River East Plaza, Ll v. Lnv Corpora , 669 F.3d 826 ( 2012 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 11-3263
IN RE:
R IVER E AST P LAZA , LLC,
Debtor.
A PPEAL OF:
R IVER E AST P LAZA , LLC and G ENEVA
L EASING A SSOCIATES, INC., et al.
LNV C ORPORATION,
Appellee.
Appeal from the United States Bankruptcy Court
for the Northern District of Illinois, Eastern Division.
No. 11 B 05141—Eugene R. Wedoff, Bankruptcy Judge.
A RGUED D ECEMBER 6, 2011—D ECIDED JANUARY 19, 2012
Before P OSNER, F LAUM, and S YKES, Circuit Judges.
P OSNER, Circuit Judge. This is an appeal directly to us,
skipping the district court, from the dismissal of what is
called a “single asset real estate” bankruptcy proceeding.
The debtor, River East Plaza, LLC, is the principal ap-
pellant. The appellee, LNV Corporation, is River East’s
2 No. 11-3263
principal creditor and had successfully urged the dis-
missal of the proceeding.
Section 158(d)(2)(A) of the Judicial Code authorizes a
court of appeals to permit the district court to be
bypassed if, so far as relates to this case, the order ap-
pealed from involves a question of law that has not
been definitively resolved, or involves a matter of
public importance, or if an immediate appeal “may ma-
terially advance the progress of the case.” The first and
last of these considerations point to our allowing this
appeal—the last because, as we’ll see, the Bankruptcy
Code directs speedy resolution of single asset real estate
bankruptcies for reasons well illustrated by this case. 11
U.S.C. § 362(d)(3); see River Road Hotel Partners, LLC v.
Amalgamated Bank, 651 F.3d 642, 645 (7th Cir. 2011), cert.
granted under the name RadLAX Gateway Hotel, LLC v.
Amalgamated Bank, No. 11-166, 2011 WL 3499633 (Dec. 12,
2011).
A single real estate asset, within the meaning of the
Bankruptcy Code, is a nonresidential property, or a
residential property containing five or more apartments
or other residential units, “on which no substantial busi-
ness is being conducted by a debtor other than the busi-
ness of operating the real property and activities in-
cidental thereto.” 11 U.S.C. § 101(51B). The single asset
in this case is a building in downtown Chicago called
River East Plaza that houses offices and a restaurant.
LNV Corporation, a banking firm, has a first mortgage
on the building.
The building’s owner and mortgagor, River East Plaza,
LLC, defaulted on the mortgage in February 2009, and
No. 11-3263 3
LNV promptly started foreclosure proceedings in state
court, prevailed, and a foreclosure sale of the property
was scheduled. That was almost three years ago, and the
sale has yet to take place. For in February 2011, just
hours before it was to occur, River East filed for bank-
ruptcy under Chapter 11 (reorganization, as distinct
from liquidation), and the filing automatically stayed
the sale. 11 U.S.C. § 362(a)(4).
As a secured creditor, LNV could have bypassed the
bankruptcy proceeding and continued its efforts to
enforce its secured claim in state court. In re Penrod, 50
F.3d 459, 461-63 (7th Cir. 1995). But stymied by the auto-
matic stay, it decided to become a party to the bank-
ruptcy proceeding so that it could ask the bankruptcy
judge, as it did, to lift the automatic stay. But by
becoming a party it subjected itself to the authority of
the bankruptcy judge to approve a plan of reorganiza-
tion that might affect its lien. Id. at 462; In re Airadigm
Communications, Inc., 519 F.3d 640, 647-48 (7th Cir.
2008). Normally a mortgage lien remains a lien on the
mortgaged property until the mortgage is paid off, even
if the property is sold, because a lien runs with the prop-
erty. But if the bankruptcy judge confirms a plan of
reorganization that removes the lien of a participating
creditor, the lien is gone. Id. at 648.
The creditor can try to protect himself against such a
fate by objecting to the plan, and his objection will block
it, see 11 U.S.C. § 1129(a)(8)(A), unless it can be crammed
down his throat under one of the three subsections of
11 U.S.C. § 1129(b)(2)(A). Under (i), the reorganized
4 No. 11-3263
debtor keeps the property and may be allowed to
stretch out the repayment of the debt beyond the
period allowed by the loan agreement, but the lien
remains on the property until the debt is repaid. Under
(ii), the debtor auctions the property free and clear of the
mortgage but the creditor is allowed to “credit bid,”
meaning to offer at the auction, not cash, but instead a
part or the whole of his claim, FDIC v. Meyer, 781 F.2d
1260, 1264-65 (7th Cir. 1984), so that, for example, LNV
could bid $20 million for River East’s building just by
reducing its claim from $38.3 million to $18.3 million.
