Appendix — United States v. Wabash Valley Power Ass'n, 117 S. Ct. 389 (1996) (No. 96-342)
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Supreme Court, U.S.
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496 342 auc 30 19%
In the Supreme Court of the United States
OCTOBER TERM, 1995
IN THE MATTER OF WABASH VALLEY
PowER ASSOCIATION, INC.
THE UNITED STATES OF AMERICA,
ON BEHALF OF THE RURAL ELECTRIFICATION
ADMINISTRATION, PETITIONER
ON PETITION FOR A WRIT OF CERTIORARI TO
THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
APPENDIX TO
PETITION FOR A WRIT OF CERTIORARI
WALTER DELLINGER
Acting Solicitor General
aia FRANK W. HUNGER
ep : Assistant Attorney General
PAUL BENDER
Deputy Solicitor General
> mi ¢ DAviD C. FREDERICK
ww |: r Assistant to the Solicitor
c> General
Be SR WILLIAM KANTER
x . An a JOHN P. SCHNITKER
+ Ne JOHN T. STEMPLEWICZ
4 Attorneys
=~ Department of Justice
an LD Washington, D.C. 20530
<a (202) 514-2217
J
JAV
TABLE OF CONTENTS
Page
Appendix A (court of appeals’ opinion dated
Mar. 21, 1996) .............sccccsssccesseeseeeneeeseserseeneeneeeeeees la
Appendix B (district court’s opinion dated
June 28, 1994) .......ccccccssecceeecereeeesseeeeeeeneneeseseeeeeeeeees 43a
Appendix C (bankruptcy court’s order, findings of
fact and conclusions of law dated Aug. 7, 1991) ...... 58a
Appendix D (court of appeals’ order denying
rehearing dated Apr. 2, 1986) ..... nhisscanpunnbiadenebintons 229a
Appendix E (statutory provisions involved) ................- 23la
Appendix F (debtor Wabash Valley Power Association,
Inc.’s third restated fourth amended plan of
YEOPZANIZATION) ........eeeesseeeeeeenee seeeeetenersneneesenentenees 24la
APPENDIX A
UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT
Nos. 94-3086, 94-3087, 94-3088 and 94-3095
IN THE MATTER OF WABASH VALLEY POWER
ASSOCIATION, InCORPORATED, DEBTOR-APPELLEE.
APPEAL OF UNITED STATES OF AMERICA,
On BEHALF OF THE RURAL ELECTRIFICATION
ADMINISTRATION
{Mar. 20, 1996]
As AMENDED ON DENIAL OF REHEARING AND
SUGGESTION FoR REHEARING EN BANC
Before: CUDAHY, COFFEY and MANION, Circuit
Judges.
Cupany, Circuit Judge.
This case had its origins in the cancellation of a
partially completed nuclear power plant—the Marble
Hill project in Jefferson County, Indiana. The Marble
Hill project was undertaken by Public Service Com-
pany of Indiana (now PSI Energy, Inc.) (PSI). Wabash
Valley Power Cooperative (Wabash), a generation-
and-transmission cooperative serving 24 rural
(la)
2a
electric membership cooperatives (Members or distri-
bution co-ops) purchased a 17% interest in the project.
It borrowed the funds for this purpose with the aid of
a loan guarantee from the Rural Electrification
Administration (REA). After an expenditure of $2.9
billion, PSI decided to cancel the Marble Hill project
in 1984. At that time, Wabash had invested $460
million in the defunct plant. Upon the cancellation,
Wabash filed suit against PSI (83% owner of Marble
Hill) and the architect-engineer of the project, Sar-
gent and Lundy Engineers (S & L).
At that point the problem was similar to that
presented elsewhere by other nuclear plant abandon-
ments or cost overruns. Who pays: the stockholders
of an investor-owned utility, the ratepayers of almost
any utility or, if there is very little or no equity (as
may be the case with a cooperative utility), the se-
cured and unsecured creditors? For example, in the
case of the extremely costly Seabrook Plant, jointly
owned by Public Service Company of New Hampshire,
the stockholders and ratepayers shared the burden of
the company’s bankruptcy. The company obtained a
rate increase covering only a fraction of the Seabrook
Plant’s cost overruns. In re Public Serv. Co., 114
B.R. 820 (Bankr.D.N.H.1990). In the case of the
Shoreham Plant on Long Island (owned by the Long
Island Lighting Company), the ratepayers apparently
contributed something by way of a series of rate
increases to keep the company out of bankruptcy
when the plant was decommissioned. Citizens for an
Orderly Energy Policy, Inc. v. Cuomo, 159 A.D.2d
141, 559 N.Y.S.2d 381 (1990), affd 78 N.Y.2d 398, 576
N.Y.S.2d 185, 582 N.E.2d 568 (1991). In the Duquesne
Light Company case, the Pennsylvania Commission
allowed amortization over a ten-year period of the
3a
sunk costs of certain abandoned nuclear plants, but
the Pennsylvania Supreme Court reversed on the
grounds that the plants were never used and useful in
the public service. Barasch v. Pennsylvania Public
Util. Comm’n, 516 Pa. 142, 582 A.2d 325 (1987), aff'd
sub nom. Duquesne Light Co v. Barasch, 488 U.S.
299, 109 S.Ct. 609, 102 L.Ed.2d 646 (1989). The utility
company then appealed to the United States Supreme
Court, claiming confiscation, but the Court affirmed,
primarily on the ground that the same impact on
allowable revenue could have been achieved by a small
adjustment in the allowed rate of return on equity.
Duquesne Light Co. v. Barasch, 488 U.S. 299, 109
S.Ct. 609, 102 L.Ed.2d 646 (1989). Following the
principle established in Federal Power Comm'n v.
Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88
L.Ed. 333 (1944), the Court held that the particular
route followed in the ratemaking process did not raise
constitutional problems so long as the “end result”
was fair. Thus, commissions and courts have followed
differing paths in accounting for defunct or high-cost
nuclear plants.
In the present case, at the time of the Marble Hill
cancellation Wabash attempted to restructure its
REA indebtedness and; at REA’s insistence, filed for
a 51% electric rate increase before the Indiana
Utility Regulatory Commission (the I[URC) (for-
merly the Public Service Commission of Indiana).
This rate hike was denied based on Citizens Action
Coalition, Inc. v. Northern Indiana Public Service
Co. (NIPSCO), 485 N.E.2d 610 (Ind.1985), cert. denied,
476 U.S. 1187, 106 S.Ct. 2239, 90 L.Ed.2d 687 (1986)
which had denied a similar increase to NIPSCO on
the grounds that a canceled plant was not “used and
useful” in the public service. In re Wabash Valley
4a
Power Ass’n, Inc., Cause No. 37472, 1987 WL 257474,
1987 Ind. PUC LEXIS 415 (Ind. Pub. Serv. Comm’n
1987). On appeal, the Indiana Supreme Court reaf-
firmed the principles enunciated in its NIPSCO
decision, denying the rate increase on the ground that
Marble Hill had never become used and useful in the
public service. National Rural Utils. Coop. Fin.
Corp. v. Public Serv. Comm’n, 552 N.E.2d 23 (Ind.
1990).
Cut off from relief at the hands of Indiana
regulators and courts, REA sought to preempt state
law and to take the rate increase decision into its own
hands. It tried to do this first by a letter directed to
Wabash and later by a notice-and-comment rule-
making. These efforts at preemption were rejected by
this court, in its decisions in Wabash Valley Power
Ass’n v. Rural Electrification Admin., 903 F.2d 445,
452-54 (7th Cir.1990) (Wabash I) and Wabash Valley
Power Ass’n v. Rural Electrification Admin., 988
F.2d 1480, 1488-91 (7th Cir.1993) (Wabash IT), respec-
tively. It is important to an understanding of the
difficult bankruptcy questions involved here that all
the efforts of REA to recoup its defaulted loan
through a Wabash rate increase have failed and that
there appears to be no further recourse in this
direction, except arguably for a 4% “viability” in-
crease to finance the reorganization plan approved by
the bankruptcy court here.
In this connection, we note that Wabash has 22
Member distribution cooperatives in Indiana, organ-
ized as not-for-profit corporations, pursuant to the
Indiana Rural Electric Membership Corporation Act,
Ind.Code §§ 8-1-13-1 et seg. (1995). Wabash itself was
formed under the Indiana Not-For-Profit Corporation
Act, Ind.Code §§ 23-7-1-1 et seq. (repealed 1971, similar
5a
provisions now at §§ 23-17-1-1 et seq.). As a not-for-
profit corporation Wabash cannot pay any earnings or
dividends to its members, and upon dissolution any
assets remaining after payment of debts escheat to
the state. Ind.Code § 23-17-30-1 (1995). Wabash also
has one Member cooperative in Michigan and one in
Ohio. Each Member is owned and controlled by its
customers, retail buyers of electricity. Wabash was
formed in 1962 to provide its Members with a reliable
and reasonably priced wholesale power supply.
Wabash is governed by a Board consisting of one
director from each of its 24 Members. Before Wabash
began supplying its Members with electric power, the
Members received power directly from one of four
adjacent investor-owned utilities—PSI, Northern
Indiana Public Service Company (NIPSCO), Indian-
apolis Power and Light Company (IPL) and Indiana &
Michigan Electric Company (I & M) (the 1OUs).
In 1977, Wabash entered into 40-year wholesale
power requirements contracts with its Members (the
Supply Contracts) and subsequently took an assign-
ment of the Members’ existing power supply con-
tracts with the adjacent IOU’s. The Supply Con-
tracts provide that (1) Wabash’s rates shall produce
revenues sufficient, but no more than sufficient, to
pay operating expenses, taxes, etc., and to provide
reasonable reserves; (2) rates must be pre-approved by
the Wabash Board (which represents the Members);
and (3) all rate requests are “subject to the approval”
of the Indiana Commission.! The IURC requires any
1 The rates charged by Wabash to one of its Member
cooperatives (Fruit Belt) are regulated by the Michigan Public
Service Commission. A Settlement Agreement with respect to
6a
excess of Wabash’s revenues over its expenses and
replacements to be credited to its Members.
As noted, efforts to restructure the REA indebted-
ness following the cancellation of Marble Hill were
unsuccessful, and in 1985 the United States Depart-
ment of Justice asserted the possibility of personal
liability of the Wabash directors. Shortly thereafter,
Wabash filed under Chapter 11 of the Bankruptcy
Code. As of the bankruptcy Petition Date, Wabash
owed REA approximately $130 million related to non-
Marble Hill assets and about $540 million related to
Marble Hill for a total of $669,058,454.25 in principal
and interest.
Subsequent to the Petition Date, Wabash voluntar-
ily paid REA $36,444,964.22 in non-Marble Hill debt
service payments. After June of 1988 Wabash made
these debt service payments into an escrow account
entitled the Timbers Account. In 1990, pursuant to an
order of the bankruptcy court, Wabash paid REA an
additional $28,928,693.22 from the Timbers Acccunt.
Order Granting United States’ Motion for Abandon-
ment of Monies in Escrow Account. Bankr.Rec.Doc.
6 (hereinafter Timbers Order). As of the Petition
Date, Wabash also owed about $35 million to the
National Rural Utilities Cooperative Finance Corpo-
ration (CFC), of which about $12 million has been
paid. The REA debt and most of the CFC debt are
secured by a pre-petition joint mortgage and security
agreement (REA mortgage) covering most of
Wabash’s assets. PSI has also filed certain unsecured
claims against Wabash, most of them related to
Marble Hill.
rate design between Wabash, Fruit Belt and the staff of the
Michigan Commission was entered into on September 4, 1991.
Ta
A settlement has been reached between Wabash and
PSI, contingent upon confirmation of the Wabash
Plan (or some other consensual resolution of the
bankruptcy case) (the PSI Settlement). That settle-
ment provides, inter alia, for payments by PSI to
REA and to CFC having a present value of $170
million. The PSI Settlement also provides that any
plan filed by Wabash shall allow PSI’s “indemnifica-
tion” claim in the amount of $466,017.00 and that PSI
will forego payment of its remaining claims. The
bankruptcy court found, there being no dispute, that
the PSI Settlement was fair and reasonable, and that
the payments worth $170 million were contingent on
confirmation of the Wabash Plan. A settlement with
S & i, to which REA did not object, was also found to
be fair and reasonable.
In order to reach an appropriate disposition of the
bankruptcy proceeding, the bankruptcy court deter-
mined the value of Wabash, both as a going concern
and upon liquidation, and evaluated the claims of the
secured and unsecured cred:tors. The court also con-
sidered reorganization proposals submitted by both
Wabash and REA.
Initially, after a hearing, the bankruptcy court
undertook to determine Wabash’s going-concern
value. Its decision on this point was, however,
remanded by the district court for the taking of fur-
ther evidence on the prospects of a rate increase for
Wabash and also on the question whether such an
increase would invalidate the Supply Contracts.
National Rural Utils. Coop. Fin. Corp. v. Wabash
Valley Power Ass’n, Inc., 111 B.R. 752 (S.D.Ind.1990),
rev’g and rem’g 77 B.R. 991 (Bankr.S.D.Ind.1987).
Further hearings were held on these issues as well as
8a
on the appropriateness of the reorganization plan
proposed by REA and the one submitted by Wabash.
The REA Plan was rejected inter alia because it
required substantial rate increases—not realistically
to be anticipated. In re Wabash Valley Power Ass’n,
Findings of Fact and Conclusions of Law on
Confirmation of Debtor's Third Restated Fourth
Amended Plan of Reorganization and Denying
Confirmation of REA’s Plan, No. 85-2238-RWV-11,
slip op. at 145-73 (Bankr.S.D.Ind. August 7, 1991)
(hereinafter Bktcy.Op.). The REA Plan provided for
full payment (including post-petition and _post-
confirmation interest) to REA and to CFC over a 37-
year period. REA estimated that the debt to it and to
CFC totaled $1 billion. Under the REA Plan, REA
and CFC were to take control of Wabash and elect its
Board of Directors. As discussed infra, this action
would presumably breach the Supply Contracts and
render them unenforceable. The REA Plan also
provided that Wabash might be liquidated at any time,
at the discretion of the REA. The bankruptcy court
held that the REA Plan violated 11 U.S.C. § 365
because it provided for the partial assumption of the
Supply Contracts without giving effect to their
express provision recognizing rate regulation by the
IURC and without honoring their implied provision
requiring Member control of the Wabash Board.
Under 11 U.S.C. § 365, an entire contract must be
assumed including any burdensome provisions that it
may have. See In re Chicago, RI. & P. Ry. Co., 860
F.2d 267, 272 (7th Cir. 1988). In addition, the REA
Plan purported to adopt the PSI Settlement, even
though that Settlement was contingent on confirma-
tion of the Wabash Plan. REA has not appealed the
rejection of its Plan.
9a
The Wabash Plan, Wabash Valley Power Ass’n,
Inc.’s Third Restated Fourth Amended Plan of
Reorganization, Bankr.Rec.Doc. 154, has been ap-
proved by both the bankruptcy court, Bktcy.Op. at
112-45, and the district court, Jn re Wabash Valley
Power Ass’n, No. IP 91-928-C (S.D. Ind. June 28, 1994)
(hereinafter Dist.Op.), and is the subject of this appeal
by REA. The approval was based primarily on the
bankruptcy court’s findings of fact regarding
Wabash’s value in various circumstances. Bktcy.Op.
at 16-101.
The stipulated liquidation value of Wabash’s tangi-
ble, useful assets is $175 million and of its Marble Hill
assets is $29.8 million. The bankruptcy court pro-
perly found that the liquidation value of the PSI
Settlement was zero because of its contingent nature
and its assumption that Wabash would continue to buy
power from PSI in the future. The S & L Settlement
was also properly found to have zero liquidation value.
The bankruptcy court found that the Supply Con-
tracts, under which the Members took power from
Wabash, had no value in liquidation. This finding was
based in part on the testimony of law professor, Ian
MacNeil, that, other than the right to fully-earned
payments, Wabash’s rights under these contracts
were not assignable nor were Wabash’s principal
duties delegable. There is thus substantial evidence
in the record that the Supply Contracts have no fair
market value if Wabash is liquidated. The finding of
the bankruptcy court that the total liquidation value
of Wabash (valuing the PSI and S & L Settlements,
the Supply Contracts and other contract rights at
zero) amounts to $213,210,000 is not clearly errone-
ous. Even giving full value to the PSI and S & L
Settlements (a procedure rejected by the bankruptcy
10a
court) the total value recoverable by a Wabash trustee
on liquidation would be less than $400 million.
The bankruptcy court also determined Wabash’s
fair market value as a going concern and thereby
fixed the amount of the secured claim held by REA
and CFC. Based primarily on Professor MacNeil’s
testimony, the bankruptcy court determined that the
Supply Contracts would be breached and rendered
unenforceable by Wabash if regulatory authority
were transferred from the IURC, if the Members lost
control over Wabash or if rates in excess of Wabash’s
costs were charged. The Contracts themselves pro-
vide that the seller of the electricity may not make a
profit. They expressly provide that only Wabash’s
Board (comprised, according to its Bylaws, of Member
representatives) may request a rate change and all
rate changes are subject to IURC approval. [URC
regulations in turn provide that any excess of reve-
nues over expenses and over a limited reserve must be
credited against fuel adjustment charges.
Any transfer of control of Wabash away from the
Members would thus nullify their purchase obligation
under the Supply Contracts. Once discharged from
their purchase obligation under the Supply Con-
tracts, the Members would be free to take their
business elsewhere if rates were raised to a profit-
creating level. The Members would be especially
inclined to depart since they presently maintain
physical connections with the very investor-owned
utilities from which Wabash purchases power.”
