In re Woodscape Ltd. Partnership
| Decision Date | 09 December 1991 |
| Docket Number | Bankruptcy No. 90-4-3559-SD,Motion No. 91M-2072-SD,91M-1966-SD. |
| Citation | 134 BR 165 |
| Parties | In re WOODSCAPE LIMITED PARTNERSHIP, Debtor. The PENN MUTUAL LIFE INSURANCE COMPANY, Movant, v. WOODSCAPE LIMITED PARTNERSHIP, Respondent. BALCOR PENSION INVESTORS VI, Movant, v. WOODSCAPE LIMITED PARTNERSHIP, Respondent. |
| Court | U.S. Bankruptcy Court — District of Maryland |
Tammy G. Cohen, Stephen E. Leach, Katherine J. Lichtmann, Washington, D.C., for debtor.
Theresa Hajost, Washington, D.C., for The Penn Mut. Life Ins. Co.
Emil Hirsch, Washington, D.C., for Balcor Pension Investors VI.
In this single real estate asset case, the pending motions for relief from stay raise the question whether Debtor's proposed plan of reorganization violates the absolute priority rule as a matter of law. The undersecured holder of a second, wrap-around deed of trust on Debtor's apartment project asserts that there is no new value exception to the absolute priority rule and, alternatively, that the fair and equitable standard is otherwise violated by the possibility of distributions on new value contributions. The factual scenario is not atypical of single asset real estate reorganization cases which raise philosophical questions about the intended purpose of reorganization, particularly when the collateralized, primary lender is undersecured and no equity exists in the real estate asset.
The Debtor is a Maryland limited partnership with 64 individual limited partners. It operates a 240 unit, luxury residential apartment complex in Raleigh, North Carolina known as the Woodscape Apartments, as its sole operating asset.
The Woodscape Apartments are subject to a first deed of trust in favor of The Penn Mutual Life Insurance Company ("Penn Mutual") to secure an outstanding balance slightly in excess of $3.8 million. It is also encumbered by a second wrap-around deed of trust in favor of Balcor Pension Investors VI ("Balcor") with an outstanding balance of approximately $8.1 million, including the amount owed to Penn Mutual. Further, there are approximately $102,000 in prepetition real estate taxes outstanding.
At the time of the hearing, the parties stipulated that Debtor's appraisal fixed the fair market value of the Woodscape Apartments at $5.6 million, while Balcor's fair market appraisal was $6.5 million. Since the hearing on these motions, the court has conducted a valuation hearing and fixed the fair market value at $6.1 million. Regardless, Penn Mutual is an oversecured creditor and Balcor is an undersecured creditor. The significance of this distinction is that Penn Mutual is entitled at this juncture to interest and costs pursuant to its loan documents, while Balcor is not. 11 U.S.C. § 506(b); United Savings Ass'n v. Timbers of Inwood Forest Assocs., 484 U.S. 365, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988). To provide Balcor with adequate protection of its undersecured position, the court previously entered an order requiring the Debtor to make the regular monthly installment payments due to Penn Mutual under the promissory note secured by its first lien and to pay all real estate taxes accruing postpetition. Debtor has complied with this order to date.
Debtor has proposed a plan of reorganization, and a hearing has been held on Debtor's disclosure statement at which the court granted leave to amend. Under Debtor's proposed plan, Penn Mutual will be paid interest monthly at its ten percent per annum contract rate, and it will retain its first lien. Debtor does not propose to cure its arrearage to Penn Mutual on the effective date of the plan. Rather, Debtor commits either to refinance or to sell Woodscape Apartments and pay Penn Mutual in full after three years, but not later than ten years, from confirmation of its plan, failing which it will surrender the property. Further, Debtor maintains that ten percent is also the fair market rate of interest.
Balcor is allowed a secured claim of approximately $1.9 million under the proposed plan. This amount must now be increased somewhat as the result of the valuation hearing. Its claim is to be paid in full at the same time as the Penn Mutual claim at a promised overall yield of 12%. Balcor is promised deferred cash payments in equal monthly installments with interest at a pay rate of 10.5%. The balance of Balcor's claim would be treated as unsecured and placed in a separate class by itself. Balcor's unsecured claim would also be paid in full at the end of ten years, or the earlier sale or refinancing of the property. Beginning after three years, interest would be paid monthly on a scale increasing from seven to nine percent per annum. Other unsecured trade debt would be paid in full without interest over 90 days after confirmation in equal monthly installments.
