In re Barrington Oaks General Partnership

• Decision Date: 09 December 1981
• Docket Number: Bankruptcy No. 80-01233,80-01234.
• Citation: 15 BR 952
• Parties: In re BARRINGTON OAKS GENERAL PARTNERSHIP, a general partnership, Debtor. In re STARCREST PROPERTIES, LTD., a limited partnership, Debtor.
• Court: U.S. Bankruptcy Court — District of Utah

15 B.R. 952 (1981)

In re BARRINGTON OAKS GENERAL PARTNERSHIP, a general partnership, Debtor In re STARCREST PROPERTIES, LTD., a limited partnership, Debtor.

Bankruptcy Nos. 80-01233, 80-01234.

United States Bankruptcy Court, D. Utah.

December 9, 1981.

William G. Fowler, Bryce E. Roe, Anna W. Drake, Roe & Fowler, Salt Lake City, Utah, for debtors.

Herschel J. Saperstein, Weston L. Harris, Watkiss & Campbell, Salt Lake City, Utah, William H. Bingham, McGinnis, Lochridge

& Kilgore, Austin, Tex., for First Nat. Bank of Minneapolis.

MEMORANDUM OPINION

RALPH R. MABEY, Bankruptcy Judge.

STATEMENT OF ISSUES AND FACTUAL BACKGROUND

This case raises two issues: whether changing buyers under a trust deed "impairs" the lienor within the meaning of 11 U.S.C. Section 1124, and whether a plan of reorganization may be confirmed if no impaired class accepts in light of 11 U.S.C. Section 1129(a)(10).

On August 12, 1977, Starcrest Properties, Ltd. (Starcrest), a limited partnership, through Coordinated Financial Services (Coordinated), its corporate general partner, executed a "Promissory Note," "Loan Agreement," "Deed of Trust and Security Agreement," and "Assignment of Rents" for the acquisition of an apartment complex in San Antonio, Texas. The lender was First National Bank of Minneapolis (bank). The loan was "exculpatory" or "non-recourse," i.e., in the event of default, the bank may foreclose on the property but may not collect any deficiency from Starcrest or Coordinated. The trust deed contained a "due on sale" clause which forbade transfer of the property without the consent of the bank.¹

In December, 1978, Starcrest made an "Earnest Money Contract" to sell the property to Richard Breithaupt, Jr., who was purchasing for BMP, a general partnership.² The contract (Addendum ¶ B.5) recognized the due-on prerogative of the bank. In April, 1979, Starcrest transferred the property by "Special Warranty Deed" to Barrington Oaks (Oaks), another general partnership.³ This transfer was subject to the lien of the bank. The bank learned of both transactions in the spring of 1979.

In November, 1979, litigation ensued between Starcrest, Oaks, and BMP, which in May, 1980, was compromised by a "Settlement Agreement." The settlement provides for sale of the property from Oaks to BMP. It also provides for lease of the property to BMP. BMP is in possession of the property as lessee and buyer.⁴ The agreement (¶ 7.D.), as does the earnest money contract, acknowledges the due on impediment to sale.

On June 3, 1980, because of nonpayment and other defaults, the bank gave notice of foreclosure. Sale was scheduled for July 1. On June 30, Starcrest and Oaks filed petitions under Chapter 11. On July 7, their cases were consolidated for purposes of administration. On October 28 and December 30, they filed a plan and disclosure statement.

The plan implements the settlement with BMP. Claims are divided into three classes. The first consists of priority claims, the second of unsecured creditors, and the third of secured creditors, i.e., the bank and another lienor on the property, John Hancock Mutual Life Insurance Company (Hancock).⁵ Classes one and two are to be paid in full on the effective date of the plan⁶ and are thus described as unimpaired.⁷ The obligations owing to the bank and Hancock will be assumed by BMP. Defaults (except any violation of the due on clause) are to be cured on the effective date of the plan. Thus class three is also described as unimpaired.⁸

On January 20, 1981, a confirmation hearing was held. The bank lodged several objections: (1) that classification of the bank and Hancock together was improper under 11 U.S.C. Section 1122; (2) that description of the bank as unimpaired was improper under Section 1124; (3) and that without acceptance by at least one impaired class, the plan could not be confirmed because of Section 1129(a)(10). The court ruled that the bank and Hancock must be separately classified and took the remaining objections under advisement.⁹ It now rules that the bank is impaired under Section 1124 and that the plan cannot be confirmed because of Section 1129(a)(10).^9a

IMPAIRMENT UNDER SECTION 1124

Positions of the Parties

Section 1124 defines impairment. It provides:

