Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:
In JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props., Inc. (In re Transwest Resort Props., Inc.), 881 F.3d 724 (9th Cir. 2018), the U.S. Court of Appeals for the Ninth Circuit held that an election under section 1111(b)(2) of the Bankruptcy Code does not require that a chapter 11 plan contain full due-on-sale protections, and that section 1129(a)(10) of the Bankruptcy Code applies on a “per plan” (not a “per debtor”) basis. To read the full published decision, click here: http://cdn.ca9.uscourts.gov/datastore/opinions/2018/01/25/16-16221.pdf.
In 2010, a group of five entities (collectively the “Debtors”) filed for chapter 11. The Debtors consisted of one parent company, two “Mezzanine Debtors” that were owned by the parent company, and two “Operating Debtors” that were each owned by one of the Mezzanine Debtors. Each Operating Debtor owned and operated a resort hotel.
The bankruptcy cases were jointly administered, but not substantively consolidated. The Debtors filed a joint chapter 11 plan which did not (at least not expressly) propose to substantively consolidate the Debtors.
Undersecured creditor JPMCC 2007-C1 Grasslawn Lodging, LLC (“Lender”), was owed $247 million. Its claim was against the two Operating Debtors and was secured by liens on the two hotels. Pursuant to section 1111(b) of the Bankruptcy Code, Lender elected to have its claim treated as a fully secured claim.
In their plan, the Debtors proposed to pay Lender monthly interest-only payments for 21 years, with a balloon payment at the end of the term. The plan included a due-on-sale clause which generally provided that Lender would be paid in full if the hotels were sold during the 21-year term, except that the hotels could be sold subject to the restructured loan between years 5 and 15 of the plan.
Under the plan, Lender’s claim comprised one of ten classes of claims. A second class was comprised of secured claims originally held by another lender against the Mezzanine Debtors. This second class was the only class of claims asserted against the Mezzanine Debtors. After the plan was proposed, Lender acquired these claims and, therefore, controlled the only class of claims asserted against the Mezzanine Debtors.
Lender voted to reject the plan, and objected to confirmation of the plan on at least two grounds. First, it argued that the 10-year exception to the due-on-sale clause would improperly allow the Debtors to partially negate the benefit of Lender’s section 1111(b) election. Second, it argued that the plan did not satisfy section 1129(a)(10) because no class of creditors holding claims against the Mezzanine Debtors voted to accept the plan.
The bankruptcy court overruled Lender’s objections and confirmed the plan. Ultimately, the district court affirmed on the merits. On further appeal, the Ninth Circuit also affirmed. Judge Milan D. Smith authored the Ninth Circuit’s opinion, and Judge Michelle T. Friedland filed a concurrence.
The court started by rejecting Lender’s argument that, because it had made an 1111(b) election, the plan needed to provide that Lender would be paid in full if the hotels were sold. Section 1111(b) allows an undersecured creditor to obtain certain benefits reserved for secured creditors. But neither the plain language of section 1111(b) nor the broader context of chapter 11 requires that a plan contain a due-on-sale clause when a creditor makes an 1111(b) election. Indeed, section 1123(b)(5) provides that a plan may modify secured creditors’ rights (and thereby remove due-on-sale clauses in prepetition loan agreements). Further, as long as a secured creditor retains its lien, a cram-down under section 1129(b)(2)(A)(i) is permissible even when “the property subject to such lien is . . . transferred to another entity.” Thus, “the statute expressly allows a debtor to sell the collateral to another entity so long as the creditor retains the lien securing its claim, yet the statute does not mention any due-on-sale requirement . . . .”
The court was careful to note that this does not mean that due-on-sale protections are wholly irrelevant to the question of whether a plan is “fair and equitable” under section 1129(b). However, the court concluded that Lender had waived any argument that the Debtors’ plan was not “fair and equitable.”
The court then rejected Lender’s argument that when a plan is filed on behalf of multiple debtors in a jointly administered case, section 1129(a)(10) must be evaluated on a debtor-by-debtor basis. Section 1129(a)(10) provides that if a class of claims is impaired under a plan, the plan may be confirmed only if at least one impaired class of claims accepts the plan. The plain language indicates that Congress intended a “per plan” approach, not a “per debtor” approach. The court observed that neither section 1129(a)(10) nor any other part of section 1129(a) distinguishes between single-debtor plans and multi-debtor plans.
In her concurrence, Judge Friedland acknowledged Lender’s argument that, despite being the sole creditor of the Mezzanine Debtors, it was unfairly deprived of the ability to object effectively to the reorganization of those debtors. She opined that any unfairness did not result from the bankruptcy court’s interpretation of section 1129. Instead, it resulted “from the fact that this particular reorganization treated the five Debtor entities as if they had been substantively consolidated. . . . Because there was no consensus over these bankruptcy proceedings, there should have been an evaluation [under In re Bonham, 229 F.3d 750 (9th Cir. 2000)] of whether substantive consolidation was appropriate before it (effectively) occurred.” However, since Lender did not challenge the plan on that basis prior to confirmation, any objection on that ground was waived. Nevertheless, Judge Friedland concluded:
[I]f a creditor believes that a reorganization improperly intermingles different estates, the creditor can and should object that the plan – rather than the requirements for confirming the plan – results in de facto substantive consolidation. Such an approach would allow this issue to be assessed on a case-by-case basis, which would be appropriate given the fact-intensive nature of the substantive consolidation inquiry. . . .
The court’s adoption of the “per plan” approach in jointly administered cases is significant. At least in this circuit, objecting creditors (such as Lender) can no longer buy up all of the claims against one debtor and then use that position to block confirmation or leverage a better deal for itself. In some cases with many debtors, the ruling also will make the confirmation process more efficient.
The court’s statutory analysis of section 1129(b)(2)(A)(i) is correct. There is nothing in section 1129(b)(2)(A)(i) itself that requires a reorganized debtor to pay off a secured claim when collateral is sold post-confirmation (regardless of whether the claimant made an 1111(b) election). The real question is (or should have been) whether the plan was “fair and equitable.” Though there may be more to the story, it seems remarkable that Lender never raised, or subsequently waived, that issue.
These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles, California (firstname.lastname@example.org). Editorial contributions were provided by ILC member Michael W. Davis of Brutzkus Gubner Rozansky Seror Weber LLP in Woodland Hills, California (email@example.com).
Insolvency Law Committee
Radmila A. Fulton
Law Offices of Radmila A. Fulton
Danning, Gill, Diamond & Kollitz, LLP
Marcus O. Colabianchi
Duane Morris LLP
Rebecca J. Winthrop
Norton Rose Fulbright US LLP
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