In a direct appeal to the 7th Circuit—bypassing the district court—debtor, River East Plaza LLC, appealed an adversary action ruling issued by the U. S. Bankruptcy Court for the Northern District of Illinois rejecting River East’s Chapter 11 plan and dismissing the bankruptcy case. River East Plaza, LLC, et al. v. LNV Corporation (In re River East Plaza, LLC), Case No. 11-3263 (7th Cir. Jan. 19, 2012). The 7th Circuit affirmed and found the denial of confirmation, lifting of the automatic stay and dismissal of the bankruptcy case appropriate.
River East, the owner of a building in downtown Chicago, had sought Chapter 11 bankruptcy protection just hours before its lender, LNV Corp., the holder of a first priority mortgage, foreclosed. Rather than immediately seeking relief from the automatic stay imposed by 11 U.S.C. section 362, LNV actively participated as a creditor within the Chapter 11 case.
River East’s bankruptcy case was designated a “single asset real estate case.” Bankruptcy Code section 362(d)(3)(A) requires a bankruptcy judge, in a single-asset bankruptcy case, upon request of a party to “grant relief from the [automatic] stay…,such as by terminating, annulling, modifying, or conditioning such stay” unless within 90 days of the filing of the Chapter 11 petition, “the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable period of time.”
After one failed plan attempt, River East filed a second Chapter 11 plan where it sought to “cram down” and provide LNV substitute collateral (in the form of a lien on 30-year Treasury bonds), for its first priority lien on the debtor’s property, thereby extinguishing LNV’s lien against River East’s building. LNV objected.
11 U.S.C. section 1129 (b)(2)(A) provides three alternatives for cram down against a secured creditor:
- Subsection (i) allows the reorganized debtor to keep the property and modify the repayment of obligations beyond the contractual maturity date with the lien remaining against the property until the debt is repaid or the secured creditor receives at least the value of its claim.
- In subsection (ii), the debtor sells the property free and clear of the secured creditor’s lien, but the secured creditor’s lien attaches to the proceeds of sale and remains until the obligation is repaid or the creditor receives at least the value of its claim.
- Subsection (iii) allows the debtor to exchange the lien for its “indubitable equivalent.” It was this last alternative that River East invoked.
LNV was owed $38.3 million. River East’s building (by River East’s own appraisal) was valued at $13.5 million. LNV, therefore, was undersecured and held a secured claim for the value of the collateral ($13.5 million) and an unsecured claim for the balance ($24.8million).
The Bankruptcy Code at section 1111(b), however, provides a creditor like LNV with the opportunity to elect the treatment of its claims. LNV could elect to hold a secured claim for the value of the collateral and an unsecured claim for the balance owed or it could choose to assert a single secured claim equal to the outstanding debt. LNV chose the latter so it had a secured claim for $38.3 million and no unsecured claim.
River East argued that the lien on the 30-year Treasury bonds would be equivalent to LNV’s lien. That may have been true if LNV had elected to split its claim into a secured claim of $13.5 million and an unsecured claim for the balance. Analyzing fluctuating interest rates on 30-year Treasury bonds, the 7th Circuit assessed the value of the substitute collateral and found that the return on the 30-year Treasury bonds wouldn’t yield amounts anywhere close to the $38.3 million amount of LNV’s claim, and LNV would have to wait another 25 years to recover the amounts owed.
In determining whether the substituted collateral was the indubitable equivalent of LNV’s lien, the court noted that indubitable equivalent collateral would be substitute collateral that “was no more volatile than a creditor’s current collateral even in the case of an undersecured debt.” Here, because of the different risk profiles of the two forms of collateral, they are not equivalent, and there is no reason why the choice between them should be left to the debtor to decide.
Acknowledging that LNV was undersecured, the court had trouble imagining what purpose could be served by substituting collateral other than to reduce the likelihood that LNV would ever be repaid in full. In affirming the bankruptcy court’s denial of plan confirmation, the 7th Circuit found that the lien on the 30-year Treasury bonds proposed by River East would not be equivalent to LNV’s retaining its lien on the property and the plan didn’t meet the requirements for cram down.
The 7th Circuit then turned on whether to affirm the Bankruptcy Court’s granting of relief from the automatic stay in favor of LNV and dismissal of the bankruptcy case.1 The court noted that the 90-day deadline had expired long ago, LNV had waited years to enforce its lien and the bankruptcy judge wasn’t required to stretch out the Chapter 11 proceeding for a debtor who had multiple failed confirmation attempts. The automatic stay was lifted and dismissal of the case was affirmed.
As seen above, a secured creditor’s election under Bankruptcy Code section 1111(b) will be determinative of how the creditor is treated and whether it ever receives repayment of the debt owed. Had LNV chosen not to give up the unsecured portion of its claim, the plan would have met the cram down requirements and been confirmed over LNV’s objection with LNV receiving some fraction of its unsecured claim and a far delayed recovery on its secured claim.
Similarly, the debtor could have offered LNV to retain its lien on the building and avoid the failed indubitable equivalent determination. Instead, because this single-asset real estate debtor didn’t propose a plan with a reasonable possibility of being confirmed within a reasonable period of time, LNV obtained relief from the stay and was able to complete its foreclosure.
1. After the bankruptcy judge denied confirmation of the second proposed plan, River East proposed a third plan or reorganization. By that point, the bankruptcy judge had lost patience with River East and found River East’s credibility lacking. The third plan was rejected, the automatic stay was lifted and the case was dismissed.