of creditors. If a plan proponent can produce evidence demonstrating
that different treatment between similarly situated, albeit unalike, creditors results in more equitable
treatment for those creditors, as the debtor in this case has done, a plan should not automatically
become unfairly discriminatory because a reorganization without the discrimination may
theoretically be possible. 12 In light of the unique circumstances of this case, the finding that the
discrimination is not absolutely necessary for the reorganization is far outweighed by the findings
with respect to the other factors of the four-part test.
IV. 	Fair and Equitable
To be fair and equitable with respect to a dissenting class of unsecured claims, a plan must,
at a minimum, comply with the specific requirements set forth in Section 1129(b)(2)(B). 	In re
12 The requirement that the discrimination be necessary for the reorganization, adhered to
by some courts, has actually been criticized by scholars and other courts. In his article A New
Perspective on Unfair Discrimination in Chapter 11, Professor Bruce A. Markell is highly critical
of any test that in some way requires the discrimination to be necessary for a reorganization.
72 Am. Bankr. L.J. 227, 254 (1998). He states that such a requirement is “fatally flawed” because
“discrimination is never necessary” in that “[a]ny nonindividual Chapter 11 case theoretically is
capable of confirmation through plans which do not discriminate.” Id.; see also Dow Corning, 244
B.R. at 702 (stating that Markell’s critiques of the four-part test and similar versions of it are well-
founded, particularly his criticism of the necessity requirement).
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Maharaj, 449 B.R. 484, 491 (2011), aff’d, Maharaj v. Stubbs & Perdue, P.A., 681 F.3d 558 (4th Cir.
2012). 	With regard to a class of unsecured creditors, a plan may satisfy these requirements by
providing that each holder of a claim within the dissenting class of unsecured claims “receive or
retain on account of such claim property of a value, as of the effective date of the plan, equal to the
allowed amount of such claim.” 11 U.S.C. § 1129(b)(2)(B)(i). Alternatively, a plan may provide
that the holder of any claim or interest that is junior to the claims of a dissenting class of unsecured
creditors will not receive or retain any property under the plan on account of such junior claim or
interest. 11 U.S.C. § 1129(b)(2)(B)(ii). This latter requirement, which is at issue in this case, is
commonly referred to as the absolute priority rule. Maharaj, 449 B.R. at 491. This rule requires all
unsecured creditors within a dissenting class to be paid in full before any junior claims or interests
receive or retain any property under the plan. Id.
The Committee argues that the circumstances in the instant case are analogous to those in
Bryson in which the Fourth Circuit held that the debtor’s proposed plan violated the absolute priority
rule. See Bryson, 961 F.2d at 504-05. In Bryson, the plan provided the debtor’s equityholders with
the exclusive right to contribute new capital and the right to a return of the new capital while a
senior class only recovered 3.5% of its unsecured deficiency claim. Id. at 504. The court stated that
the exclusive right to contribute new capital constituted “property” under Section 1129(b)(2)(B)(ii),
which was “received or retained on account of a prior interest.” 	Id. 	Since a senior class of
unsecured creditors was not being paid in full, the court held that the plan violated the absolute
priority rule because the equityholders had received or retained property on account of a junior
interest. Id.
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The shareholders who loaned money to the debtor pre-petition comprising Class 15 are given
the exclusive right to Tract 16 under the Plan and are thus clearly receiving “property” under
Section 1129(b)(2)(B)(ii). 	However, in contrast to the equityholders in Bryson, they are not
receiving or retaining this property on account of their equity, i.e., a junior claim or interest. Rather,
the shareholders in Class 15 are receiving this property based on their legal status as unsecured
creditors of the debtor. Additionally, the unsecured claims within Class 15 are not junior to the
unsecured claims within Class 14, and therefore providing Class 15 with property even though
Class 14 will not be paid in full, does not implicate the absolute priority rule.
Finally, Class 16 is a separate class comprising all equity interests in the debtor. The Plan
provides that this class will not receive any distributions on account of their equity interests until
all senior classes have been paid in full. Accordingly, the Plan does not violate the absolute priority
rule because the shareholders within Classes 15 and 16 are not receiving any property based on a
junior claim or interest, and the Plan is fair and equitable to Class 14.
CONCLUSION
The court concludes that the disclosure statement provides adequate information, and that
the Plan properly classifies the claims of the unsecured trade creditors and the shareholder creditors
into separate classes. The court also concludes that the Plan does not unfairly discriminate against,
and is fair and equitable to, the unsecured trade creditors within Class 14. The Plan is therefore
confirmed.
SO ORDERED
END OF DOCUMENT
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