D. MICHAEL LYNN, Bankruptcy Judge.
Before the court is the Second Amended Plan of Reorganization of Village at Camp Bowie I, L.P. (the "Plan").
The court conducted a confirmation hearing respecting the Plan over three days, May 19, 2011, June 7, 2011, and June 23, 2011 (together, the "Hearing"). During the Hearing the court heard testimony of Woodrow (Bo) Brownlee ("Brownlee"), a principal of Debtor, John Sledge ("Sledge"), a principal of Western, Dr. Allyn Bryant Needham ("Needham"), Debtor's expert witness respecting the interest
The court will consider prior proceedings in this case, specifically including hearings respecting Western's original Motion for Relief from the Automatic Stay and Adequate Protection (respectively, the "Stay Hearing" and the "Stay Motion").
This contested matter is subject to the court's core jurisdiction. See 28 U.S.C. §§ 1334 and 157(b)(2)(L) and (O). This memorandum opinion contains the court's findings of fact and conclusions of law. Fed. R. Bankr.P. 7052 and 9014.
Debtor owns a low-rise, mixed-use development in southwest Fort Worth, Texas, known eponymously as the Village at Camp Bowie (the "Property").
Debtor, a partnership, acquired the Property in 2004. In addition to equity investment which, up to the time of commencement of this case, totaled approximately $10,000,000, Debtor executed documents to borrow up to $36,535,000 from SouthTrust Bank ("SouthTrust") and Texas Capital Bank, National Association ("TCB") on a short-term basis, partly for purchase of the Property and partly for refurbishing it. The loan was financed by a promissory note in the original maximum principal amount of $26,535,000, payable to the order of SouthTrust (the "SouthTrust Note"), and a second promissory note in the original maximum principal amount of $10,000,000, payable to the order of TCB (the "TCB Note" and, with the SouthTrust Note, the "Notes"). At commencement of this case, Debtor calculated the principal and interest owed on the Notes as $32,264,938.
Wachovia Bank, N.A. ("Wachovia") became successor by merger with SouthTrust to the SouthTrust Note and successor by assignment to the TCB Note. Wells Fargo Bank, N.A. (the "Bank") became successor in interest to the Notes by merger with Wachovia.
The original maturity date of the Notes was January 22, 2008, but the Bank entered into a series of modification agreements with Debtor on January 18, 2006, November 20, 2006, October 22, 2008, and February 11, 2009. As a result of these modifications, the Notes ultimately matured on February 11, 2010. The principal amount owed by Debtor on that date was
After the expiration of the forbearance period, the Bank decided to auction off the Notes. Western acquired the Notes at a discount and posted the Property for August 2010 foreclosure. This case was commenced voluntarily on August 2, 2010.
Western assumed its position as a secured creditor of Debtor in order to acquire the Property. Western is not in the lending business, and, as Sledge testified, it wishes to own and operate the Property. See, inter alia, TR (Sledge) November 22, 2010 at 49:5-14.
Western filed the Stay Motion on August 10, 2010. The court conducted the Stay Hearing over six days.
At the conclusion of the Stay Hearing, the court announced that the stay would not lift. The court further stated that there was a small amount of equity in the Property above Western's lien. The court now specifically finds the value of the Property to be $34,000,000.
At the time of the Stay Hearing Debtor had filed a plan that called for an infusion of equity capital of $600,000.
Besides Western, Debtor owes general unsecured creditors approximately $60,000. Under the Plan the latter will be paid in three equal monthly installments commencing on the effective date of the Plan. See Plan, art. (III)(B)(2). Western's claim will be satisfied by interest-only payments (Debtor proposes an interest rate of 5.83%) for three years, followed by two years of payments of interest and principal amortized over 30 years. At the end of five years, Western's remaining debt is to be paid in full. See Plan, arts. (II)(A) and (III)(B)(1)(b).