2 Although not developed in the record below, we can take
judicial notice that a trend toward competition is running
strong in the electric utility industry—which at some point
may make it even more difficult to maintain substantial rate
ee ee
lla
Assuming inability to obtain a rate increase and a
need to renegotiate the Supply Contracts in the
context of easy access to competitive power from the
four adjacent IOUs, Wabash presented testimony as
to its going-concern value based on sale to a profit-
motivated IOU with the existing customer base of 24
distribution co-ops. The bankruptcy court found that
any benefits that an investor-owned utility could
realize from acquiring Wabash would be tightly
constrained by the need to renegotiate the Supply
Contracts.’ It also found that no prospective buyers
had actually appeared (except PSI and the terms of its
offer were not disclosed by REA). Further, there was
little prospect of another not-for-profit cooperative
seeking to buy Wabash since no such entity could
realize an economic benefit from doing so. The
testimony, using a cash flow approach and a 10.2%
discount rate arrived at a going-concern valuation,
differentials between utilities in adjoining service territories.
See, e.g., Peter Passell, A Makeover for Electric Utilities:
Power Industry, Facing Competition, Struggles With Change,
N.Y. Times, Feb. 3, 1995 at D1; Irwin Stelzer, Restructuring
the Electric Utility Industry: Further Tentative Thoughts, 7
Electricity Journal 36 (Oct. 1994).
3 Because Wabash’s generation of electricity is relatively
meager, it serves primarily as a bulk purchasing agent for its
Members. The Members presumably bear the expense of coor-
dinating their purchasing efforts through Wabash only because
they can reap the benefits of potentially lower rates. Even if
the necessary rate increases could have been obtained, the
Members would be unlikely to renegotiate the Supply Con-
tracts with a “for profit Wabash” on any basis allowing more
ample recovery by REA. A far likelier scenario, if the Supply
Contracts were breached, would have Wabash’s member coop-
eratives simply returning to the practice of direct purchases
from the adjacent investor-owned utilities.
12a
and fair market value, of $190,000,000. This value
produced a market-to-book ratio that was consistent
with ratios of stock value to asset book values of
comparable electric utilities. The bankruptcy court
found $190 million to be a maximum going-concern
and fair market value and that finding is not clearly
erroneous.
The value of Wabash to its Members exceeds its
value to any third-party buyer because Wabash is
tailored exactly to the Members’ requirements. Dr.
Wilbur G. Lewellen testified with respect to the total
value of Wabash to its Members based on cost savings
they realize in buying Wabash power as opposed to
direct purchases from the adjacent IOUs. The
measurement of the cost savings to the Members of
using Wabash involved a study of power costs with
and without Wabash. Lewellen used a 13% discount
rate as applied to cost savings of $69.4 million and
added the debt associated with Wabash’s operating
assets to reach a total value to the Members of $221.7
million. The bankruptcy court accepted this testi-
mony and this finding is not clearly erroneous.
According to the bankruptcy court, the $190 million
going-concern value represents the amount the se-
cured creditors could expect to receive following a
sale of Wabash to a third party as a going concern and
satisfies the requirements of 11 U.S.C. § 506(a) and §
1129(b)(2)(A). Using this going-concern value of $190
million, and adding the PSI Settlement of $170
million, the S & L Settlement of $15 million, Marble
Hill assets, investment accounts, CFC investments
and vehicles, the bankruptcy court arrived at a total
value of Wabash’s assets for purposes of 11 U.S.C. §
506(a) and § 1129(b) of approximately $431.9 million.
Based on this value, REA and CFC were found to be
13a
undersecured, with the secured portion of REA’s
claim valued at approximately $400 million.
The bankruptcy court found that the value to the
Members of $221.7 million was also relevant to the
confirmability of the plan because it defined the
maximum amount which could possibly be made
available to creditors. The Wabash Plan provides for
a “viability” rate increase (enabling a reorganization
plan to be approved) from the IURC based on this
value to the Members. This rate increase will allow
Wabash to satisfy a fraction of the unsecured claims,
assuring that creditors are receiving the maximum
amount possible for purposes of 11 U.S.C. §
1129(b)(2)(B). The bankruptcy court found it reason-
able (because of benefit to ratepayers) to expect that
the IURC would approve a “viability” rate increase to
Wabash. This would enable Wabash to pay $221.7
million to REA and CFC and thereby come out of
bankruptcy. Under the Wabash Plan, based on
Wabash’s value to its Members, REA is to receive a
total of $430,639,122.00 (including funds from the PSI
_and S & L Settlements) in addition to the $36.4 mil-
lion that Wabash voluntarily paid REA after the
Petition Date. CFC is to receive $26,207,506.00 in
addition to the $12 million that Wabash voluntarily
paid CFC subsequent to the Petition Date. PSI is to
receive $466,017.00 payable in equal installments over
five years without interest. The Members’ unsecured
claims for patronage capital (totaling $7,184,740.07)
are to be reduced to the same extent that the unse-
cured portions of the claims of REA and CFC are not
honored.
The Wabash Plan also provides that Members are to
make capital contributions to Wabash of $3,213,346.00
payable in cash or through rates over 12 months.
l4a
This sum is intended to form a part of the amount
allowed as a capital reserve in Wabash’s 1983 rate
ease. Article IX of the Wabash Plan contains the
essential provision that Wabash is to assume the
Supply Contracts with its Members in order to
generate the revenues necessary to fund the Plan.
This assumption will obligate the Members to fulfill
all their obligations under the Contracts and will
entitle them to all the benefits of the Contracts in-
cluding the right to name Wabash’s Board of Direc-
tors. REA and CFC voted to reject the Wabash Plan.
PSI, also an impaired creditor, and almost all the
Members voted to accept it.
The bankruptcy court found that the Wabash Plan
provided the maximum amount that REA and CFC
could possibly obtain. It met the requirements of 11
U.S.C. § 1129(b) and was confirmable. All objections
to the Wabash Plan were denied and the Wabash Plan
was confirmed.
On appeal, REA raises numerous objections to the
Wabash Plan. Because the Plan is being affirmed over
REA’s objection it must satisfy the requirements for
“cramdown.” “Cramdown” is the procedure for ap-
proving a reorganization plan in the face of creditor
resistance. It requires that at least one class of
impaired creditors approve the plan and that the plan
satisfy the absolute priority rule, which precludes the
payment of junior claims as long as senior claims
remain unsatisfied. REA contends on appeal that the
Wabash Plan fails to meet these requirements. It also
argues that the valuation performed by the bank-
ruptecy court underestimates the value of REA’s
secured claim in two respects: first, it offsets the
money paid into the Timbers Account against REA’s
secured claim, and second, it values the security
Feet AO pee tt eats te eens ae he
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15a
interest at the going-concern value rather than at the
“value to the Members.” We address these issues
below, and find, although some close questions are
presented, that the Wabash Plan was properly upheld
by the district court.
ABSOLUTE PRIORITY RULE
The most significant obstacle to confirmation of the
Wabash Plan is the question of its compliance with
the “absolute priority rule.” As codified for the first
time in the Bankruptcy Code, the rule provides that,
in order for a bankruptcy plan to be approved in the
face of the refusal of an unsecured creditor to accept
it (a “eramdown”), the holder of any claim or interest
junior to that of the dissenter may not “receive
or retain under the plan on account of such junior
claim or interest any property.” 11 U.S.C. §
1129(b)(2)(B)(ii).
The rule thus stated has three components: (1) the
identification of junior claims or interests; (2) the
identification of any property retained by the holders
of such claims or interests; and (3) the determination
whether the property is retained “on account of” a
junior claim or interest. The term “interest” in this
context means equity interest. See, e.g., 5 Collier on
Bankruptcy, § 1122.08[3] (15th ed. 1994). (“A plan of
reorganization must separately classify nonpriority
prepetition unsecured claims, priority claims, se-
cured claims, including secured setoff claims, and
equity interests.”).
The difficulty in resolving the absolute priority
problem in the case before us primarily reflects the
unusual structure of the entities involved. Not one of
the players in this drama is typecast. The corpora-
tion undergoing bankruptcy is a not-for-profit coop-
16a
erative. The creditor is not a private lender but a
federal agency.
Wabash’s Members are not owners in any usual
sense of the term. By design, “in a co-operative asso-
ciation the concept of profit is inappropriate, because
profit, in its recognized economic sense, is the wage
of the entrepreneur, and in a co-operative there is no
entrepreneur.” Emmanuel 8. Tyson, Annotation, Co-
operative Associations: Rights in Equity Credits or
Patronage Dividends, 50 A.L.R.3d 435 (1995). Pursu-
ant to state law and the rules of the co-operative,
Wabash Members receive no profits, nor do they have
any current or prospective ownership rights in the
corporate assets. Under Indiana law any assets re-
maining to the cooperative after a liquidation or
dissolution escheat to the state. Bktcy.Op. at 8, citing
Ind.Code §§ 23-7-1.1-4(c), 14(a), and 33(b)(3)(E) (re-
pealed 1991, similar provisions now at §§ 23-17-1-1 et
seq.). Indeed, almost the only prerogative Members
share with shareholders in an ordinary business
corporation is the right to elect a board of directors.
The primary benefit to the members of an electric
co-operative accrues to them in their role as custom-
ers with access to electric power at favorable rates.
These rates, in Wabash’s case, are largely controlled
by Indiana regulations and must be approved by state
authorities. State law requires that ratepayers pay
only the cost to produce the electricity they
purchase. Cooperatives are arguably able to offer
lower rates, primarily because they are so
constituted that profit or return to equity is not part
of their cost to produce and they can borrow money at
low interest rates.
Given all of this, it is small wonder that the rules
of Chapter 11 bankruptcy, primarily designed as they
ee ee an ene en ae re ea
17a
are for profit-seeking enterprises, are less than
straightforward to apply here.
L The Absolute Priority Rule—Background
In its origins, the absolute priority rule was a
judicial invention designed to preclude the practice in
railroad reorganizations of “squeezing out” inter-
mediate unsecured creditors through collusion be-
tween secured creditors and stockholders (who were
often the same people). Northern P. Ry. Co. v. Boyd,
228 U.S. 482, 33 S.Ct. 554, 57 L.Ed. 931 (1913). See
also, e.g., John D. Ayer, Rethinking Absolute Prior-
ity after Ahlers, 87 Mich.L.Rev. 963, 969-73 (1989)
(discussing the history of the absolute priority rule).
The rule was thus devised primarily to deal with a
situation of overlapping ownership and creditor inter-
ests.
More recently, however, courts have dealt with a
second type of overlap—that between owner and man-
ager or employee. Most of these cases seem to involve
either farmers or owners of close corporations. See,
e.g., Norwest Bank Worthington v. Ahlers, 485 USS.
197, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988); Case v. Los
Angeles Lumber Products Co., 308 U.S. 106, 60 S.Ct.
1, 84 L.Ed. 110 (1939); In re Stegall, 865 F.2d 140 (7th
Cir.1989); Unruh v. Rushville State Bank, 987 F.2d
1506 (10th Cir.1993); In re Snyder, 967 F.2d 1126 (7th
Cir.1992); Kham & Nate’s Shoes No. 2, Inc. v. First
Bank of Whiting, 908 F.2d 1351 (7th Cir.1990). These
eases deal with the situation in which an equity
owner also performs important functions in running
the business—contributing intangibles such as labor,
reputation and experience. These owner-managers
have, in these and other cases, argued that they
should retain an ownership interest in the reorgan-
ie Ol inhaled ee cciickitn # A
18a
ized corporation, not on account of their past owner-
ship per se, but in exchange for a promise to contrib-
ute their labor and managerial skills to the future
running of the corporation. ,
Courts have taken a dim view of such exchanges
and the Supreme Court in Ahlers roundly rejected
the contention that such contributions may justify
the retention of an ownership interest in the face of
creditor disapproval. 485 U.S. at 204-05, 108 S.Ct. at
967-68. In rejecting these attempts the courts have
cited the difficulty of valuing and enforcing these
intangible contributions and have also been reluctant
to overrule the creditors’ view that retention of
management is not worth what it may cost. 485 U.S.
at 204-07, 108 S.Ct. at 967-69; 908 F.2d at 1359-60; 865
F.2d at 142.
At the same time, however, in recognition of the
fact that prior owners may sometimes be the best
“buyers” of a reorganized corporation, courts are
reluctant to squeeze the old owners out entirely. 967
F.2d at 1130. This reluctance is especially evident
when the debtor is a closely held corporation or a sole
proprietorship. This tension has been a driving force
behind the development of the new value “exception”
which allows old owners to retain equity if they
contribute new value in the form of “money or
money’s worth” which is “necessary” to the reor-
ganization and “reasonably equivalent” to the inter-
est they retain. 308 U.S. at 121, 60 S.Ct. at 10; Jn re
Potter Material Serv., Inc., 781 F.2d 99, 101 (7th
Cir.1986).
With the codification of the absolute priority rule,
the continued validity of the new value exception has
been questioned, with some authorities arguing it is
no longer valid because it does not appear expressly in
19a
the Code. Other decisions simply assume its contin-
ued validity as part of the context within which Con-
gress enacted the Bankruptcy Code. Still others have
suggested that it is not an exception at all, but simply
a concrete example of an interest which is retained
not “on account of’ a prior interest but for other
reasons. See, e.g., Julie L. Friedberg, Wanted Dead
or Alive: The New Value Exception to the Absolute
Priority Rule, 66 Temple L.Rev. 893 (1993); Clifford
S. Harris, A Rule Unvanquished: The New Value
Exception to the Absolute Priority Rule, 89
Mich.L.Rev. 2303 (1991) (assessing the continued
vitality of the new value exception and collecting
eases). See also, In re Bonner Mall Partnership, 2
F.3d 899 (9th Cir.1993) (discussing various approaches
to the new value exception and upholding its contin-
ued validity). The question has been left open by the
Supreme Court and by this circuit, see Kham &
Nate’s Shoes, 908 F.2d at 1362 and In re Snyder, 967
F.2d at 1130-31, and there is no need to decide it here.
In an attempt to satisfy the new value exception,
the Wabash Plan provides for its Members to con-
tribute $3.2 million to Wabash in new capital (to
support ongoing utility operations). The bankruptcy
court found that this contribution exceeds the value
of any interest the Members might be retaining or
receiving under the Plan. The bankruptcy court also
found that this contribution qualified the arrange-
ment for invocation of the new value exception. As
noted, we will not address this issue here.
The common thread running through cases involv-
ing the absolute priority rule is a refusal to allow
prior equity owners to trade on their “insider” status
to acquire new equity for less than its value. The
situation we examine here appears to involve a
20a
similar sort of confluence of interests since the Mem-
bers are both customers and controllers of the corpo-
ration. However, our analysis must differ substan-
tially from that followed in many other cases because
a member of a non-profit cooperative occupies a posi-
tion different from that of a stockholder of a business
corporation. Because of the way in which the rights
of Members of Wabash are constrained both by state
law and by the organization’s own bylaws, we believe
that the Members may continue in control of the reor-
ganized co-operative without violating the absolute
priority rule. Beyond complying with the rule, this
outcome also seems to make economic sense, since it
maximizes the value available to meet creditor claims.
II. Application of the Absolute Priority Rule to the
Wabash Pian
REA contends that the Wabash Plan violates the
absolute priority rule in two ways. First, REA
argues that certain “patronage capital accounts,”
which previde a credit to customers for the amount by
which rates exceed fluctuating costs, are not claims,
as they are classified in the Wabash Plan, but are,
instead, equity interests. REA thus argues that the
Members may not, under the absolute priority rule,
receive any part of the amounts credited to them. As
classified by Wabash, the accounts are claims and are
not junior to REA’s unsecured claim. If this classifi-
cation is correct, they may be paid to the same extent
as other unsecured debt. Equity interests, on the
other hand, would be subordinate to REA’s unsecured
debt, which is not fully paid under the Plan. Payment
with respect to equity interests would violate the
absolute priority rule. We find, however, that the
patronage capital accounts give rise to claims and
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2la
may be paid as the Wabash Plan prescribes. The Plan
contemplates payment of these claims in the same
proportion as other unsecured debt is paid.’
Second, REA argues that the control over the
reorganized cooperative (and thereby over the rates
paid by Members) which the Members will exercise by
virtue of their continued Board representation is
property which the Members “retain on account of”
their prior interests in the organization. We believe,
however, that Wabash Members do not hold equity
interests in the cooperative. It is therefore impossi-
ble for them to retain any property “on account of”
such interests.
A. Patronage Capital
The cooperative Members are classified under the
Wabash Plan as holding “claims” for the reimburse-
ment of “patronage capital.” Wabash Plan at §§ 3.11
and 3.12. Because of the difficulty of anticipating
exactly what the costs of producing power will be,
utilities sometimes collect excess revenues. State
law requires that customers be reimbursed for these
overcharges. Ind.Code § 8-1-13-17(d) (1995). Patron-
age capital is a somewhat misleading term which
refers to a portion of this excess revenue which the
Wabash Bylaws allow it to retain in order to cover
fluctuations in production costs and to make capital
expenditures without having first to raise rates and
4 REA contends that, even if the patronage capital ac-
counts are claims, they are junior to REA’s unsecured claim.
REA Brief at 21, n. 14; 41, n. 27. The only one of its arguments
which is relevant here is that patronage capital, whether a
claim or an interest, is only payable at dissolution if other
creditors are paid in full. The case cited to support this
contention is not in point and REA cites no other authority.
22a
accumulate the necessary funds. Because the Mem-
bers must eventually be reimbursed for overcharges,
however, the “patronage capital” funds are credited to
individual cooperative Members in amounts propor-
tional to their purchases of electricity. | Wabash
Bylaws, Art. VII, Sec. 2. The timing of repayment of
these overcharges is left to the discretion of the
Wabash Board. Transcript of Confirmation Hearing,
Jan. 3, 1990, Testimony of Edward P. Martin, p. 24.
REA argues that these accounts are not claims but
rather equity interests junior to REA’s unsecured
claims, and that the payment of any portion of these
amounts, as envisioned in the Wabash Plan, violates
the absolute priority rule. The district court, affirm-
ing the bankruptcy court, held, however, that these
accounts were correctly classified as claims, the
proportionate payment of which under the Wabash
Plan is not a violation of the rule. Dist.Op. at 7-10.
Although this is an extraordinarily elusive question,
we agree.
