Amicus Curiae Brief — US Bancorp Mortgage Co. v. Bonner Mall Partnership

No. 93-714 q )

In The

Supreme Court of the United States

October Term, 1993

U.S. BANCORP MORTGAGE COMPANY,

Petitioner,

BONNER MALL PARTNERSHIP,

Respondent.

On Writ Of Certiorari

To The United States Court Of Appeals

For The Ninth Circuit

MOTION FOR LEAVE TO FILE A BRIEF AS AMICUS

CURIAE AND BRIEF OF THE AMERICAN COLLEGE OF

REAL ESTATE LAWYERS AS AMICUS CURIAE

IN SUPPORT OF PETITIONER

Of Counsel:

Paut A. Roserts

President, American College

of Real Estate Lawyers

THomas C. HomMBuRGER

Co-Chair, Amicus Briefs

Committee, American College

of Real Estate Lawyers

Pror. WALTER J. TAGGART

Chair, Bankruptcy

Committee, American College

of Real Estate Lawyers

Micnuaet S. KHoury

Davin Foster

CiarK, Krein & BEAUMONT

EuGeNne YAMAMOTO

LANDELS, RipLey & DIAMOND

CureisTINA L. Feece

THACHER, Prorritr & Woop

COCKLE LAW BRIEF

Counsel of Record:

Pror. Rospert M. ZinMAN

St. John’s University

School of Law

8000 Utopia Parkway

Jamaica, New York 11439

(718) 990-6646

Co-Chair, Amicus Briefs

Committee, American College

of Real Estate Lawyers

CHristorpHer F. GraHAM

THACHER, Prorritt & Woop

2 World Trade Center

New York, New York 11048

(212) 912-7400

PRINTING CO., (800) 225-6964

OR CALL COLLECT (402) 342-2831

No. 93-714

rY

In The

Supreme Court of the United States

October Term, 1993

°

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wee: : y The American College of Real Estate Lawyers

r (“ACREL”) by and through their undersigned attorney

ELS Re Sate Oe | . = hereby respectfully moves this Court for leave to file the

a er Ss Ej Seas a - ; ¢ | -. attached amicus curiae brief in support of U.S. Bancorp

Fogg ean™ Teer Sei : ae Company (the “Petitioner”) in the above captioned mat-

Se hs Jue i ter (the “Appeal”) and respectfully represent as follows:

. | a Consent of Parties

a The consent of the attorney for the Petitioner has

’ Be been obtained. A letter evidencing such consent is

- attached hereto as exhibit A. The consent of the attorney

for the Respondent was requested but refused.

Interest of the Amicus Curiae

I. ACREL is a non-profit corporation organized for the

purpose of gathering together lawyers to improve and

reform real estate law. ACREL’s membership consists of

approximately 800 attorneys from nearly ever state and

the District of Columbia who have concentrated their

practice in real estate law for a period of ten years or

more, and law professors specializing in the field of real

estate law. The case at bar involves a single asset debtor

owning commercial real estate.

II. ACREL believes that the decision of the Ninth Cir-

cuit, if upheld, will have serious adverse affects upon the

availability of financing for the acquisition and develop-

ment of commercial real property in the United States.

III. ACREL therefore has an interest in presenting to the

Court the view that in the broad context of public policy

and future economic development, the interpretation of

the Bankruptcy Code advanced by the Ninth Circuit is

erroneous and should be overruled.

The Proposed Amicus Curiae Brief

IV. A copy of the proposed amicus curiae brief is submit-

ted herewith. The proposed brief focuses on legal and

policy arguments not made in the brief of the Petitioner.

Conclusion

Due to the Amicus’ substantial interest in the out-

come of the Appeal and due to the importance of the

issues presented, the Amicus hereby requests that their

motion for leave to file an amicus curiae brief in the

Appeal be granted.

Dated: New York, New York

February 22, 1994

Respectfully submitted,

CuristorHer F. GraHAM Proressor Rosert M. ZiINMAN

THACHER Prorritr & Woop St. John’s University

Two World Trade Center School of Law

New York, New York 10048 8000 Utopia Parkway

(212) 912-7400 Jamaica, New York 11439

(718) 990-6646

Attorneys for American

Counsel of Real Estate

Lawyers

No. 93-714

S

In The

Supreme Court of the United States

October Term, 1993

U.S. BANCORP MORTGAGE COMPANY,

Petitioner,

BONNER MALL PARTNERSHIP,

Respondent.

On Writ Of Certiorari

To The United States Court Of Appeals

For The Ninth Circuit

BRIEF OF THE AMERICAN COLLEGE

OF REAL ESTATE LAWYERS AS AMICUS CURIAE

IN SUPPORT OF PETITIONERS

~_

QUESTION PRESENTED

1. Whether the “new value exception” to the “abso-

lute priority rule” survived the codification of a modified

absolute priority rule under §1129(b)(2)(B)(ii) of the

Bankruptcy Code, which does not reflect such exception?

“

2. Assuming, arguendo, the existence of a “new

value exception” did the Ninth Circuit properly apply

such exception? ®

a

**

TABLE OF CONTENTS

Page

QUESTION PRESENTED. ....... 0.606060 e eee eens i

TABLE OF AUTHORITIES. ............ 5600 eee eeeee iv

STATEMENT OF INTEREST OF AMICUS CURIAE... 1

SUMMARY OF ARGUMENT........... 06560000 e ues 2

ARGUMENT

Il. “NEW VALUE EXCEPTION” DOES NOT

SURVIVE THE ENACTMENT OF THE

BANKRUPTCY CODE...........6 6666000 3

ee BI on o.oo c 60600 60060660601 3

B. Origin of the “New Value Exception”

Under Prior Law.......cccsesceceeeees 7

C. Congress Revises the Absolute Priority

ED, 0 cn ncokueccasevenbusunedeeseeuses )

THE ADOPTION OF THE “NEW VALUE

EXCEPTION” BY THE NINTH CIRCUIT

AND ITS APPLICATION TO SINGLE ASSET

REAL ESTATE REORGANIZATIONS IS A

DISTORTION OF THE “NEW VALUE

EXCEPTION” AND ABROGATES THE

ABSOLUTE PRIORITY REQUIREMENTS OF

THE BANKRUPTCY CODE............-.>- 11

THE NINTH CIRCUIT'S APPLICATION OF

THE “NEW VALUE EXCEPTION” IS CON-

TRARY TO THE EXPRESS PROVISIONS OF

§1129(B)(2) OF THE BANKRUPTCY CODE... 15

IV.