Debtor's partners have been solicited for capital contributions, and the Debtor has committed its partners to invest at least $150,000 of new capital. If a partner does not make the new investment, the partner's interest will be extinguished. Excess cash flow, after making all plan payments that are due, will be available for distributions to partners who have retained their interests by making the required new investment of capital. A third party investor has been identified who will invest $60,000 in conjunction with the general partner to cover the shares of existing partners who elect not to make an additional contribution of new capital.
Balcor advances three arguments why Debtor's plan is not confirmable as a matter of law and therefore relief should be granted under 11 U.S.C. § 362(d)(2):
1. There is no exception for new value to the absolute priority rule under 11 U.S.C. § 1129(b)(2)(B);
2. The proposed plan is otherwise not fair and equitable to Balcor because the plan would allow distributions to limited partner investors from excess cash flow prior to payment of Balcor's unsecured claim in full; and
3. Debtor's solicitation for investment in the plan violates Section 12(2) of the Securities Act of 1933.
Other fact specific and time variable issues raised by Balcor in objecting to Debtor's plan, such as the required interest rate for deferred cash payments on secured claims and feasibility, have been deferred until there is a confirmation hearing, if there is one. See In re Ledgemere Land Corp., 125 B.R. 58 (Bankr.D.Mass.1991); In re Northgate Terrace Apartments, Ltd., 126 B.R. 520 (Bankr.S.D.Ohio 1991).
Since Debtor does not have equity in the property, the remaining issue under 11 U.S.C. § 362(d)(2) is whether the Woodscape Apartments are necessary for an effective reorganization by Debtor. United Savings Ass'n v. Timbers of Inwood Forest Assocs., 484 U.S. 365, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988). "What this requires is not merely a showing that if there is conceivably to be an effective reorganization, this property will be needed for it; but that the property is essential for an effective reorganization that is in prospect." Timbers, 484 U.S. at 375-76, 108 S.Ct. at 632. (Emphasis in original). Further, it must be established that there is "`a reasonable possibility of a successful reorganization within a reasonable time.'" Id. Preliminarily, since this case involves a single asset of real property, there exists no possibility of reorganization for Debtor without it.
The New Value Exception to the Absolute Priority Rule.
The term "new value exception" is a misnomer. There is simply no new value exception to the absolute priority rule set out in Section 1129(b)(2)(B) of the Bankruptcy Code. 11 U.S.C. § 1129(b)(2)(B). Likewise, there was no new value exception codified in the former Bankruptcy Act. Rather, there has been an acknowledgement by courts that it is possible for new equity to be invested in a reorganizing enterprise. One recognized source of that new investment of equity, and in fact a natural source for new equity capital, is from among pre-reorganization owners. However, to avoid a sham which would infringe upon the rights of creditors to a debtor's property values, and would thus violate the absolute priority rule, new investment must be needed and substantial, and it must be in money or money's worth.
Balcor posits that Case v. Los Angeles Lumber Products Co., Ltd., 308 U.S. 106, 60 S.Ct. 1, 84 L.Ed. 110 (1939), the decision which often is cited as recognizing a new value exception, was decided under the Bankruptcy Act. Unlike the Code, the Act did not codify a definition for fair and equitable. Consequently, Balcor argues that the term retained its common law meaning under the Act, and the doctrine protected individual creditors, as opposed to classes of creditors. Balcor urges this court to follow cases which have expounded on this point of reason and have found the new value exception inapplicable under the Code.
The court disagrees with Balcor's position. Equity interest holders may contribute new capital of money or money's worth in exchange for participation in a plan of reorganization under Chapter 11 of the Bankruptcy Code, provided that full allowance has been accorded to the value of creditors' claims against a debtor's property interests. The core issue is not whether a new value exception has survived under the Bankruptcy Code. Rather, the core issue, recognizing that risks of valuation should be borne by the debtor and not the creditors, is on what terms equity interest holders may be allowed to participate in a plan of reorganization where a class of unsecured creditors will not be paid the full present value of its claims. The assertions made by Balcor, and the rationale underlying this court's contrary conclusions, require inquiry into the history and purpose of the absolute priority rule and its so-called new value exception.
The absolute priority rule...
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