The definition of “claim” under the bankruptcy code
is very broad, encompassing any “right to payment,
whether or not such right is reduced to judgment,
liquidated, unliquidated, fixed, contingent, matured,
unmatured, disputed, undisputed, legal, equitable,
secured, or unsecured.” 11 U.S.C. § 101(5)(A). Thus
the fact that the patronage capital accounts are not
payable at a specified time or under specified condi-
tions does not foreclose their treatment as claims for
bankruptcy purposes.’
5 Cases cited by REA which resolve disputes about the
redemption of patronage capital accounts upon the bankruptcy
of a member are distinguishable. Besides presenting different
substantive issues, these cases involve agricultural cooperatives
23a
In reaching this conclusion we have carefully con-
sidered the opinion of the bankruptcy court in Jn re
Eastern Maine Electric Coop., Inc., 125 B.R. 329
(Bankr. D. Me. 1991) (in re EMEC), in which a simi-
lar issue was presented. The court in that case con-
cluded that patronage capital accounts were not
“claims” under the bankruptcy code because “all such
claims have one feature in common: there exists or
may come to exist a set of facts, capable of proof, that
will require the debtor to encounter liability, whether
it chooses to do so or not.” Jd. at 338 n. 42. The
bankruptcy court believed that the patronage capital
accounts involved in that case lacked this character-
istic because repayment was at the discretion of the
board of directors. (In fact, the accounts apparently
were due upon dissolution or liquidation of the
cooperative in that case.) Primarily on that basis, the
court concluded that “allocated patronage capital the
directors have not voted to retire remains an owner-
ship interest.” Jd. at 339.
In re EMEC is distinguishable because it was
decided under Maine law and under different corpo-
rate articles and bylaws, but, in any event, we ques-
tion the apparent basis of the decision. First, we are
not persuaded that the apparent absence of a specified
date or condition for maturity of the obligation to
and were decided under the law of states other than Indiana.
In re Axvig, 68 B.R. 910 (Bankr. D. N.D. 1987); In re FCX,
Inc., 853 F.2d 1149 (4th Cir.1988); Jn re Beck, 96 B.R. 161
(Bankr. C.D. Ill. 1988). In re F.L.F. Farmers Coop. Ass'n, 170
F.Supp. 497 (D. N.J. 1958), cited by the EMEC court, also
involved an agricultural cooperative and was decided under
New Jersey law.
24a
repay is sufficient to require classification of the
patronage capital accounts as ownership interests."
Because patronage capital accounts are unique to
the cooperative scheme, they differ from more com-
monly encountered forms of corporate debt. However,
while they may lack a specified maturity, they do not
otherwise evince the usual attributes of equity
investment. For example, the amount credited to a
Member’s patronage capital account is proportionate
to the amount of electricity the Member purchases
rather.than being the same for all Members (as would
be typical of an “ownership” interest). The refund is
determined by the amount by which Wabash’s reve-
nues exceed the approved revenue requirement. The
sum credited is therefore essentially a rate adjust-
ment.
Second, the characterization of patronage capital
accounts in different jurisdictions does not admit of a
uniform resolution; instead it is determined by state
law and the relevant articles and bylaws as applied to
particular cooperative organizations. 68 B.R. at 915;
125 B.R. at 336. See also 50 A.L.R.3d 435 (citing state
non-utility cases holding both for and against the
proposition that patronage capital accounts consti-
6 We note that there have been other debt instruments
having no maturity date. One of the best known is the English
consol, a bond issued without maturity and perpetually out-
standing. The total value of these bonds issued and outstanding
is not known but it certainly was very substantial. It is true
that these bonds regularly paid interest, but their principal
never became due and payable (unless they were called). The
United States issued consols having no maturity to finance the
Panama Canal. These bonds were eventually called. Randolph
W. Westerfield & Jeffrey F. Jaffe, Corporate Finance 119 (3d
ed. 1990)
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Dis Ciitbe: Sore SAEED AEE AI AMER He BA gid at: oslo
25a
tute a “debt” owed to the Members and cases reaching
various results as to the priority of member claims to
patronage capital in bankruptcy). In addition, rele-
vant decisions of the state courts involving Wabash
and the particulars of the Wabash bylaws both
distinguish this case from Jn re EMEC.
The Indiana statutes governing electric coopera-
tives do not permit the members to receive or retain
ownership interests in the assets of the cooperative.
Instead, if a cooperative is dissolved, “any assets
remaining after a!! liabilities or obligations of the
corporation have been satisfied or discharged shall
pass to and become the property of the state.”
Ind.Code § 8-1-13-21 (1995). Neither is the cooperative
itself allowed to retain revenues which have been
collected in excess of the cost of service Ind.Code § 8-
1-13- 17(d) (1995). The seeming inconsistency be-
tween the ban on member ownership of cooperative
assets and the existence of the patronage capital
accounts is most easily resolved if these accounts are
viewed as loans or advances by the member to the
cooperative to fulfill various corporate needs. Such
loans or advances are specifically authorized by
Indiana law. Ind. Code § 23-17-7-9 (1995) (similar
provisions formerly at § 23-7-1.1-7 (1990)). The
reference to patronage capital in the Wabash Bylaws
containing the assertion that the accounts “are the
property of the members . . . furnished by the
members as contributions to capital,” is entirely
consistent with this analysis Wabash Bylaws, Art.
VII, Sec. 2. This language (“property of the mem-
bers”) strongly suggests an advance of a determinate
amount of money from the Member to the cooperative
with a fixed obligation to repay.
26a
Our own analysis of Indiana law aside, the issue
whether Wabash’s Members are investors having
ownership interests has been decided by the Indiana
Supreme Court. In its decision denying a rate in-
crease for the purpose of repaying Marble Hill debt,
the Court discussed the status of Wabash’s Members
with respect to monies paid for electric service in
excess of the “cost of production.” National Rural
Utils. Coop. Finance Corp., 552 N.E.2d at 26 27. The
Supreme Court found that the cooperative’s Members
are not investors because “. . . the terms of Wabash’s
articles of incorporation provide that patrons or
owners are not to furnish capital to finance utility
plants nor are they to recover profits from utility
operations, thus precluding meaningful participation
in the utility as investors.” Jd. at 27. If Wabash
Members are not investors, it is difficult to conclude
that they have equity interests.
Under Indiana law, the patronage capital accounts
are not equity interests but credits for overpayments
for electric service. The district court was therefore
correct in concluding that the patronage capital ac-
counts are properly classified as unsecured claims on
behalf of the Members and that the partial and
proportionate payment of these claims under the
Wabash Plan does not violate the absolute priority
rule.
B. Control of the Reorganized Cooperative
REA makes another argument that the Wabash
Plan violates the absolute priority rule by allowing
the Members to retain control of the cooperative
through the appointment of representatives to its
Board. The issue is whether this type of control
Miah pi atthe xa, ta hide MBPs
27a
constitutes “property” which is retained “on account
of’ prior interests of the Members.
The absolute priority rule is an aspect of the
requirement that a plan be “fair and equitable.”
There is some appearance of unfairness in the Wabash
Plan. Wabash’s member distribution cooperatives,
whose representatives approved the Marble Hill fi-
asco, emerge from bankruptcy in the driver’s seat,
still paying low rates, and still not paying off the
REA debt. This outcome, however, is justified, even
dictated, by Wabash’s cooperative structure. The
Members, by controlling Wabash, control their own
rates, making it possible for them to be served under
the 40-year requirements contracts, which are, in
turn, Wabash’s most valuable possession. .
In addition to its technical compliance with the
absolute priority rule, the retention of control by
Wabash Members is not as unfair as it might seem,
given REA’s role in encouraging investment in nu-
clear plants.’ In addition, since Wabash was
specifically designed to supply its own Members,
7 See, e.g., Greensboro Lumber Co. v. Georgia Power Co.,
643 F.Supp. 1345, 1360-61 (N.D.Ga.1986), aff'd, 844 F.2d 1538
(11th Cir.1988); Vermont Co-op Refunding 19.5% Hike as PSB
Rejects Debt Restructuring, Electric Utility Week, Jan. 24,
1994, Rates & Regulation at 5 (quoting comments of the Ver-
mont Public Service Board regarding REA encouragement of
nuclear plant investment by Vermont Electric Cooperative);
John Hall & Charlie Chapple, Cajun Electric Cooperative Seeks
Bankruptcy Protection, New Orleans Times-Picayune, Dec. 22,
1994, Money Section (quoting Public Service Commission
lawyer regarding REA encouragement of nuclear plant invest-
ment by Cajun Electric Cooperative); Rep. Richard J. Durbin,
Letter to the Editor: Nuclear Plants Fuel a Rural-Electric
Nightmare, N.Y. Times, Sept. 15, 1986, at Al4 (citing REA
encouragement of nuclear plant investment).
28a
their continuation as customers in eontrol of Wabash
is a means of maximizing the value of the estate for
the benefit of creditors.
1. Control of Wabash is Not an Equity Interest
Non-profit cooperatives are creations of the legis-
lature. Cooperatives are designed explicitly to allow
customers to receive the benefits, in the form of lower
prices, which might ordinarily accrue to the owners
of equity. While it is true that customers “profit”
from this arrangement in some rough sense, the
statutory scheme specifically rejects the concept that
these savings are profits accruing to ownership. The
potential for lower prices is simply not an interest
cognizable in bankruptcy. Nor, for that matter, are
price benefits income for tax purposes. Members join
electric cooperatives with the expectation of access to
electricity and in anticipation of low rates. But,
neither the lower rates themselves nor any refunds of
overcharges, which are mandated to avoid the making
of a profit, constitute property received on account of
an equity interest.
REA cites cases holding that control is property
for purposes of the absolute priority rule. See, e.9.,
Ahlers; In re Stegall; In re Genesee Cement, Inc., 31
B.R. 442 (Bankr.E.D.Mich.1983); In re Pecht, 53 B.R.
768 (Bankr.E.D.Va.1985). These are, however, busi-
ness corporation cases. In the ordinary commercial
context, the prerogatives of equity ownership include
not only the right to control corporate decisionmak-
ing but also the right toa share in profits and in the
ownership of corporate assets on dissolution. When
associated with an equity interest in a business
corporation, control contributes to value—hence the
premium investors are willing to pay for a controlling
29a
interest in a business corporation. Indeed, as recog-
nized by the Supreme Court in Ahlers, control of a
profit-making entity in which one holds an equity
interest is valuable even “where debts far exceed the
current value of assets” because of “the interest in
potential future profits of a now-insolvent business.”
485 U.S. at 208, 108 S.Ct. at 969 (dismissing the “no
value” argument made by the debtor). Control is not
essential to an equity interest, as the existence of
non-voting stock demonstrates. A share of profits,
however, is essential. Control alone, divorced from
any right to share in corporate profits or assets, does
not amount to an equity interest.
The mere fact that the Members of Wabash are
benefited by Wabash’s operation and might be disad-
vantaged by its demise also does not give them an
| “interest” cognizable in bankruptcy. Employees,
| managers and customers, among others, always have
. an interest, in the broadest sense, in a corporation.
The factor which distinguishes these parties from
stockholders is not “control” per se (managers, after
all, have at least a limited control) but the ability to
. make use of that control to generate profits or to
increase their own share of profits.
; In re Whittaker Memorial Hospital Ass’n, 149
B.R. 812 (Bankr.E.D.Va.1993) illustrates this point.
- Whittaker concerned a non-profit hospital. There the
bankruptcy court held that the retention of control of
the hospital by the same individuals who controlled it
prior to bankruptcy did not violate the absolute prior-
ity rule since “the present group retaining control
over the debtor entity does not give them anything,
certainly not a favored position over [the dissenting
creditor]. . . . Clearly there is no distribution to this
group and nothing beyond control that passes to it.”
30a
Id. at 816. Cf. In re S.A.B.T.C. Townhouse Ass’n, 152
B.R. 1005 (Bankr.M.D.Fla.1993) (precluding members
of non-profit cooperative from retaining control of
cooperatively owned real estate).
The Whittaker result seems clear since, among
other things, the individuals exercising control over
that non-profit corporation were not themselves
users of its service. In an electric cooperative, on the
other hand, each member has two roles. As a partici-
pant in control of the cooperative, each member is
required by Indiana law and the rules of the organiza-
tion to keep rates low. In its role as customer, each
member benefits to the extent that rates are kept low.
This is an inescapable product of the cooperative
form, however, and of the identity of users and
controllers. This is not exploitation of insider status
of the sort the absolute priority rule was designed to
prevent.
There is no essential difference between allowing
the Whittaker board to remain in control of the hospi-
tal and allowing the Members to remain in control of
Wabash. The board of a non-profit organization has a
fiduciary duty to manage the organization according
to the best interests of the population it is intended to
serve (in the case of Wabash, the Member-customers).
The cooperative structure simply recognizes the ob-
vious fact that the Members themselves can be
counted on to take that duty seriously.
2. The Retention of Wabash’s Essential Structure is
Not Unfair to REA
REA was and is, of course, fully aware of the
identity of Wabash’s Members as (1) controllers of its
operations and (2) users of its power. In making
loans, REA may be charged with knowledge of
3la
Wabash’s structure in the same way that a lender to a
business corporation would know that stockholders
are not ordinarily liable for the debts of the corpora-
tion. To address the problem of Wabash’s structure,
REA relied primarily on its security interest in
Wabash’s 40-year Supply Contracts with its Mem-
bers, which were to provide a reliable source of
revenue from which Wabash could pay its debt. See
Tri-State Generation & Transmission Ass'n v.
Shoshone River Power, Inc., 874 F.2d 1346, 1349-50
(10th Cir.1989); United States v. Southwestern
Electric Coop., Inc., 869 F.2d 310, 312 (7th Cir.1989)
(discussing this REA practice). The principal reason
that these contracts did not fulfill this purpose was
the refusal of Indiana regulators to recognize Marble
Hill as an asset for rate-making purposes. If the
issue is whether REA or Wabash’s Members should
bear the burden of the Marble Hill debacle, it is not
immediately apparent why the Members are more
culpable. Presumably, REA, a promoter of nuclear
power,” knew the risks as well as anyone.
3. The Wabash Plan Makes Economic Sense
REA is by far the biggest unsecured and secured
creditor of Wabash. A cramdown of the Wabash Plan
over REA’s strenuous opposition is therefore a very
serious matter and one requiring the most careful
consideration of whether the Plan is fair and equita-
ble to REA. To be weighed in the balance, however, is
the fact that the only apparent alternative to a cram-
down is liquidation, under which REA’s recovery
would be less than under the Wabash Plan. Thus, the
bankruptcy court found that Wabash has a going-
8 See note 7, supra.
32a
concern value of $190 million, a liquidation value of
$213.2 million and a maximum value to Wabash’s
Members of $221.7 million. The greater magnitude of
the last figure provides a good reason for leaving
Wabash’s structure intact. The REA Reorganization
Plan, on the other hand, which would have required
substantial (and presumably unrealizable) rate in-
creases, was rejected by the bankruptcy court and no
appeal has been‘taken. There is, therefore, no indica-
tion that an alternative to the Wabash Plan, other
than liquidation, exists. This is a consideration
which certainly does not excuse compliance with the
absolute priority rule, but it is nonetheless a fact of
which we must remain aware.
Under the Wabash Plan, REA is being awarded its
share of Wabash’s going-concern value in partial
satisfaction of its secured debt. In addition, and ex-
tremely important to the economics of the Wabash
Plan, REA will also recover a portion of the PSI
Settlement, which is only available under the Wabash
Plan, and small amounts from other sources. The
total amount REA will receive in satisfaction of its
secured claim is approximately $400 million. Fur-
ther, under the Plan, REA is to receive, in partial sat-
isfaction of its unsecured debt, an additional amount
representing the value to Wabash’s Members of the
cost savings achieved by having Wabash as a supplier
of power. Thus REA’s total recovery under the
Wabash Plan is $430.6 million and all creditors to-
gether will receive approximately $457 million. No
non-Member control could squeeze as much out of
Wabash as a going concern and considerably less
could be realized by liquidation, particularly consider-
ing the loss of the PSI Settlement.
33a
Ill. The Absolute Priority Rule—Conclusion
In summary, while Wabash’s member cooperatives
obtain some economic benefit as customers from their
participation on Wabash’s Board, they do not improp-
erly retain property “on account of” either their pa-
tronage capital accounts (which are mere refunds of
overpayments) or their control over Wabash. Control
of the cooperative provides no opportunity, either
currently or in the future, for the Members to obtain
profits or any equity in Wabash’s assets and control
itself is not an equity interest. Further, control of
Wabash’s Board provides the Members with no oppor-
tunity to benefit at REA’s expense. Two factors out-
side the Members’ control have prevented REA from
collecting more of its outstanding debt: the non-profit
structure of cooperatives and, most important, the
fact that the only conceivable source of funds—in-
creased rates—is foreclosed by state law and the
prior decisions of this court.
OTHER WABASH ISSUES
L The Plan’s Compliance with 11 U.S.C. §
1129(a)(10)
11 U.S.C. § 1129(a)(10) requires that at least one
non-insider impaired class of creditors accept a
proposed reorganization plan before it is eligible for
cramdown. The bankruptcy court found that the
Wabash Plan was accepted by two such classes of
creditors—Class 9 (PSI) and Class 11 (Members’
Patronage Capital Claims)—thus fulfilling the
requirements of § 1129(a)(10). On appeal, REA objects
to these findings. As Wabash points out in reply,
these objections were not raised by REA until after
the close of the objection period set by the bankruptcy
court and the completion of the confirmation hearing.
34a
While they were raised in a post-hearing brief, the
bankruptcy court apparently considered these objec-
tions waived, since it found that “no objections to con-
firmation were filed under this section.” Bktcy.Op. at
119. REA argues, however, that, since the waiver
rule is applied more flexibly in bankruptcy
proceedings and the court is required to ascertain
whether a plan complies with the cramdown require-
ments, Everett v. Perez (In re Perez), 30 F.3d 1209,
1213-14 (9th Cir.1994), it may appropriately raise its
objections here.”
We need not determine the extent to which REA’s
various objections are waived by its failure to raise
them in a timely fashion because we find that the Plan
properly classifies PSI’s claims separately from
those of the other unsecured creditors and there is no
clear error in the bankruptcy court’s determination
that PSI’s claims are impaired by the Plan.