V.

eee

TABLE OF CONTENTS -— Continued

Page

A. Under the “New Value Exception” as

Articulated by the Ninth Circuit, The

Holder of the Secured Claim Will Not

Receive the Allowed Amount of its

Claim as Required by §1129(b)(2}(A)(i)

of the Bankruptcy Code...............

B. Under the “New Value Exception” as

Reformulated by the Ninth Circuit, the

Debtor Will Retain an Interest Without

Providing the Unsecured Creditors with

Property of a Value Equal to the Allowed

Amount of their Claims Contrary to the

Express Language of §1129(b)(2)(B) ....

THE APPLICATION OF THE “NEW VALUE

EXCEPTION” TO SINGLE ASSET REAL

ESTATE REORGANIZATIONS SERVES NO

PUBLIC PURPOSE AND ABROGATES THE

PROTECTION FOR THE MORTGAGEE

BUILT INTO THE BANKRUPTCY CODE...

Pi. TED FURS FUG oo ccc sivevveccecss

B. Abrogation of Mortgagee Protection. ...

1. Absolute Priority............ fnacnes

2. Treatment of Absolute Priority

Under the Bankruptcy Code... ...

IF THE NINTH CIRCUIT'S DECISION IS

ALLOWED TO STAND, IT WOULD HAVE A

SEVERE AND NEGATIVE IMPACT ON BOR-

ROWERS, LENDERS AND THE REAL ESTATE

awe ¥athsetisie cas eb oteb eevbaued:

SEE hn 400 6p pe uwkbate cee ¥ccedenansce cues

15

16

18

19

iv

TABLE OF AUTHORITIES

Page

CAsEs

Case v. Los Angeles Lumber Product Co., 308 U.S. 106

i. PP Prrrrerrrrrerrrrrerr rrr rere re passim

Caminetti v. United States, 242 U.S. 855 (1917) ........ 6

Dewsnup v. Timm, 112 S. Ct. 773 (1992)........... 10, 11

In re KRO Associate, 4 Bankr. Ct. Dec. (CCH) 462

Se. ED des saad euband bedanionabaoun 22

Northern Pacific Railway Co. v. Boyd, 228 U.S 482

SN 4G av va Natneepaddsiedakeudseeudeieeieate 13, 20

Norwest Bank Worthington v. Ahlers, 485 U.S. 197

Sess bi keneud suds rebasedenssueetesenes 11, 14, 24

In re Outlook/Century Ltd., 127 B.R. 650 (Bankr.

ft fe MmeeeprrrrorriT Tere terre 14, 20

In re Pine Gate Associates, Ltd., 2 Bankr. Ct. Dec.

(CCH) 1478 (Bankr. N.D.Ga. 1976) ......... 21, 22, 24

United States v. Ron Pair Enterprises, Inc., 489 U.S.

RPP er ere rrr re Te reer errr er Terre 6

STATUTES

OE Wiis SD bn ckddcdeddcedustanassaviesees passim

Se ies EN b cashed cnecacusdeueundettceaubeanance 4

GS Be MED een nccvencesccccsassvesedsesavssucc 4

BD Ts eer ccdccececcsgavsncesessseecens passim

v

TABLE OF AUTHORITIES —- Continued

Page

MISCELLANEOUS

Broude, Cramdown and Chapter 11 of the Bankruptcy

Code: The Settlement Imperative, 39 BUS. LAW

ee SDs ee wndsenasicbddeisstvecendsseddensai 21

Brudney, The Bankruptcy Commission's Proposed

“Modification” of the Absolute Priority Rule, 48

Fa, TR. Eide Fe BOG CMPD cc ccccccccccisncecs

5 Collier on Bankruptcy (L. King 15th Ed. 1986) ....

Collier Real Estate Transactions and the Bank-

ruptcy Code (L. Cherkis 1965) .............0e000-

Note, The Proposed Bankruptcy Act: Changes in the

Absolute Priority Rule of Corporate Reorganiza-

tions, 87 Harv. L. Rev. 1786, 1817 (1974)...........

Report of the Commission on the Bankruptcy

Laws of the United States (H.R. Doc. No. 137,

Parts I and II, Cong., Ist Sess. (1973)) ............

S. Rep. No. 989, 95th Cong. 2d Sess. 65, reprinted in

1978 U.S. Code Cong. Admin. News 5851.........

Salvatore G. Gangemi and Stephen Bordanaro,

New Value Exception: Square Peg in a Round Hole,

1 Am. Bankr. Inst. L. Rev. 173, 194 and n.130

SUPE G6 6g WibeGnednséhicdeandcossenehieavatkacees

STATEMENT OF INTEREST OF AMICUS CURIAE

The American College of Real Estate Lawyers

(“ACREL”) is a nonprofit corporation, organized for the

purpose of, inter alia, gathering together lawyers “to

improve and reform real estate law and practice.”

(ACREL Articles of Incorporation at 2). ACREL’s mem-

bership consists of over 800 attorneys from nearly every

state and the District of Columbia who have concentrated

their practice in real estate law for a period of ten years

or more and law school professors specializing in the

field of real estate law. In addition, members elected to

ACREL must have demonstrated a willingness to devote

time to improving real property law through writing,

teaching or participation in professional association activ-

ities. ACREL’s membership represents the entire spec-

trum of the real estate industry including borrowers,

lenders, investors and developers. The case at bar - like

almost all cases under the 1978 Bankruptcy Code involv-

ing the applicability of a “new value exception” to the

present Bankruptcy Code’s requirements for confirmation

of a plan notwithstanding creditor rejection — involves a

single asset debtor owning commercial real estate that

has declined in value to a point where the debtor’s real

estate is worth less than the amount of secured debt on

the property. ACREL is therefore in a position to offer an

unbiased and knowledgeable opinion as to the proper

resolution of the issues now before this Court.