The Plan designates only two voting, impaired creditor classes: Western (class
Western objects to confirmation of the Plan based on Code § 1129(a)(1), (3), (9), (10), (11) and (b)(2)(A)(i). These objections are based on the following: (1) the Plan contains improper releases; (2) the Plan is intended only to benefit equity; (3) the Plan artificially impairs class 2 creditors; (4) the Plan provides for payment of a return to new equity in preference to Western; (5) Debtor will be unable to make payments called for by the Plan (including payment of actual administrative claims), thus failing the tests of Code § 1129(a)(9) and (11); and (6) the Plan provides Western with an interest rate inadequate to return to Western the present value of its claim.
Debtor has modified the Plan to eliminate the release provision and the preferential return to new equity. See Modification, ¶ 2. Moreover, the infusion of $1,500,000, as testified to by French (see Audio (French) June 23, 2011 at 3:47:05-3:48:21), ensures that the Plan is feasible and that payments required by Code § 1129(a)(9) can be made by Debtor. The court does not consider an effort by a debtor to preserve equity for its owners to be a basis, standing alone, for denying confirmation of the Plan. Thus, the court finds and holds that the Plan is feasible and otherwise confirmable provided that it is not tainted by an artificial impairment of class 2 and that it provides present value to Western for its claim as required by Code § 1129(b)(2)(A)(i). The court will address these issues below.
Artificial impairment refers to the technique of minimally impairing a class of creditors solely to satisfy the prerequisite to cramdown of an accepting class.
Western contends—and Debtor cannot dispute—that there will be sufficient cash on hand at confirmation of the Plan to pay unsecured creditors in full, with interest. While, facially, payment in full does not constitute unimpaired treatment under section 1124,
Given that the definition of impairment in Code § 1124 is clear—and broad—and given that Congress did not, as it might have, condition the accepting class requirement of section 1129(a)(10) on meaningful impairment of that class,
The court therefore concludes that, if the Plan is to fail confirmation due to artificial impairment, it must be because Debtor did not propose the Plan in good faith as required by section 1129(a)(3). The generally applicable test for good faith under section 1129(a)(3) is that the plan has been "proposed with the legitimate and honest purpose to reorganize and has a reasonable hope of success." Sun Country, 764 F.2d at 408. There is no question that the Plan meets this test: Debtor clearly proposed it with an honest intent that its debt be restructured, and the plan is feasible and so is likely to succeed.
But the broader statement of the good faith test requires that the court consider "the totality of circumstances surrounding establishment of a Chapter 11 plan." Id. It is into this analysis that the court must factor Debtor's treatment through minimal impairment of class 2 under the Plan. See Sandy Ridge, 881 F.2d at 1353.
It seems clear that, in the usual case, artificial impairment does not amount per se to a failure of good faith.
Western argues that Debtor's purpose— motive
Given Congress's obvious concern for fair treatment of equity owners, the court cannot fault Debtor's concern for its equity owners. Indeed, the Court of Appeals for the Seventh Circuit did not find improper a debtor's desire to save its equity owners from unfavorable tax consequences in assessing the debtor's good faith in proposing a plan. See In re 203 N. LaSalle Street P'ship, 126 F.3d 955, 969-70 (7th Cir.1997), rev'd on other grounds, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999). In that case, moreover, the effect of the plan was to strip down the principal lender's lien to the value of the collateral, providing only a 16% return on the lender's deficiency. See id. at 969.
In the case at bar, Western will receive under the Plan the full value of its claim. That Debtor can only accomplish its restructuring—including preservation of equity interests—through minimal impairment of class 2 does not mean its motive in pursuing chapter 11 relief is tainted, as might be true if the case were initiated solely to gain the benefit of the automatic stay or to strip down debt.
If any party has a questionable motive in this case, it is Western. By bidding in the Bank's debt at a discount,
Certainly this case does not present a situation where artificial impairment was used simply to avoid negotiation with the debtor's principal secured creditor. The only option available to Debtor if it was to retain value for equity was to file under chapter 11 and use the small class of unsecured creditors to satisfy the requirement of section 1129(a)(10) so that it could impose cramdown treatment on Western. In another case artificial impairment might be evidence of a lack of good faith. In this case, facing a creditor that will not be satisfied other than by cash payment in full or the demise of Debtor, the court cannot make such a finding.
