ARTICLES - Certified Specialist in Bankruptcy Law | State Bar of California Board of Legal Specialization

2011-05-15 You Say "Equity", I Say "Adequate Protection"

"Adequate protection" is a phrase often uttered interchangeably in the context of both Motions for Relief and Cash Collateral motions. In the case of Motions for Relief, the entirety of all liens are added together to determine if the value of the property exceeds the creditor's interest by a sufficient equity cushion, thereby giving cause to give relief to the creditor. In the case of Cash Collateral motions, where a creditor might demand "adequate protection" payments, the sum total of all liens are NOT calculated to determine if there is sufficient equity cushion. In re Mellor (1984) 734 F.2d 1396, 1402 [junior liens relevant to determine "equity", but not for determining "adequate protection."]

Thus, a senior creditor was “adequately protected” although there was no “equity” in the property because the senior creditor in question held a 20% equity cushion. In re Mellor at 1402 [citing In re Breur, 4 B.R. 499 (B.Ct.S.D.N.Y 1980)]. In fact, some courts have held that even a 10% equity cushion was sufficient adequate protection for a secured creditor. In re McGowan, 6 B.R. 241, 243 (B.Ct.E.D.Pa. 1980); see also In re Rogers Development Corp.,2 B.R. 679, 685 (B.Ct.E.D.Virg.1980) [an equity cushion of approximately 15% to 20% was sufficient adequate protection to the creditor, even though the debtors had no equity in the property.]; In re Breuer,4 B.R. 499, 501 [creditor protected by equity cushion of $21,000 despite fact that debtor lacked equity in the property.].

2011-06-02 When the Absolute Priority Rule is Not So Absolute

Depending on the court, it may recognize the "new value" exception to the absolute priority rule.There is a non statutory “exception” or “corollary” to the absolute priority rule under which junior classes may receive property or retain interests in the debtor to the extent they contribute substantial “new capital” to the estate—even where the plan does not pay senior classes in full. In re Bonner Mall Partnership (9th Cir. 1993) 2 F3d 899, 906 [It is ... the set of conditions under which former shareholders may lawfully obtain a priority interest in the reorganized venture.

The main issue is whether a reorganization plan that gives stock to former equity holders does so primarily because of their old interests in the debtor or for legitimate business reasons. There must be causation between “holding the prior claim or interest and receiving or retaining property.” Causation may be lacking (and the plan therefore disqualified) whenever junior classes acquire or retain an interest at a price that fails to provide the greatest possible addition to the bankruptcy estate; “and it would always come at a price too low when the equity holders obtained or preserved an ownership interest for less than someone else would have paid.”

The requirements are that the contribution must be: 1] new; 2] substantial; 3] money or money's worth; 4] necessary for successful reorganization; 5] reasonably equivalent to the value or interest received; and 5] tested in the marketplace

1] "New Contribution": What is offered must be new capital or some other new contribution. Loaning money to the debtor secured by the debtor's assets does not constitute a “present contribution of new value.”

2] The new value contributed must be “substantial” in comparison to:

—the total amount of unsecured claims;

—the total amount of claims being discharged; or

—the dividend being paid on unsecured claims by virtue of the contribution.

3] The new value contributed must:

—consist of money or property that is freely traded in the economy; and

—be a present contribution, occurring on the effective date of the plan.

That is, no future contributions or services, no personal guarantees or release of debts would suffice.

4] "Necessary for a successful reorganization": Under this requirement, the plan proponent must show that the reorganization effort may fail without the new value contribution. The Ninth Circuit has stated that the old owners may demonstrate the “necessity” for their new value contribution simply by showing that they are “the most feasible source of the new capital.” But the Supreme Court has found that "[t]he old owners must do more than demonstrate that the new capital is necessary for a successful reorganization. The old owners must also show that the reorganized entity needs funds from the prior owner-managers because no other source of capital is available.”

5] The “new value” contributed must be reasonably equivalent to the value of the interest received or retained. The equivalency requirement ensures that equity holders will not eviscerate the absolute priority rule by means of gratuitous, token cash infusions proposed primarily to ‘buy’ cheap financing.” This ordinarily requires the value of the debtor's business to be determined on a “going concern” basis. A debtor's “going concern” value is generally determined by estimating the debtor's future earnings and discounting those earnings to present value using an appropriate discount rate.

6] Marketplace exposure required: The best way to determine the value of the interest offered for new value is marketplace exposure.

2011-07-01 The Politics of Chapter 11 Voting

Acceptance by a class of claims is determined by 2/3 of the dollar amount and more than 1/2 of the number of claims who actually vote. Thus, it is imperative to know who is likely to vote and who is not likely to vote.