This brief supports the position of the Petitioner in

this case. Due to the background of the Amicus and its

experience as counsel to lenders and borrowers, it is in a

unique position to offer its expertise to this Court con-

cerning the adverse effects caused by an affirmance of the

decision below on the availability of financing for the

acquisition and development of commercial real property

in the United States.

SUMMARY OF ARGUMENT

The Court of Appeals’ decision in In re Bonner Mail

upholding the application of the “new value exception”

to the absolute priority rule is contrary to the express

language of §1129(b)(2)(B) of the Bankruptcy Code and

the intention of Congress. Nothing in the express lan-

guage of the Bankruptcy Code supports the Ninth Cir-

cuit’s conclusion that the “new value exception” survived

enactment of the Bankruptcy Code in 1978 and, in fact,

the plain language of §1129(b)(2)(B) controverts such a

conclusion.

Even assuming, arguendo, that the “new value excep-

tion” is still viable, the Ninth Circuit's decision neverthe-

less should be reversed, as the Ninth Circuit's application

of the exception is a distortion of the traditional “new

value exception” for operating businesses created by this

Court in Case v. Los Angeles Lumber. This distortion arises

from the application of the “new value exception” to a

single asset real estate plan, which would allow the

debtor and its principals to keep the assets of the enter-

prise without compensating unsecured creditors, thus

abrogating the absolute priority requirements of the

Bankruptcy Code. In addition, the Ninth Circuit's articu-

lation of the “new value exception” violates the express

provisions of §1129(b)(2) of the Bankruptcy Code by pre-

venting both secured and unsecured creditors from

receiving the allowed amount of their claims.

As a final matter, the public policy rationale for the

application of the “new value exception”, which is based

on the desire to maintain the going concern’s value of the

debtor’s business and to keep people employed, is inap-

plicable in the single asset real estate context because the

commercial real estate involved will continue in opera-

tion — only the ownership will change. Thus, there is no

public policy rationale to uphold the application of the

“new value exception” in the instant case.

— + ————

ARGUMENT

I. “New Value Exception” Does Not Survive the Enact-

ment of the Bankruptcy Code.

A. Relevant Statutes.

Nothing in the language of the Bankruptcy Code

supports the Ninth Circuit’s conclusion that the new

value “exception” survived the enactment of the Bank-

ruptcy Code. The Bankruptcy Code contains extensive

provisions governing confirmation of plans of reorgani-

zation by the Bankruptcy Courts. 11 U.S.C. §1129.

Section 1129(b) of the Bankruptcy Code’ details the

limited circumstances under which a Bankruptcy Court

may confirm — or “cramdown” ~ a plan even if a class of

* 11 U.S.C. §101 et seq. All section references are to the Bank-

ruptcy Code.

creditors has not voted to accept the plan in accordance

with §1129(a)(8).' Under this section, such a plan may be

confirmed despite the non-acceptance of a creditor class

“if the plan does not discriminate unfairly, and is fair and

equitable, with respect to each class of claims or interests

that is impaired under, and has not accepted, the plan.”

11 U.S.C. §1129(b)(1). Unlike the prior Bankruptcy Act,

§1129%(b) proceeds to define “fair and equitable” with

respect to particular classes that have not accepted the

plan. Congress chose not to include any “new value

exception” in such definition. Section 1129(b)(2)(B)

requires that for a plan to be “fair and equitable” with

respect to a non-accepting class of unsecured claims

' Pursuant to §1129(a)(8) of the Bankruptcy Code,

each class of claims or interests must either vote to

“accept” the plan or not be “impaired” under the

plan. See generally 11 U.S.C. §1124. Very few bank-

ruptcy cases involve a situation where a class of

unsecured creditors is not impaired under a plan.

Pursuant to §1126 of the Bankruptcy Code, a class of

creditors is deemed to have accepted a plan if such

plan has been accepted by creditors that hold at least

two thirds in amount and more than one half in

number of the allowed claims of such class held by

creditors that have voted to accept or reject the plan.

11 U.S.C. §1126(c). In short, individual dissenting

creditors in a class can be outvoted by similarly situ-

ated creditors thus making possible confirmation of a

plan that has been accepted by the requisite major-

ities. Significantly, the Bankruptcy Act of 1898, as

amended by the Chandler Act of 1938, under which

Case v. Los Angeles Lumber was decided, did not per-

mit creditor majorities to accept a plan over the dis-

sent of a single creditor in a class. (See discussion

below).

(including a class containing a secured creditor's defi-

ciency claim)? the plan must either (i) provide for full

’ Pursuant to §LLLI(b)OL)(A), a deficiency claim of a non

recourse lender is treated as a recourse unsecured claim against a

debtor The subsection provides in pertinent part

A claim secured by a lien on property of the estate

shall be allowed or disallowed under section 5902 of

this Title, the same as if the holder of such claim had

recourse against the debtor on account of such claim

whether or not such holder has such recourse, unless

(i) the class of which such claim is a part elects, by at

least two thirds in amount and more than half in

number of allowed claims of such class, application of

paragraph (2) of this subsection, or

(11) such holder does not have such recourse and

such property is sold under section 363 of this title or

is to be sold under the plan

Indicative of Congressional intent is that fact that neither excep

tion to this rule permits a debtor to maintain the property in

question and pay the secured creditor less than the full amount

of its claim.

Section 506(a) of the Bankruptcy Code provides that any

such deficiency claim “is an unsecured claim”. The section pro

vides in pertinent part:

“An allowed claim of a creditor secured by a lien on

property in which the estate has an interest, or that is

subject to set-off under section 553 of this title, is a

secured claim to the extent of the value of such credi-

tor’s interest in the estate's interest in such property,

or to the extent of the amount subject to set-off, as the

case may be, and is an unsecured claim to the extent

that the value of such creditor's interest or the

amount so subject to set-off is less than the amount of

such allowed claim.” 11 U.S.C. §506(a).