Under (iii), the lien is exchanged for an “indubitable
equivalent.” In re Philadelphia Newspapers, LLC, 599 F.3d
298, 304-05 (3d Cir. 2010); In re Sun Country Development,
Inc., 764 F.2d 406, 409 (5th Cir. 1985); In re Murel Holding
Corp., 75 F.2d 941, 942 (2d Cir. 1935) (L. Hand, J.). The last
subsection is the one River East invoked in its proposed
plan of reorganization—unsuccessfully. The bankruptcy
judge rejected the plan, lifted the automatic stay, and
dismissed the bankruptcy proceeding.
A question before the Supreme Court in the River Road
case (the case, cited earlier, now called RadLAX Gateway
Hotel), but unnecessary to try to answer in this case,
is whether the third form of cramdown, the “indubitable
equivalent” cramdown, can be used to eliminate a
creditor protection imposed under the second subsec-
tion, which allows encumbered property to be auctioned
free and clear of an existing lien only if the lien creditor
is allowed to credit bid at the auction. In River Road
we rejected rulings by the Third and Fifth Circuits that
No. 11-3263 5
a plan allowing sale of property free and clear of a
secured creditor’s lien without letting the creditor
credit bid can still be crammed down, under the third
rather than the second subsection, so long as the plan
provides some means of assuring that the creditor
receive the indubitable equivalent of its claim. See In re
Philadelphia Newspapers, LLC, supra, 599 F.3d at 311-13;
In re Pacific Lumber Co., 584 F.3d 229, 246-47 (5th Cir.
2009). We said that to allow the debtor in such a case
to elude credit bids by convincing the bankruptcy
court that it has given the creditor an indubitable equiva-
lent in the form of substitute collateral would circum-
vent the procedure established by subsection (ii), and
by so doing deprive the creditor of the opportunity con-
ferred by that subsection to benefit from an increase in
the value of the property if, the credit bid having been
the high bid, the creditor becomes the owner of the en-
cumbered property.
While the debtor in River Road sought to avoid the
creditor’s right to credit bid under subsection (ii) by
invoking indubitable equivalence, River East seeks to
avoid the requirement in a subsection (i) cramdown of
maintaining the mortgage lien on the debtor’s property
by transferring LNV’s lien to different collateral, also in
the name of indubitable equivalence. The logic of River
Road forbids such an end run, but even if the Supreme
Court reverses River Road, River East’s plan could not
be confirmed because the substitute collateral that it
proposed was not the indubitable equivalent of LNV’s
mortgage. (Later we’ll explain when substitute collateral
can be indubitably equivalent to the original collateral.)
6 No. 11-3263
LNV is owed $38.3 million but River East’s building
is currently valued at only $13.5 million (this is River
East’s valuation, and may as we’ll see be too low). So
LNV’s secured claim is undersecured, and an under-
secured creditor who decides, as LNV has decided, to
participate in his debtor’s bankruptcy proceeding has
a secured claim for the value of the collateral at the time
of bankruptcy and an unsecured claim for the balance.
11 U.S.C. § 1111(b)(1)(A). But generally he can exchange
his two claims for a single secured claim equal to the
face amount of the unpaid balance of the mortgage.
§§ 1111(b)(1)(B), (2). LNV made this choice, so instead
of having a secured claim for $13.5 million and an unse-
cured claim for $24.8 million it has a secured claim
for $38.3 million and no unsecured claim.
The swap is attractive to a mortgagee who believes
both that the property that secures his mortgage is under-
valued and that the reorganized firm is likely to default
again—which often happens: between a quarter and a
third of all debtors who emerge from Chapter 11 with
an approved plan of reorganization later re-enter
Chapter 11 or have to restructure their debt (that is,
default—“restructure” is just a euphemism for default)
by some other method. See, e.g., Lynn M. Lopucki, Courting
Failure 97-1222 (2005); Harvey R. Miller & Shai Y.