The Facts: A single asset real estate debtor files for Chapter 11. There are 4 secured liens: 1) 1st Mortgage of $2 Million; 2) 2nd Mortgage of $300,000; 3) 3rd Mortgage of $200,000; and 4) 4th Mortgage of $100,000. There are also some unsecured wage claims totaling $50,000. There are also some unpaid vendors in the amount of $30,000. If the building is worth $1.5 million, the debtor may want to file a motion to value the property at $1.5 million, thus treating $500,000 of the 1st Loan unsecured as well as the rest of the 2nd, 3rd and 4th Loans as unsecured. Debtor files a plan to extend the term of the 1st mortgage and to pay less interest due to the historically low interest rates. Debtor also wishes to pay only 20% of the unsecured trade vendors and to pay the back wages over a period of time.

Debtor files a plan that classifies the secured 1st Mortgage as Class 1, the priority unsecured wage claims as Class 2, and the rest of the Unsecured Mortgages and the trade vendors as Class 3.

Scenario #1: If all the claims voted on this plan, it is more than likely that the unsecureds left by the 1st, 2nd, 3rd and 4th mortgages will overwhelm and outvote the remaining unsecured claims. This is usually the reason why a single asset real estate plan cannot be crammed down.

Scenario #2: What if the employees with back wages decided that they would vote to accept the plan ? But for some reason, not all the employees voted and only 1 voted to accept the plan ? That would mean that the priority unsecured class of claims for priority wages would have accepted the plan. Why ? 100% of the dollar amount and more than 1/2 of the number of claims have accepted the plan because only one vote was actually cast. The same would not be true if only one of the vendors decided to cast a vote and the rest of the unsecured mortgages decided to cast a vote.

The result of Scenario #2 would be that Class 1 Claim of $1.5 million would be paid in deferred payments. Class 2 would be paid over time. How Class 3 is paid depends on whether the debtor was a corporate entity or an individual. If a corporate debtor, then Class 3 may have to be paid 100% of its claims due to the "absolute priority" rule. If an individual, then the absolute priority rule does not apply and less than 100% can be paid to Class 3.

2011-09-01 All or Nothing ? Student Loans May be Partially Dischargeable

A popular misconception is that a student loan is either entirely dischargeable or non-dischargeable. However, it is possible to partiallydischarge a student loan debt, provided the debtor satisfies the burden of meeting the requirements of all three prongs of the “undue hardship” test. [In re Saxman (9th Cir. 2003) 325 F3d 1168, 1173–1175; In re Carnduff (9th Cir. BAP 2007) 367 BR 120, 130–131; In re Craig (9th Cir. 2009) 579 F3d 1040, 1044]

First prong: Inability to maintain minimal standard of living. Dire circumstances nor below poverty income is necessary. However, a spouse [or domestic] partner's income may count. IRS standards are considered but not the sole measure. A deficit after subtracting expenses from income may suffice.

Second prong: Additional circumstances indicating debtor's financial condition likely to continue. While a "serious" illness or "certainty of hopelessness" is not a requirement, the courts take the following factors into account: 1] serious mental or physical disability of debtor or debtor's dependents; 2] debtor's obligations to care for dependents; 3] lack of, or severely limited education; 4] poor quality of eduction; 5] lack of usable or marketable job skills; 6] underemployment; 7] maximized income potential in chosen field and no more lucrative job skills; 8] limited years remaining in work life; 9] age or other factors limiting retraining or relocation; 10] lack of assets; 11] potentially increasing expenses outweighing potential appreciation in assets or income; and 12] lack of better financial options elsewhere.

Third prong: Debtor's good faith effort to repay. Efforts to repay can include debt consolidation, deferment and/or attempts to negotiate. Efforts can be shown by maximizing professional or personal resources and minimizing expenses. A time lapse does need to occur between graduation and the filing. Immediate filing after graduation can show bad faith.

2011-10-01 Are Negative Amortization Plans Available in Chapter 11 ?

How do you get a Negative Amortization confirmed in Chapter 11 for a single asset real estate case ?

The Facts: A single asset real estate [commercial office building] case comprised of 4 secured liens: 1) 1st Mortgage of $2 Million; 2) 2nd Mortgage of $300,000; 3) 3rd Mortgage of $200,000; and 4) 4th Mortgage of $100,000. Tenants have defaulted and/or moved out, resulting in lower gross rental income. Debtor-in-Possession [DIP] wishes to stretch out the loan term and pay less interest due to historically low interest rates. DIP wishes to keep the property and simply pay lenders less over a longer period of time, thus obtaining a court sanctioned refinance.

