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The Mysterious 1111(b)(2) Election

Why, when, and how a residential mortgage creditor should take
an 1111(b)(2) election in a Chapter 11 bankruptcy case.
By: Matthew L. Underwood, Esq.Brock & Scott, PLLC
As many secured creditors know, Chapter
11 bankruptcy cases often result in knockdown,
drag-out arguments over the value of property
securing their lien. This is because a debtor can
reduce a secured creditors lien down to the value
of the collateral securing that lien and grant the
creditor an unsecured claim for the difference.
The 11 U.S.C. 1111(b)(2) election can serve as
a benecial alternative to the property value battle
and can greatly benet the undersecured real
property creditor when appropriately used.

The Pine Gate Case

The often misunderstood and underutilized
1111(b)(2) election in Chapter 11 arose mainly
as a result of a decision in a Northern District of
Georgia case decided under the old Bankruptcy
Act of 1898, called In Re Pine Gate Associates,
Ltd.2 Bankr. Ct. Dec. (CRR) 1478 (Bankr. N.D.
Ga. 1976). In Pine Gate, the debtor obtained
two loans from two different lenders secured by
rst-priority mortgages on separate portions of
real property known collectively as the Pine Gate
Apartment Complex. The debtors plan proposed
to pay the secured lenders the appraised values of
their respective collaterals, which was signicantly
lower than the amounts owed. The court
conrmed the plan over the lenders strenuous
objections, holding that the proposed treatment of
a secured claim through a cash payment equal to
the appraised value of the collateral was reasonable
under the Bankruptcy Act as it then existed.
The Pine Gate decision was widely criticized
on the grounds that it forced a secured creditor
to solely bear the risk for any undervaluation
of property by the court as well as allow a
borrower to exclusively reap any benet from the
appreciation in value of the property after a plan
was conrmed. Congress took note, and in 1978
enacted 11 U.S.C. 1111(b). While 1111(b)
made numerous signicant changes to Chapter
11 bankruptcy practice across the country, most
important to this discussion is specically,
1111(b)(2). Simply put, 1111(b)(2) allows
an undersecured creditor to elect to have its
claim treated as fully secured, thereby foregoing
participation in any payout to unsecured creditors
under the plan.
How it Works the Mechanics of
the 111(b)(2) Election It Works
The most complex part of the 1111(b)(2)
election arises when calculating the payment
stream required for the now fully secured loan
resulting from the election. For a Chapter 11
plan to be conrmed and meet the Chapter 11
conrmation standards prescribed by 11 U.S.C
1129 et. seq., the present value of the electing
creditors stream of payments need only equal
the present value of the collateral, which is
the same amount that must be received by the

non-electing creditor,
but the sum of the
payments must be in
an amount equal to at
least the creditors total
claim. First Fed Bank
of Cal. v. Weinstein
(In re Weinstein), 227
B.R.284, 294 (B.A.P.
9th Cir. 1998). What
does this mean in
practice? It means that
when an undersecured
creditor elects to have
its claim treated as
fully secured under
1111(b)(2), it must
receive: (1) payments
in the aggregate that
equal its total allowed claim under 506 (i.e.
its loan payoff amount), and (2) payments that
have a present value of the collateral securing the
creditors claim (i.e., the appraised value of the
real property securing the creditors claim).
The best way to explain the mechanics of
the 1111(b)(2) election is by way of example.
Lets say Big Bank has an allowed claim for $2
million secured by real property appraised at $1
million and Big Bank doesnt like the debtors
proposed Chapter 11 plan treatment bifurcating
its claim into an unsecured claim for $1 million,
which will be paid at 10 percent of the total
claim, and a secured claim for $1 million, which
will be amortized over a new period at a less than
favorable interest rate. Big Bank decides to take an
1111(b)(2) election and now has a fully secured
claim in the amount of $2 million. Big Bank must
now receive a total of payments in the aggregate
that equal $2 million but whose present value
is $1 million. Thus, the debtor would be forced
to modify his plan treatment to something like
this to comply with the Chapter 11 conrmation
standard now that the 1111(b)(2) election has
been made: 360 monthly payments of $5,522.04
(this uses an amortizing balance of the collateral
value, $1 million, and assumes a market interest
rate of 5.25 percent), with a balloon payment of
$12,065.60 due on the 360th month. Specically,
the amortizing balance, $1 million, amortized over
30 years at 5.25 percent interest pays Big Bank a
total of $1,987,934.40, thus requiring a balloon
payment of $12,065.60 at the end of 360 months,
equaling an aggregate payment amount to Big
Bank of Big Banks total secured claim of
$2 million.

notice that the election

has been made. Rule
3014 of the Federal
Rules of Bankruptcy
Procedure requires that
the election be made
before the conclusion
of the hearing on the
Disclosure Statement
or at a date to be set
later by the Bankruptcy
Court. Rule 3014
further states that the
election must be made
in writing, signed by
a creditor or creditors
attorney and led
with the court, or the
election may be made
orally at the hearing on the Disclosure Statement.

Establishing a Timeline
The next procedural step when taking an
1111(b)(2) election is determining the time
frame for taking the election and, once you have
decided to take the election, how to put parties on

Matthew Underwood is a senior associate with Brock

& Scott, PLLCs, bankruptcy group.
Matt.Underwood@brockandscott.com
bankruptcy@brockandscott.com
704.369.0676

Should a Lender Take the Election?

The last and certainly most important question
when it comes to 1111(b)(2) is, When should
we use this option? Unfortunately there is no
mathematical formula in which a creditor can
plug numbers to determine if the election is a
good choice; however, there are some factors to
consider in making the decision. Arguably the most
important factor of all is the value of the property
securing the creditors lien as compared to the
total amount the debtor owes the creditor. If there
is a very large gap in that amount, and the loan is
signicantly underwater, it generally behooves
a creditor to take the election on the anticipation
that property values will increase as time goes on,
thus ensuring maximum return to the creditor.
However, a creditor should also consider the
amount it would receive as an unsecured creditor
under the plan terms if its claim were bifurcated
and the creditor were granted an unsecured claim.
If a plan proposes to pay unsecured creditors 75
percent of their respective claims within ve years,
then an 1111(b)(2) election would probably not
be a wise decision.
In summary, the 11 U.S.C. 1111(b)(2)
election is not a perplexing monster that creditors
should run from, but a frequently overlooked
useful tool. Often, the threat alone of an 1111(b)
(2) election is enough to coerce a debtor into
providing a more favorable plan treatment or even
into the surrender of the collateral, if thats what a
creditor wants. When dealing with a Chapter 11,
the 1111(b)(2) election is something that every
undersecured mortgage creditor should consider.

Legal League Quarterly 3