A debtor in bankruptcy has considerable discretion
to classify claims and interests in a chapter 11 reor-
ganization plan. In re Woodbrook Assocs., 19 F.3d 312
(7th Cir. 1994). While a debtor may not separately
classify claims solely in order to “gerrymander an af-
firmative vote on reorganization,” claims may be
classified separately if “significant disparities exist
between the legal rights of the holder[s of the differ-
ent claims] which render the two claims not substan-
9 REA also contends that it sufficiently raised these objec-
tions by virtue of its timely objections to other aspects of the
classification scheme, which it claims gave Wabash sufficient
notice of the objections. In re Woodbrook Assocs., 19 F.3d 312,
316 (7th Cir.1994). This contention is patently wrong, espe-
cially as regards PSI, since the REA’s own proposed confirma-
tion plan classified PSI exactly the same way as does the
Wabash Plan it now opposes.
35a
tially similar.” Jd. at 318. Claims may also be sepa-
rately classified if there are “good business reasons”
to do so or if the claimants have sufficiently different
interests in the plan. See In re U.S. Truck Co., 800
F.2d 581, 583-87 (6th Cir.1986); Heartland Fed. Sav. &
Loan Ass’n v. Briscoe Enters. (In re Briscoe Enters.),
994 F.2d 1160, 1166-67 (5th Cir.1993), cert. denied, —
U.S. ——, 114 S.Ct. 550, 126 L.Ed.2d 451 (1993).
Because the confirmation of this Plan affects PSI’s
interests both with respect to its settlement of other
litigation between it and Wabash and with respect to
its ongoing business relationship with Wabash, its
stake in the Wabash reorganization differs signifi-
cantly enough from that of the other unsecured
creditors to warrant the separate classification of its
claims. (Indeed, REA apparently recognized this fact
since its own proposed reorganization plan also clas-
sified PSI’s claims separately.)
We review the determination whether PSI’s claim
is impaired for clear error. REA contends that,
because PSI agreed to the terms of the PS! Settle-
ment, it cannot remain impaired under the Wabash
Plan which is, after all, in accordance with those
terms. The PSI Settlement, however, is not a
separate agreement entered into by the debtor prior
to filing a reorganization plan. Instead, it is inextri-
cably intertwined with and dependent on the reor-
ganization plan. PSI’s recovery under the settlement
will depend on whether the Wabash Plan is approved.
Thus, this is not a situation in which a claim has been
settled prior to confirmation of a reorganization plan
and confirmation therefore leaves the parties’ rights
unaffected. Cf. 5 Collier on Bankruptcy 4 1124.03[(1]
(15th ed. 1994). The standard for impairment is very
lenient and “any alteration of the rights constitutes
36a
impairment even if the value of the rights is en-
hanced.” Jd. PSI’s rights are certainly affected by
the confirmation of the Wabash Plan. There is thus
no clear error in the bankruptcy court’s determina-
tion that PSI is an impaired creditor whose accep-
tance of the Plan fulfills the requirements of §
1129(a)(10).”
Because we find that Class 9 (PSI) is impaired
under the Wabash Plan we need not decide whether
Wabash’s Members are “insiders” whose acceptance
of the Plan would not be sufficient to justify a
cramdown. Cf. In re EMEC, 125 B.R. at 334-35
(members of retail electric cooperative not insiders
for cramdown purposes).
© REA also suggests that, even if PSI is impaired by the
Plan, it is an “artificial impairment” invented solely for the
purposes of effectuating a cramdown. See, e.g., Windsor on the
River Assocs. v. Balcor Real Estate Fin. (In re Windsor on
the River Assocs.), 7 F.3d 127 (8th Cir.1993). Because REA did
not raise this objection until after the close of the confirmation
hearing, no evidence on this question appears in the record.
While it may be true that rules regarding waiver are applied
more flexibly in bankruptcy proceedings than in the context of
ordinary adversarial litigation, we will not revisit issues, such
as the allegedly improper purposes of the debtor, which were
impliedly decided by the bankruptey court. Jn re Perez, 30
F.3d at 1218-14. A finding of “artificial impairment” requires
an inquiry into the purposes of the debtor which is not appro-
priately undertaken by a reviewing court when the creditor
pressing the argument has failed to develop a record on the
issue which we might review. /d. at 1214. See also In re
Woodbrook Assocs., 19 F.3d at 318 (rule against artificial
classification difficult to apply since it is about the debtor's
purpose).
37a
Il. The Deduction of the Prepayments from _ the
Timbers Account from REA’s Secured Claim
REA disputes the deduction from its secured claim
of approximately $28 million of debt service paid to it
by Wabash during the post-petition period. This
payment resulted from an earlier dispute in this case.
Wabash initially contested its obligation (and indeed
its right under rate regulations) to continue to make
payments to REA in service of its non-Marble Hill
debt after filing its bankruptcy petition. Because
Wabash believed itself relieved of the obligation of
servicing its debt during the pendency of the bank-
ruptcy petition. Wabash argued that it was therefore
required to reduce its rates rather than to continue
to make such payments to REA. While that dispute
was under consideration by the bankruptcy court,
Wabash made its payments into an escrow account
(the Timbers Account). In July 1990 the bankruptcy
court ordered the funds turned over to REA as “a
payment to reduce the principal of the non-Marble
Hill debt.” Timbers Order at 4-5.
The bankruptcy court reasoned that, since rate
payments may, in principle, be used to pay for
Wabash’s non-Marble Hill debt, it was of no import
when those payments were made. “[IJn either case,
the members will pay the non-Marble Hill debt
through the rates they are charged.” Jd. at 5. The
court thus concluded that it was pointless to allow
Wabash’s rates to be adjusted downward due to the
temporary suspension of its obligation to pay the debt,
only to be raised again at a later date when the
obligation was reimposed. As the bankruptcy court
pointed out: “It can make no difference to the Debtor,
and little difference to the members, whether the
38a
funds are in effect returned to the members through
lower rates now or whether the members pay lower
rates in the future as a result of application of the
funds to the non-Marble Hill debt now.” Id.
Pursuant to the court’s order, Wabash released the
money in the Timbers Account to REA and, in its
reorganization plan, deducted the payment from
REA’s claim. The issue on appeal is whether it was
appropriate for REA to deduct this payment from the
secured portion of REA’s claim.
A secured creditor is not ordinarily entitled to any
“property acquired by the . . . debtor after the
commencement of the case.” 11 U.S.C. § 552(a) (1995).
Post-petition debt payments to an undersecured
creditor which are taken from after-acquired prop-
erty will thus ordinarily be used to reduce the princi-
pal amount of the secured debt. See, e.g., In re Maun,
95 B.R. 94 (Bankr. S.D. 11.1989). There is an excep-
tion to this rule that secured creditors are not
entitled to after-acquired property. The exception
applies if the security agreement specifically provides
that the security interest created extends to “pro-
ceeds, product, offspring, or profits” of the collateral
or to “rents” paid on it. 11 U.S.C. § 552(b) (1995).
REA has not argued that the monies in the Timbers
Account fall into any of these categories—nor would
there seem to be any basis to conclude that they do.”
REA also appears to take issue with the fact that
the calculation of Wabash’s “going-concern value”
1! REA cites In re Veeco Inv. Co., L.P., 170 B.R. 149
(Bankr.E.D.Mo.1994) in support of its argument. However, In
re Veeco concerns a situation in which the secured creditor had
a perfected security interest in rents, clearly distinguishing it
from the present case.
39a
was based on projected revenues beginning in 1991
and did not include the revenues already earned and
deposited in the Timbers Account. However, the
Supreme Court’s decision in United Sav. Ass'n v.
Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365,
108 S.Ct. 626, 98 L.Ed.2d 740 (1988) generally pre-
cludes including as part of a secured claim any value
stemming from the debtor’s use of the collateral
during the pendency of the bankruptcy proceedings.
All revenues, except for those specifically excepted
under § 552(b), as discussed supra, are deemed part of
this unavailable “use value.” This holding squarely
prohibits the inclusion of the Timbers Account
revenues in the going-concern valuation of Wabash.
The bankruptcy court thus properly treated these
funds as post-petition payments for debt service, to be
credited against the secured part of REA’s claim.
Ill. The Use of the Going-Concern Value Rather than
the Value to the Members in Valuation of REA’s
Security Interest
The valuation of a secured claim is a question of
fact which can be overturned only if it is clearly
erroneous. In re Vitreous Steel Products Co., 911
F.2d 1223, 1233 (7th Cir.1990). Here the bankruptcy
court carefully considered extensive expert testi-
mony on the valuation issue. The methods used by
the experts on whose testimony the bankruptcy court
relied were standard methods for determining fair
market value using the “willing buyer/willing seller”
framework. This determination of the fair market
value was not clearly erroneous.
However, REA also contends that the use of the
fair market value rather than the value to the
Members in determining the extent of its secured
40a
claim is incorrect under 11 U.S.C. § 506(a). REA
Reply Br. at 17-18. Under this statute, a secured
claim reaches “to the extent of the value of such
creditor’: interest in the estate’s interest in such
property” as “determined in light of the purpose of
the valuation and of the proposed disposition or use”
of the property. Courts have differed as to how to
value the creditor’s interest pursuant to § 506(a) in
those cases where the debtor is to retain the property
securing the debt. The issue is whether the “value of
such creditor’s interest” is the amount that a credi-
tor could recover through a sale of the assets
securing the debt (either separately or as part of a
going concern). The alternative standard where
there is no sale is that the security interest covers
the entire value that the assets retain in the debtor’s
hands under the reorganization plan. Most of the
eases concern whether the hypothetical costs of
selling the assets should be deducted from the
secured creditor’s claim even though the debtor
intends to retain the property after reorganization.
See, e.g., In re Balbus, 933 F.2d 246 (4th Cir.1991);
Metrobank v. Trimble (In re Trimble), 50 F.3d 530
(8th Cir.1995) (discussing cases). Here, REA con-
tends that, if the Members are to retain control of
Wabash, its secured claim must be valued at the
“value to the Members” rather than at the value that
could be obtained in a hypothetical sale to a third
party.
This circuit has vet to resolve this § 506(a) issue,
nor need we resolve it here, because REA has waived
the argument. In its brief to the district court, in
fact, REA freely conceded that “the value of REA’s
and CFC’s security interests is the going-concern
value of all of Wabash’s assets.” Dist.Ct.Rec.Doc. 7 at
4la
44, Throughout that brief REA assumed without
discussion that the “willing buyer/willing seller”
model (an approach to determining fair market value)
was the correct approach to valuing its claim
(although it disputed Wabash’s implementation of the
model). Even in its brief to this court, REA states
only that “it is anomalous to fix REA’s lien at the
lower of Wabash’s value to a third party or to its
owners where the plan gives to the owners the
property being valued.” Appellant’s Br. at 45. The
brief cites neither case law nor statute in support of
this statement. Only in its reply brief does REA
raise the question whether the valuation approach
taken by the bankruptcy court comports with the
dictates of § 506(a), citing only one case discussing
the issue. Such minimal treatment of the issue is too
little, too late. Doe v. Johnson, 52 F.3d 1448, 1457 (7th
Cir.1995). The matter is not properly preserved for
our consideration. We might add that, in any event,
under the Wabash Plan, REA and the other secured
creditor, CFC, are in fact awarded the difference
between the two valuations in satisfaction of their
unsecured claims; thus no inequity results.
IV. Validity of the Rate Realignment Settlements
Finally, REA challenges a provision in the Rate
Realignment Settlements, which Wabash negotiated
with its Members and with the relevant state regula-
tory agencies. The challenged provision would go
into effect only if the Wabash Plan were not con-
firmed. Since we uphold confirmation of the Plan, the
issue is now moot.
42a
For all the foregoing reasons, the judgment of the
district court affirming the approval of the Wabash
Plan by the bankruptcy court is
AFFIRMED.
43a
APPENDIX B
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF INDIANA
INDIANAPOLIS DIVISION
Cause Nos. IP 91-928-C
IP 91-929-C
IP 91-930-C
IP 91-301-C
IP 92-1468-C
IP 93-1551-C
UNITED STATES OF AMERICA, APPELLANT
v.
WABASH VALLEY POWER ASSOCIATION, INC., APPELLEE
IN RE: WABASH VALLEY POWER ASSOCIATION,
INC., DEBTOR
{June 28, 1994]
BACKGROUND
These cases pend on appeal from the bankruptcy
court. This is the second opportunity that this Court
has had to look at the plethora of litigation surround-
ing the failed nuclear power experiment in Indiana.
Detailed histories of the experiment and the litiga-
tion are found in all the prior reported cases on this
situation and will not be repeated today. Wabash
Valley borrowed $486,000,000 in funds guaranteed by
44a
the REA and invested that amount in the Marble Hill
nuclear facility. The Marble Hill project was aban-
doned. Wabash Valley went into Chapter 11 Bank-
ruptey. When this Court last looked at the litigation,
several legal questions remained unanswered by the
courts. Those questions have now been answered and
the landscape of this litigation has been fundamen-
tally altered.
At the time of the last appeal this Court was con-
cerned about the: valuation of the debtor Wabash
Valley. Just prior to that appeal, Wabash Valley had
filed for a 51% rate increase to pay for its Marble Hill
debt. While that rate increase was pending, the
Indiana Supreme Court in Citizens Action Coalition
v. NIPSCO, 485 N.E.2d 610 (Ind. 1985), cert. denied,
476 U.S. 1173 (1986), ruled that an investor owned
utility could not raise its rates to recover the costs of
a cancelled nuclear power plant. Citing the princi-
ples outlined in that case, the Utility Commissioner
denied the 51% rate request of Wabash Valley. The
Commissioner’s decision was appealed, and the Court
of Appeals in National Rural Utilities Cooperative
Finance Corp. v. Public Service Commission, 528
N.E.2d 95 (Ind. App. 1988), aff'd, 552 N.E.2d 23 (Ind.
1990), affirmed the decision of the Public Service
Commission. The matter was then appealed to the
Indiana Supreme Court. The Supreme Court of Indi-
ana had not spoken at the time this Court reversed
the decision of the bankruptcy court.
NEW CASE LAW
The Indiana Supreme Court in National Rural
Utilities Cooperative Finance Corp. v. Public Ser-
vice Commission, 552 N.E.2d 23 (Ind. 1990) affirmed
the lower Court. The Indiana Supreme Court dealt
45a
directly with the issue of who bears the burden of this
debt guaranteed by the REA. “A utility may impose a
charge on its ratepayers only for service, which is
defined as ‘the furnishing of energy, and the render-
ing of engineering, financial, accounting, or educa-
tional services incidental to the production, transmis-
sion, or use of energy.’” I.C. 8-1-13-3(m). Further, the
rate a utility charges for the service provided to its
ratepayers may include the expenses incurred in the
operation of its system, which is defined as “any
plant, works, system, facilities, or properties
used or useful in the generation, production,
transmission, or distribution of energy.” 552 N.E.2d
at 27. The court reasoned that because Marble Hill
was never either used or useful, “none of the
operation expenses associated with the project were
properly chargeable to the Wabash ratepayers.” 552
N.E.2d 23, 28. The “used and useful” rule from
NIPSCO was thus unequivocally applied by the
Indiana Supreme Court to Wabash Valley.
The Indiana Supreme Court declined to address the
proposition that the REA might be able to pre-empt a
state regulatory commission where the ability of the
cooperative to repay its federal loan is seriously com-
promised. This declination spawned another federal
lawsuit which culminated in the decision of the Sev-
enth Circuit Court of Appeals reported as Wabash
Valley Power Ass’n. Inc. v. Rural Electrification
Administration, 988 F.2d 1480 (7th Cir. 1993).
The Seventh Circuit entertained an appeal from a
district court decision published at 773 F. Supp. 1178
(S.D. Ind. 1991). The Seventh Circuit met the issue
the Indiana Supreme Court had declined to address.
The Seventh Circuit held that the REA did not have
the authority to issue regulations pre-empting the
46a
state regulatory commission. The court acknowl-
edged that the Indiana Supreme Court had clearly
established the “used and useful rule.” The court
opined that the security for this loan, given the
vicissitudes of the regulated utility industry, should
have been a guarantee of the loans by the “customers,
whose promise to buy power [is] the real security for
the debt.” 988 F.2d at 1491.
THE PRIOR REVERSAL
This discussion deals specifically with IP 91-928
and 91-929. These are the appeals from the bank-
ruptey court’s affirmance of the Wabash Valley plan
and the rejection of the two REA plans. The remain-
ing cases on appeal depend upon findings of this Court
in these two appeals. The initial discussion is of the
new plans, that is, new from the time this Court last
looked at this case.
Most of the basis of the reversal of the bankruptcy
court’s approval of the first Chapter 11 plan was that
the bankruptcy court had failed in its valuation
analysis of Wabash Valley to include the possibility
that Wabash Valley might be able to recover some of
its Marble Hill debt with a rate increase of a more
moderate nature than the 51% that was rejected.
This Court noted that the Public Service Commission
had in fact invited such an attempt. This failure was
at the center of the bankruptcy court’s analysis of the
willing buyer-willing seller valuation.
The bankruptcy court over emphasized the risk to a
willing buyer. It assumed without considering evi-
dence on the subject that the all-requirements con-
tracts were voidable on the granting of a large rate
increase. The court concluded that even if a rate
increase were available to pay the debt the customers
47a
of Wabash Valley might be able to break their con-
tracts to purchase power, thus making a willing
buyer wary and lowering the value of Wabash Valley.
This Court included also in its reasons for reversal
a failure of the bankruptcy court to consider the
Government’s mid-level valuation. Again, this
Court’s concern was the failure of the bankruptcy
court to take into account in its valuation the possi-
bility that part of the debt could be recouped by a
lesser rate increase. This Court found it erroneous
for the bankruptcy court to assume that no rate
increase at all was possible and thus no amount of the
debt could be paid through any kind of rate increase.
