Gladstone Glen, Matter of, s. 83-2394

• Citation: 739 F.2d 1233
• Decision Date: 19 July 1984
• Docket Number: 83-2461 and 83-2485,Nos. 83-2394,s. 83-2394
• Parties: Bankr. L. Rep. P 69,943 In the Matter of GLADSTONE GLEN, a Partnership, Debtor, Appeals of GLADSTONE GLEN, John Hancock Mutual Life Insurance Company, Michael Sparks.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1233

739 F.2d 1233

Bankr. L. Rep. P 69,943

In the Matter of GLADSTONE GLEN, a Partnership, Debtor Appeals of GLADSTONE GLEN, John Hancock Mutual Life Insurance Company, Michael Sparks.

Nos. 83-2394, 83-2461 and 83-2485.

United States Court of Appeals, Seventh Circuit.

Argued Feb. 14, 1984.

Decided July 19, 1984.

Louis W. Levit, Levit, Miller and Mason, Chicago, Ill., for Gladstone glen.

John D. Lien, Wilson & McIlvaine, Chicago, Ill., for John Hancock Mut. Life Ins. Co.

David N. Missner, Schwartz, Cooper, Kolb & Gaynor, Chicago, Ill., for Michael Sparks.

Russell M. Pelton, Jr., Peterson, Ross, Schloerb and Seidel, Chicago, Ill., for Union Dime Sav.

Before BAUER, WOOD and ESCHBACH, Circuit Judges.

ESCHBACH, Circuit Judge.

This appeal, involving Chapter XII of the Bankruptcy Act of 1898 ("Act"), 11 U.S.C. Secs. 801-926 (1976) (repealed), raises questions of first, and probably last, impression in this circuit. More common challenges to factual findings are also presented. With one exception, we agree with the Bankruptcy Court's resolution of the case. Our single disagreement is significant, however, and requires us to remand the case for further proceedings.

I.

The subject of this Chapter XII proceeding is a heavily encumbered apartment complex in Prospect Heights, Illinois. By 1975, this property was subject to three mortgages securing non-recourse notes: John Hancock Mutual Life Insurance Company ("Hancock") and Union Dime Savings Bank ("Union Dime") held first mortgages on different parts of the real estate, and State Mutual Investors ("SMI") held a second mortgage on the entire property.

In January of 1975, John Markay and Vincent Bolger formed a partnership, Gladstone Glen, to acquire and operate this apartment complex. Gladstone Glen purchased the property from Michael Sparks and, as part of the transaction, executed and delivered to Sparks two non-recourse notes evidencing a principal debt of $630,000; these notes are secured by a third mortgage on the real estate. To make the purchase sufficiently attractive, Hancock agreed to an 18-month moratorium on principal payments. This assistance proved inadequate, however, and in 1977 Gladstone Glen failed to make payments owing to the second mortgagee--SMI. Thus SMI commenced a foreclosure action, which prompted Gladstone Glen to file its Chapter XII petition on September 23, 1977.

When the Chapter XII proceedings became protracted, SMI pressed for a prompt cash settlement. SMI negotiated with Markay and Bolger, Gladstone Glen's partners, and reached an agreement in December of 1978. Markay and Bolger, together with Frank Muriello, formed a partnership known as MBM Associates ("MBM"), which purchased the SMI mortgage and related papers for a price of $250,000. Muriello's capital contribution was minimal and, in fact, he was included in the deal only to ensure that the SMI mortgage did not merge into the fee held by Gladstone Glen.

Union Dime also sought relief from Chapter XII's strictures, but unlike SMI, turned to the statute's provisions. Citing Sec. 517 of the Act, 11 U.S.C. Sec. 917, Union Dime contended that as a Federal Home Loan Bank it was exempt from Chapter XII. The Bankruptcy Court disagreed, and, consequently, proceeded to consider the merits of the debtor's Second Amended Arrangement ("Plan").

On May 4, 1982, the Bankruptcy Court entered an order confirming the Plan over the objections of Hancock, Union Dime, and Michael Sparks. The Plan, which purports to cure all arrearages owed to Hancock and Union Dime, provides no distribution to Sparks. The Bankruptcy Court also awarded Hancock $174,302 and Union Dime $1,000 in attorneys' fees.

The Bankruptcy Court's orders did not survive long on appeal. The District Court held, contrary to the Bankruptcy Court's decisions, that (1) Sec. 517 of the Act exempts Union Dime from Chapter XII, (2) the second mortgagee, MBM, is not entitled to assert fully its claim, and (3) Union Dime is entitled to attorney's fees greater than $1,000. In all other respects, the District Court affirmed the Bankruptcy Court's orders. Gladstone Glen, Hancock, and Sparks appeal from the District Court's judgment.

II.

Before filing its Chapter XII petition, Gladstone Glen made all payments owing to Union Dime; once this case commenced, however, no payments were made for a year. In October of 1978, Gladstone Glen resumed making full payments as required by the Union Dime note. Moreover, the Plan provides that, upon confirmation, all arrearages will be paid to Union Dime in cash, and thereafter Gladstone Glen will make payments according to the note. Nevertheless, Union Dime maintains that the Chapter XII proceedings and Plan run afoul of Sec. 517 of the Act, which states that Chapter XII's provisions shall not "be deemed to allow extension or impairment of any secured obligation held by ... any Federal Home Loan Bank."