Waisman, “Does Chapter 11 Reorganization Remain a
Viable Option for Distressed Businesses for the Twenty-
First Century?” 78 Am. Bankr. L.J. 153, 188-89 (2004); Stuart
C. Gilson, “Transaction Costs and Capital Structure
Choice: Evidence from Financially Distressed Firms,” 52
J. Finance 161, 162 (1997); Edith Shwalb Hotchkiss,
No. 11-3263 7
“Postbankruptcy Performance and Management Turn-
over,” 50 J. Finance 3 (1995); Lynn M. LoPucki & William C.
Whitford, “Patterns in the Bankruptcy Reorganization of
Large, Publicly Held Companies,” 78 Cornell L. Rev. 597,
608 (1993); but cf. Robert K. Rasmussen, “Empirically
Bankrupt,” 2007 Colum. Business L. Rev. 179, 223-27
(2007). The swap enables the creditor, in the event of a
further default after the value of the property has
risen, to apply a higher value of the collateral to the
satisfaction of the debt than if he had accepted a
secured claim equal to the lower value of the collateral
at the time of bankruptcy. Had LNV chosen not to
give up its unsecured claim in exchange for a larger
secured claim, it would receive some fraction of its unse-
cured claim in the Chapter 11 proceeding, and would
continue after the bankruptcy to have a $13.5 million claim
secured by the building. The building would continue to be
owned by the debtor if the latter had emerged from
bankruptcy, having been permitted to reorganize. If the
debtor later defaulted and the building was sold, LNV
would realize a maximum of $13.5 million (the amount
of its secured claim) from the sale, even if the building
was sold for more. In contrast, given the swap, if the
value of the building rose say to $20 million by the time
the former debtor again defaulted, LNV, if allowed to
foreclose, would realize all $20 million because his
secured claim would exceed that amount. In June 2011,
when LNV made its choice, the U.S. real estate market,
commercial as well as residential, was severely depressed
(as it still is), but LNV expected real estate prices to
rise, which may be why it made that choice.
8 No. 11-3263
River East, joined by several creditors listed as appel-
lants on River East’s briefs but about which the briefs
say very little and we shall say nothing, was unhappy
with LNV’s choice. Probably like LNV it expected the
value of the building to appreciate and didn’t want to
share that appreciation with its creditor. Or maybe, as
it argues, prospective financiers of the reorganized firm
wanted to have a senior lien on the building. Whatever
the precise motive, River East wanted LNV out of there
and decided to seek confirmation of a plan of reorganiza-
tion that would replace the lien on the building with a
lien on $13.5 million in substitute collateral, namely 30-
year Treasury bonds that would be bought by an
investor in the reorganized firm. At current interest rates,
River East argued, the bonds would grow in value in
30 years through the magic of compound interest to
$38.3 million, thus guaranteeing that LNV would be
repaid in full. The substitute collateral would be
equivalent to LNV’s lien.
The bankruptcy judge rejected the plan (River East’s
second plan—River East is not complaining about the
rejection of the first, a rejection based on the plan’s
failure to comply with the cramdown statute once
LNV chose to waive its unsecured claim in exchange
for retaining a larger secured claim). Section 362(d)(3)(A)
of the Code requires the bankruptcy judge, in a single
asset real estate bankruptcy, upon the request of a party
to “grant relief from the [automatic] stay . . ., such as
by terminating, annulling, modifying, or conditioning
such stay,” unless within 90 days of the filing of the
Chapter 11 petition “the debtor has filed a plan of
No. 11-3263 9
reorganization that has a reasonable possibility of being
confirmed within a reasonable time.” See In re Williams, 144
F.3d 544, 546 (7th Cir. 1998). When River East’s second plan
was rejected, the 90-day deadline had expired, and the
bankruptcy judge at LNV’s request vacated the auto-
matic stay, thus allowing the long-delayed foreclosure
sale to proceed. We stayed the sale pending the decision
of this appeal. Once the stay is lifted and the sale takes
place, there will be nothing left to reorganize, this being
a single-asset bankruptcy. That’s why, having decided
to lift the automatic stay, the bankruptcy judge
dismissed the bankruptcy proceeding.
River East argues that the reason LNV chose to
convert the entire $38.3 million debt that it was owed to a
secured claim is that it wanted to thwart the bank-
ruptcy proceeding. No doubt. LNV wanted to fore-
close its mortgage and doubtless expected to be the
high bidder at the foreclosure sale and thus become the
building’s owner and so the sole beneficiary of any
appreciation if and when the real estate market recov-
ered. But there is nothing wrong with a secured creditor’s
wanting the automatic stay lifted so that it can maximize
the recovery of the money owed it.