Except as provided in Section 1123(a)(4) of this title, a class of claims or interests is impaired under a plan unless, with respect to each claim or interest of such class, the plan

(1) leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest;

(2) notwithstanding any contractual provision or applicable law that entitles the holder of such claim or interest to demand or receive accelerated payment of such claim or interest after the occurrence of a default —

(A) cures such default, other than a default of a kind specified in section 365(b)(2) of this title, that occurred before or after the commencement of the case under this title;

(B) reinstates the maturity of such claim or interest as such maturity existed before such default;

(C) compensates the holder of such claim or interest for any damages incurred as a result of any reasonable reliance by such holder on such contractual provision or such applicable law; and

(D) does not otherwise alter the legal, equitable, or contractual rights to which such claim or interest entitles the holder of such claim or interest; or

(3) provides that, on the effective date of the plan, the holder of such claim or interest receives, on account of such claim or interest, cash equal to —

(A) with respect to a claim, the allowed amount of such claim; or

(B) with respect to an interest, if applicable, the greater of—

(i) any fixed liquidation preference to which the terms of any security representing such interest entitle the holder of such interest; and

(ii) any fixed price at which the debtor, under the terms of such security, may redeem such security from such holder.

The bank argues that Starcrest breached the due on clause when it sold the property to Oaks and that debtors breached this provision when they sold the property to BMP. The latter sale is being implemented, and thus the breach will be perpetuated, through the plan. The contractual rights of the bank are "altered" under Section 1124(1), and the breach, unlike a default for nonpayment, is incurable under Section 1124(2). Even if it were curable, since the rights of the bank are altered, debtors cannot satisfy the requirement of Section 1124(2)(D).

Debtors counter that their failure to cure the breach does not impair the bank because due on provisions, as unreasonable restraints on alienation, are unenforceable. See, e.g., Wellenkamp v. Bank of America, 21 Cal.3d 943, 148 Cal.Rptr. 379, 582 P.2d 970 (1978). The bank has no right in this regard which may be altered or the breach of which requires a cure.

Hence, the validity of the due on provision, as a matter of state law, has been the point of departure for the parties in their analysis of impairment under Section 1124. Resolution of the due on problem, however, is unnecessary.¹⁰ The bank is impaired because the sale to BMP, even without a due on restriction, changes obligors and therefore alters rights under the instruments memorializing the loan. This conclusion flows from an examination of the role and language of Section 1124, and its relation to 11 U.S.C. Section 1129(b).

The Role of Impairment

Impairment stands at the intersection of two conflicting ideals of reorganization. The first is represented in Chapter X of the Act, with its provision for an independent trustee and the "fair and equitable" rule. The second is reflected in Chapter XI of the Act, with its emphasis on speed, economy, informal negotiations, and consensual arrangements.¹¹

The premise of Chapter X, born of the Douglas report on protective committees,¹² was that creditors, for the most part, were unsophisticated and disorganized; their rights were subverted by "insiders" who manipulated the reorganization machinery. "The timid souls, the guileless and confiding masses," as one observer put it, "have been forgotten men." Foster "Conflicting Ideals for Reorganization," 44 Yale L.J. 923, 924 (1935).¹³ An independent trustee displaced these insiders and exposed corporate wrong-doing; he proposed a plan which satisfied the "fair and equitable" rule.

The rule, briefly put, is that no class may participate under a plan unless classes having priority are compensated in full.¹⁴ The reasons for the rule are manifold. It vindicates the contractual priorities for which parties bargained and on which their expectations in the event of liquidation rest: seniors who bargained for a moderate return and safety of principal expect to be paid first; juniors who supplied risk capital must accept the consequence of their speculation. These priorities, once fixed, are honored as a matter of equity not bargaining strength. The rule thus assists the trustee in neutralizing insiders who may conspire to dilute the claims of others. The rule also encourages the simplification of capital structures, so that businesses are not artificially reorganized. This in turn prevents the foisting of worthless securities on unsuspecting investors.¹⁵ Indeed, the rule is the foundation upon which a plan in Chapter X is constructed; a judicial finding that it has been satisfied precedes and preconditions any vote on a plan.¹⁶

But critics of the rule questioned whether this degree of judicial control struck a proper balance between creditor democracy and the fairness of a plan. They asked whether the rule was self defeating, especially where retention of management equity holders might be essential to preserve the going concern value of a business. In these situations, there might be "merit to the proposition that the creditors themselves should be permitted to bargain out the allocation of the going concern bonus with the debtor." Trost, "Corporate...