These were the major faults that this Court found
with the bankruptcy court’s opinion. This Court did
have some difficulty with Wabash Valley’s inability to
produce a tariff which would allow the REMC custom-
ers to wheel power over NIPSCO’s lines and thus
have an alternative source of power should the all-
requirements contracts be declared null and void.
This ability to wheel power would eliminate an in-
crease to the valuation of Wabash Valley as the only
source of power for its members. The bankruptcy
court did nothing more than assume the tariff’s
existence, thus contributing to its valuation errors.
EFFECT OF NEW CASE LAW ON PLAN ON APPEAL
Since the time of this Court’s 1990 reversal of the
bankruptey court, both the Indiana Supreme Court
and the Seventh Circuit have spoken as outlined
above. The impact of these decisions on this appeal is
as follows: The valuation of the debtor which does not
include the possibility of a rate increase to pay the
Marble Hill debt is not only the proper approach
under Indiana and federal law, it is the only approach.
48a
After the decision of the Supreme Court of Indiana
that Marble Hill was never used or useful, and the
Seventh Circuit decision that federal regulations
could not trump the used and useful rule, one need no
longer speculate on the ability of Wabash Valley to
pay the REA. It can not.
Because both of the evaluations offered by the REA
in this Chapter 11 plan review depend upon ratepayers
at one level or another providing funds for the
repayment of this debt, and because Wabash Valley’s
evaluation correctly acknowledges that it can not
raise rates to repay the debt, the Wabash plan be-
comes the only plan for further consideration by this
Court.
This Court finds that the bankruptcy court pro-
perly applied, unlike the last time, the willing
buyer/willing seller valuation. The valuation of the
bankruptcy court is between, in this Court’s view, the
incorrigible optimism and confirmed pessimism
warned against in Estate of Tully v. United States, 41
A.F.T.R.2d (P-H) J 148,219, at 78-1477, 1978 WL 3453
(Ct. Cl. 1978).
As this Court has concluded above, once a determi-
nation is made that no rate increase can be achieved
to pay the REA debt, and that no funds are in exis-
tence nor are likely to be in existence from ratepay-
ers to discharge the debt, the necessity of considera-
tion of a plan that includes a rate increase to pay this
debt dissolves. Other problems that plagued the first
plan disappear. The need to be concerned with the
issues surrounding the possible breaking of the all-
requirements contracts in the event of a large rate
increase likewise disappears. There will be no
increase to call into question those contracts. Addi-
tionally, the problem with the tariff disappears
49a
because the existence of a tariff goes to the economic
decision on the part on the customers as to whether
to break the all-requirements contracts or not.
The REA argues that the bankruptcy court cannot
make and accept an evaluation of Wabash Valley in a
lesser amount than one which “includes the value” of
this debt. This argument assumes that the debt
somehow is collectable. The REA continues to think
of the debt as Wabash Valley’s account receivable.
However, once the Indiana Supreme Court decided
that this debt could not be collected by a rate increase
and once the Seventh Circuit decided that the REA
could not raise the rate by any sort of preemption, the
debt could hardly be considered a valuable account
receivable.
REA’S ABSOLUTE PRIORITY ARGUMENT RETAINED
PROPERTY
The REA in an attempt to convince this Court that
the plan which has been approved by the bankruptcy
court should be disapproved invokes the absolute
priority rule. The absolute priority rule forbids a
bankruptcy court from forcing on a senior creditor a
plan which allows a junior creditor to retain property.
That is, the REA avers that this plan cannot be
affirmed because the REA did not consent to any
interest junior to its own receiving and retaining
property under the plan.
The controversy is whether the right to future
payments of the membership capital accounts of the
member customers of Wabash Valley violates the
absolute priority rule since the claims of the member
customers are classified in the plan as inferior to the
claim of the REA. The record reflects that the
members of Wabash have an unsecured claim to
50a
patronage accounts of some $7.2 million. These are
the Class 11 claims. The Wabash plan provides that
these “shall be reduced by the same amount as
unsecured claims of REA and CFC in Class 10 are not
paid. Any remaining amounts are to stay on the
debtor’s books and be paid pursuant to its by-laws.”
The REA argues also that Wabash Valley has
refunded money to its membership even in the face of
this debt. The “excess margins” that these monies
represent should have been paid to the REA, it says.
These are patronage capital amounts that have been
paid during the pendency of the bankruptcy. Wabash
Valley admits that it has refunded “excess margins”
to its customers. It does so, it says, as it is obligated
to by Indiana law.
The point for Wabash Valley is that under Indiana
law the rate payer pays only for the cost of the fuel
produced. Any amount paid over that does not belong
to the utility, it belongs to the members or the
consumers. I.C. 8-1-2-42 (d) (8) states clearly that
while a fuel adjustment charge may be applied for by
the utility to properly reflect the cost to produce or
provide the power to the consumer, “if the fuel charge
applied for will result in the electric utility earning a
return in excess of the return authorized by the
commission [the funds REA wants applied to its loan],
in the last proceeding in which basic rates and
charges of the electric utility were approved, the fuel
charge applied for will be reduced to the point where
no such excess of return will be earned.” Thus, the
statute makes it impossible to impress these funds.
1.C. 1971 8-1-2-42(e) gives the Public Service Commis-
sion the authority to suspend the rule should an
emergency exist that could result in an abnormal
change in fuel costs. In such case, the Commission
5la
may do what is necessary to protect the public and the
utility from harm. The public presumably is the rate
payer, not the federal taxpayer or the REA.
I.C. 8-1-2-42 (d) (3) requires any overpayments to be
paid back to the customer, and thus creates a statu-
tory obligation on the part of Wabash to repay its
member consumers any amounts collected above and
beyond the actual amounts needed to produce power.
Nothing in the supply contracts trumps that notion.
That statute creates a right to repayment, or repay-
ment’s equivalent, reinvestment in Wabash. If, as
has been decided by the Indiana Supreme Court, a rate
increase to pay the REA is impermissible because
Marble Hill was never used to produce power, the use
of overpayments from past years to pay that same
debt is. likewise impermissible. These overpayments
are not “property” of the debtor for purposes of the
absolute priority rule any more than past payments
or refunds are preferential transfers. Thus, it cannot
be said that the retention by the Class 11 debtors of a
right to a portion of the patronage capital is a reten-
tion of property in violation of the absolute property
rule.
The bankruptcy court agreed with Wabash that
these monies are not cash assets available for pay-
ment of REA’s debt. The plan reduces the “patron-
age capital” in direct proportion to the lack of pay-
ment of REA’s debt, so that under the plan these
amounts are not returned completely, as would other-
wise be the case.
The REA argues that the power supply or “all-
requirements” contracts obligate the consumer mem-
bers of Wabash Valley to pay the debt. This Court
disagrees. The power supply contracts do not fix a
rate at which the members buy power from Wabash.
52a
The members are committed to pay a rate set by the
Indiana regulating authority, designed to allow the
REA debt to be paid specifically as a “cost to pro-
duce.” Again, since the rate can be set, pursuant to
the Indiana Supreme Court’s directive, only for used
and useful projects that result in the production of
power, thus defining the contractual term “cost to
produce”, the supply contract does not bind the mem-
bers to pay the REA.
The customer members are said by the REA to
have retained other property. That property is the
right to maintain an association that will provide
power to themselves at the cost of producing that
power which more likely than not is less than the
price available from any other source. It is true that
right relieves each member from having to worry
about where its next kilowatt will come from. Yet,
that right does not guarantee a particular price. The
REA does not suggest that there is a market for that
right such that the right to buy power from Wabash
would have an ascertainable price. There is no
evidence in this record that one member could sell its
right to buy electricity from Wabash Valley to any
entity. Without that evidence it is difficult to call a
member’s right to buy electricity from Wabash Val-
ley property. This Court declines the invitation of
the REA to do so. This Court holds that such a right
is not property for purposes of the absolute priority
rule.
In addition, what Wabash Valley’s members have
retained is the right over time to adjustments in their
rates based on prepayments. No refund, as was
rejected by Eastern Maine Electric Cooperative,
Inc., 125 B.R. 329, 332 (Bky. D. Me. 1991), is available
under this plan. No immediate cash redemption is
ee ee ee SAS ee SS a ee
53a
contemplated by this plan as was rejected by Jn Re:
Axvig, 68 B.R. 910, 916-17 (Bk. D. N.D. 1987). These
amounts, then, limit the future revenues of Wabash
Valley. They are appropriately listed as adding to the
current value of the debtor for purposes of determin-
ing fair market value, yet these funds are not avail-
able for execution on the debt of REA, nor can assets
be considered as equity for purposes of the absolute
priority analysis.
The REA argues further that because the members
will own and control 100% of Wabash Valley, they
thus retain property. The property is that 100% con-
trol and ownership. The plan approved by the bank-
ruptcy court provides that the members’ interest in
any property of Wabash Valley is cut off. The rela-
tionship between the members and Wabash Valley is
to be governed only by the supply contracts and not by
any relationship otherwise controlled by the plan.
What the members will retain under this plan is the
right to purchase power through the Wabash Valley
Cooperative.
To summarize, the REA has argued that there is a
remaining economic value unrecognized by the bank-
ruptcy court that is retained by the members of
Wabash Valley and that that retained value violates
the absolute priority rule. That value is represented
by the overpayment of power costs in the past,
referred to as “overpayments,” “excess margins,” and
“patronage capital.” These terms are interchange-
able. This Court holds that for the reasons set out
above these amounts are not “property” the retention
of which is prohibited by the absolute property rule.
Additionally this Court holds that the right to buy
electricity does not amount to prohibited property.
Thus, this Court finds that the Chapter 11 Plan af-
54a
firmed by the bankruptcy court does not provide for
the retention of value by a class of debtors lower than
that class which did not approve the proposed plan.
FAIRNESS
The underlying concern of the absolute priority
rule is the fairness of a plan. The REA argues that
this plan is unaffirmable because it is simply not fair.
This absolute priority argument is an attempt to
circumvent the effect of the decisions of the Seventh
Circuit and the Indiana Supreme Court. The REA
cannot accept the effect of the decisions of both upper
courts that a plan can not include a rate raise to pay
this debt. It holds on to the argument that any plan
that does not provide for payment of its debt through a
rate increase is simply not fair. It is too late in this
Court’s opinion to make that argument. This Court
in a bankruptcy appeal does not sit as the appeals
court for decisions either of the Seventh Circuit or
the Indiana Supreme Court.
Both sides cite Norwest Bank Worthington v.
Ahlers, 485 U.S. 197 (1988). That case at page 202
tells this Court that the theory of the absolute prior-
ity rule is to ensure that the reorganization plan be
“fair and equitable.” What is fair and equitable in
each instance depends upon what the courts and the
legislators, both state and federal, have said. It seems
to this Court that the upper courts together with the
State legislature have defined what is fair in this
case.
The REA reminds this Court that many courts
have said that no debtor should profit from a bank-
ruptcy. This is a common thought expressed when
assessing the essence of the absolute priority rule as
well as a general tenet of bankruptcy theory. No
eee aS ee eee) ee
— = Oe a ee eee
—_— eee Se ee a a we
wre ee eee LS ee ee eS a
55a
citation is really necessary to establish that proposi-
tion. The REA argues that by approving a plan which
washes the REA debt this court would allow Wabash
to profit from the bankruptcy.
Wabash Valley is not an ordinary debtor. Wabash
Valley is a regulated not-for-profit corporation. The
price it can demand for its service is limited by the
Public Service Commission’s idea of the cost to pro-
duce its product, electric power. It does not itself
know what its costs will be from year to year. When
it overestimates its costs and charges customers ac-
cordingly, it must reimburse those funds in some
manner. Thus even its excess margins are regulated
as discussed above.
Just as there are no unregulated funds now
available to pay.the REA debt, there is no way for
Wabash Valley to profit from its Chapter 11 experi-
ence in the classic profiting sense of being able to
make money and keep it for itself to do with as it
wishes. Wabash Valley can be said to profit from the
Chapter 11 bankruptcy in the sense that it does not
have to pay the REA. Yet the nonpayment of the debt
is not the voluntary decision of Wabash Valley or its
members or of a lower class of debtors than Wabash
Valley’s members. Thus even though the statutes
and rulings which will not allow a rate increase to pay
this debt still appear unfair to the REA, and this
Court can certainly understand the disgruntlement of
being left with a colossal debt and nowhere to turn,
the absolute priority rule will not yield the result
sought by the REA.
56a
CONCLUSION
The concerns of this Court in the reversal of the
previous plan have been met by the new plan. The
impact of the new case law is dispositive. These
rulings would have to be ignored in order for the
absolute priority rule to be imposed for the benefit of
the REA. The Court therefore affirms the judgment
of the bankruptcy court. In affirming the bankruptcy
court’s confirmation of the plan, the Court also
affirms the bankruptcy court’s denial of the plans
offered by the REA. This Court’s ruling also
necessarily finds against the REA and in favor of the
debtor in cause IP-91-930 on the issue of an automatic
stay. This opinion also decides cause number IP-93-
1551. The Court finds for Wabash Valley and against
the REA on the issues raised in that appeal for the
same reasons set out in this decision. Additionally, an
acknowledgement by this Court of the Indiana
Supreme Court’s ruling that the Marble Hill debt
cannot be repayed from a rate increase and a finding
by this Court that the debt cannot under Indiana law
be repaid from member overpayments effectively finds
for Wabash Valley and against the REA in cause
number 1P-9T-1301.
The REA’s motion to withdraw reference in cause
number 1P 92-1468 is overruled. The decision in the
appeal in IP-91-928 and IP-9]-929 controls here also.
In addition, a different bankruptcy judge is now
sitting in these cases. All pending appeals are now
decided.
57a
IT IS SO ORDERED this 28th day of June, 1994.
/s/ LARRY J. MCKINNEY, JUDGE
LARRY J. MCKINNEY, JUDGE
United States District Court
Southern District of Indiana
Distribution to: [Omitted]
58a
APPENDIX C
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF INDIANA
INDIANAPOLIS DIVISION
Case No. 85-2238-RWV-11
IN RE: WABASH VALLEY ASSOCIATION, INC., DEBTOR.
[Aug. 7, 1991]
ORDER CONDITIONALLY CONFIRMING
WABASH VALLEY POWER ASSOCIATION, INC.’S
THIRD RESTATED FOURTH AMENDED PLAN
OF REORGANIZATION
Wabash Valley Power Association, Inc. (“Debtor”),
having filed its Third Restated Fourth Amended Plan
Of Reorganization (“Plan”) on August 23, 1990, under
Chapter II of the United States Bankruptcy Code
(“Code”), the Plan having been duly transmitted to
creditors and parties in interest, objections to said
Plan having been filed by various parties, the Court
having conducted a hearing on the Plan and the
objections thereto following due notice, and the Court
having contemporaneously herewith entered its
Findings Of Fact And Conclusions Of Law that:
1. The Plan complies with the applicable provi-
sions of the Code;
2. The Debtor has complied with the applicable
provisions of the Code;
3. The Plan was proposed in good faith and not by
any means forbidden by law;
59a
4. A. Any payment made or promised by the
Debtor, or by any persons issuing securities or
acguiring property under the Plan, for services or for
costs and expenses in, or in connection with, the case,
or in connection with the Plan and incident to the
case, have been disclosed to the Court; and
B. Any such payment made before confirmation is
reasonable, or if such payment is to be fixed after con-
firmation of the Plan, such payment is subject to the
approval of the Court as reasonable;
5. A. The Debtor has disclosed the identity and af-
filiations of any individual proposed to serve, after
confirmation of the Plan, as a director, officer or
voting trustee of the Debtor, an affiliate of the Debtor
participating in a joint plan with the Debtor, or a suc-
cessor to the Debtor under the Plan, and the appoint-
ment to, or continuance in, such office of such indi-
vidual, is consistent with the interest of creditors,
eguity security holders and with public policy;
B. The Debtor has disclosed the identity of any in-
sider that will be employed or retained by the reor-
ganized Debtor, an the nature of any compensation for
such insider;
6. The Plan is expressly conditioned upon approval
by any regulatory commission with jurisdiction, after
confirmation of the Pian, over the rates of the Debtor,
which approval has not yet been obtained;
7. With respect to each class, each holder of a
claim or interest of such class has accepted the Plan,
or will receive or retain under the Plan on account of
such claim or interest property of a value, as of the
effective date of the Plan that is not less than the
amount that such holder would receive or retain if the
Debtor were liquidated under Chapter 7 of the Code;
60a
8. The Plan has been accepted in writing by the
classes of creditors or equity security holders whose
acceptances are required by law or the Plan does not
discriminate unfairly and is fair and equitable with
respect to each class of claims or interests that are
impaired under, and has not accepted the Plan;
§. The Plan properly deals with creditors having
claims under 11 U.S.C. Sec. 507(a);
10. At least one class of claims has accepted the
Plan, determined without including any acceptance of
the Plan by any insider holding a claim of such class;
11. Confirmation of the Plan is not likely to be
followed by the liquidation, or the need for further
financial reorganization, of the Debtor or any succes-
sor to the Debtor under the Plan;
12. All bankruptcy fees owed pursuant to 28 U.S.C.
Sec. 1930 have been paid or are to be paid following
confirmation of the Plan;
13. Retiree benefits are to continue after the effec-
tive date of the Plan, in compliance with 11 U.S.C.
Sec. 1114. Accordingly, it is
ORDERED, ADJUDGED AND DECREED that
the Plan filed by Wabash Valley Power Association,
Inc., on August 23, 1990, be and hereby is, confirmed
conditioned upon the approval of such rates as is
required by the Plan and 11 U.S.C. Sec. 1129(a)(6), and
the Debtor shall file with this Court evidence that
such regulatory approval has been obtained, at which
time this Order shall become unconditional.
At such time as this Order becomes unconditional,
IT IS FURTHER ORDERED, ADJUDGED AND
DECREED:
1. that except as otherwise provided in 11 U.S.C.