Consequently, a deficiency claim of an undersecured creditor is

accorded the treatment of an unsecured claim and is normally

classified together with other unsecured claims.

payment on such claim or (ii) the holder of any claim or

interest junior in priority to the claims of such class will

not receive or retain under the plan on account of such

junior claim or interest any property. 11 U.S.C.

§1129(b)(2)(B) (emphasis added). As explained below, the

statutes detailing confirmation and voting provisions do

not contain any exception to this absolute priority rule in

the case of a plan seeking confirmation over the non-

acceptance of a creditor class. The “new value exception”

to the absolute priority rule recognized by the Ninth

Circuit below permits the owners of a debtor to retain the

ownership of all the property of the debtor without pay-

ing in full the claims of the unsecured creditors — includ-

ing the deficiency claims of secured creditors who would

prefer to own the property and realize any later apprecia-

tion. The language of the Bankruptcy Code permits no

such result.

There is no mention in the Bankruptcy Code of any

exception to the clear and precise plan confirmation

requirements of §1129(a) and §1129(b)(2)(B), which are

unequivocal, without exception, and must be enforced as

written. United States v. Ron Pair Enterprises, Inc., 489 U.S.

235, 241, (1989) (where the statute's language is plain the

sole function of the court is to enforce it according to its

terms) (quoting Caminetti v. United States, 242 U.S. 855

(1917)).

Indeed there is no reason for the “new value excep-

tion” to be applicable under the Bankruptcy Code since,

as established below, the drafters of the Bankruptcy Code

addressed and cured the problem giving rise to the adop-

tion of the “new value exception”.

B. Origin of the “New Value Exception” Under

Prior Law.

The “new value exception” was judicially fashioned

in response to the strict requirements of the corporate

reorganization provisions of prior law, specifically §77B

of the Bankruptcy Act of 1898 and its successor Chapter X

of the Chandler Act of 1938. 5 Collier on Bankruptcy at

1100-1108, 4 1101.01[2] (Lawrence P. King ed. 1993). In

order to protect individual dissenting creditors within

accepting classes, it was provided that a plan could not

be confirmed unless the plan was approved by the requi-

site majority of each class and judicially determined to be

fair and equitable, 1.e. met the absolute priority require-

ments.’ As a result, notwithstanding approval of the plan

by the requisite majorities of members of each class of

creditors, a plan designed by senior creditors to motivate

and keep effective management by giving the prior

owners/managers an equity interest in the reorganized

enterprise could not be confirmed if a single creditor

objected.

In Case v. Los Angeles Lumber Prod. Co., 308 U.S. 106

(1939), the debtor (with overwhelming creditor support)

attempted to circumvent this strict rule by arguing that

* In short, in contrast to the present Bankruptcy Code con-

firmation requirements which are disjunctive, viz., class accep-

tance or fair and equitable, the prior Bankruptcy Act

requirements were conjunctive — class acceptance and fair and

equitable. Under the present Bankruptcy Code, individual dis-

senting creditors are protected by, inter alia, the best interests of

creditors test contained in 11 U.S.C. §1129(a)(7).

the old stockholders were paying for their retained inter-

est in the reorganized entity by contributing their experi-

ence, contacts and management ability. This court

rejected that argument stating that old equity could par-

ticipate only if they paid for their interest in “money or

money's worth” (/d. at 122). Thus this court created what

became known as the “new value exception” to the abso-

lute priority rule, under which junior interests (e.g. stock-

holders) could contribute new capital to a bankruptcy

plan in exchange for an interest in the reorganized enter-

prise equal to the value of their contribution. Actually

this is not an “exception” to the absolute priority rule, it

is in fact an affirmation of the requirement of absolute

priority and a rejection of attempts at “easy evasion of the

principle of full or absolute priority” Id. (citations omit-

ted)

Obviously, requiring payment of money for the inter-

est was not the bargain that the senior creditors or old

stockholders had in mind in the rejected plan in Los

Angeles Lumber. They had agreed on equity participation

without any payment. Los Angeles Lumber’s “new value

exception” did not solve the problem of the absolute

priority rule permitting a single creditor to veto the plan

approved by the requisite majorities of those who had an

interest in the firm. When the Bankruptcy Code was

being drafted, numerous suggestions were made for leg-

islative changes that would deal with the problem by

overcoming the rigid absolute priority requirements of

Chapter X.

C. Congress Revises the Absolute Priority Rule.

On July 24, 1970, then President Nixon appointed the

Commission on the Bankruptcy Laws of the United States

(“Commission”) to consider a review of the Bankruptcy

Act. The Commission completed its work in July 1973

after an extensive study and submitted its Report (“Com-

mission Report”) containing a proposed new bankruptcy

law. The Commission Report discussed the nature, devel-

opment, justification and deficiencies of the absolute pri-

ority rule, not’ og that it had become a “straight jacket”

since under it, equity security holders could not partici-

pate —- even by agreement of all classes of creditors.

Commission Report, Part L, at 256-57. The Commission's

solution was to modify the absolute priority rule by

permitting juniors who make a contribution important to

the operation of the reorganized debtor to participate on

a basis reasonably approximating the value of their con-

tribution.*

* The Commission Bill (H.R. Doc. No. 137, Parts I and II,

Cong., Ist Sess. (1973) provided in §7-303(4) that the plan of

reorganization:

may provide, if the court finds that. . . certain part-

ners or equity security holders will make a contribu-

tion which is important to the operation of the

reorganized debtor or successor under the plan, for

participation by the individual debtor, such partners,

or such holders under the plan on a basis which rea-

sonably approximates the value, if any, of their inter-

ests and the additional estimated value of such

contribution.

