Prudential Ins. Co. of Am. v. City of Bos. (In re SW Bos. Hotel Venture, LLC)

• Decision Date: 01 October 2012
• Docket Number: MB 11–085,MB 11–086.,BAP Nos. MB 11–079,MB 11–082,Bankruptcy No. 10–14535–JNF.
• Citation: 479 B.R. 210
• Parties: SW BOSTON HOTEL VENTURE, LLC, et al., Debtors. The Prudential Insurance Company of America, Appellant/Cross–Appellee, v. City of Boston, Appellee, and SW Boston Hotel Venture, LLC, et al., Appellees/Cross–Appellants.
• Court: U.S. Bankruptcy Appellate Panel, First Circuit

479 B.R. 210

SW BOSTON HOTEL VENTURE, LLC, et al.,¹ Debtors.The Prudential Insurance Company of America, Appellant/Cross–Appellee,

v. City of Boston, Appellee,andSW Boston Hotel Venture, LLC, et al., Appellees/Cross–Appellants.

BAP Nos. MB 11–079, MB 11–082, MB 11–085, MB 11–086.

Bankruptcy No. 10–14535–JNF.

United States Bankruptcy Appellate Panel of the First Circuit.

Oct. 1, 2012.

Gina L. Martin Esq., and Emanuel C. Grillo, Esq., on brief for Appellant/Cross–Appellee.

Joseph F. Ryan, Esq., and E. Kate Buyuk, Esq., on brief for Appellee, City of Boston.

Harold B. Murphy, Esq., Charles R. Bennett, Jr., Esq., and John C. Elstad, Esq., on brief for Appellees/Cross–Appellants.

Before HAINES, DEASY, and TESTER, United States Bankruptcy Appellate Panel Judges.

DEASY, Bankruptcy Judge.

The Prudential Insurance Company of America (“Prudential”) appeals from the following orders of the bankruptcy court: (1) the October 4, 2011 order (the “506(b) Order”) granting, in part, and denying, in part, the Motion of The Prudential Insurance Company of America for an Order Authorizing the Application of Payments Received during the Chapter 11 Cases to Payment of Postpetition Interest Pursuant to Section 506(b) of the Bankruptcy Code; ² and (2) the Order Fixing Amount of Allowed Prudential Secured Claim as of October 4, 2011 (the “Prudential Claim Order”) entered by the bankruptcy court on October 20, 2011. The Debtors filed cross-appeals with respect to both orders, arguing that the bankruptcy court erred by awarding Prudential interest at the default rate (the “Default Rate Calculation”). For the reasons set forth below, we AFFIRM in part, REVERSE in part, and REMAND both orders for further proceedings consistent with this opinion.

BACKGROUND

In 2007, the Debtors, a group of affiliated companies run by Carol Sawyer Parks, sought financing for the development of certain property located at 100 Stuart Street, Boston, Massachusetts (the “Property”). See In re SW Boston Hotel Venture, LLC, 449 B.R. 156, 159 (Bankr.D.Mass.2011) (reciting stipulated facts in connection with Prudential's motion to lift stay) (the “Lift Stay Decision ”). This development became the “W” Hotel and Residences, a mixed-use property located in Boston's downtown theater district, consisting of a hotel (the “Hotel”), residential condominiums (the “Residences”), a parking garage, restaurant, lobby bar, retail store, spa, and theme bar. Id. SW Boston was formed to own and operate the Debtors' main assets, the Hotel and Residences.

A. The Prudential Loan

After financing with another lender fell through, Prudential agreed to finance the construction of the project. In January 2008, Prudential and SW Boston entered into a Construction Loan Agreement, whereby Prudential agreed to provide up to $192.2 million in financing to SW Boston (the “Prudential Loan”). See Lift Stay Decision, 449 B.R. at 160.³ The Construction Loan Agreement provided for the payment of interest at the rate of 9.5% per annum, and that after the occurrence of an event of default (as defined therein), the interest rate would increase to a default rate of 14.5%. In addition to scheduled debt service payments, the Debtors were required to pay Prudential 92% of the proceeds of each Residence sale as it occurred.

1. Prudential's Collateral

To secure SW Boston's obligations under the Construction Loan Agreement, SW Boston granted Prudential, among other things, a first priority mortgage and security interest on SW Boston's real and personal property, and all proceeds from the sale of the foregoing. See Lift Stay Decision, 449 B.R. at 160. SW Boston also executed pledge agreements and account control agreements in favor of Prudential with respect to two accounts in SW Boston's name at Sovereign Bank. In addition to the collateral provided by SW Boston, certain of the Debtors other than SW Boston (the “Affiliated Debtors”) provided guarantees and pledged additional collateral as security. See Lift Stay Decision, 449 B.R. at 160–61.

2. Letter of Credit

Under the Construction Loan Agreement, one of the Affiliated Debtors, Frank Sawyer Corporation, was required to arrange for the issuance of a letter of credit for Prudential's benefit as additional security for the loan. As a result, two of the Debtors' non-debtor affiliates, SE Berkeley Street, LLC and SW McClellan Highway, LLC, obtained from Sovereign Bank a letter of credit in favor of Prudential in the approximate amount of $17.3 million (the “Letter of Credit”). See Lift Stay Decision, 449 B.R. at 161.