Sec. 1141 or in the Plan, this Order discharges the
Pe Re en ee ae te BAI cr
6la
Debtor from any debt that arose before the date of
such confirmation and any debt of a kind specified in
11 U.S.C. Sec. 502(g), 502(h), or 502(i);
2. that pursuant to 11 U.S.C. Sec. 524, the dis-
charge effected by this Order:
A. Voids any judgment at any time obtained, to the
extent that such judgment is a determination of the
personal liability of the Debtor with respect to any
debt discharged under 11 U.S.C. Sec. 1141, whether or
not discharge of such debt is waived; and
B. Operates as an injunction against the com-
mencement or continuance of an action, the employ-
ment of process, or an act, to collect, recover or off-
set any such debt as a personal liability of the Debtor,
whether or not discharge of such debt is waived.
3. that, except as otherwise specifically provided in
11 U.S.C. See. 1141, the provisions of the Plan bind
the Debtor, any entity acquiring property under the
Plan, and any creditor or equity security holder,
whether or not the claim or interest of such creditor
or equity security holder is impaired under the Plan
and whether or not such creditor or equity security
holder has accepted the Plan;
4. that, except as otherwise provided in the Plan,
all property of the estate, tangible or intangible, be,
and hereby is, vested in the Debtor;
5. that, except as otherwise provided in 11 U.S.C.
Sec. 1141 or in the Plan, the property dealt with by
the Plan is free and clear of all claims and interests of
creditors and equity security holders;
6. that, except as otherwise provided in the Plan,
the Debtor shall retain and remain in possession of all
causes of action as the Debtor may have under the
Code or any other laws; and
62a
7. that the Debtor and any other person or entity
deemed by the Debtor to be necessary, shall prepare
and/or join in the execution or delivery or perform-
ance of any instrument or document that the Debtor
deems necessary, helpful or appropriate to effect a
transfer of property or an adjustment of rights in
property or the granting, satisfaction, or termination
of any lien dealt with by the Plan or this Order that is
necessary for the consummation of the Plan.
DATED, at Indianapolis, Indiana, this 7th day of
August, 1991.
/s/ RICHARD W. VANDIVIER
RICHARD W. VANDIVIER, J UDGE
UNITED STATES BANKRUPTCY JUDGE
DISTRIBUTION:
See Attached.
DISTRIBUTION OMITTED:
63a
UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF INDIANA
INDIANAPOLIS DIVISION
Case No. 85-2238-RWV-11
IN RE: WABASH VALLEY ASSOCIATION, INC., DEBTOR.
[Aug. 7, 1991]
FINDINGS OF FACT AND CONCLUSIONS OF LAW
ON CONFIRMATION OF DEBTOR’S THIRD RESTATED
FOURTH AMENDED PLAN OF REORGANIZATION AND
DENYING CONFIRMATION OF REA’S PLAN
This Court having considered, upon full evidentiary
hearings and argument of counel, the matters above
captioned, the following is presented as procedural
narrative:
I. PROCEDURAL HISTORY
Wabash Valley Power Association, Inc., the Debtor
herein (“Wabash” or “Debtor”), has requested the
Court to confirm its Third Restated Fourth Amended
Plan of Reorganization (“Wabash Plan”) filed on
August 23, 1990. The Wabash Plan is a cumulative
version of Wabash’s Fourth Amended Plan Of
Reorganization filed on June 12, 1989, including all
amendments, restatements and modifications thereto
Wabash’s Disclosure Statement was approved by the
Court on October 19, 1989. Following due notice of a
confirmation hearing on Wabash’s Restated Fourth
Amended Plan Of Reorganization, filed on October 20,
1989, objections were filed by the Rural Electrifica-
tion Administration (“REA”), National Rural Utili-
64a
ties Cooperative Finance Corporation (“CFC”), Fruit
Belt Electric Cooperative (“Fruit Belt”) and the
Indiana Utility Consumer Counselor (“IUCC”). As a
result of said objections, Wabash filed a Second
Restated Fourth Amended Plan on December 6, 1989,
and also filed a Response to said objections on
December 11, 1989.
In addition, REA has requested the Court to con-
firm its (Restated) First Amended Plan Of Reorgani-
zation (“REA Plan”) filed on November 13, 1989.
Objections to the REA Plan were filed by Wabash, the
Official Members’ Committee, Fruit Belt, the IUCC,
the State of Michigan and the Michigan Public
Service Commission (“MPSC”).
Beginning on December 11, 1989, and continuing on
January 3 through January 5, 1990, the Court con-
ducted a consolidated confirmation hearing on Wa-
bash’s Second Restated Fourth Amended Plan and the
REA Plan. At the hearing, the [UCC withdrew its
objections to Wabash’s Second Restated Fourth
Amended Plan. On January 19, 1990, prior to a deci-
sion on confirmation, the District Court reversed and
remanded this Court’s 1987 decision finding Wabash’s
going concern value to be $212,055,000.00. National
Rural Utilities Cooperative Finance Corp. v. Wa-
bash Valley Power Ass’n., Inc., 111 B.R. 752 (S.D. Ind.
1990), rev'g and rem’g, 77 3.R. 991 (Bankr. S.D. Ind.
1987) (Sufana, J.) (the “Valuation Case”). As a result
of the District Court’s decision, on June 12, 1990, the
Court issued notice that a continued confirmation
hearing and remanded valuation hearing would
commence on September 24, 1990.
Beginning on September 24, 1990, and ending on
October 10, 1990, the Court conducted a continued
confirmation hearing on the Wabash and REA Plans
65a
and a remanded valuation hearing. Only Wabash and
REA presented evidence at the hearing. The parties
agreed that the transcripts and evidence from the
1987 valuation hearing and January, 1990 confirma-
tion hearing should be included as evidence in this
proceeding. References to the 1987 valuation hearing
transcript will be denoted by “Val. T. ___., p.
References to the January, 1990 confirmation hearing
transcript will be denoted by “Conf. T. — as
References to the September, 1990 continued confir-
mation hearing and remanded valuation hearing
transcript shall be denoted by “C/V T. p. ___.”
Unless otherwise indicated, all capitalized terms used
herein shall have the meanings assigned to them in
the Wabash Plan or the REA plan.
lil. SUMMARY OF ISSUES
The three overriding issues for the Court are: (1)
what is the fair market value of Wabash as a going
concern for purposes of 11 U.S.C. §§ 506(a) and
§ 1129(b); (2) whether the Wabash Plan is confirmable
under 11 U.S.C. § 1129; and (3) whether the REA Plan
is confirmable under 11 U.S.C. (1129. Only if both
Plans are confirmable must the Court consider which
Plan to confirm under 11 U.S.C. § 1129(c).
A. VALUATION ISSUE AND REMAND DECISION
The valuation issue is back before the Court be-
cause of the District Court’s remand in the Valuation
Case. Although the District Court did not preclude a
going concern value in the low $200 million range, and
it did not disturb the finding that REA’s $864 million
66a
valuation is excessive,’ it was critical of this Court’s
perceived failure to adequately apply the “willing
seller” aspect of the willing buyer-willing seller
valuation standard, and to reasonably estimate
certain risks which affect Wabash’s going concern
value. 111 B.R. at 776.2 The two risks specifically
identified by the District Court were (i) whether
Wabash could obtain any level of rate increase from
the Indiana Utility Regulatory Commission
(“IURC”) to recover any portion of the Marble Hill
debt, and (ii) whether the power supply contracts
between Wabash and the Members are legally enforce-
able. 111 B.R. at 756. On remand, substantial evi-
dence was offered on these two issues, and the Court
has carefully considered such evidence.
Wabash and REA have again presented vastly
different appraisals of Wabash’s going concern value.
Whereas Wabash’s experts testified that the fair
market value of Wabash as a going concern value is
$190 million,s REA’s expert opined that the value is
| The District Court also left undisturbed this Court’s
findings on the appropriate inflation rate and discount rate.
111 B.R. at 776.
2 The District Court also criticized this Court’s perceived
falure to consider REA’s Case A-1 scenario which was based on
annual 4% rate increases resulting in a value of $495 million.
On remand, REA has altered the assumptions and value conclu-
sion of its scenario 1 valuation, which are considered by the
Court herein; therefore, this error is essentially moot.
3 As discussed herein, although Wabash presented evidence
that its going concern value determined by the traditional
willing buyer-willing seller standard is $190 million, it also
presented evidence that Wabash would remain the most viable
power supply option for the Members so long as the going
concern value does not exceed $221.7 million.
ke “
67a
either $450 million or $750 million depending on
whether the regulatory body is the [URC or the
REA. Thus, from the reams of evidence submitted by
the parties and consistent with the District Court’s
directives, the Court must reconsider the issue of
Wabash’s fair market value as a going concern.
B. SUMMARY OF THE WABASH PLAN
The Wabash Plan proposes to pay approximately
$457 million to creditors, including nearly $431 mil-
lion to REA (which equals roughly 65% of REA’s pre-
petition claim). The amount to be paid to creditors
would come from three primary sources: (1) $221.7
million from rate revenues paid by the Members; (2)
$185 million from settlements reached in the Marble
Hill litigation; and (3) approximately $50 million from
various cash accounts. The Wabash Plan further
provides that the Supply Contracts shall be assumed,
and that the Members shall continue to elect the
Wabash Board. Confirmation of the Wabash Plan
would be conditional upon the [URC and MPSC
approving a revenue increase to pay the $221.7 mil-
lion. See 11 U.S.C. § 1129(a)(6).
Because REA and CFC rejected the Wabash Plan,
Wabash has requested that its Plan be confirmed
under the “cram down” provisions of § 1129(b). Based
on REA’s objections to the Wabash Plan and the
evidence introduced at the hearing, the major sub-
issue under the broader issue of confirmation is
whether the Wabash Plan satisfies the absolute prior-
ity rule with respect to the class containing the
unsecured claims of REA and CFC.
The absolute priority rule is at issue because,
although the unsecured claims of REA and CFC are
not paid in full under the Wabash Plan, the Plan
68a
allows the Members to retain control over Wabash.
The Wabash Plan proposes to satisfy the absolute
priority rule by basing the Members’ retention of
control on: (i) the fact that the Supply Contracts
being assumed by Wabash require such control and
(ii) the fact that this is not a typical cram down case
where equity holders may receive some economic
value to the detriment of unsecured creditors. While
the Wabash Plan proposes to satisfy the absolute
priority rule, it also requires the Members to make
fresh capital contributions that satisfy the new
capital exception to the absolute priority rule.
C. SUMMARY OF THE REA PLAN
Under the REA Plan, REA would preempt the
IURC and the MPSC as the regulatory authorities
with jurisdiction over Wabash’s rates, and the
secured creditors (i.e... REA and CFC) would be
issued stock entitling them to elect the Wabash
Board. Assuming that REA can gain control over
both the regulation of Wabash and the Wabash Board,
the REA Plan provides that Wabash’s rates shall be
increased to the extent necessary to pay REA and
CFC in full, including post-petition and post-confir-
mation interest. Thus, the REA Plan provides that
REA and CFC shall receive payments over the next
37 years having a present value of more than $1
billion. If the payments are not made, the REA Plan
provides that Wabash shall be liquidated (in fact,
under the REA Plan, the REA-controlled Board may
liquidate Wabash at any time for any reason).
In spite of the dramatic changes in regulation and
Board control proposed in the REA Plan, the REA
Plan provides that the Supply Contracts shall be
assumed. Although Wabash and others have filed
69a
many objections to the REA Plan, the most serious
issue is whether confirmation of the REA Plan would
breach the Supply Contracts, freeing the Members to
purchase power elsewhere.
Il. UNIQUE FACTORS DISTINGUISHING THIS CASE.
Further complicating these already complex valua-
tion and confirmation issues, and distinguishing this
case from other Chapter 11 cases, are the following
unique factors: (1) Wabash is a not-for-profit coopera-
tive organized to reduce costs for its Members — not
a typical Chapter 11 corporation organized to earn
profits for its shareholders — which means that, as a
matter of state law, Wabash’s Members may not
receive dividends during the life of Wabash, or receive
any distribution upon the liquidation of Wabash; (2)
Wabash is a regulated public utility which is required
to provide wholesale electricity to its 24 Members at
rates that do not permit any profit and that must
correspond with the actual services provided by
Wabash; and (3) the Supply Contracts that hold Wa-
bash and the Members together provide the Members
with substantial rights and control over Wabash,
including the right to elect Wabash’s Board of Direc-
tors and the right to set rates subject to [URC ap-
proval.
The Court having considered the objections to the
Wabash and REA Plans, the evidence submitted by
the parties, the post-hearing filings and arguments,
and the entire record, now makes its Findings Of
Fact and Conclusions Of Law pursuant to Bank-
ruptcy Rules 9014 and 7052:
70a
IND ACT
I. BACKGROUND*
1. Wabash filed its Chapter 11 petition on May 23,
1985 (the “Petition Date”).
2. Wabash is a not-for-profit, generation and trans-
mission electric cooperative (“G & T”), formed in 1962
under the Indiana Not-For-Profit Corporation Act,
I.C. §§ 23-7-1-1 et seg. (now I.C. §§ 23-7-1.1-1 et seq.).
Conf. T. I., p. 14-15, 19, 21.
3. Because Wabash is a not-for-profit cooperative,
it is eligible for tax-exempt status under 26 U.S.C.
§ 501(c)(12). Although Wabash was not tax-exempt in
1989 because its non-member revenue exceeded 15% of
total revenues, Wabash anticipates that it will regain
its tax exempt status for 1990 and beyond. Conf. T. L.,
p. 67-69.
4. As a not-for-profit corporation, Wabash is not
permitted to pay any earnings or dividends to its
Members and, upon a dissolution of Wabash, any
surplus assets remaining after the payment of debts
and the return of capital contributions escheat to the
State of Indiana. See I.C. §§ 23-7-1.1-4(c), 14(a), and
33(b)(3)(E). ,
5. Edward P. Martin (“Martin”) has been the gen-
eral manager of Wabash since 1976. Martin has an
undergraduate degree in electrical engineering and
an MBA from Indiana University. Conf. T.I., p. 12.
6. Wabash provides wholesale electric energy and
other services to 24 rural electric distribution coop-
eratives (the “Members”), 22 of which are located in
4 A complete recitation of the historical facts is found at 77
B.R. 991, 992-1000 and at 111 B.R. 752, 756-58.
7la
northern Indiana, one of which is located in Michigan
(Fruit Belt), and one of which is located in Ohio
(Paulding-Putnam). Conf. T. I., p. 15; Dr. Ex. D. The
22 Members located in Indiana are rural electric
membership cooperatives formed pursuant to the
Indiana Rural Electric Membership Corporation Act,
I.C. §§ 8-1-13-1 et seg. Conf. T. I., p. 15.
7. Historically, Wabash has approved membership
for any electric distribution cooperative that filed an
application and paid a $5.00 fee. Conf. T. I., p. 22-23.
Recently, the Wabash Board passed a resolution con-
tinuing this policy, provided that the applicant agrees
to make the same financial contributions required of
the current Members under the Wabash Plan. Conf.
T. L, p. 26-28; Dr. Ex. B.
8. Wabash’s Members serve approximately 400,000
retail customers in northern Indiana and southwest-
ern Michigan. Wabash’s business is predominantly
residential. Conf. T. I., p. 21. Each Member is a not-
for-profit corporation owned and controlled by its
customers, the retail buyers of electricity. Val. T. L.,
p. 76-77.
9. Wabash is geverned by a Board of Directors
elected by the Members and comprised of one nominee
from each of the 24 Members. Conf. T. [., p. 14-15.
This is consistent with Wabash’s By-laws, requiring
that the Wabash Board consist of a representative
from each Member. Dr. Ex. H.
10. The individuals serving as Wabash’s directors
are identified in Article X of the Wabash Plan.
Martin identified Wabash’s principal officers at the
January confirmation hearing. Conf. T. I., p. 16. The
only compensation received by Wabash’s officers and
directors is $200.00 per meeting attended. Conf. T. [.,
p. 17-18.
72a
11. Wabash maintains a patronage capital account
for each Member, which is based on the total sales to
each Member. The patronage capital generally repre-
sents the amount of money earned by Wabash over and
above its required expenditures. Conf. T. I[., p.23.
Although repayment of the patronage capital is at the
discretion of the Wabash Board, Wabash considers the
patronage capital to be a debt obligation. Conf. T. I., p.
24. As of the Petition Date, the total amount
of patronage capital owed to the Members was
$7,184,740.07. Dr. Ex. C.
12. When Wabash was formed in 1962 it had 21 Mem-
bers, and its sole source of income was dues paid by
the Members. The purpose of Wabash was to provide
the Members with a reliable and reasonably priced
wholesale power supply. Through 1976, when Wabash
hired Martin, Wabash was still not supplying electric
power to the Members, and its capitalization was only
$100,000.00. Val. T. L., p.47-50.
13. Before Wabash began supplying the Members
with electric power, the Members received their
power directly from one of four investor owned utili-
ties (“IOUs”): Northern Inetiana Public Service Com-
pany (“NIPSCO”), Indianapolis Power & Light Com-
pany (“IPL”), Public Service Company of Indiana,
now known as PSI Energy, Inc. (“PSI”) and Indiana
& Michigan Electric Company, now known as Indiana
Michigan Power Company (“I & M”). Each Member
generally bought power from the IOU located closest
to it. Val. T. I., p. 51-89; WVPA Exs. 1-6.
14. In 1977, Wabash entered into wholesale power
supply contracts (the “Supply Contracts”) with each
of the Members, that provide that the Members will
purchase all of their requirements for electric power
from Wabash for a 40-year term (later extended by 10
ee Tag
73a
years). Val. T. I, p. 91. In 1978, the Members as- |
signed their existing power supply contracts with the
four IOUs to Wabash, although IPL has never recog-
nized the assignment and I & M only assented to the
assignment after Wabash filed an action with the
FERC. Val. T. IL, p. 89-99. Energy is physically
transferred to the Members today in the same manner
as when the Members purchased directly from the
four I0Us; the only changes have been contractual.
Val. T. L., p. 89.