10

This proposal created a storm of controversy® and

was rejected by Congress. In its place, Congress modified

the absolute priority rule in a different way, presently

reflected in §1129 of the Bankruptcy Code, under which

each class is free to agree by the requisite majority to

accept a plan that affords the class less than absolute

priority. Only where an impaired class rejects the plan is

it entitled to absolute priority treatment. If §77B and

Chapter X of the former Bankruptcy Act had contained a

similar provision, the issue in Los Angeles Lumber, which

gave rise to the creation of the “new value exception”,

would never have arisen.

Thus Congress dealt in a fundamental way with the

problem for which the “new value exception” was devel-

oped. Senior classes of creditors are free to allow junior

class participation if the senior class votes to accept such

a plan. If a senior impaired class does not accept a plan,

absolute priority must be provided or the plan cannot be

confirmed as fair and equitable. See §1129(b)(2)(B)(ii).

Any attempt to obviate the absolute priority requirements

in court imposed plans (so-called “cramdown” plans) has

no validity under the Bankruptcy Code as adopted by

Congress.®

5 See e.g. Brudney, The Bankruptcy Commission's Proposed

“Modification” of the Absolute Priority Rule, 48 Am. Bankr. L. J.

305, 337 (1974) and Note, The Proposed Bankruptcy Act: Changes in

the Absolute Priority Rule of Corporate Reorganizations, 87 Harv. L.

Rev. 1786, 1817 (1974)

* Some courts have argued that this Court's decision in

Dewsnup v. Timm, 112 S. Ct. 773 (1992) may require a finding that

the new value “exception” survives the enactment of the Bank-

ruptcy Code. This is not correct. While it is true as this Court

11

Il. The Adoption of the “New Value Exception” by the

Ninth Circuit and its Application to Single Asset

Real Estate Reorganizations is a Distortion of the

“New Vaiue Exception” and Abrogates the Abso-

lute Priority Requirements of the Bankruptcy Code.

As discussed above, given the Bankruptcy Code’s

extensive revisions to plan confirmation requirements,

the “new value exception” has no raison d'etre in the

Bankruptcy Code. Assuming arguendo, this Court con-

cludes that the “new value exception” is still a viable

judicial supplement to Chapter 11, or if this Court

declines to reach the issue of the “exception’s” validity’,

the Ninth Circuit should be reversed because the “new

value exception” — as reformulated by the Ninth Circuit

into the new value principle — is not the “new value

exception” created by this Court in Case v. Los Angeles

Lumber. In that decision, this Court concluded that a

reorganization plan could permit a junior interest, with

majority creditor consent, to participate in the reor-

ganized entity only to the extent that the junior interest

contributed money or money’s worth to the enterprise.

stated in Dewsnup that Congress does not “write ‘on a clean

slate’ ” when it amends the bankruptcy laws, 112 S. Ct. at 779,

no doctrine requires application of a pre-Code practice devel-

oped to meet a pre-Code requirement that no longer exists. As

discussed above, it was the restrictive nature of the pre-Code

absolute priority rule that resulted in the creation of the limited

“new value exception”. That restrictive nature has been

removed from the Bankruptcy Code absolute priority provi-

sions. Pre-Code practice cannot be said to survive into a new

law that has eliminated the problem for which the practice was

developed.

7? Norwest Bank Worthington v. Ahlers, 485 U.S. at 203, n.3.

12

Such participation would not violate the absolute priority

rule because in the context of a multi-asset reorganiza-

tion, no creditor’s interest was adversely affected by the

retention of an interest in exchange for a contribution.

The junior’s contribution “enlarged the pie” of available

assets and the junior was entitled to an interest to the

extent its funds resulted in the enlargement. See Salvatore

G. Gangemi and Stephen Bordanaro, New Value Exception:

Square Peg in a Round Hole, 1 Am.Bankr.Inst.L.Rev. 173,

194 and n.130 (1993).

Under the Ninth Circuit’s version of the “new value

exception”, by making a contribution, the debtor's princi-

pals can keep the property — free of the interests of

unsecured creditors including the mortgagee’s substan-

tial deficiency claim. Instead of enabling the junior inter-

est holder to participate to the extent it enlarges the

“pie”, the Ninth Circuit permits the junior interest to

keep the property in question, and any subsequent appre-

ciation to the detriment of all unsecured creditors and the

mortgagee’s deficiency claim. This is clearly contrary to

the spirit, language and purpose of the “new value excep-

tion” and this Court's decision in Los Angeles Lumber.

The reason the Ninth Circuit’s decision so distorts

the “new value exception” is that the “exception” is being

applied to a court imposed single asset real estate plan.

As observed above, the “new value exception” arose in

the context of multi-asset reorganizations where there

was some value to be distributed to creditors. In a single

asset court imposed plan such as the instant case, the

debtor has only one property and that property is worth

less than the debt to the mortgagee. The undersecured

mortgage has been reduced under §1129(b)(2)(A) of the

13

Bankruptcy Code to the value of the collateral as deter-

mined under §506(a) of the Bankruptcy Code. Since, the

plan reduces the secured creditor’s mortgage to 100% of

the previously court-determined property value, the

debtor’s principals argue that there is no equity for

unsecured creditors. The self-serving alchemy of the plan

is then invoked. Any “substantial” contribution, the

debtor’s principals argue, will be sufficient to enable

them to keep the property and discharge the claims of

unsecured creditors.®

This concept, that if there is no equity in the property,

the creditors have no rights, was specifically rejected by

this Court in Northern Pacific Railway Co. v. Boyd, 228 U.S.

482, 508 (1913) where this Court stated:

“If the value of the [property] justified the issu-

ance of stock in exchange for old shares, the

creditors were entitled to the benefit of that

value, whether it was present or prospective, for

dividends or only for purposes of control. In either

event it was a right of property out of which the

creditors were entitled to be paid before the

stockholders could retain it for any purpose what-

ever.” (emphasis added.)

228 U.S. at 508.

8 The inequity of such a scheme is particularly apparent in

the commercial real estate industry where property values are

affected little by management expertise and cyclical fluctua-

tions are common. The Ninth Circuit’s approach shifts the

downside risk to the lenders.

