Cramming Down Taxi Medallions Loans in Chapter 11 Bankruptcy

One of the most common questions that we’re asked by clients who own “underwater taxi medallions” (where the value of the medallions is less than the amount of the loan secured by the medallions) that are owned by a corporation or a LLC is if we can “cram down” the taxi medallion loan in a chapter 11 bankruptcy filing. “Cram down” means that the bank/secured lender is required to accept less than full repayment of their loan.

If it were possible to cram down the average taxi medallion loan, the result would be advantageous to many taxi medallion owners–however, the reality is more complicated.

For purposes of illustration, let’s assume that a corporation or an LLC owns one medallion that is subject to a $700,000 bank loan and the medallion has a current value of $165,000. Section 506(a) of the Bankruptcy Code provides that the bank (secured lender) has a secured claim of $165,000 (the value of the medallion) and an unsecured claim of $535,000 ($700,000 less $165,000). In a typical chapter 11 case under this scenario, the secured portion of the lender’s claim would be paid the present value of $165,000 over the duration of the plan (which could be five or more years) and the unsecured portion of the claim would be paid pennies on the dollar (let’s assume for this example 10 cents on the dollar or $16,500). Accordingly, in the chapter 11 plan, the bank would be paid a total of $222,120.02 ($205,620.02 (the present value of $165,000 over five years at a discount rate of 4.5%) + $16,500) over the duration of the plan instead of $700,000.

The above scenario would be a wonderful result for the underwater taxi medallion owner, but it’s difficult to achieve. Section 1111 of the Bankruptcy Code governs claims and interests in a chapter 11 case and § 1129 pertains to the confirmation of a chapter 11 plan. With respect to the confirmation of a chapter 11 plan, the following needs to be noted:

In this author’s experience, about 10% of the chapter 11 bankruptcy filings for small businesses in the Southern District of New York are confirmed.

2.     

It’s an expensive process to file a chapter 11 bankruptcy.  The filing fee is $1,717, the debtor’s legal fees are approximately $20,000 to $25,000, U.S. Trustee quarterly filing fees must be paid and the debtor (medallion owner) needs to obtain insurance, set up debtor-in-possession bank accounts and file monthly operating reports with the U.S. Trustee’s office (necessitating the retention of an accountant or an accounting firm). 

3.     

To be confirmed, a chapter 11 plan must pass several tests.  One of these tests is the “best interest of creditors” test–creditors must not receive less in chapter 11 reorganization then they would if the case was filed as a chapter 7 liquidation. What that means is if the medallion is worth $165,000, then the secured creditor in a chapter 11 case must receive payments with a present value of $165,001. The plan proponent must also show “feasibility,” that the debtor will be able to make the payments required under the plan based on future earnings or assets or property that they own.

4.     

Section 1129(b)(2)(a) of the Bankruptcy Code provides three possibilities related to the “fair and equitable” test to “cram down” a secured creditor: (1) full payment of the claim through a new loan at market value interest secured by the pre–petition collateral (not possible in the present market for taxi medallions); (2) sell the collateral with liens attached in the proceeds of the sale (not possible for taxi medallion owners who wants to continue to own their medallion); or (3) they must give the secured creditor the “indubitable equivalent” of its claim (essentially, payment in full or abandonment of the collateral to the lender).

5.     

If the above obstacles to confirmation of a chapter 11 plan were not enough, there is yet another hurdle–§ 1111(b)(2)  of the Bankruptcy Code, which provides that if the loan was made on a non-recourse basis to the debtor, then the secured creditor can elect to have the full amount of their loan treated as secured (under our fact pattern to have their secured loan valued at  $700,000 not $165,000).  A non–recourse loan means that the loan documents provide that in the case of a foreclosure, the secured creditor is only able to obtain possession or seek recourse against the medallion and other collateral for the loan and not any other assets of the debtor.

Having reviewed the loan documents for many medallions, including the promissory note, the security agreement and the UCC-1 filing, it is this author’s experience that the vast majority of taxi medallion loans are non–recourse; accordingly, the secured creditor has the right and will be expected to make the §1111(b)(2) election. Moreover, since most taxi medallions are subject to a loan, the debtor must make loan payments and most medallions subject to a loan are not profitable, if the § 1111(b)(2) election is made, it will be almost impossible for an underwater taxi medallion owner to confirm a chapter 11 plan.

So, if the “cram down” of a secured creditor in chapter 11 bankruptcy isn’t possible, what is the underwater taxi medallion owner to do? We believe that the optimal strategy is to do the following: (1) retain an experienced attorney for asset protection planning (proactive legal action that protects your assets from future creditors, divorce, lawsuits or judgments); (2) engage in aggressive negotiations with the bank to refinance the loan or negotiate to surrender the medallion and other collateral for the loan; and (3) if the negotiations are unsuccessful, the taxi medallion owner (or guarantor) should consider filing for chapter 7 bankruptcy. Medallion owners who own underwater taxi medallions are encouraged to contact Jim Shenwick and arrange for a consultation to discuss the best solution for them. Jim Shenwick.