The Court of Appeals for the Fifth Circuit has not directly addressed the issue of artificial impairment. The opinion that comes closest to doing so—that of Judge Reavely in Sun Country—suggests that Windsor is not good law in the Fifth Circuit. In that case, the debtor modified its plan from providing full payment (which, at that time was unimpaired treatment under section 1124) of unsecured creditors that were owed only $3,805 in order to create an accepting class that would satisfy section 1129(a)(10). The court was not troubled by the rather obvious manipulation, stating:
Sun Country, 764 F.2d at 408.
Western's argument that the decision of the Court of Appeals in Phoenix Mutual Life Insurance v. Greystone III (In re Greystone), 995 F.2d 1274 (5th Cir.1991), requires a different result is inapposite. That case involved a misuse of Code § 1122(a), which sets no specific test for division of claims into classes, but simply imposes one requirement on classification. Section 1124, in contrast, provides a clear definition of impairment. If that broad definition usually protects creditors, that does not mean that, where suitable, it cannot assist a debtor.
In the case at bar, Debtor has done no more than author a plan that fits the plain meaning of sections 1124 and 1129(a)(10). As the Sun Country Court opined, Debtor has simply used the tools created by Congress to structure a reorganization plan that is likely to succeed. That cannot amount to bad faith, as would a manipulation of classification that is meant to isolate and neutralize a lender's large deficiency claim, the situation presented by Greystone.
Finally, Western argues that this court, in its opinion in In re Texas Rangers Baseball Partners, disapproved of artificial impairment. See 434 B.R. at 410. It is true that the court stated there and continues to believe artificial impairment should not be encouraged; that does not mean it is never permissible. Where a fair and equitable restructuring may be accomplished only through artificial impairment, it should not be prohibited. In the case at bar, where the court has found value available to equity, it would be contrary to the requirements of section 1129(b)(2)(C) to decline approval of the only plan that will achieve a fair and equitable result for both equity owners and creditors.
In sum, the court does not find Debtor's treatment of class 2 in the Plan proof of bad faith. Based on the totality of the circumstances, the court finds and concludes that the Plan was proposed in good faith and meets the test of Code § 1129(a)(3).
Having determined that it satisfies all the requirements of Code § 1129(a) except section 1129(a)(8), the Plan qualifies to be tested against section 1129(b) to determine if it should be confirmed notwithstanding
Western does not argue—nor would the court find—that the Plan discriminates unfairly. Thus, the question for the court is whether the Plan is fair and equitable.
Section 1129(b)(2)(A) offers three options for treating a dissenting class of secured creditors, and the Plan adopts the first option: the secured class must retain its liens and must receive "deferred cash payments ... of a value, as of the effective date of the plan," at least equal to the amount of the class's secured claims. Whether the payments provided to Western over the five year term proposed in the Plan have a value equal to Western's secured claim depends on whether the interest rate—5.83%—provided under the Plan results in Debtor's obligation to Western having a present value equal to the claim.
In determining whether the interest rate Debtor proposes is sufficient, the court looks to Till v. SCS Credit Corporation, 541 U.S. 465, 124 S.Ct. 1951, 158 L.Ed.2d 787 (2004), the Supreme Court's recent statement respecting the interest rate necessary to meet the requirements of section 1129(b)(2)(A)(i).
Needham and French, in adopting a formula approach to calculating an appropriate interest rate, each began with a "risk-free" rate and then added to it components designed to account for risk. See Till, 541 U.S. at 466-67, 124 S.Ct. 1951. Needham, like the Till Court, used the prime rate as his base, while French used the five year treasury note. As this court has previously noted,
Starting with the five year treasury bill rate of 1.71% as his risk-free rate, French adjusted it to account for (1) risk factors he analyzed in his expert report, (2) a debtor-specific risk factor and (3) an adjustment based on the term of the Plan that provides Western with only interest for three years. Of these, the debtor-specific risk factor is sensitive to the value of Western's collateral and the amount of its debt. The result of this computation is a base—i.e., senior debt—interest rate of between 4.76% and 5.01%.
Based on his research, French concluded that this "senior" component of his aggregate interest rate would be applicable for a loan up to 65% of collateral value. Thus, the extent of application of the senior rate would be limited, its coverage depending upon the amount of Western's debt and the value of its collateral.