14

Control is a property right and whether or not the

court finds equity in the property, the creditors are enti-

tled to the benefit of that control. This principle is embod-

ied within §1129(b)(2)(B) and was specifically endorsed

by this court in Norwest Bank Worthington v. Ahlers, 485

U.S. 197, 207-09 (1989).%

The “new value exception” as reformulated and

applied by the Ninth Circuit takes a rule designed to

protect creditors and converts it to a rule under which the

debtor and its principals can keep the assets of the enter-

prise without compensating unsecured creditors, thus

abrogating the absolute priority requirements of

§1129(b)(2)(B). This violates the Bankruptcy Code and

rule of absolute priority rule as it has long been articu-

lated by this Court.

* See also In re Outlook/Century Ltd., 127 B.R. 650, 656 (Bankr.

N.D. Cal. 1991) where the court recognized that the plain lan-

guage of §1129(b)(2)(B) does not permit any “new value excep-

tion”:

The ‘new value exception’ is inconsistent with the

principle of creditor control, because it would permit

Debtor to force the plan of reorganization on creditors

who do not believe that the plan is in their best inter-

est and whom Debtor does not propose to pay in full.

127 B.R. at 657-658 (citations omitted).

15

Ill. The Ninth Circuit's Application of the “New Value

Exception” is Contrary to the Express Provisions of

§1129(b)(2) of the Bankruptcy Code.

A. Under the “New Value Exception” as Articu-

lated by the Ninth Circuit, the Holder of the

Secured Claim Will Not Receive the Allowed

Amount of its Claim as Required by

§1129(b)(2)(A)(i) of the Bankruptcy Code.

Section 1129(b) of the Bankruptcy Code provides that

where a dissenting, impaired class of creditors rejects a

plan, the plan may be confirmed notwithstanding this

rejection by a class only if the plan is “fair and equitable”

as to that class. With respect to secured classes, under

§1129(b)(2)(A)(i), where the dissenting, impaired secured

creditor’s lien is retained under the plan, the plan is not

fair and equitable as to that class if the lien does not have

a value as of the effective date of the plan equal to the

amount of the secured claim.

The amount of an undersecured creditor’s claim is

determined under §506(a) which provides that a claim is

a secured claim to the extent of the value of the collateral

and an unsecured claim to the extent that the debt

exceeds the value of the collateral. In the instant case, the

value of the collateral was determined under §506(a) and

the mortgage was reduced to that value. Section 506(a) is

subject to redetermination for various purposes during

the reorganization including a redetermination in connec-

tion with “any hearing . . . on a plan affecting such

creditor’s interest.” 11 U.S.C. §506(a).

The best indicia of the value of real property is what

a person will pay for the property. In the instant case the

16

debtor's plan proposes that certain of its partners acquire

the property subject to a mortgage equal to 100% of the

earlier §506(a) determined property value upon the pay-

ment of an additional $200,000. In other words, those

partners are willing to buy the property for $200,000 in

excess of the §506(a) value. This indicates that the earlier

valuation is incorrect and that the amount of the allowed

secured claim should be increased to at least the amount

the debtor's principals are willing to pay for the property.

Unless the secured claim is increased to that amount, the

secured creditor is being deprived of its interest in the

collateral contrary to the express provisions of

ST 129 )(2)(A)."°

B. Under the “New Value Exception” as Reformu-

lated by the Ninth Circuit, the Debtor Will Retain

an Interest Without Providing the Unsecured

Creditors with Property of a Value Equal to the

Allowed Amount of their Claims Contrary to the

Express Language of §1129(b)(2)(B).

Under §1129(b)(2)(B), for a plan to be fair and equita-

ble as to an unsecured class of creditors, the debtor's

owners may not receive or retain on account of their

' The Plan may also be violative of §1129(a)(3), which

requires that the plan be proposed in good faith. Where the

court determines the value of the property under §506(a) based

on information received from the debtor who is in control of the

flow of information concerning the status of the property, and

the debtor later proposes a plan under which the debtor's prin-

cipals will be given the property for a price in excess of the court

determined value, serious questions arise as to whether the

good faith requirement has been met.

17

junior interests any property unless all members of a dis-

senting impaired unsecured class receive property equal

to the full allowed amount of their claims.

The debtor’s plan in the instant case provides that

the debtor's prior owners retain their ownership interest

in the debtor retaining the property while the dissenting

unsecured class receives less than 10% of their claims.

This is a clear violation of the provisions of

§1129(b)(2)(B). The debtor’s principals argue, however,

that they are not retaining the property “on account of”

their old ownership in violation of §1129(b)(2)(B)(ii), but

are acquiring the interest for value, much as a third party

could acquire the property by bidding for it. What the

debtor ignores is that such acquisition, whether by the

debtor or a third party bidder is not permitted under the

Bankruptcy Code unless the interests of creditors are

protected. The carefully drafted provisions of subsections

(A) and (B) of §1129(b)(2) preclude such acquisition.'' As

'! In Bonner Mall, the Ninth Circuit transmogrifies the “new

value exception” into the “new value principle” which -

is an extra-statutory doctrine that specifically

regulates the conditions under which plans calling for

an infusion of capital by old equity in exchange for

participation in a reorganized debtor may be

confirmed in a cramdown.

2 F.3d at 910, n. 25. The Ninth Circuit acknowledges that “such a

statutory exception does not exist.” /d. Yet, it eagerly embraces

as well-established law the concept of a cramdown plan - a

lender's worst nightmare - by a route not specified by Congress

when it defined fair and equitable treatment. The upshot of the

Ninth Circuit’s decision will be that any party unhappy with the

limitations of the present Bankruptcy Code will rummage

through repealed laws hoping to find some helpful doctrine.

