What Is a Cramdown in Business Bankruptcy?
Posted on Tuesday, October 15th, 2024 at 12:16 pm
Businesses can file for Chapter 11 bankruptcy, which allows companies to restructure/reorganize their debts to stay in business. Companies filing for Chapter 11 must submit a reorganization plan to the bankruptcy court for approval. Businesses must also obtain majority approval from their creditors. However, a bankruptcy reorganization plan may propose aspects that creditors do not approve of, such as reducing the amounts owed on debts or reducing collateral to fair market value. Courts may sometimes approve reorganization plans over creditors’ objections, resulting in a “cramdown.”
Understanding Cramdowns in Bankruptcy
A cramdown occurs when a bankruptcy court approves a debtor’s reorganization plan over the objection of the debtor’s creditors. The Bankruptcy Code allows a bankruptcy court to approve a reorganization plan despite objections from creditors if the plan otherwise meets all the statutory requirements for confirmation. The court finds that the plan does not unfairly discriminate against creditors and equitably treats the claims of the creditors who have withheld their approval.
Cramdowns commonly occur in Chapter 11 bankruptcies as businesses restructure their debts to continue operations. Businesses frequently have secured debts, with real estate, inventory, or equipment as collateral for loans. Reorganization plans may alter how outstanding loans treat collateral, potentially leading to objections from secured creditors.
Cramdowns ensure that debtors can move forward with their bankruptcy and restructuring despite some creditors’ objections to the plan.
When and How a Cramdown Occurs
When a bankruptcy court approves a business’s reorganization plan, it must find that a debtor has proposed a cramdown provision in good faith and that the plan will feasibly put the business on the path toward financial health. However, a feasible reorganization plan may require restructuring the terms of various loans, including extending repayment schedules, decreasing interest rates, changing the value of collateral-securing loans, or reducing the principal owed on loans.
Creditors may object to these changes as they may cause creditors to receive less payment than anticipated. However, a bankruptcy court may approve a proposed reorganization plan if it provides a feasible path for the debtor business and treats all creditors fairly by not discriminating against similar classes of creditors.
Effects of a Cramdown for Creditors
A bankruptcy cramdown can affect creditors depending on whether they hold secured or unsecured debts. Secured creditors may fare better under a cramdown; although a cramdown can change the terms of a secured loan, such as reducing the interest rate or extending the repayment schedule, secured creditors still have the value of the collateral backing the loan. Conversely, unsecured creditors may receive partial repayment or no payment at all under a cramdown. As a result, creditors may decline to make future loans to businesses that have obtained a cramdown from the bankruptcy court.
Benefits of Cramdowns for Businesses
Although obtaining a business bankruptcy cramdown may cause some reputational damage for a business, cramdowns offer various benefits for companies restructuring their debts, including:
- Restructuring opportunities: A cramdown may allow businesses to restructure their debts and make them affordable under the company’s finances.
- Improved cash flow: Reducing debt burdens can relieve pressure on a company’s finances, allowing it to stabilize and invest in growth.
- Increased chances of long-term survival: A cramdown increases the likelihood of success in a reorganization plan and the chances that the business will exit bankruptcy in a financially healthy position.
Potential Challenges and Risks
Companies that seek a cramdown in Chapter 11 bankruptcy may face various challenges or risks during the process, such as:
- The need for court approval: A reorganization plan that proposes restructuring debts over creditors’ objections may be rejected by the bankruptcy court if it finds that the plan does not treat creditors fairly.
- Vigorous creditor opposition: Creditors may appeal a bankruptcy court’s order approving a cramdown plan, which can delay a struggling business’s reorganization and increase legal costs as parties litigate the appeal.
- Difficulties obtaining future financing: Creditors may look unfavorably upon businesses that have obtained a cramdown in bankruptcy as they may worry that if the business enters bankruptcy again, they may not receive full repayment of their loans.
- Possible liquidation: If the bankruptcy court refuses to approve a reorganization plan, the business may end up in liquidation bankruptcy due to the infeasibility of restructuring.
Contact a Bankruptcy Lawyer Today
When your business needs to file for bankruptcy restructuring, an experienced bankruptcy law firm can guide your company through the process. Call Bradford Law Offices today at (919) 758-8879 for an initial consultation with a Raleigh business bankruptcy attorney to discuss your business’s options in Chapter 11 bankruptcy, such as seeking a cramdown of your company’s debts to facilitate its reorganization.
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