The bankruptcy judge stated flatly that a secured
creditor cannot be forced to accept substitute collateral
if the creditor has chosen to convert a combination of a
secured and unsecured claim into a secured claim equal
to the total debt that it is owed. Banning substitution
of collateral indeed makes good sense when as in the
present case the creditor is undersecured, unlike a case
10 No. 11-3263
in which he’s oversecured, in which case the involuntary
shift of his lien to substitute collateral is proper as long
as it doesn’t increase the risk of his becoming under-
secured in the future. See, e.g., In re Sun Country Develop-
ment, Inc., supra, 764 F.2d at 409; In re San Felipe @ Voss, Ltd.,
115 B.R. 526, 530-31 (S.D. Tex. 1990). It is proper because
the existing lien may make it difficult for the debtor to
obtain new financing, cf. Olive Can Co. v. Martin, 906 F.2d
1147, 1149 (7th Cir. 1990); Spartan Mills v. Bank of America
Illinois, 112 F.3d 1251, 1255-56 (4th Cir. 1997); Restatement
(Third) of Property: Mortgages § 7.3, comment e (1997),
which he may need in order to be able to reorganize
successfully; and provided the substitute collateral
gives the creditor an ample cushion against becoming
undersecured, he can have no reasonable objection to
the substitution. The secured creditor is thus not allowed
to “paralyze the debtor and gratuitously thwart the other
creditors by demanding superfluous security.” In re James
Wilson Associates, 965 F.2d 160, 171 (7th Cir. 1992); see
also In re Pacific Lumber Co., supra, 584 F.3d at 247.
Substituted collateral that is more valuable and no
more volatile than a creditor’s current collateral would
be the indubitable equivalent of that current collateral
even in the case of an undersecured debt. But no rational
debtor would propose such a substitution, because it
would be making a gift to the secured creditor. And a
case in which the creditor, by making the choice
authorized by section 1111(b), gives up his unsecured
claim—the amount by which the debt exceeds the
present value of the security—is a case of an undersecured
claim. The debtor’s only motive for substitution of col-
No. 11-3263 11
lateral in such a case is that the substitute collateral is
likely to be worth less than the existing collateral.
And so it comes as no surprise that the lien on the
Treasury bonds proposed by River East would not be
equivalent to LNV’s retaining its lien on the building.
Suppose the building turns out to be worth $40 million
five years from now, yet River East, having borrowed
heavily in the interim to finance improvements that
bring the building’s value up to that level, defaults. With
its lien intact and the bankruptcy court unlikely in this
second round of bankruptcy to stay foreclosure, LNV
would be able to foreclose, and so would be paid in full.
In contrast, if its lien were transferred to the sub-
stituted collateral, it would have to wait another 25 years
to recover the $38.3 million owed it. Over that long
period there almost certainly would be some inflation,
so that in real terms the substituted collateral would
turn out to be worth less.
Suppose, moreover, that during that period interest
rates on 30-year Treasury bonds rose because of the
nation’s deteriorating fiscal position, or because of actual
or expected inflation. The price of a fixed-income
security is inverse to prevailing interest rates. With the
interest rate on Treasury bonds 3 percent when River
East proposed their substitution for the building as
LNV’s collateral, a $1000 bond would yield $30 in
interest every year until the bond matured. Suppose
interest rates doubled and as a result newly issued
$1000 Treasury bonds carried a 6 percent interest
rate and so yielded $60 in annual interest. Then no one
12 No. 11-3263
holding a 3 percent bond would be able to sell it for
$1000. The price would not fall all the way to $500
(the level at which a $30 annual interest payment in
perpetuity, as on a British consol, would constitute a
6 percent return on the buyer’s investment), because
the principal would be repaid when the bond matured,
and so the price would creep upward as that date ap-
proached and knowing this current buyers would pay
more than $500. But the bondholder may have a less
valuable asset than the building owner if maturity is far
in the future and interest rates rise in the meantime;
and in that case a lien on the bond would be less valuable
than a lien on the building, especially since the market
value of the building might be growing while that of
the bond was shrinking.
Assessments of risk differ, moreover, and there are
multiple sources of risk. Treasury bonds carry little
default risk (though more since the financial crisis of
2008 and the ensuing surge in the nation’s sovereign
debt), but long-term Treasury bonds carry a substantial
inflation risk, which might or might not be fully im-
pounded in the current interest rate on the bonds.