The requirements of a tair and equitable plan have been pain-

1k

discussed above, the undersecured mortgage must equal

the value of the collateral. A bid by a third party or by the

debtor would determine the property value and raise the

amount due under the mortgage. In other words, no plan

under which the debtor or a third party keeps the prop-

erty without compensating creditors in full may be con-

firmed over the objection of the unsecured creditor's

class.

Thus the attempt to reformulate and apply the “new

value exception” to cases involving undersecured mort-

gages on single asset properties is prohibited by the

express provisions of the Bankruptey Code.

IV. The Application of the “New Value Exception” to

Single Asset Real Estate Reorganizations Serves

No Public Purpose and Abrogates the Protection

for the Mortgagee Built into the Bankruptcy Code.

A. No Public Purpose.

The application of the “new value exception” is often

urged as a matter of public policy in order to keep the

debtor in business, preserve the going concern value and

keep people employed. While these objectives may be

valid in connection with multi-asset reorganizations and

industrial corporations, they are wholly inapplicable to

single asset real estate cases.

stakingly articulated by Congress and there is no need to

resurrect judicially created exceptions to an earlier Act's

undefined version of the fair and equitable standard which

exception was not adopted by Congress.

19

In a single asset real estate transaction, the debtor's

business is the operation of the real property, which is

leased to tenants who occupy space in the building. Such

operation of real estate will be continued no matter who

is the owner of the property. It is a non-sequitur to say

that the “reorganization will fail” if there is no infusion of

new value. The only thing that may fail is the debtor's

principals’ attempt to keep the property without paying

creditors. If the plan cannot be confirmed and no plan

consistent with the language of the Bankruptcy Code can

be proposed, liquidation will follow and the mortgagee

or other purchaser will acquire and operate the property.

Tenants will still occupy space in the property; the ten-

ants’ employees will continue to be employed in the

premises, whoever operates the property will continue to

employ maintenance and other personnel. The question is

not whether the business will continue. The question is

only who will own the property — the debtor's principals

who have not paid the debtor's obligations to creditors,

or the creditors who have not been paid by the debtor.

The decision below grants exclusive control and any

appreciation rights to the debtor's principals.

B. Abrogation of Mortgagee Protection.

1. Absolute Priority.

The Ninth Circuit ignores the intent of Congress that

reorganization plans be confirmed only if they are “fair

and equitable” as to dissenting impaired classes. The plan

at issue in the instant case is impermissibly unfair and

inequitable with respect to the dissenting creditor class.

20

The debtor's principals are permitted to retain the mort-

gaged property in exchange for only a $200,000 capital

contribution while the dissenting creditor is forced to

accept a pro-rata distribution of 300,000 shares of pre-

ferred stock in the new enterprise, which would be val-

ued at $1 per share, in full satisfaction of its deficiency

claim of approximately $3.4 million. In addition, the dis-

senting creditor will receive no interest in the property.

This turns the concept of “risk capital” on its head since

only the lender permanently loses value.

This Court has held that the dissenting creditor's

interest in the debtor is a property right. Northern Pacific

Railway Co. v. Boyd, supra, 228 U.S. at 508. In the instant

case, U.S. Bancorp’s property rights have been violated

by the plan which permits the transfer of the property to

the debtor’s principals. The statutory framework set up

by Congress requires that such decisions be negotiated by

the debtor with its creditors. The absolute priority rule of

§1129%(b) is the basic ground rule for that negotiation

process. It levels the playing field between the debtor's

management, which controls the enterprise and its assets,

and the debtor's creditors who, if the debtor is insolvent

effectively own the enterprise. See In re Outlook/Century

Ltd., supra, 127 B.R. at 650.

Absolute priority is of critical importance to the

mortgage lending industry. Absolute priority for the

unsecured portion of the mortgagee’s claim (the claim of

the mortgagee in excess of the value of the collateral as

determined under §506(a) of the Bankruptcy Code) is the

linchpin in the package of protection designed by Con-

gress to protect the mortgagee from attempts by the

ee ee em

— ee

21

debtor’s principals to keep the property without paying

creditors.

A major purpose of §1129(b)(2)(B) was to overcome

the so-called Pine Gate line of cases that treated non-

recourse mortgagees as the Ninth Circuit treats all mort-

gagees. See In re Pine Gate Associates, Ltd., 2 Bankr. Ct.

Dec. (CCH) 1478 (Bankr. N.D.Ga. 1976). Those cases

under Chapter XII of the former Bankruptcy Act allowed

borrowers to retain the mortgaged property while paying

the non-recourse mortgagee the depressed value of the

collateral, leaving such mortgagee with no compensation

for the amount of the debt exceeding the property value,

no control of the property, and no appreciation potential.

Bonner Mall produces similar but harsher consequences

for mortgagees since under Bonner Mall the mortgagee

receives in lieu of cash equal to the value of the collateral,

only a reduced mortgage in an amount determined by the

court to be equal to the value of the collateral and

deferred payments that the court has determined have a

present value equal to the value of the collateral.

To overcome the Pine Gate inequity, Congress speci-

fically provided in §1111(b)(1) of the Bankruptcy Code

that every undersecured mortgagee would be able to

have an unsecured claim for the debt in excess of the

property value, and that the dissenting, impaired

unsecured class would be afforded absolute priority.

Thus, the debtor would not be able to retain the property

while unsecured debts remain unpaid.'?

12 See 5 Collier On Bankruptcy, ¥ 1111.02{2] (1. King 15th ed.

1986); |. Cherkis, Collier Real Estate Transactions and the Bank-

ruptcy Code,{ 1.11 (L. King ed. 1985); Broude, Cramdown and

Chapter 11 of the Bankruptcy Code: The Settlement Imperative, 39

22

Under the Pine Gate line of cases, secured creditors

willing to take the collateral in satisfaction of the debt

were not permitted to do so. The plan would be con-

firmed and the secured creditors paid the value of their

collateral which might be significantly less than their

debt.'* Due to the non-recourse nature of the debt, the

secured creditors would not have had an unsecured claim

for their loss."