15. The Supply Contracts further provide that (1)
Wabash’s rates shall produce revenues which shall be
sufficient, but only sufficient, to pay operating ex-
penses, taxes, principal and interest, and to provide
for reasonable reserves; (2) the Wabash Board (which
is elected by the Members) must pre-approve all rate
requests; and (3) all rate requests are “subject to the
approval of the Public Service Commission of Indi-
ana.” Dr. Ex. A, ¥ 4. These provisions are consistent
with the relevant Indiana statutes and Wabash’s
Articles of Incorporation and By-laws.
16. Although the Supply Contracts were derived
from an REA form contract, the provisions making all
rate requests subject to the approval of the Public
Service Commission of Indiana is not a standard REA
provision. Conf. T. I. p. 34-36. In fact, REA is un-
aware of any other wholesale power supply contract
securing REA loans which includes such a specific
reference to a state regulatory body’s approval of
rates. C/V T. p. 1418. [The Supply Contracts are dis-
cussed in more detail under section IV. A. 2., infra.].
17. With the exception of Fruit Belt, the rates
which Wabash charges the Members are regulated by
the IURC, formerly known as the Public Service
Commission of Indiana. The MPSC regulates the
74a
rates charged to Fruit Belt. Val. T. L, p. 164-65.
[Unless otherwise indicated, references to the LURC
or the state commission(s) include the MPSC to the
extent applicable. |
18. Wabash’s last general rate case was in 1983.
Conf. T. I., p. 50. In the 1983 rate case, the IURC set
Wabash’s rate level and established a capital reserve
of approximately $3.2 million for extensions and re-
placements to plant. Conf. T. L, p. 51. If the rates
approved by the IURC produce revenues exceeding
Wabash’s expenses and the capital reserve, the excess
revenues are referred to as “cash margins” or “ex-
cess margins.” Wabash has been experiencing excess
margins since the Petition Date. Conf. T. I. p. 52.
The IURC requires Wabash’s excess margins to be
applied as a credit against increased fuel cost charges
to the Members. Conf. T. I., p. 52-54. Wabash’s
attorneys’ fees and litigation costs are treated as
operating expenses which serve to reduce the amount
of excess margins, thereby reducing the available
credit against fuel cost charges. Conf. T. [., p. 54.
The net effect is that the Members pay Wabash’s legal
expenses and the payments do not come from funds
available to pay creditors. Conf. T. I., p. 54-55; Dr. Ex.
Pi
19. REA, Wabash’s largest creditor, was created by
the Rural Electrification Act of 1935, 7 U.S.C. §§ 901,
et seq. The Congressional purpose in creating REA
was to make loans for rural electrification. Conf. T.
IIl., p. 83. All of Wabash’s loans from REA were
obtained through the guaranteed loan program,
whereby REA guarantees loans made by the Federal
Financing Bank (“FFB”). Conf. T. I., p. 72-73; Conf.
T. II., p. 84.
asa.
75a
20. In 1978, Wabash became contractually involved
with the Marble Hill nuclear power plant (“Marble
Hill”) being constructed by PSI. Wabash was a 17%
investor in said project, and PSI owned 83%. Wabash
borrowed the funds for its 17% investment in Marble
Hill from FFB, and REA guaranteed said loans.”
PSI’s estimate of the total construction cost in 1978
was approximately $1.8 billion. When the project was
officially cancelled in January, 1984, approximately
$2.9 billion had been expended on the project, and the
estimated completion cost was between $7 and $10
billion. Based on PSI’s cost projections, Wabash
originally estimated that its investment in Marble
Hill would be approximately $360 million; however,
Wabash had invested approximately $460 million by
the time Marble Hill was terminated. Conf. T. L, p.
55-57.
21. Following the cancellation of Marble Hill, Wa-
bash filed suit against PSI (and later against other
Marble Hill participants) and undertook efforts to
determine whether the project could be converted to a
coal-fired plant or completed as a nuclear facility.
Conf. T. I., p. 59. At the same time, Wabash attempted
to restructure its REA loans and, at the insistence of
REA, sought rate relief from the IURC for the
purpose of repaying the Marble Hill debt. Conf. T. L.,
5 REA’s policy has been to encourage electric cooperatives
to invest in nuclear power plants. Speaking to Congress in
1968, former REA Administrator Norman Clapp echoed this
policy by citing “the urgent necessity for providing at this time
assurance of participation by all electric utilities . . ., including
the electric cooperatives, in nuclear power plants planned for
construction.” Participation by Small Electric Utilities in Nu-
clear Power: Hearings Before the Joint Comm. on Atomic
Energy, 90th Cong., 2d Sess. 114 (1968).
76a
p. 58-59. Applying Indiana’s “used and useful” rule,
the IURC dismissed Wabash’s petition for a rate in-
crease and ruled that Wabash could not recover its
sunk costs for Marhle Hill through a rate increase.
WVPA Exs. 10, 11. Ultimately, the Indiana Court of
Appeals and Indiana Supreme Court affirmed the
IURC’s decision. National Rural Utilities Coopera-
tive Finance Corp. v. Public Service Commission of
Indiana, 552 N.E.2d 23 (Ind. 1990), aff’g, 528 N.E.2d 95
(Ind. App. 1988) (the “Rate Case”).
22. On April 19, 1985, after negotiations between
REA and Wabash to restructure the loans failed, the
United States Justice Department sent Martin and
all of Wabash’s directors a letter that asserted that,
pursuant to 31 U.S.C. § 3713, each recipient would be
held personally liable for the REA debt to the extent
of any payments made by Wabash to other creditors.
WVPA Ex. 14. Faced with this potential individual
liability, Wabash filed its Chapter 11 petition on May
23, 1985. Conf. T. I., p. 58-59, 159.
23. As of the Petition Date, Wabash owed REA
$669,058,454.25, consisting of $621,997,000.00 in princi-
pal and $47,061,454.25 in interest. Conf. T. 1., p. 69. Of
this amount, approximately $540 million was related
to Marble Hill and approximately $130 million was
related to non-Marble Hill assets. Wabash Disclosure
Statement, p. 20-21. Subsequent to the Petition Date,
Wabash voluntarily paid REA $36,444,964.22, repre-
senting debt service payments on non-Marble Hill
debt. Conf. T. I., p. 69. Although Wabash designated
the payments to be applied to non-Marble Hill debt,
REA has not recognized the distinction between
6 REA and CFC were allowed to intervene in, and fully
participated in, the Rate Case. 528 N.E.2d at 98.
77a
Marble Hill and non-Marble Hill debt. C/V T. p. 794-
95. In June of 1988, Wabash ceased making payments
to REA and, pursuant to a Stipulation and Court
order, began making non-Marble Hill debt service
payments to an escrow account entitled the “Timbers
Account.” Conf. T. I., p. 70; Conf. T. IL., p. 93. On July
19, 1990, the Court entered its Judgment On Order
Granting United States’ Motion For Abandonment Of
Monies In Escrow Account, directing Wabash to close
the Timbers Account and pay the funds to REA, and
directing REA to apply said funds “to the principal
amount of the ‘non-Marble Hill debt.’” Pursuant to
such Judgment, in August, 1990, Wabash, paid REA an
additional $28,928,693.22. C/V T. p. 795.
24. CFC is a not-for-profit cooperative association
which provides its members with funding to supple-
ment REA’s loan program. As of the Petition Date,
Wabash owed CFC $35,491,876.29. Conf. T. I., p. 72. Of
this amount, $8,719,458.00 represents a loan to make a
debt service payment to REA on the Marble Hill debt,
and the balance represents loans to build Wabash’s
headquarters and to pay for pollution control facili-
ties at Gibson Unit No. 5. Conf. T. I., p. 58; Wabash
Disclosure Statement, p. 21. Subsequent to the Peti-
tion Date, Wabash paid CFC $11,845,045.00 on the non-
Marble Hill loans. Wabash Disclosure Statement, p.
17.
25. The REA debt and CFC debt (excluding the
$8,719,458.00 Marble Hill debt owed to CFC) are se-
cured by a pre-petition, joint mortgage and security
agreement (“REA Mortgage”) covering most of Wa-
bash’s assets. REA Ex. 8.
26. PSI has filed three (3) unsecured claims against
Wabash which, collectively, assert a liquidated liabil-
ity in the amount of $29.5 million and a contingent
78a
liability in an amount not to exceed $110 million.
Other than a claim for indemnification in the amount
of $466,017.00, all of PSI’s claims are related to
Marble Hill. Wabash Plan, § 2.9.
il. ASSETS OF THE ESTATE AND
LIQUIDATION VALUE OF WABASH
27. In an effort to recover its investment in Marble
Hill, Wabash filed suit against PSI, Sargent & Lundy
Engineers (“S & L”) and other defendants. Conf. T.
I., p. 32-33, 61. With the exception of PSI and S & L,
final settlements have been approved with all of the
defendants in said litigation and the settlement
proceeds received have been escrowed into the Marble
Hill Contractor Escrow Account. Conf. T. I., p. 62.
28. On February 1, 1989, Wabash and PSI executed a
“Memorandum of Agreement” (the “PSI Settle-
ment”), which represents a tentative settlement of
the disputes between Wabash and PSI arising out of
the construction of Marble Hill. Wabash Disclosure
Statement, Ex. B. This tentative settlement is con-
tingent upon confirmation of the Wabash Plan, or
some other consensual resolution of the bankruptcy
ease. Jd. ¥ 24. The PSI Settlement contains numer-
ous cash terms, power supply terms and miscellane-
ous terms and conditions intended not only to resolve
Wabash’s lawsuit against PSI, but also to settle PSI’s
claims against Wabash in the bankruptcy case and to
lay the ground work for a 35-year power supply
contract between the parties. The PSI Settlement
provides, inter alia, that REA and CFC will receive
payments from PSI with a present value of $170
million. Of this amount, $80 million is to be paid in
cash and the remaining $90 million is to be paid by
79a
PSI over 35 years from the proceeds generated by the
power supply contract mentioned above. Jd. 7 18-20.
29. The PSI Settlement also seeks to resolve PSI’s
claims against Wabash (which range from $29.5
million to $110 million) by providing, inter alia, that
any plan filed by Wabash shall allow PSI’s indemni-
fication claim in the amount of $466,017.00 and treat
such claim substantially the same as other unsecured
claims. Wabash Disclosure Statement, Ex. B. ¥ 7.
The PSI Settlement further prevides that PSI will
“forego” payment of its remaining claims. /d. { 5.
30. The PSI Settlement is not binding on the
parties until approved by the Court as part of an order
confirming the Wabash Plan, or as part of a consen-
sual resolution of the bankruptcy case. Jd. | 24. For
several reasons, the Court finds that the Wabash Plan
and PSI Settlement are interdependent, with neither
capable of being approved or performed without the
other. First, as demonstrated by the competing plans
filed by Wabash and REA, a consensual resolution of
this bankruptcy case has not been possible. Second,
Section 14.4 of the Wabash Plan and paragraph 24 of
the PSI Settlement expressly provide for such inter-
dependence. Third, the underlying and fundamental
premise of the PSI Settlement is that Wabash will
continue in business after confirmation of its Plan
and will be able to purchase power from PSI to supply
the I & M area. Conf. T. L., p. 65. Finally, it is clear
that when the Wabash Board approved the PSI Settle-
ment as being reasonable, they did so only as part of a
total package which would include confirmation of the
Wabash Plan. Conf. T. 1., p. 67.
31. It has not been disputed, and the Court now
finds, that the PSI Settlement is fair and reasonable;
however, final approval of the settlement and realiza-
80a
tion of the $170 million is contingent on confirmation
of the Wabash Plan.
32. For purposes of a hypothetical liquidation analy-
sis, the Court finds that the liquidation value of the
litigation against PSI is zero because of the contin-
gent nature of the PSI Settlement, the fact that even
under the PSI Settlement $90 million is to be paid
over time from PSI’s sale of power to Wabash in the I
& M area, and the unlikelihood that a Chapter 7 trus-
tee could successfully pursue such litigation (which
was filed in 1984, and has been inactive for two years).
33. The Wabash Plan also incorporates a proposed
settlement with S & L (the “S & L Settlement”),
which provides, inter alia, that REA and CFC shall
receive $15 million from S & L within thirty (30) days
after a final order is entered confirming the Wabash
Plan, plus interest as provided in the agreement.
REA previously stipulated to an estimated value of
the S & L litigation at $20 million, Conf. T. IIL, p. 5-6,
and no objections have been filed to the proposed
settlement. Thus, the Court finds that the S & L
Settlement is fair and reasonable; however, by its
terms, final approval of said settlement is also contin-
gent on confirmation of the Wabash Plan.
34. S & L is a co-defendant in Wabash’s litigation
against PSI. For purposes of a hypothetical liquida-
tion analysis, the Court finds that the liquidation
value of the litigation against S & L is zero because
the tentative S & L Settlement is contingent on con-
- firmation of the Wabash Plan, and it is unlikely that a
Chapter 7 trustee could successfully pursue such liti-
gation.
35. PSI has liquidated most of the tangible personal
property associated with Marble Hill, and Wabash’s
share of the liquidation proceeds is deposited in the
Sla
Marble Hill Salvage Account. REA and Wabash have
stipulated that the liquidation value of the remaining
Marble Hill real estate and personal property, Marble
Hill Salvage Account, Marble Hill Contractor Escrow
Account, Marble Hill to Columbus Line and 765 KV
Switchyard is $29,800,000.00. Dr. Ex. I. Said assets
are not included in the Generation and Transmission
Assets as defined in Section 1.15 of the Wabash Plan
and were not part of the assets from which the going
concern value was derived. The amount paid to credi-
tors by reason of said assets would be the same in
either a liquidation or under a plan of reorganization.
36. Wabash’s tangible, useful assets consist of: (1) a
25% interest in Gibson Unit No. 5; (2) an ownership
interest in transmission facilities; (8) distribution
facilities, including substations; (4) headquarters
building; (5) load management system; and (6) furni-
ture, miscellaneous equipment and vehicles. Conf. T.
I., p. 28-31. Pursuant to a stipulation between REA
and Wabash, the liquidation value of said assets is
$175 million. Dr. Ex. I. The book value of said assets
is approximately $130—$150 million. Dr. Ex. A-10;
C/V T. p. 1574, 1619. All of said assets (except vehi-
cles) are included in the Generation and Transmis-
sion Assets as defined in Section 1.15 of the Wabash
Plan, and are included in the assets from which the
going concern value was derived.
37. Wabash’s intangible assets consist of: (1) the
Supply Contracts mentioned above; (2) capital in CFC
(approximately $8 million to be set off against CFC’s
claim); (3) the litigation against PSI and S & L de-
scribed above, and (4) various interconnection and
power agreements with other utilities. Conf. T I. p.
31-33. Martin testified that in his business opinion
the Supply Contracts have no independent liquidation
82a
value because the Members effectively set the price
they pay for power by virtue of their control over the
Wabash Board. Conf. T. IL. p. 36-38. Martin further |
testified that Wabash’s contracts with other utilities .
have no liquidation value primarily because such :
contracts would be meaningless without Wabash in
existence and could be obtained in the market directly
from the utilities. Conf. T.I., p. 38-44. )
38. As further evidence that the Supply Contracts
have no independent liquidation value, Wabash pre-
sented the testimony of Dr. Shannon P. Pratt, whose
credentials are summarized in § 133 below. Pratt
reviewed the Supply Contracts, along with relevant
portions of the Wabash By-laws and Articles of
Incorporation, to determine the fair market value of
said contracts. Conf. T. I, p. 186. Pratt’s expert
opinion was that the Supply Contracts have no fair
market value because the contracts would preclude a
buyer from earning a return on his purchase. Conf.
T. L., p. 87. Pratt testified that a buyer of the Supply:
Contracts would be unable to earn a return on his
purchase for several reasons. First, the Supply Con-
tracts provide that the seller of the electricity may
not make a profit. Conf. T. L, p. 188-89, 194-95; Dr. Ex.
A, 4. This is consistent with Wabash’s Articles of
Incorporation and Bylaws. Dr. Exs. F, G. Second, the
Supply Contracts expressly provide that only Wa-
bash’s Board may request a rate change, and the
Wabash Board is comprised of nominees from the
Members. Conf. T. I., p. 195-96; Dr. Ex. A, 4; Dr. Ex.
H. It is illogical to believe that a buyer would pay any
significant amount for the Supply Contracts since the
customers have the right to establish the rates.
Third, the Supply Contracts provide that all rate
changes are subject to the approval of the IURC.
me
83a
Conf. T. L., p. 196; Dr. Ex. A, 9 4. Under IURC regula-
tions, excess margins are credited against increased
fuel cost charges to the Members. Dr. Ex. P. Based
on his analysis, Pratt found that the Supply Con-
tracts “have no separate value outside of the value of
Wabash as a going concern.” Conf. T. 1., p. 199.
39. Dr. Wilbur G. Lewellen, whose qualifications
are summarized in 175 below, also testified that the
Supply Contracts are “worth nothing” because
“ftlhere is no rational reason for anyone to buy
them.” Conf. T. II., p. 20. Lewellen stated that the
Supply Contracts have no liquidation value because
the Members are able to control the price which they
pay for power. Conf. T. II., p. 19-20.
40. REA offered no evidence that the Supply Con-
tracts or Wabash’s contracts with other utilities have
any independent liquidation value. The testimony of
Martin, Pratt and Lewellen on this valuation issue
stands unrebutted. The Court finds that the Supply
Contracts and Wabash s contracts with other utilities
have no independent liquidation value, and that their
value is only reflected in the value of Wabash as a
going concern.
41. The only Wabash asset not previously men-
tioned is cash in the Investment Accounts (approxi-
mately $19 million) and cash maintained for Operating
Funds (approximately $7,100,000.00). Wabash Plan,
§§ 1.18, 1.28.
42. Based on the foregoing, the Court finds that the
liquidation value of Wabash is approximately
$213,210,000. 00, summarized as follows:
Headquarters building, transmission
and distribution assets, 25% interest
in Gibson 5, general plant and equipment
84a
and vehicles (ver stipulation, Dr. Ex. I) 3
$175,000,000.
