First S. Nat'l Bank v. Sunnyslope Hous. Ltd. P'ship (In re Sunnyslope Hous. Ltd. P'ship)

• Decision Date: 26 May 2017
• Docket Number: No. 13-16164, No. 13-16180,No. 12-17241, No. 12-17327,12-17241
• Citation: 859 F.3d 637
• Parties: IN RE SUNNYSLOPE HOUSING LIMITED PARTNERSHIP, Debtor. First Southern National Bank, Plaintiff-Appellant, v. Sunnyslope Housing Limited Partnership, Defendant-Appellee. In re Sunnyslope Housing Limited Partnership, Debtor. Sunnyslope Housing Limited Partnership, Plaintiff-Appellant, v. First Southern National Bank, Defendant-Appellee. In re Sunnyslope Housing Limited Partnership, Debtor. First Southern National Bank, Plaintiff-Appellant, v. Sunnyslope Housing LP, Defendant-Appellee. In re Sunnyslope Housing Limited Partnership, Debtor. Sunnyslope Housing LP, Plaintiff-Appellant, v. First Southern National Bank, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

859 F.3d 637

IN RE SUNNYSLOPE HOUSING LIMITED PARTNERSHIP, Debtor.

First Southern National Bank, Plaintiff-Appellant,

v.Sunnyslope Housing Limited Partnership, Defendant-Appellee.

In re Sunnyslope Housing Limited Partnership, Debtor.

Sunnyslope Housing Limited Partnership, Plaintiff-Appellant,

v.First Southern National Bank, Defendant-Appellee.

In re Sunnyslope Housing Limited Partnership, Debtor.

First Southern National Bank, Plaintiff-Appellant,

v.Sunnyslope Housing LP, Defendant-Appellee.

In re Sunnyslope Housing Limited Partnership, Debtor.

Sunnyslope Housing LP, Plaintiff-Appellant,

v.First Southern National Bank, Defendant-Appellee.

No. 12-17241

No. 12-17327

No. 13-16164

No. 13-16180

United States Court of Appeals, Ninth Circuit.

Argued and Submitted En Banc January 17, 2017 San Francisco, California

Filed May 26, 2017

Amended June 23, 2017

Edward K. Poor (argued), Quarles & Brady LLP, Chicago, Illinois; Brian Sirower and Walter J. Ashbrook, Quarles & Brady LLP, Phoenix, Arizona; for Plaintiff-Appellant.

Susan M. Freeman (argued), Henk Taylor, and Justin Henderson, Lewis and Roca LLP, Phoenix, Arizona; Bradley D. Pack, Scott B. Cohen, and David Wm. Engelman, Engelman Berger P.C., Phoenix, Arizona; for Defendant-Appellee.

Donald L. Gaffney and Jasmin Yang, Snell & Wilmer LLP, Phoenix, Arizona, for Amici Curiae Arizona Bankers Association, California Bankers Association, Hawaii Bankers Association, Idaho Banks Association, Montana Bankers Association, and Washington Bankers Association.

Before: Sidney R. Thomas, Chief Judge, and Alex Kozinski, Diarmuid F. O'Scannlain, Susan P. Graber, Ronald M. Gould, Richard C. Tallman, Carlos T. Bea, Jacqueline H. Nguyen, Andrew D. Hurwitz, John B. Owens, and Michelle T. Friedland, Circuit Judges.

Dissent by Judge Kozinski

OPINION

HURWITZ, Circuit Judge:

When a debtor, over a secured creditor's objection, seeks to retain and use the creditor's collateral in a Chapter 11 plan of reorganization through a "cram down," the Bankruptcy Code treats the creditor's claim as secured "to the extent of the value of such creditor's interest." 11 U.S.C § 506(a)(1). That value is to "be determined in light of the purpose of the valuation and of the proposed disposition or use of such property." Id.

In Associates Commercial Corp. v. Rash , the Supreme Court adopted a "replacement-value standard" for § 506(a)(1) cram-down valuations. 520 U.S. 953, 956, 117 S.Ct. 1879, 138 L.Ed.2d 148 (1997). The Court held that replacement value, "rather than a foreclosure sale that will not take place, is the proper guide under a prescription hinged to the property's ‘disposition or use.’ " Id. at 963, 117 S.Ct. 1879 (quoting In re Winthrop Old Farm Nurseries, Inc. , 50 F.3d 72, 75 (1st Cir. 1995) ).

In rejecting a "foreclosure-value standard," the Court also noted that foreclosure value was "typically lower" than replacement value. Id. at 960, 117 S.Ct. 1879. Today, however, we confront the atypical case. Because foreclosure would vitiate covenants requiring that the secured property—an apartment complex—be used for low-income housing, foreclosure value in this case exceeds replacement value, which is tied to the debtor's "actual use" of the property in the proposed reorganization. Id. at 963, 117 S.Ct. 1879. But we take the Supreme Court at its word and hold, as Rash teaches, that § 506(a)(1) requires the use of replacement value rather than a hypothetical value derived from the very foreclosure that the reorganization is designed to avoid. Thus, the bankruptcy court did not err in this case in approving Sunnyslope's plan of reorganization and valuing the collateral assuming its continued use after reorganization as low-income housing.

