In re GAC Storage Lansing, LLC, No. 11-40944 (Bankr. N.D. Ill., Feb. 27, 2013)
The court denied confirmation of the debtor’s plan, finding that: (i) the debtor failed to demonstrate that it would be able to obtain financing to pay off the balloon payment; (ii) the proposed transfer of new equity to an individual with indirect ownership interest violated the absolute priority rule; and (iii) the plan’s injunction barring actions by the secured creditor against the guarantors was overly broad.
GAC Storage Lansing, LLC was the owner/operator of a self-storage facility. GAC executed a note and granted a security interest to the bank to refinance the original construction loan. GAC defaulted and filed for chapter 11 bankruptcy. The debtor continued to operate the business as a debtor in possession. The bank filed a proof of claim in the amount of $12.4 million; the property was valued at $8.1 million.
The debtor’s plan proposed to treat the secured portion of the bank’s claim as follows: the claim would be amortized over a 30-year period at 4.9 percent interest, monthly payments of principal and interest would be made, and a balloon payment of the unpaid balance would be made on the maturity date of the loan. The plan also proposed a Master Lease Agreement, under which GAC Storage El Monte, LLC (a 50 percent owner of the debtor), as landlord, would lease the storage facility to the tenant, SE El Monte Leasehold, LLC, which would operate the storage facility. This tenant would pay to the debtor the monthly rental payments equal to the net operating income set forth in the debtor’s cash flow projections. Rent from the storage facility tenants would effectively flow through El Monte to the debtor to fund the debtor’s payments to the bank. The plan also called for a $146,000 new equity contribution from Mr. Schwartz, the sole member of Newco (the reorganized debtor), and a contribution of $100,000 from the original loan guarantors. Both of these contributions were contingent upon court approval of the Guarantors Injunction (prohibiting suits against the guarantors).
The debtor sought plan confirmation under the cramdown provisions of section 1129(b) of the Bankruptcy Code.
The court began by citing the plan feasibility requirements set forth in section 1129(a)(11) of the Bankruptcy Code. The bank argued that the plan failed to meet the feasibility standard because the debtor could not prove that, with respect to the balloon payment of $8.1 million, it could either execute a refinance or complete a full payment sale by the maturity date. The court said that "the key issue concerns the reliability of the prospective value figure which the Debtor proffers to be $9,600,000 in year 2019 and whether the Debtor has the ability to pay off the Bank’s claim after the balloon payment comes due through a refinancing or sale." The court concluded that the debtor’s appraisal methodology was not reliable, and that the debtor had not satisfied its burden of proof. Accordingly, the court held that the feasibility standard of section 1129(a)(11) had not been met. The bank also argued, and the court agreed, that the debtor’s financial projections were unrealistic, and for this reason also, the plan was not feasible.
The court then turned to the cramdown requirements of section 1129(b), which provide that a plan may be confirmed over objections if the plan does not discriminate unfairly between impaired classes, and is fair and equitable to the classes of creditors that have rejected the plan. The bank objected on this basis, arguing that the proffered interest rate of 4.9 percent did not adequately reflect the risk of non-payment, submitting that the appropriate rate of interest was at least 8.6 percent. Applying Supreme Court guidance set forth in Till to the testimony provided by the debtor’s expert and the bank’s expert, the court agreed with the bank that the debtor’s proposed rate failed to capture the security and default risks of the plan, and that 8.6 percent was the appropriate rate of interest.
The bank next objected that the plan violated the absolute priority rule. The "rule," set forth in section 1129(b)(1)(B), provides that claims of any objecting impaired class must be paid in full before a junior class of claims is allowed to retain any interest. Citing In re Castleton Plaza, LP, the court said that the rule "prohibits insiders of the debtor and current holders of equity from retaining any interests or property on account of their equity interests unless senior classes are paid in full." The bank argued that the "insider nature" of the plan warranted application of the rule, and that Schwartz formulated the plan primarily for his own benefit and the benefit of other insiders. The debtor countered that the plan did not involve the transfer of "old equity," so that the rule did not apply.
The court cited the U.S. Supreme Court decision, Bank of America Nat. Trust and Sav. Ass’n. v. 203 North LaSalle St. P’ship, in which the Court held that vesting equity in the reorganized business in the debtor’s partners without extending an opportunity to anyone else either to compete for that equity or to propose a competing plan was a violation of the rule. In Castleton, the Seventh Circuit applied LaSalle, holding that plans giving insiders preferential treatment in the reorganized debtor should be subject to the same opportunity for competition as plans in which existing claim-holders put up new money. The GAC court found that Schwartz was an "insider" as defined in the Bankruptcy Code, and that because the plan contemplated issuance of 100 percent of the equity in the reorganized debtor to Schwartz before paying senior claims in full, the plan "is therefore subject to competitive bidding, as the holding in Castleton instructs."
The court found that the debtor "failed to prove the reasonable possibility of a successful reorganization within a reasonable period of time," and that there was no equity in the property. The court therefore denied confirmation of the plan and granted the bank’s lift stay motion.
Equity holders of the debtor often run into the restrictions of the absolute priority rule, and have endeavored to create ways around it. Some courts have allowed equity holders to contribute so-called "new value" as consideration for their "new" equity interests, but courts are increasingly expanding the reach of the absolutepriority rule to a broad class of insiders, even if those persons are not direct owners or investors. When there appears to be preferential access to investment opportunities motivated by insiders, courts are becoming increasingly willing to require that any pre-bankruptcy equity investor seeking to retain an ownership interest in the reorganized debtor submit to a competitive bidding process.