Marble Hill real estate and personal
property, Marble Hill Salvage
Account, Marble Hill Contractors
Eserow Account, Marble Hill to
Columbus Line, and 765 KV
Switchyard (per stipulation, Dr. Ex. I) 29,800,000.00
PSI Settlement 0.00
S & L Settlement 0.00
Supply Contracts and other contract rights 0.00
CFC Investments 8,000,000.00
Investment Account 19,000,000.00
Operating Funds 7,100,000.00
SUB-TOTAL: 236,900,000.00
Less 10% Liquidation Cost and Taxes: 23,690,000.00
TOTAL LIQUIDATION VALUE: $213,210,000.00'
43. Although no evidence of liquidation costs was
presented, the Court knows from past experience
with cases before it that Chapter 7 liquidation costs,
including professional fees and taxes, would be at
least 10%.
7 The Court notes that even if the full amounts of the PSI
Se tlement and S & L Settlement could be recovered by a
Chapter 7 tr stee (a proposition which the Court rejects), the
total Ii uidation value of Wabash would still be less than $400
million.
:
4
SS ”——lClCOE
85a
Ill. REGULATORY JURISDICTION OVER WABASH
44. Because Wabash is a public utility, it is subject
to regulation. Historically, as noted, the IURC and
MPSC have exercised (and continue to exercise)
regulatory jurisdiction over Wabash and its rates. As
discussed below, litigation is pending in the District
Court concerning whether the REA may preempt the
jurisdiction of the state commissions. The merits of
the preemption issue are not before this Court, but
the likelihood and effect of REA preemption are
critical to the REA valuations and feasibility of the
REA Plan. Thus, the Court will review the status of
the regulatory jurisdiction over Wabash.
45. On November 23, 1988, REA sent letters to
Wabash, the IURC and the MPSC purporting to pre-
empt the ratemaking jurisdiction of the state commis-
sions. Wabash brought an action against REA in the
District Court, seeking a declaratory judgment that
REA lacks any authority to regulate the rates of
Wabash. On May 16, 1989, the District Court granted
summary judgment in favor of Wabash and held that
REA’s assertion of jurisdiction over Wabash’s rates
was “arbitrary, capricious, not in accordance with
law, and of no force and effect whatever.” Wabash
Valley Power Association, Inc. v. Rural Electrifica-
tion Administration, 713 F. Supp. 1260 (S.D. Ind.
1989) (“Wabash v. REA (1)”). Dr. Exs. L, N.
46. Following an appeal by REA and CFC, the
Seventh Circuit Court of Appeals unaminously af-
firmed the District Court’s decision in Wabash v.
REA (1). 903 F.2d at 445 (7th Cir. 1990). In affirming,
the Seventh Circuit stated that “{a]fter all, the REA
made its loans and guarantees on the assumption that
state regulation would apply.” Jd. at 455.
86a
47. On September 19, 1990, just prior to the begin-
ning of this proceeding, REA again tried to preempt
the rate making jurisdiction of the [URC—this time
by adopting and publishing rules in the Federal
Register. See REA Ex. B-37. On September 24, 1990,
Wabash filed a Complaint against REA in the District
Court, requesting a declaratory judgment that the
preemption rules are invalid and unenforceable as
applied to Wabash. Wabash Valley Power Associa-
tion, Inc. v. REA, Cause No. IP90-1858C (S.D. Ind.
1990) (“Wabash v. REA (II)”). That action is pend-
ing.” On October 4, 1990, Wabash objected to the .
admissibility into evidence of the REA preemption
rules on the grounds that such rules violate the
automatic stay, 11 U.S.C. § 362, and are, therefore,
null and void. The Court admitted the rules into |
evidence as being “potentially relevant.” C/V T. p. |
:
Pe ee ee
1354.
48. REA concedes that Wabash is regulated by the
state commissions unless or until such time as REA
prevails in Wabash v. REA (II). C/V T. p. 1345.
7?
IV. EVIDENCE ON WABASH’S FAIR MARKET
VALUE AS A GOING CONCERN
49. For purposes of 11 U.S.C. §§ 506(a) and 1129(b),
the Court must determine Wabash’s fair market value
as a going concern. Wabash’s going concern value
fixes the amount of the secured claims held by REA
and CFC, § 506(a), and also determines the minimum
amount which must be paid to creditors under
* REA and Wabash have filed cross motions for summary
judgment in Wabash v. REA (II), and the matter is fully
briefed.
87a
§ 1129(b). In this connection, the Court will summa-
rize the valuation evidence presented by Wabash and
REA.
A. WABASH’S CASE IN CHIEF
50. Wabash called six witnesses during its case in
chief. Generally, Richard Setlif f and Paul D. Reising
testified regarding Wabash’s power cost forecast,
Professor Ian Macneil provided opinions concerning
the effect of certain actions on the Supply Contracts,
Robert Gross testified concerning Wabash’s fair
market value as a going concern, Dr. Wilbur’ G.
Lewellen testified regarding the additional value of
Wabash to the Members, and Dr. Robert E. Olley
reviewed the economics of the Wabash valuations.
51. Wabash’s power cost forecast, Dr. Ex. A-I, was
prepared by Richard Setliff and Paul D. Reising.
Setliff is Wabash’s manager of planning, and has a
Master’s Degree in economics from Indiana State
University. C/V T. p. 33-34. Reising is a partner in
the engineering and consulting firm of R.W. Beck &
Associates (“Beck”), has an undergraduate degree
from Purdue University in engineering, and has an
MBA from Butler University. C/V T. p. 210. Reising
has been doing consulting work for Wabash since
about 1979. C/V T. p. 219. Generally, in the prepara-
tion of Dr. Ex. A-I, Setliff was responsible for project-
ing load growth, annual expenses relating to existing
assets, administrative expenses, and expansion plan-
ning. Reising was responsible for projecting expan-
sion costs and future wholesale power rates for
Wabash and other utilities. C/V T. p. 40-47.
88a
52. Dr. Ex. A-I was prepared at the direction of
Wabash’s two valuation experts, Robert Gross and
Dr. Lewellen (whose qualifications and valuations are
discussed below). The purpose of Dr. Ex. A-I was to
analyze and contrast the annual power supply costs
for the Members—both with Wabash in existence (the
“with-Wabash scenario”), and without Wabash in
existence (the “without-Wabash scenario”). In the
with-Wabash scenario, costs were projected based on
Wabash’s continuation as a going concern with its
existing contracts and future power supply needs.
The without-Wabash scenario assumes that the
Members would purchase all of their power require-
ments directly from their host utilities, PSI, I & M,
NIPSCO and IPL, at average embedded cost.” Under
both scenarios, variable expenses were escalated
using a 4% inflation rate, and costs related to Marble
Hill debt were excluded. C/V T. p. 37-49.
53. Dr. Exs. A-2 and A-3 are flow charts identifying
the cost inputs for the with-Wabash and without-
Wabash scenarios, respectively, and which result in
the revenue requirements under each scenario. Table
1 in Dr. Ex. A-I summarizes the annual cash require-
ments under both scenarios, and this information was
used by Wabash’s valuation experts. C/V T. p. 52-58.
54. Dr. Ex. A-4 is a graph comparing the revenue
requirements under Wabash’s most costly scenario
9 “These are the same four 10Us that supplied the Members
prior to Wabash, and that are physically connected to the
Members. C/V T. p. 228; Val. T. 1., p. 89. The term “average
embedded costs” should be used, for purposes of this case,
synonymously with “average system costs.” “Average system
costs” is considered to be the total costs (fixed and variable)
divided by the units produced (i.e., the average unit cost of
production).
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(i.e., the without-Wabash scenario) and the revenue
requirements under REA’s purportedly least costly
scenario (i.e... REA scenario 1, which is discussed
below). To illustrate the difference between the
studies, in the year 2020 the Wabash study projects
revenue requirements of $750 million, while the REA
study projects revenue requirements of $1.7 billion—
more than a two-fold difference. Conf. T. p. 59-60.
2. The Supply Contracts; Testimony Of Professor
Ian Macneil
55. As will be seen, the paramount factor affecting
the going concern value of Wabash (as well as the conf
irmation issues) is the continuing enforceability of
the Supply Contracts. Based on the District Court’s
directive, see 111 B.R. 761, 765, 773, Wabash presented
Professor Ian Macneil as an expert on contract law to
interpret the Supply Contracts and their enforceabil-
ity under the Plans proposed by the parties. C/V T. p.
486-560. REA did not offer any evidence on this issue.
Macneil received his LL.B., magna cum laude, from
Harvard Law School in 1955 and is currently the John
Henry Wigmore Professor of Law at the Northwest-
ern University School of Law. C/V T. p. 487. The
Court accepted Macneil as an expert witness to give
independent legal opinions on the Supply Contracts.
C/V T. p. 492, 494-95. Dr. Ex. A-9 is Macneil’s report
containing his opinions on various issues concerning
the Supply Contracts.
a. Terms Of The Supply Contracts And Effect Of
REA Preemption And The REA Plan On The
Supply Contracts
56. Based on his review of the Supply Contracts
and other pertinent circumstances, Macneil testified
that the parties’ (i.e. Wabash and the Members)
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“bargain in fact” included the following: (1) the
Supply Contracts require that the IURC regulate
Wabash’s rates, C/V T. p. 501, 508-10; (2) the Supply
Contracts empower the Wabash Board to set rates,
prohibit Wabash from earning a profit, and require
that rates be no higher than necessary to produce
revenue to pay operating expenses, taxes, principal
and interest payments,” and to provide a reasonable
capital reserve, C/V T. p. 502, 511-12; (3) the Supply
Contracts are conditioned on the Members retaining
their right to manage Wabash, including its rate-
setting functions, C/V T. p. 502, 513-21; and (4) the
Supply Contracts are conditioned on the absence of
significant changes in the regulatory scheme. C/V T.
p. 503, 523-25.
57. Based on the foregoing provisions of the Supply
Contracts, Macneil testified unequivocally that “the
introduction of any regulatory scheme that changes
the terms of the contracts,” such as (1) the transfer of
regulatory power from the IURC, (2) the loss of
Member control over Wabash and its rates, or (3) the
charging of rates in excess of Wabash’s costs, will
cause Wabash to breach the Supply Contracts. C/V
T. p. 523-24. In response to the question of what effect
REA preemption would have on the enforceability of
the Supply Contracts, Macneil testified that:
If REA is going to take over regulation for the
purpose of paying itself off, what - I have [referred
© Qn cross examination, Macneil emphasized that the list of
allowable costs (and particularly principal and interest) is
limited or qualified by the clause requiring that rates be
approved by the IURC. C/V T. p. 578. Thus, reading the con-
tract provisions to ether, Wabash may recover through rates
only those costs which are recoverable under IURC rules.
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to as) predatory regulation rather than traditional
regulation .. .; if that is their purpose and to carry
out that purpose with ... regulation, then it is
going to result in breaches of these contracts if
Wabash Valley has to abide by those regulations.
C/V T. p. 525.
58. Concerning the effect that confirmation of the
REA Plan would have on the enforceability of the
Supply Contracts, Macneil concluded in his report
that “confirmation of the REA’s plan to transform
Wabash Valley into a rate-hiking profit center for the
benefit of REA and other creditors would breach
every [Supply Contract.)” Dr. Ex. A-9, p. 28; C/V T. p.
594. In the event that the REA Plan is confirmed,
resulting in a breach of the Supply Contracts,
Macneil testified that Wabash would be the breaching
party, and that the Members would be relieved of any
obligation to perform under the Supply Contracts.
C/V T. p. 661-62.
b. Doctrine Of Frustration Of Purpose
59. Macneil not only determined that REA’s pro-
posed changes would breach the parties’ “bargain-in-
fact” as expressed in the Supply Contracts, but he
also concluded that the doctrine of frustration of
purpose would provide an additional basis for relieving
the Members of their obligations under the contracts
(though it was unnecessary to utilize this doctrine to
discern the clear provisions discussed above). C/V T.
p. 528. Macneil testified that the following events, or
a combination thereof, would frustrate the purposes of
the Supply Contracts, thereby giving the Members a
valid defense to enforcement of the contracts: (1) the
Members’ loss of control over Wabash; (2) the loss of
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regulation by the [URC; (8) a fundamental change in
the regulatory scheme; and (4) the loss of tax-exempt
status if it results in financial costs to the Members.
C/V T. p. 536-42.
c. Assignment Of Rights; Delegation Of
Performance
60. Macneil also testified concerning the assignabil-
ity of the Supply Contracts. Assuming that any of
Wabash’s rights under the Supply Contracts are
assignable, Macneil testified that the assignee would
take those rights subject to all of the terms of the
contracts and, therefore, to whatever extent such
terms affect the value of the contracts, they would
affect the value of the contracts in the hands of the
assignee. C/V T. p. 505, 543-45. Other than the right
to fully-earned payments, Macneil testified that
Wabash’s rights under the Supply Contracts are not
assignable. C/V T. p. 506, 546-47. Macneil also testi-
fied that performance of Wabash’s principal duties
under the Supply Contracts is not delegable. C/V T.
p. 507, 550.
3. Wabash’s Going Concern Value To A_For-
Profit Willing Buyer; Testimony Of Robert J.
Gross
61. Wabash presented Robert J. Gross as its expert
witness on the issue of Wabash’s fair market value as
a going concern. Gross has been doing appraisal work
since 1979, has been project manager on 100 to 150
appraisals, and has performed 40 to 50 going concern
valuations of businesses during the two years preced-
ing his testimony. C/V T. p. 278-79. Gross is certi-
fied as a senior member of the American Society of
Appraisers (“ASA”), with a designation in business
—_—— -
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valuation. C/V T. p. 279. Gross previously worked for
American Appraisal Associates, and is currently a
vice president in charge of Merrill Lynch’s business
brokerage and valuation division. C/V T. p. 280-82.
Dr. Ex. A-11 is Gross’ valuation report.
62. Gross testified that the purpose of valuing a
business as a going concern is to estimate its fair
market value, and he defined “fair market value” as
the estimated value at which the business might
exchange hands between a willing buyer and willing
seller, each having reasonable knowledge of all
relevant facts, neither being under compulsion and
with equity to both. C/V T. p. 285. Gross testified
that the definition of fair market value contemplates
that an actual sales transaction will occur, and that
the typical willing seller is someone motivated to sell
at the highest possible price. C/V T. p. 288. Accord-
ing to Gross, Wabash is not a typical willing seller
because of its motivation to maintain low rates;
therefore, for purposes of his valuation, Gross
assumed the Bankruptcy Court to be the willing
seller because of its motivation to obtain the highest
value. C/V T. p. 288-89.
63. Gross identified the following relevant facts and
information that the willing seller and willing buyer
of Wabash as a going concern should be aware of: (a)
the most likely buyer of Wabash would be a profit-
motivated, tax-paying IOU; (b) the Members, in their
role as customers, would have a great deal of leverage
on the transaction; c) the Wabash Articles of Incor-
poration and Bylaws place certain limitations on the
transaction; (d) the customer base consists of 24
Members; (e) the Supply Contracts provide the Mem-
bers with certain rights (see the discussion of
Macneil’s opinions, supra); (f) the Indiana Supreme
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Court has explicitly denied a rate increase to obtain a
return on the Marble Hill investment; and (g) the
Wabash power cost study (Dr. Ex. A-I). C/V T. p. 290-
91.
64. The information relied on by Gross to prepare
his report and render his opinion on value included
financial statements, operating statements, load fore-
casts, conversations with Wabash personnel, research
of the capital markets, and research of the general
economic environment in the electric market in
Indiana. C/V T. p. 303. Specifically, Gross also re-
viewed certain of Wabash’s Articles of Incorporation
and By-laws (Dr. Exs. A-5, A-6 and A-7), a copy of one
of the Supply Contracts (Dr. Ex. A-8) and Professor
Macneil’s written opinion concerning the Supply
Contracts (Dr. Ex. A-9). C/V T. p. 293-94.
65. Gross testified that there are three approaches
to valuing anything—the cost, market, and income
approaches—and that the market and income ap-
proaches are typically used to determine going
concern value. C/V T. p. 303-04. Gross selected the
income approach as being most applicable to Wabash
and testified that such approach seeks to determine
the lung range cash flows of the business and,
depending on the risks of those cash flows, discount
the cash flows back to the present at a rate that
provides the buyer with an adequate return. C/V T. p.
305.
66. Because of the willing buyer’s profit motivation,
Gross testified that a sales transaction involving
Wabash would require the willing buyer to renegoti-
ate the Supply Contracts (which, as currently
drafted, do not permit any profit). C/V T. p. 306. In
Gross’ view, the need to renegotiate the Supply Con-
tracts would give the Members a great deal of
— il ttt it he et a a a
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leverage in the transaction with the result being that
a willing buyer “would not .. . factor into the valua-
tion prices that exceed those that the [Members]
could get on the open marketplace. To do so would
risk the economic disintegration of Wabash Valley.”
C/V T. p. 307. Gross testified that the same four
10Us identified in Dr. Ex. A-I (NIPSCO, I & M, PSI
and IPL) are alternative sources of power available to
the Members. Given the availability of alternative
power suppliers for the Members, Gross testified that
a willing buyer would perceive that the Supply
Contracts could be successfully renegotiated “only if
the pricing ... of power to the [Members] was at a
price ... exactly the same that they could get on the
open market.” C/V T. p. 308. Thus, Gross concluded
that the rates of the neighboring IOUs have a limit-
ing effect on the value of Wabash in the market. C/V
T. p. 308.
67. The cash flows used in Gross’ valuation are
based on the presumption that “all 24 [Members]
remain intact, that they ...unaminously agreed to
revision of their contracts ... in such a way that
would reduce or even eliminate their board involve-
ment, [aJnd lastly, that they agreed to prices that
were the same as they could get from the neighboring
[1OUs].” C/V T. p. 309-10. Gross testified that an
appraiser must deal with the risks associated with
the foregoing factors, and that risk in valuation is
accounted for by modifying the discount rate, taking a
discount off the value, or both. C/V T. p. 310-11.
68. Gross used a debt-free, cash-flow approach,
which produces a fair market value of what the overall
business is worth, and determines what the return
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