Three affiliated debtors (RMI, CBTC and CBI) proposed a plan of reorganization that, among other things, required transfer of the collateral (interests in a tennis resort) of an objecting undersecured lender (Colony Lender) free and clear of its liens in exchange for either an unspecified payment or return of the collateral after one year. The convoluted ownership structure of the resort and treatment of the lender’s claims gave rise to a variety of related questions.
The Colony Resort had been a world class tennis resort. Fifteen acres was part of a condominium consisting of guest units, accessory units and common areas. The guest units were sold to the public, and the unit owners were members of a condominium association (the Association). An additional three acres, which included a swimming pool and tennis courts, were not included in the condominium. The three acres together with the spa and clubhouse condo units were leased to the Association for 99 years.
When the debtor that operated the property (the Partnership) tried to finance a major restoration by having the Association assess unit owners more than $12 million, the unit owners objected. After the Partnership sued the Association, the Association filed a chapter 11 petition. As part of its bankruptcy, the Association rejected the lease and the landlords filed lease rejection damage claims. The Partnership subsequently filed a chapter 11 petition, which was converted to a chapter 7, and RMI (the Partnership’s general partner) and CBTC and CBI (owners of 45% and 35% tenant in common interests in the leased property) also eventually filed bankruptcy.
In 2010 Colony Lender acquired Bank of America’s outstanding project loans for $4.5 million. Although Colony Lender filed an amendment to the Bank of America financing statement, it did not continue the financing statement beyond the initial five-year period so that the financing statement lapsed in October 2010.
Colony Lender asserted a claim in the CBI, CBTC and RMI bankruptcies for ~$15.6 million, of which ~$6.4 million was claimed to be secured based on the value of the collateral. This included a mortgage on the undivided 80% tenant in common interests of CBTC and RMI. In 2011 Colony Lender also acquired an undivided 15% tenant in common interest in the leased property from a non-debtor. As described by the court:
Colony Lender’s stated purpose in 2010 was to partner with a hedge fund, York Capital, to acquire and redevelop the Resort. That effort ended in April or May of 2010 when York Capital withdrew from further discussions with the association.
If Colony Lender was able to acquire 100% of the leased property, it threatened to assert certain rent collection claims in order to acquire ownership of the unit owner interests. In contrast, if the Association was able to acquire 100% of the interest in the leased property, it was likely that the liability of the unit owners would disappear.
Under the proposed plans of reorganization and a related settlement agreement, CBTC and CBI were to convey their 80% interest in the leased property to the Association free and clear of Colony Lender’s liens, and Colony Lender would be compelled to transfer its 15% undivided interest to the Association. The Association was obligated to propose a plan of termination of the condominium, with a judicial valuation on the project, and then pay Colony Lender and the other co-owners the value of their proportionate interests. If it failed to pay Colony Lender within a year, the Association would surrender the leased property to Colony Lender.
Among the issues addressed by the court in resolving various adversary proceedings and ruling on confirmation the proposed plans were the following:
Effect of lapse of a UCC financing statement during bankruptcy: Prior to 2001, under Article 9 of the Uniform Commercial Code (UCC) a financing statement that was in effect on the date a bankruptcy was filed remained effective until the later of (1) the normal five-year period or (2) 60 days after the bankruptcy proceedings were terminated. However, the Bankruptcy Code was amended to expressly allow secured creditors to file continuation statements during a bankruptcy without regard to the automatic stay. Since the tolling provision was no longer necessary, the UCC was amended in 2001 to remove the provision.
However, this raised the question of what happens when a financing statement is not continued while a bankruptcy is pending. This became an issue in the Partnership bankruptcy case. The court agreed with the conclusion as articulated in another case: “When is a financing statement that is no longer effective, still effective? When it lapses, of course!”
The court concluded that the lien was not extinguished by lapse of the financing statement, but rather the priority of the lien could change. The court provided a detailed analysis of the UCC provisions regarding the effect of a lapse of a UCC financing statement as well as the circumstances under which a perfected secured claim can become unsecured. The court noted that while a challenge to the Colony Lender claim itself might be successful, exercise of bankruptcy “strong arm” powers wouldnot be successful since this was based on the status of a lien on the date a bankruptcy commences, and Colony Lender’s security interest was perfected at the time the Partnership filed bankruptcy.
Indubitable equivalent: Another issue related to the transfer of the debtors’ 80% interest in the leased property to the Association. In seeking approval of their plan, the debtors were very careful to avoid calling the transfer a sale, and instead sought to justify confirmation over the objection of Colony Lender on the basis that the treatment under the plan provided the “indubitable equivalent” of its secured claim.
The court did not agree and found that the alternative of a deferred payment or return of the collateral where there was no equity cushion and no compensation for risks resulting from the delay did not provide the indubitable equivalent of Colony Lender’s secured claim. Further, the court found that the plan in effect called for the sale of a secured creditor’s collateral free and clear of its claims. The Supreme Court made it clear in RadLAX that a sale cannot be supported under the indubitable equivalent cramdown alternative. Instead the secured creditor must be permitted to make a credit bid.
Forced sale of joint interests held by non-debtor: The compelled transfer of Colony Lender’s 15% tenant in common interest in the leased property presented additional stumbling blocks to confirmation. Section 363(h) permits the forced sale of a non-debtor tenant in common interest under certain conditions. One of those conditions is that the non-debtor must have an opportunity to match the price – which was not part of the plan.
Based on these and other issues, the court denied confirmation, denied approval of a related settlement agreement, converted the RMI, CBTC and CBI chapter 11 cases to chapter 7, and granted Colony Lender’s motion for relief from the stay in certain of the cases.
In its conclusion the court noted: “Even though Colony Lender has been characterized in the negative as a ‘claims buyer,’ it is legally entitled to seek recovery of the nearly $14 million that was awarded in state court.”
Anyone purchasing a secured claim as a means to acquire collateral should be aware that it may not be smooth sailing, particularly if the borrower files bankruptcy. Bankruptcy modifies the rules of the game in a way that significantly affects a secured creditor’s ability to realize on its collateral. Theoretically the creditor’s motives in buying a claim should not matter. However, that may not always be the case.