BACKGROUND

I. The Sunnyslope Project

Sunnyslope Housing Limited Partnership ("Sunnyslope") owns an apartment complex in Phoenix, Arizona. Construction funding came from three loans. Capstone Realty Advisors, LLC, provided the bulk of the funding through an $8.5 million loan with an interest rate of 5.35%, secured by a first-priority deed of trust. The Capstone loan was guaranteed by the United States Department of Housing and Urban Development ("HUD"), and funded through bonds issued by the Phoenix Industrial Development Authority. The City of Phoenix and the State of Arizona provided the balance of the funding. The City loan was secured by a second-position deed of trust, and the State loan by a third-position deed of trust.

A. The Covenants

To secure financing and tax benefits, Sunnyslope entered into five agreements:

1. To obtain the HUD guarantee, Sunnyslope signed a Regulatory Agreement requiring that the apartment complex be used for affordable housing.

2. Sunnyslope also entered into a Regulatory Agreement with the Phoenix Industrial Development Authority, requiring Sunnyslope to "preserve the tax-exempt status" of the project, and use 40% of the units for low-income housing. The agreement provided that its covenants "shall run with the land and shall bind the Owner, and its successors and assigns and all subsequent owners or operators of the Project or any interest therein." The restrictions, however, terminated on "foreclosure of the lien of the Mortgage or delivery of a deed in lieu of foreclosure."

3. The City of Phoenix required Sunnyslope to sign a Declaration of Affirmative Land Use Restrictive Covenants, mandating that 23 units be set aside for low-income families. The restriction ran with the land and bound "all future owners and operators" but, similarly, would be vitiated by foreclosure.

4. The Arizona Department of Housing required Sunnyslope to enter into a Declaration of Covenants, Conditions, and Restrictions. That 40-year agreement set aside five units for low-income residents. The agreement ran with the land and bound future owners, terminated upon foreclosure, and was expressly subordinate to the HUD Regulatory Agreement.

5. Finally, in order to receive federal tax credits, Sunnyslope agreed with the Arizona Department of Housing to use the entire complex as low-income housing. The tax credits, and restriction on use, would terminate on foreclosure.

B. The Default and its Aftermath

In 2009, Sunnyslope defaulted on the Capstone loan. As guarantor, HUD took over the loan and sold it to First Southern National Bank ("First Southern") for $5.05 million. In connection with the sale, HUD released its Regulatory Agreement. The Loan Sale Agreement confirmed, however, that the property remained subject to the other "covenants, conditions and restrictions."

First Southern began foreclosure proceedings, and an Arizona state court appointed a receiver. In December 2010, the receiver agreed to sell the complex to a third party for $7.65 million.

II. The Bankruptcy Proceedings

Before the sale could close, Sunnyslope filed a Chapter 11 petition. Over First Southern's objection, Sunnyslope sought to retain the complex in its proposed plan of reorganization, exercising the "cram- down" option in 11 U.S.C. § 1129(b)(2)(A). A successful cram down allows the reorganized debtor to retain collateral over a secured creditor's objection, subject to the requirement in § 506(a)(1) that the debt be treated as secured "to the extent of the value of such creditor's interest" in the collateral.

The central issue in the reorganization proceedings was the valuation of First Southern's collateral, the apartment complex. Sunnyslope asserted that the complex should be valued as low-income housing, while First Southern contended that the complex should instead be valued without regard to Sunnyslope's contractual obligations to use it as low-income housing, which would terminate upon foreclosure.

In that regard, First Southern's expert valued the complex at $7.74 million, making the "extraordinary assumption" that a foreclosure would remove any low-income housing requirements. First Southern's expert also opined, however, that the value of the property was only $4,885,000 if those requirements remained in place. Sunnyslope's expert valued the property at $2.6 million with the low-income housing restrictions in place, and at $7 million without.

During its original proceeding, the bankruptcy court held that, under § 506(a)(1), the value of the property was $2.6 million because Sunnyslope's plan of reorganization called for continued use of the complex as low-income housing. The court also declined to include in the valuation of the complex the tax credits available to Sunnyslope. First Southern then elected to treat its claim as fully secured under 11 U.S.C. § 1111(b).

The bankruptcy court subsequently confirmed the plan of reorganization, which provided for payment in full of the First Southern claim over 40 years, at an interest rate of 4.4%, with a balloon payment at the end without interest. The reorganization plan required the City and State to relinquish their liens, but provided for payment of their unsecured claims in full, albeit without interest, at the end of the 40 years.

The bankruptcy court found the plan fair and equitable under 11 U.S.C. § 1129(b)(1) because First Southern retained its lien, would receive an interest rate equivalent to the prevailing market rate, and could foreclose (and, therefore, obtain the property without the restrictive covenants) should Sunnyslope default. The court also found the plan feasible under 11 U.S.C. § 1129(a)(11), citing Sunnyslope's financial projections, and noting that "the Creditor has come in with no evidence of a lack of feasibility." The court concluded that it was more likely than not that Sunnyslope could make plan payments based on the history of comparable properties. The court also noted that, when the balloon payment came due, the property would be free of the low-income housing restrictions, making the collateral an even more valuable asset.

After confirmation, First Southern obtained a stay of the plan of reorganization from the district court pending appeal. The district court denied First Southern's request for a stay. Cornerstone at Camelback LLC invested...