The substituted collateral might, it is true, turn out to be
more valuable than the building and thus provide LNV
with more security. But because of the different risk
profiles of the two forms of collateral, they are not equiva-
lents, and there is no reason why the choice between
them should be made for the creditor by the debtor.
Since LNV is undersecured, we have trouble imagining
what purpose could be served by substituting collateral
No. 11-3263 13
other than to reduce the likelihood that LNV will ever
collect its mortgage debt in full. A striking omission
from River East’s brief is a description of the subsec-
tion (iii) plan itself, beyond a statement that River
East hopes to attract $40 to $50 million in loans or
equity investment to refurbish the building. Were that
feasible River East should have been able to strike a deal
with LNV. River East’s aim may have been to cash out
LNV’s lien in a period of economic depression and
reap the future appreciation in the building’s value
when the economy rebounds. Such a cashout is not the
indubitable equivalent of a lien on the real estate, and
to require it would be inconsistent with section 1111(b)
of the Code, which allows the secured creditor to
defeat such a tactic by writing up his secured claim to
the full amount of the debt, at the price of giving up
his unsecured claim to the difference between the
current value of the debt and of the security.
It’s true that a secured claim is altered by a subsection (i)
cramdown because the debtor is allowed to stretch out
the payments due the creditor. But at least the creditor
retains his collateral. That is the quid for the quo of giving
up the right to immediate payment. By proposing to
substitute collateral with a different risk profile, in
addition to stretching out loan payments, River East was
in effect proposing a defective subsection (i) cramdown
by way of subsection (iii).
Even a valid subsection (i) cramdown may be hard on
the secured creditor—his retention of the lien may be a
poor substitute for immediate payment, or payment on
14 No. 11-3263
the schedule set forth in the original loan agreement,
since he could, in principle anyway, have bypassed
bankruptcy, thus retaining his lien without having to
make any concessions to his debtor. Had River
East proposed a subsection (i) plan (it did eventually—
but that was too late, as we’re about to see), it would
have owed LNV $38.3 million, but that sum of money,
paid over 30 years, has a present value of only
$13.5 million at a 3 percent interest rate. It is easy to see
why the creditor might prefer the original, tougher pay-
ment schedule, which might precipitate a default,
enabling the creditor to foreclose at a time when the
lien was worth a lot more, and thus his recovery would
be greater, and earlier, than if he had to wait 30 years.
True, if he foreclosed immediately, he might get just
the depressed value of the building—but not if he were
the high bidder at the foreclosure sale, for then he
would get the building itself. It is also true that if the
debtor doesn’t default again, the creditor will have to
wait for repayment in accordance with the repayment
schedule in the original loan agreement.
So subsection (i) is friendly to debtors; River East
wanted to make it friendlier still by squeezing a modified
form of a subsection (i) cramdown into subsection (iii).
As an aside, we point out that bankruptcy provisions
“friendly to debtors” are so only in the short run; in the
long run, the fewer rights that creditors have in the
event of default, the higher interest rates will be to com-
pensate creditors for the increased risk of loss.
After its subsection (iii) plan was rejected, River East
submitted a third proposed plan, which was—at
No. 11-3263 15
last—for a genuine subsection (i) cramdown. LNV would
retain its lien on the building, and the $13.5 million in 30-
year Treasury bonds would guarantee payment in full
of LNV’s mortgage over 30 years. But the bankruptcy
judge had lost patience. He refused to consider the
third proposed plan, lifted the automatic stay, and dis-
missed the Chapter 11 proceeding. In doing these things
he did not abuse his discretion—the applicable standard
of appellate review. Colon v. Option One Mortgage Corp.,
319 F.3d 912, 916 (7th Cir. 2003); In re Williams, supra,
144 F.3d at 546. The third proposal left the Chapter 11
proceeding still far from completion, because there was
bound to be a wrangle over the current value of the
building and the proper interest rate. With River East
having compromised its credibility by submitting two
plans that sought to circumvent the statute, and the 90-
day deadline having expired long ago (the Chapter 11
petition was filed on February 10, 2011, and the third
proposed plan on August 23—194 days later), and LNV
having waited years to enforce its lien, the bankruptcy
judge was not required to stretch out the Chapter 11
proceeding any longer. We therefore affirm his decision
and vacate the stay that we granted pending appeal.
A FFIRMED.
1-19-12