2. Treatment of Absolute Priority Under the

Bankruptcy Code

As a direct response to the inequity of the Pine Gate

line of cases, Congress was asked to restore absolute

priority to real estate arrangements and to overrule Pine

Gate.'° Congress responded. It enacted a series of com-

plex provisions as part of the Bankruptcy Reform Act of

BUS. LAW. 441 (1984); and S. Rep. No. 989, 95th Cong. 2d Sess.

65, reprinted in 1978 U.S. CODE CONG. ADMIN. NEWS 5851

(commenting on Section 502(i) in an earlier version of Section

1111(b)).

13 See In re KRO Assoc., 4 Bankr. Ct. Dec. (CCH) 462 (Bankr.

S.D.N.Y. 1978), where there were approximately $14 million in

mortgages on the property and the court found the value of the

property to be $895,000.

14 While in Bonner Mall the mortgagee has an unsecured

claim, the decision renders that claim of little value because it

does not afford it absolute priority. Thus the result under Bonner

Mall is similar to Pine Gate.

1S See, e.g., Testimony of John J. Creedon on behalf of the

American Council of Life Insurance, Hearings on S.2266 and

H.R. 8200 Before the Subcommittee on Improvements in the

Judicial Machinery, Senate Committee on the Judiciary, 95th

Cong., Ist Sess. 853, 855-56 and 864-67 (1977).

23

1978 designed to protect the undersecured creditor by

overcoming the Pine Gate rule. This package of protection

included §§506(a), 1111(b) and 1129(b)(2). Together they

insure that (i) the mortgagee may have a secured claim

for the value of the collateral and an unsecured claim for

the difference between the value and the amount of the

indebtedness, and (ii) absolute priority for each of these

claims. '¢

By effectively reading absolute priority for the

unsecured claim out of §1129, the Ninth Circuit's decision

undermines this Congressional package of mortgagee

protection. The knot of protection for the mortgagee is

tied with the absolute priority requirement for the

unsecured claim. Under §1129(b)(2)(B), the dissenting

impaired unsecured class must receive property of a

value equal to the allowed amount of its claims before

any junior interest receives any property.

Of course, there may not be property available to pay

the unsecured claim in full. However, the debtor will not

be able to retain its interest in the property unless such

'e Specifically, this package was designed to protect the

mortgagee in the following manner:

Section 1111(b) provides that a non-recourse claim will be con-

verted to a recourse claim for the purpose of plan confirmation

(unless a fully secured claim is elected under §1111(b)(2), not

germane here) thus assuring that the non-recourse mortgagee

will have a claim for the unsecured portion of the debt as

determined under §506(a). Section 1129(b)(1) requires absolute

priority for every class that is impaired and has not accepted the

plan. Thus, whether a mortgage is recourse, or has been con-

verted to a recourse claim, the mortgagee has absolute priority

for both the secured and unsecured claim (assuming the

unsecured class rejects the plan by the requisite majority).

24

debts are so paid. If the debtor in Bonner Mall is permit-

ted to keep the property without fully paying, unsecured

claims, the foundation of mortgagee protection will have

been removed from the Bankruptey Code, and the mort-

gagee will have been relegated to a situation even more

harmful than under Pine Gate. This result would imper-

missibly expand the “new value exception” and contra-

vene both the intention of Congress and the express

language of the Bankruptcy Code.”

Vv. If the Ninth Circuit's Decision is Allowed to Stand,

It Would Have a Severe and Negative Impact on

Borrowers, Lenders and the Real Estate Industry.

If not reversed, the decision below will have a severe

adverse impact on the real estate industry. Literally bil-

lions of dollars of insurance policyholders, bank deposs-

tors, pensioners, trusts and mortgagees have been loaned

to borrowers on the strength of real property collateral

and the protection built into the Bankruptcy Code. These

Bankruptcy Code provisions were written to protect

lenders whose rights were seriously jeopardized by the

Pine Gate rule and to mandate priorities not in the former

Bankruptcy Act.

The decision below can only result in tighter credit

standards and higher interest rates for borrowers. It not

only threatens existing mortgage debt held by lenders,

'7 See Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 205

(1988), where this Court stated: “Even if Congress meant to

retain the Los Angeles Lumber exception . . . it is clear that

Congress had no intention to expand that exception any fur-

ther.”

25

but also threatens the future of the real estate industry,

which relies so heavily on mortgage financing.

The Bankruptcy Code was carefully drafted by Con-

gress to balance the interests of debtors and creditors and

provide for the efficient administration of bankruptcy in

the United States. If Courts are permitted by judicial

legislation to undermine the foundations of the protec

tion afforded to real estate mortgagees, the real estate

industry and with it the national economy, will be

severely and adversely affected.

°

CONCLUSION

For all of the reasons set forth herein, the American

College of Real Estate Lawyers respectfully urges this

Court to reverse the decision of the Ninth Circuit below

Respectfully submitted,

Cresrornek F. Gratam Peoressor Ropert M. Zinman

THacher Prorsrt & Wooo St. John’s University

Two World Trade Center School of Law

New York, New York 10048 8000 Utopia Parkway

(212) 912-7400 Jamaica, New York 11439

(718) 990-6646

Attorneys for American

Counsel of Real Estate

Lawyers

ems bent See

App. |!

EXHIBIT A

STOEL RIVES BOLEY

JONES & GREY

Attorney at Law

16th Floor

One Union Square

600 University Street

Seattle Washington 98101-3197

Telephone (206) 624-0900

Telefax (206) 386-7500 MCI Mall No. 495-5830

Complaint No. 624-7580 TDD (206) 628-6206

(206) 386-7634

February 18, 1994

VIA FACSIMILE

Chris Graham, Esq.

Thacher Proffitt & Wood

Two World Trade Center

New York, N.Y. 10048

Re: In re Bonner Mall Partnership — Supreme Court

#93-714

Dear Mr. Graham:

Pursuant to Rule 37.3 of the Rules of the Supreme

Court, we hereby grant consent to you to appear as amici

curiae in the above-referenced case.

Very truly yours,

/s/ Bradford Anderson

Bradford Anderson