In re Olde Prairie Block Owner, LLC, Bankr. No. 10B22668 (Bankr. N.D. Ill. March 11, 2011)  

CASE SNAPSHOT

The single-asset chapter 11 debtor sought approval from the Bankruptcy Court to borrow funds from a new lender, and grant the new lender superpriority status over the liens of the debtor’s pre-petition secured lender. The debtor had a substantial equity cushion in the subject property, and planned to use the relatively small new loan to complete the steps necessary to attract investors to develop the property. The secured lender objected to the new loan priming its lien. In holding for the debtor, the court stated that it did not rely solely on the $30 million equity cushion of the debtor as the basis for its ruling. The court evaluated the likelihood that the new loan would benefit the property and advance the purposes of reorganization, and evaluated whether the secured lender’s interest would be adequately protected.  

FACTUAL BACKGROUND

Olde Prairie Block Owner, LLC, the debtor in this case, owned parcels of what the court described as “choice” real estate in Chicago. CenterPoint Trust Properties was the debtor’s pre-petition secured lender, having loaned approximately $50 million for the purchase of the property. Olde Prairie Block had defaulted on its mortgage obligations to CenterPoint, and the lender initiated foreclosure proceedings. Before the foreclosure action was completed, Olde Prairie Block filed its chapter 11 petition. An evidentiary hearing determined that the property was worth $81 million, and the balance due CenterPoint was $48 million; thus, the debtor had an equity cushion in excess of $30 million in the property.

The debtor had been taking steps to develop the property into a hotel complex, which steps included substantial investments in pursuing Tax Increment Financing for the property, as well as obtaining and monetizing various tax credits (such as “historic tax credits” and “new market” tax credits). The debtor had retained several experts to help with this process, including consultants, attorneys, and architects.

The debtor faced an immediate problem, though, in the form of an imminent due date for payment of property taxes. The debtor had negotiated for a relatively small loan of $4 million from JMB Capital Partners, LP. In exchange for this loan, the debtor proposed that the JMB loan be given senior priority over CenterPoint’s lien and superpriority administrative expense status.

The debtor filed a motion with the court, proposing to use the JMB loan proceeds to pay the property taxes, and pay several other expenses related to the development of the property into a hotel complex.

CenterPoint objected to the debtor’s motion. The Bankruptcy Court approved in part, and denied in part, the debtor’s motion.

COURT ANALYSIS

A debtor-in-possession may incur debt only in accordance with the requirements of section 364 of the Bankruptcy Code. If a debtor is unable to obtain unsecured credit, a court may authorize the debtor to obtain new, secured credit with priority over other administrative expenses (sometimes called “superpriority” administrative expenses). Section 364(d) authorizes the debtor to obtain credit secured by a senior or equal lien on encumbered estate property (a “priming” lien), after notice, hearing and court approval, only if: (1) the debtor is unable to obtain credit otherwise; and (2) the interest of the creditor to be primed is adequately protected.

In the instant case, CenterPoint objected to the debtor’s motion, arguing that its interest was not adequately protected, and that the various expenditures proposed by the debtor would not advance its reorganization.

In approving the motion in part, the court took into consideration the sizable equity cushion in the property, but found that the equity cushion was not, by itself, determinative of the motion. Instead, the court held that “[i]t is not enough for Debtor to rely on a large equity cushion resting on expert opinions as to the value of the property…. The uses contemplated for the new loan must have serious likelihood of benefitting the property and advancing the purposes of reorganization. A priming lien without such a showing would impose unwarranted risk on the secured creditor if reorganization failed.” In doing so, the court recognized that valuations (and, by implication, equity cushions) are determined by expert testimony that could prove to be inaccurate. As such, “some restraint is warranted in allowing priming liens based on equity cushions.” The court evaluated the proposed uses of the JMB loan, and found that most of the expenses would likely advance the value of the property and make it easier for the debtor to reorganize. The court further noted with approval the steps the debtor had already taken with respect to obtaining TIF financing and various tax credits, to make the project more appealing to potential investors, and concluded that the debtor had shown a serious business justification for most of the proposed uses of the JMB loan.

The court, however, declined to allow the JMB facility to be used to pay expenses that had already been incurred. Instead, it held that, because the debtor had already succeeded in obtaining those services on an unsecured basis, it was unable to prove that it was “unable to obtain unsecured credit” from those entities as required by section 364(d)(1). As such, “permitting Debtor to borrow from JMB in exchange for a priming lien in order to pay past due expenses would be contrary to the plain language of the requirements under section 364(d).” For these reasons, the Bankruptcy Court authorized the borrowing for expenses necessary to fund future, but not past, services that will be provided to the debtor.

PRACTICAL CONSIDERATIONS

Although the existence of a substantial equity cushion certainly makes it easier to obtain approval of DIP facilities conditioned upon the provision of priming liens or superpriority claims, the size of the equity cushion is not always determinative of these issues. Instead, because valuation analysis is sometimes imperfect, a debtor must still be able to demonstrate that the purposes for which the facility will be used benefit the estate and that they are unable to obtain financing on an unsecured basis.