B. The City Loan

After construction of the project was underway, the City of Boston agreed to lend SW Boston an additional $10.5 million under the terms of a Subordinate Loan Agreement (the “City Loan”) to complete construction of certain amenities and facilities. See Lift Stay Decision, 449 B.R. at 161. As security for the City Loan, the Debtors granted to the City of Boston a second priority security interest and mortgage on much of the same collateral on which Prudential had a first lien. Id. Prudential and the City of Boston entered into an Intercreditor and Subordination Agreement, under which the City of Boston agreed, among other things, to subordinate its liens against, and right to payment from, the collateral pledged to both of them. See In re SW Hotel Venture, LLC, 460 B.R. 4, 17 (Bankr.D.Mass.2011) (the “506(b) Decision ”).

C. The Commencement of Bankruptcy Proceedings

On April 28, 2010 (the “petition date”), SW Boston and four of the Affiliated Debtors filed chapter 11 petitions. The other Affiliated Debtors filed chapter 11 petitions on June 4, 2010. Shortly after the petition date, Prudential drew the full amount of the Letter of Credit ($17.3 million), and applied the funds to the principal balance due on the Prudential Loan.

1. The Debtors' Use of Cash Collateral

From the inception of the cases, the Debtors requested authority from the bankruptcy court to use Prudential's cash collateral, i.e. Hotel-related revenue and the proceeds of the sale of the Residences. Although Prudential objected in most instances, the bankruptcy court regularly allowed the Debtors to use cash collateral.

2. The Lift Stay Motion

In August 2010, Prudential filed a Motion for Relief from the Automatic Stay pursuant to § 362(d)(1) and (d)(2) (the “Lift Stay Motion”) so that it could enforce its rights and remedies under the loan documents. Prudential argued that it was entitled to relief from stay because, among other things, SW Boston did not have sufficient Residence sales, had not completed the theme bar, could not close existing Residence sales or obtain new sales, and did not have the ability to emerge successfully from chapter 11. The Debtors opposed the motion asserting, among other things, that Prudential's interest in the Hotel and Residences was more than adequately protected by its collateral and by SW Boston's continued operation of the Hotel and sales and leases of the Residences. According to the Debtors, Prudential's interest in the Hotel and Residences was being enhanced by the completion of the spa and theme bar using the proceeds of the City Loan, and the Debtors' successful reorganization was in progress.

In November 2010, the bankruptcy court conducted a three-day evidentiary hearing on the Lift Stay Motion that involved multiple expert witnesses and extensive exhibits. See Lift Stay Decision, 449 B.R. at 158–59. At the hearing, the bankruptcy court heard expert testimony as to the value of the Hotel and Residences, and admitted into evidence competing appraisals of the Hotel and Residences, and stipulated values for other collateral. See id. On January 28, 2011, the bankruptcy court entered an order denying Prudential's Motion for Relief from the Automatic Stay. In the bankruptcy court's extensive Lift Stay Decision, the bankruptcy court scrutinized the competing valuation evidence submitted by the parties, and ultimately found that the Hotel was worth $65,600,000 and the unsold Residences were worth $88,000,000. Id. at 172–173. The bankruptcy court also accepted the stipulated value of the other collateral as $14,754,000, for an aggregate collateral value of $168,354,000. Id. at 171–73. The bankruptcy court found the value of Prudential's claims to be $154,000,000. Id. at 161–62.

In denying relief from stay, the bankruptcy court concluded that Prudential had not demonstrated cause for relief from stay due to lack of adequate protection under § 362(d)(1). Noting that Prudential did not introduce evidence of lack of adequate protection at trial and did not address it in its brief, the bankruptcy court stated: “Given the total value of the collateral package, an equity cushion exists with respect to Prudential's claim in an amount in excess of $19 million.” Id. at 176. The bankruptcy court also noted that the Debtors were reducing the amount of debt owed to Prudential from the proceeds of the Residence sales, and that the value of the collateral was not declining. The bankruptcy court concluded, therefore, that Prudential did not lack adequate protection. Id.

The bankruptcy court also held that Prudential was not entitled to relief from stay under § 362(d)(2). In its analysis, the bankruptcy court found that SW Boston lacked equity in the Hotel and Residences, even though the “total value of the collateral package” provided Prudential with an equity cushion. Id. at 176 and 178. However, the bankruptcy court also found that the Debtors had sustained their burden of demonstrating that a plan of reorganization was in prospect, and, therefore, that the Property was necessary for their reorganization.

3. The Hotel Sale

On March 28, 2011, the Debtors filed a motion requesting approval of a purchase and sale agreement to sell the Hotel and Residences and certain other related facilities to an unrelated third party for $89.5 million (the “Hotel Sale”). This amount was substantially more than the opinions expressed by both parties'...