Basic Requirements for Confirming a Non-Consensual Plan: In addition to the requirements necessary to confirm a Consensual plan [one of which is that at least one impaired class accepts the plan], a Non Consensual plan requires the following: 1) The plan does not discriminate unfairly; and 2) The plan is fair and equitable with respect to each class of impaired claims that has not accepted the plan ["absolute priority rule"].

No Unfair Discrimination

The unfair discrimination rule applies only to those who have not accepted the plan. For example, the DIP cannot treat a junior secured creditor more favorably than a senior secured creditor. So, if you are going to negatively amortize the 1st Mortgage, then you'd better do it for the 2nd Mortgage also.

Fair and Equitable Treatment

Next, the plan must be fair and equitable [absolute priority rule] to each class of impaired claims that have not consented to the plan. This rule says that a non-consenting class of creditors must be compensated in full before any junior class may receive or retain property under the plan. This rule does not apply to individual Chapter 11 debtors.

Options for "Fair and Equitable" Treatment of Secured Creditors

There are 3 options for "fair and equitable" treatment of non-consenting, impaired, secured creditor classes:

Option 1: Secured Creditor retains lien on collateral and receives deferred payments.

Option 2: Sell property and creditor gets lien on proceeds. Then creditor is treated under Option 1 or 3.

Option 3: Creditor receives "indubitable equivalent" of its claim.

Application to Facts

For the DIP that wishes to keep the property, only Option 1 makes sense. This allows the DIP to make deferred payments as long as they equal the present value of the collateral. Assuming that the DIP does not wish to strip down the lien to a lower value/amount, this simply means the loan amount is amortized at a rate that compensates the lender for its present value, i.e. a refinanced loan.

One of the impaired classes must accept the plan. In the fact pattern above, the DIP is lucky in that the value of the property has fallen below the total owed on the 1st, 2nd and 3rd Mortgages. The 4th Mortgage is more than happy to agree to the plan because they feel lucky enough to receive anything at all.

Appropriate Discount Rate

But what is that discount rate ? The Ninth Circuit has held that the appropriate discount rate must be determined on the basis of the rate of interest which is reasonable in light of the risks involved and on a case-by-case basis. In re Camino Real Landscape Maintenance Contractors, Inc. (9th Cir. 1987) 818 F2d 1503, 1505; In re Patterson (9th Cir. BAP 1988) 86 BR 226, 227.

Some courts have used the "formula" approach where a "base rate" (e.g. treasury bond rates, prime rate, or other established index) that is adjusted based on factors such as 1) nature of the loan, 2) quality of the collateral; and 3) risk of default. In re Villa Diablo Assocs. (BC ND 1993) 156 BR 650, 653. This is most useful when no reliable market data exists for the plan's treatment of the claim, e.g. 100% loan to value ratio.

Negative Amortization: Deferred Amount Must be Capitalized Correctly

Even negative amortization plans do not necessarily violate the "fair and equitable" rule when the DIP defers payments of interest on its debt obligation where the deferred amount can be capitalized at a rate of interest which enables the deferred amount to equal the present value of the creditor's allowed secured claim. Great Western Bank v. Sierra Woods Group (9th Cir. 1992) 953 F2d 1174, 1176-1177.

2012-03-01 A Rule is a Rule is a Rule: The 30 Day Deadline to Object to Exemptions by Trustees and Creditors

A Trustee has 30 days to object to a debtor's claim of exemption. F.R.B.P. 4003(b)(4) requires the trustee or any creditor to file an objection to exemptions within 30 days after the conclusion of the meeting of creditors held pursuant to Rule 2003(a), or the filing of any amendment to the list or supplemental schedules unless, within such period, further time is granted by the court. In 1992, the Supreme Court addressed this very issue and in spite of a trustee's argument that disallowing a late objection would merely encourage debtors to claim exemptions to which they were clearly not entitled, the Court decided that a "rule is the rule." Taylor v. Freeland & Kronz, 503 U.S. 638, 112 S.Ct. 1644, 118 L.Ed 2d 280 (1992). Otherwise, a trustee's practice of continuing creditors meetings indefinitely or simply not scheduling a continued meeting date would render the rule meaningless. A meeting that is not specifically concluded is deemed concluded if it is not continued to a specific date and time by the conclusion of the meeting or an announcement of a continued meeting made within 30 days of the last meeting.

2012-05-02 Chapter 11: Ninth Circuit BAP Rules Absolute Priority Rule Does Not Apply to Individual Cases

The Ninth Circuit BAP recently ruled that the absolute priority rule does not apply to individual Chapter 11 cases. In re Friedman BK. No. 07-02135 (AZ-11-1105-JuKiCl and AZ-11-1149-JuKiCl).

[2011-09-23]

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