To What Extent May A Secured Lender's Pre-Petition Covenants With A Debtor Be Modified By Cramdown Loan Documents?

Section 1129(b) of the United States Bankruptcy Code (the "Code") empowers the bankruptcy court to confirm a Chapter 11 plan of reorganization over the objection of an impaired class of claims if the plan does not discriminate unfairly and is fair and equitable in its treatment of the objecting class; this process is generally referred to as "cramdown." Section 1129(b)(2)(A)(i) of the Code provides that an objecting secured creditor is treated fairly and equitably by a plan if (1) the creditor retains its liens to the extent of the allowed amount of the claim, and (2) the creditor receives deferred payments of a value at least equal to the allowed amount of the secured claim as of the effective date of the plan. Parties often contest whether the Till1 "prime-plus" formula1 should be applied in Chapter 11 cases, though that approach is applied as a default rule by a vast majority of bankruptcy courts.2 However, a more interesting question is whether a secured creditor that is crammed down may retain the protections afforded by pre-petition loan agreement covenants in the post-petition relationship.

Covenants to be included in post-petition loan documents are not required to precisely track with covenants in the parties' existing loan agreement. However, modifications must be fair and equitable and must not unduly shift the risk relating to the operations and financial performance of the debtor to the secured creditor. In American Trailer and Storage, Inc., 419 B.R. 412 (Bankr. W.D. Mo. 2009), the court established a balancing test to determine whether modification of pre-petition loan documents is appropriate. American Trailer & Storage, Inc. (the "Debtor") was in the business of buying, selling, renting, and leasing portable storage containers and semi-trailers. The Debtor proposed a plan of reorganization that eliminated a covenant from the original loan agreement that required the Debtor to maintain the same financial ratios that it had agreed to with Bank of the West (the "Lender") and a covenant that prohibited the Debtor from selling containers without the Lender's consent. The Lender argued that eliminating these covenants would essentially strip the Lender of its lien and result in nothing more than a naked security interest.

The court rejected the Lender's argument, and found that a determination of whether modification of loan documents is appropriate turns on (1) whether the proposed terms and covenants unduly harm the secured...