Fourth Circuit Authorizes Partial Dirt for Debt Plan

The Bankruptcy Code requires that secured creditors realize the indubitable equivalent of their claims as a condition to confirmation of a Chapter 11 plan of reorganization. In the case of Bate Land & Timber LLC, the Fourth Circuit addressed indubitable equivalence in the context of a partial dirt for debt plan where the debtor planned to covey several tracks of real property in partial satisfaction of its obligations to its secured creditor and pay the remaining balance owed in cash.

Dirt for debt plans often raise complex issues of property valuation, including the issue of the highest and best use for a particular property. Moreover, some courts have questioned whether partial dirt for debt plans may ever provide the indubitable equivalent of a secured creditors claim since by definition, the creditor will not receive all of its collateral. In Bate Land & Timber LLC, the Debtor was obligated to its secured creditor in the approximate amount of $13 million. Because the creditor was oversecured, it was also entitled to recover post-petition interest accruing and its reasonable attorney’s fees. The Debtor proposed a Chapter 11 plan wherein it would transfer several tracts of largely undeveloped land in eastern North Carolina to the secured creditor and pay the remaining amounts owed in cash.

In order to proceed with confirmation, the Bankruptcy Court held several hearings to determine the value of the property subject to the dirt for debt exchange. A bankruptcy court is not required to value property in its current condition, but instead may consider the property’s highest and best use. It is not surprising therefore, that the Debtor and its secured creditor disagreed not only on the value of the property, but also the highest and best use. Each proffered an expert in support of its view. Ultimately, the Bankruptcy Court was convinced that the Debtor’s version of the highest and best use for the properties – mostly residential development and agriculture – was superior to the creditor’s position – timber production, management and recreation. The Bankruptcy Court valued the properties subject to the dirt for debt exchange at a combined $13.7 million and then allowed the creditor’s claim at $14.6 million after reducing the interest charged to account for delays that could not be attributable to the Debtor.

The secured creditor took an appeal to the District Court and sought a stay pending appeal. The request for a stay was denied, and the Debtor implemented its plan of reorganization. The District Court then granted the Debtor’s motion to dismiss the appeal on equitable mootness grounds, and the secured creditor appealed to the Fourth Circuit.

On appeal, the Fourth Circuit first addressed the issue of equitable mootness. Despite the fact that the plan had been implemented, the Fourth Circuit declined to find that equitable mootness precluded effective relief so as to require dismissal of the appeal. It reasoned that the case was largely a two party dispute due to the small amounts owed to other creditors, and that if it ruled in the secured creditor’s favor, requiring the Debtor to convey additional property or pay additional sums would not alter any other creditor’s recovery in the case. Further, the Fourth Circuit found that the Debtor had not engaged in significant transactions with third parties in reliance on the terms of the bankruptcy plan such that those third parties would be negatively impacted if the Court ordered a modification.

Turning to the merits of the appeal, the Fourth Circuit addressed the creditor’s argument that a partial dirt for debt plan (i.e. a plan that only transferred to the secured creditor a portion of its collateral) could not, as a matter of law, achieve the level of certitude required to provide indubitable equivalence. This argument was premised on the fact that the competing valuations necessarily led to uncertainly which, according to the creditor, must cut against a finding of indubitable equivalence. In rejecting this argument, the Fourth Circuit noted that some level of uncertainty exists in all valuations, and every determination of disputed facts. It noted that bankruptcy courts are instructed to take a conservative approach in valuation proceedings, and are “well-equipped to arrive at a valuation that represents the indubitable equivalent of a secured creditor’s claim in the face of disputed valuations.”

The Fourth Circuit next looked to the factual findings of the Bankruptcy Court and found no clear error. It found that the Bankruptcy Court “conducted a very detailed and exhaustive factual analysis” and made detailed findings “on topics such as topography, average days on the market of property in the area, the economic climate of the location of the properties, and the economic history of the particular tracts.” Ultimately, the Fourth Circuit concluded that “given the fact that the bankruptcy court’s analysis was thorough and not arbitrary” it was not left with the “definite and firm conviction that a mistake has been committed.” It therefore affirmed the Bankruptcy Court’s finding of indubitable equivalence.

Similarly, the Fourth Circuit affirmed the Bankruptcy Court’s decision to equitably disallow a portion of the interest accruing on the secured claim for delays attributable to the court’s schedule or proceedings initiated by the creditor. It ruled that the Bankruptcy Court’s conclusion that it would be inequitable to require the Debtor to pay interest that accrued through no fault of its own to be reasonable and supported by the record.

The result in Bate Land & Timber is a rare appellate case approving of partial dirt for debt plans and highlights the importance of presenting a convincing case at trial in valuation proceedings. Appellate courts are unlikely to overturn the factual findings underlying a bankruptcy court’s determination of value. Having the right expert witness and counsel can make all the difference in these complex proceedings. In addition, the decision addresses important concepts related to equitable mootness in appellate situations. Parties should recognize the importance of this doctrine and the ways in which it may impact one’s appellate rights.