An "extension" within the meaning of this section occurs when a debt is "paid in full but over a longer period of time than would otherwise be required." In re Consolidated Motor Inns, 5 Collier Bankr.Cas. 301, 307 (W.D.Ga.1975). In other words, if an obligation evidenced by a 20-year note is modified to allow payments over 30 years, the debt is extended. See In re Smith, 20 Collier Bankr.Cas. 368, 370 (E.D.Pa.1979); R. Cowans, Bankruptcy Law & Practice 355 (1978). The meaning of "impairment" is less clear, but we agree with the judicial decisions holding that a secured obligation is not impaired if the value of the creditor's security is not diminished during the Chapter XII proceeding or by operation of the confirmed plan. See In re Smith, supra, at 371; In re Hall Associates, 8 Collier Bankr.Cas. 290, 293 (E.D.Pa.1976); In re Consolidated Motor Inns, supra, at 308. Viewed in this light, plainly there has been no "extension" or "impairment" of the debt owed Union Dime, nor will there be pursuant to the provisions of the debtor's Plan; all arrearages will be cured on confirmation, payments will be made according to the terms of the note, and the obligation will remain fully secured.

We acknowledge that Union Dime has been affected by the Chapter XII proceedings. Absent the Act's automatic stay provision, Union Dime could have foreclosed on the mortgage, an option lost when the arrearages are cured upon confirmation of the Plan, see Ill.Rev.Stat. ch. 95, p 57 (1983). We do not view the impact of the stay, however, as an "extension" or "impairment" within the meaning of Sec. 517. To hold otherwise would, in essence, render Federal Home Loan Banks exempt from Chapter XII's provisions--a clearly unintended result. Congress knew how to exempt obligations from Chapter XII and, indeed, did provide in Sec. 517 that nothing in the "chapter shall be deemed to affect or apply to the creditors of any debtor under a mortgage insured pursuant to the National Housing Act." (Emphasis added.) See Matter of Thornhill Way I, 636 F.2d 1151 (7th Cir.1980). The deference accorded Federal Home Loan Banks is much less, and we will not, by focusing on the stay, interpret "extension" or "impairment" to mean "affect" or "apply to." See In re Hall Associates, supra, at 292; see generally Continental Illinois National Bank & Trust Co. v. Chicago, R.I. & Pac. Ry., 294 U.S. 648, 676-77, 55 S.Ct. 595, 606-07, 79 L.Ed. 1110 (1935). We therefore reverse the District Court's judgment directing the dismissal of Union Dime from this case.

III.

As noted above, in December of 1978 Gladstone Glen's partners formed a new partnership--MBM--to purchase the notes, mortgage, and related papers held by SMI (collectively known as the "SMI mortgage"). At the time of the transaction, $640,000 of principal and $170,333 of interest were owing on the mortgage. Because SMI naturally viewed the loan as distressed, however, MBM purchased the SMI mortgage for only $250,000. The instant dispute arose when MBM subsequently intervened in this case and sought to enforce the SMI mortgage in full. The third mortgagee, Michael Sparks, argued to the Bankruptcy Court that MBM's claim should be subordinated or, at least, significantly reduced. The Bankruptcy Court disagreed and, after considering the value of the real estate and the amount of outstanding debt, concluded that Sparks' mortgage had no value. Accordingly, the debtor's Plan, which provides no distribution to the objecting creditor Sparks, was approved pursuant to the "cram down" provision of Sec. 461(11) of the Act, 11 U.S.C. Sec. 861(11) (1976).

On appeal to this court, the debtor and Sparks cite well-known, but inapposite, rules of law. Sparks notes that MBM is, in essence, Markay and Bolger, and "the claims of individual partners may not be satisfied prior to those of firm creditors of a bankrupt partnership." 1A J. Moore & L. King, Collier on Bankruptcy 731 (14th ed. 1978). The rationale supporting this rule, however, is missing in this case; the debts are non-recourse and the partners did not use estate property to purchase the SMI mortgage. The debtor, on the other hand, quotes the rule that a "purchase of creditors' claims during reorganization is not prohibited and will be given effect." 14A J. Moore & L. King, Collier on Bankruptcy 12-30-10 (14th ed. 1978). But this rule is conditional and subject to modification when the purchaser is also the debtor. In fact, we are unaware of any statutory or common law on point. Our disposition of this issue will thus be guided by the principle that the power of a "bankruptcy court to subordinate claims or to adjudicate equities arising out of the relationship between the several creditors is complete." Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 219, 61 S.Ct. 904, 907, 85 L.Ed. 1293 (1941).

There are reasons to permit MBM to assert the rights and position held previously by SMI. When Sparks took a third mortgage on the property, he knew that his position was inferior to the SMI mortgage. He also knew that he had no recourse...