Having arrived at a rate for senior debt, the next step in French's formulation of an appropriate overall interest rate was a rate for junior, or "mezzanine" debt. Analyzing the question of what rate would be charged by a junior—or mezzanine—lender, French determined that a rate of 13.02% to 14.88% would be appropriate based on an overall loan-to-value ratio of 85%. Thus, the second component of French's interest rate would cover the next 20% of value beyond the 65% allocated to "senior" debt. Like the "senior" debt, this rate is partially dependent, and the extent of its coverage turns, on the value of the Property and the amount of Western's claim.
The final element composing French's interest rate, before adjustment, consists of an "equity" band. Because, using Loughry's appraisal, debt exceeds 85% of the value of the Property, French posited, for purposes of calculating a rate using that appraisal, that a lender was entitled to a return on that portion comparable to an equity investor. French calculated this rate as 18.63%. As to this tranche, since, using Pursley's appraisal, Western's debt equals 84% of the value of the Property, French did not need to compute a second equity rate.
French next determined what percentage of the debt (Western's claim) was represented by each of the senior, junior and equity tranches. Using these proportions he calculated a combined interest rate of between 7% (using Pursley's appraisal) and 9.25% (using Loughry's appraisal). He finally adjusted these rates for the
While the court considers French's methodology an appropriate approach to use to determine an interest rate,
On the other hand, French used $32,264,938 as the amount owed Western. This amount is too low because it does not allow for fees due Western's counsel. See Western Real Estate Equities, LLC's Motion for Determination of the Amount of Its Secured Claim, and for All Allowance of Interest, Reasonable Fees, Costs and Charges Pursuant to 11 U.S.C. Section 506(b) at 10-12. Also, the court must factor in likely reorganization costs. Since these numbers are not adequately established in the record (and probably could not have been), the court will use $33,000,000 as the amount of Debtor's debt to Western as an approximation effectively allowing for both these items.
Having pegged the debt to Western and the value of Debtor, the court will use the averages of French's interest spreads to determine a senior rate of 4.89%, a junior rate of 13.95% and an equity rate of 18.63%. Allocating these rates proportionally to the debt to Western, the court concludes that, prior to adjustments for a single lender and the benefits of bankruptcy, the overall rate of interest should be 7.422%.
French calculated a one-lender benefit at between .32% and .71% and the bankruptcy benefit at between .5% and.8%. The court believes the latter to be too high. The bankruptcy benefit in Till was partly attributable to the bankruptcy court's oversight of the debtors during the performance of their plan. See Till, 541 U.S. at 471-72, 475, 124 S.Ct. 1951. In Mirant the benefit of bankruptcy included resolution of numerous disputes and a concomitant improvement in the debtor's balance sheet. See Mirant, 334 B.R. at 834-35. In the case at bar, those benefits are not present. Unlike in the Tills' chapter 13 case, Debtor's discharge is not deferred until payments to Western are completed. See Code § 1141(d); cf. Code § 1328(a). As to Debtor's balance sheet, the effect of the Plan and the chapter 11 case is minimal. The principal benefit of Debtor's case then is the court's consideration of the Plan's feasibility, a benefit insufficient to justify a one-half percent reduction in the cramdown interest rate.
Taking all these factors into account, the court concludes that the 7.44% interest rate should be adjusted downward by between .85% and 1.17%, to arrive at a cramdown rate of 6.27% to 6.59%. The court therefore concludes that the Plan cannot be confirmed based on an interest rate to Western of 5.83%. Should the Plan be amended to provide for an interest rate of at least 6.4%, the court would be prepared to confirm it, provided the further issues mentioned below are addressed.
There remain several issues respecting Debtor's reporting requirements and documentation of Western's post-confirmation loan. Should Debtor modify the Plan to conform to the court's calculation of an appropriate interest rate,
For the reasons stated herein, the Objection is overruled in part and sustained in part. Confirmation of the Plan is denied without prejudice to its reconsideration if modified to conform to this memorandum opinion.
It is so ORDERED.
