Article Courtesy of Margaret G. Parker-Yavuz (Akin Gump Strauss Hauer & Feld LLP); Secondary Contributor Troy DeLeon (Akin Gump Strauss Hauer & Feld LLP)
In re Ocean View Motel, No. 20-21165-ABA, 2022 Bankr. LEXIS 190 (Bankr. D.N.J. Jan. 25, 2022)
Secured creditor objected to the cramdown of his claim in the confirmation of a Chapter 11 debtor’s plan on the basis that it was not fair and equitable for purposes of section 1129(b)(2)(A)(i) of the Bankruptcy Code because it voided deeds-in-lieu of foreclosure that had been granted to the creditor under a prepetition agreement. The U.S. Bankruptcy Court for the District of New Jersey overruled the objection and confirmed the plan, finding that (i) there was no different treatment of similarly situated classes and therefore no unfair discrimination and (ii) eliminating the deeds-in-lieu of foreclosure was not unfair or inequitable since the creditor retains his prepetition liens securing his claim and the property covered by the liens is worth more than his claim, he will be compensated by default interest if there is a default and he has to enforce his liens in state court, and the feasibility of the plan would be hampered if the creditor retained the deeds-in-lieu.
Ocean View Motel, LLC (the “Debtor”) owned a hotel in New Jersey. The Debtor’s original principals were Mark Jones (“Jones”) and Harry Falterbauer (“Falterbauer”). Jones bought out Faulterbauer’s ownership interest, and Jones and Falterbauer entered into loan documents secured by mortgages under which Jones agreed to pay the purchase price over time. After Jones defaulted on the loan, Jones and Faulterbauer settled in state court litigation in 2019 with a settlement agreement pursuant to which Jones signed deeds-in-lieu of foreclosure in Faulterbauer’s favor to be filed upon default. The Debtor subsequently filed for Chapter 11 bankruptcy.
On November 13, 2021, the Debtor filed a Second Modified Plan under Chapter 11. The plan provided for Faulterbauer’s existing promissory note and the existing settlement agreement to be voided, eliminating Faulterbauer’s deeds-in-lieu of foreclosure. Under the plan, Faulterbauer would receive a new promissory note with a higher interest rate. The new note would be secured by the existing mortgages, but Faulterbauer would no longer have deeds-in-lieu of foreclosure. The value of the property subject to the mortgages significantly exceeded the amount of the loan owing to Faulterbauer.
Falterbauer filed an objection to the plan, arguing that its elimination of the deeds-in-lieu of foreclosure was inequitable since, in order to enforce on the new promissory note, it would be necessary for him to start foreclosure proceedings in state court. An evidentiary hearing was held on confirmation of the plan, and the court concluded that the elements of section 1129(a) of the Bankruptcy Code had been satisfied except for section 1129(a)(8) (which provides that a court shall confirm a plan only if each class has accepted the plan or each class is not impaired under the plan). Since section 1129(a)(8) had not been satisfied, the Debtor requested the court to consider confirmation under the cramdown requirements under section 1129(b).
In considering confirmation of the plan, the court found that the Debtor’s proposed treatment of Faulterbauer’s claim was fair and equitable for purposes of section 1129(b)(2), and that the plan could therefore be confirmed. It overruled Faulterbauer’s objection and confirmed the plan.
The court explained that section 1129(b)(1) of the Bankruptcy Code provides that if the requirements of section 1129(a) are satisfied but the plan has not been accepted in accordance with section 1129(a)(8), then “the court, on request of the proponent of the plan, shall confirm the plan . . . if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.” 11 U.S.C. §1129(b)(1). Under section 1129(b)(2)(A)(i), a debtor may cram down a plan on a dissenting secured creditor class if the plan is fair and equitable.
With respect to the requirement that a plan not discriminate unfairly, the court noted that the Bankruptcy Code does not set forth a standard to determine whether unfair discrimination exists in a cramdown, but courts generally agree that the purpose of the requirement is to ensure that a dissenting class will receive equivalent value as other similarly situated classes and that a plan unfairly discriminates when it treats similarly situated classes differently without a reasonable basis. It concluded that, in this case, the plan did not discriminate unfairly since there was no different treatment of similarly situated classes.
As for the requirement that the plan be fair and equitable, the court cited In re Cellular Info. Sys., 171 B.R. 926, 937 (Bankr. S.D.N.Y. 1994), stating that, “[a]t a minimum, a fully secured creditor is treated fairly and equitably if it retains the lien securing its claim and receives deferred cash payments with a present value equal to the amount of its claim.” The court noted that in this case the plan satisfied these minimum elements since Faulterbauer retained his liens securing his claim and would receive deferred cash payments with a present value equal to the amount of his claim.
The court then considered whether the elimination of the deeds-in-lieu was fair and equitable for purposes of plan confirmation. It noted that eliminating terms of a loan agreement is not unusual in the plan confirmation process, and that in determining whether modification of loan documents is appropriate courts consider various factors, including whether the terms unduly harm the secured creditor with respect to its collateral position, whether the inclusion of terms from the pre-bankruptcy loan documents would unduly impair the debtor’s ability to reorganize, whether the debtor has demonstrated feasibility, and the protections and risks to the secured creditor. Applying certain of these factors to the Debtor’s plan, the court noted that Faulterbauer retained his prepetition liens and that the property covered by the liens was worth significantly more than his claim, and that if the Debtor defaults the claim will accrue interest at 12%, compensating him for the delay caused by having to enforce in state court (and that his attorney’s fees and costs in a state court action would be borne by the Debtor). The court also noted that the feasibility of the plan would be hampered by the ability of Faulterbauer to stop the Debtor’s operations upon a default under Faulterbauer’s claim.
Faulterbauer argued that the deed-in-lieu provision in the settlement agreement is additional security for his loan. The court rejected this argument, stating that the provision is not a security interest in the legal sense – it is instead a covenant that provided Faulterbauer with a remedy upon default, and that the mortgages were the actual security interests.