Amicus Curiae Brief — Bank of America Nat. Trust and Sav. Assn. v. 203 North LaSalle Street Partnership

MOTION FILED

MAR 3 1 1998 No. 97-1418

In The

Supreme Court of the United States

October Term, 1997

+

BANK OF AMERICA NATIONAL TRUST AND

SAVINGS ASSOCIATION,

Successor by merger to Bank of America Illinois,

Petitioner,

203 NORTH LASALLE STREET PARTNERSHIP,

Respondent.

s

On Petition For A Writ Of Certiorari

To The United States Court Of Appeals

For The Seventh Circuit

o

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 Counsel of Record

Cart J. Senexer, Il Pror. Rosert M. ZinMAN

President, American St. John’s University

College of Real School of Law

Estate Lawyers 8000 Utopia Parkway

Weenadin @° Gialeente Jamaica, New York 11439

4 (718) 990-6646

Co-Chair, Amicus Briefs

Committee, American College

of Real Estate Lawyers

CuristorpHer F. GrRaHAM

THACHER, Proreitr & Woop

COCKLE LAW BRIEF PRINTING CO., (800) 225-6964

OR CALL COLLECT (402) 442-2831

MOTION FOR LEAVE TO FILE A

BRIEF AS AMICUS CURIAE

The American College of Real Estate Lawyers

(“ACREL”) by and through their undersigned attorney

hereby respectfully moves this Court for leave to file the

attached amicus curiae brief in support of the Petitioner

in the above captioned matter (the “Appeal”) and

respectfully represent as follows:

Consent of Parties

The consent of the attorney for the Petitioner has

been obtained. The consent of the attorney for the

Respondent was requested but refused.

Il.

Interest of the Amicus Curiae

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 over 800 attorneys from nearly every

state and the District of Columbia, all of whom 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 commer-

cial real estate.

ACREL believes that the decision of the Seventh

Circuit, if upheld, will have a serious adverse affect

on the availability of financing for the acquisition

and development of commercial real property in the

United States.

ACREL therefore has an interest in presenting to the

Court the view that in the broad context of public

policy and future economic development and

growth, the interpretation of the Bankruptcy Code

advanced by the Seventh Circuit is erroneous and

certiorari should be granted to review that inter-

pretation.

The Proposed Amicus Curiae Brief

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

mitted 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, due to the Amicus’ substantial

expertise in the real estate issues involved in the Appeal,

and due to the importance of the issues presented, the

Amicus hereby requests that its motion for leave to file

and amicus curiae brief in the Appeal be granted.

Dated: Jamaica, New York

March 31, 1998

Respectfully submitted,

Proressor Rosert M. ZINMAN

St. John’s University

School of Law

8000 Utopia Parkway

Jamaica, New York 11439

(718) 990-6646

Attorney for the American

College of Real Lstate Lawyers

QUESTIONS 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 an excep-

tion.

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

value exception” as articulated by this Court in dicta in

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

(1939), whether the Seventh Circuit properly applied the

exception.

TABLE OF CONTENTS

Page

QUESTIONS PRREGENTED ..ccccccccccccscvccsccess i

THe Ce PI 6 5 0 0 Fa cans ve bnes Shnsabees iv

STATEMENT OF INTEREST OF AMICUS CURIAE... 1

SUMMARY OF ARGUMENT..............5.000008: 2

RTGS «vines chiunessscindddcavesacas cancel 3

THE SO-CALLED NEW VALUE EXCEPTION

OR NEW VALUE COROLLARY WAS NOT

INCORPORATED INTO THE BANKRUPTCY

Ce 6b cdccs un chbenchowetschsaehineGvadeees:

A. Confirmation of New Value Plans Prior to

the Adoption of the Bankruptcy Code Is an

ee ee ee ee

B. Congress Rejected the New Value Exception

When Adopting the Bankruptcy Code.....

THE NEW VALUE EXCEPTION AS ADOPTED

BY THE SEVENTH CIRCUIT DISTORTS THE

NEW VALUE COROLLARY AS ARTICULATED

IN DICTA BY THIS COURT AND ABROGATES

THE ABSOLUTE PRIORITY REQUIREMENTS

OF THE BANKRUPTCY CODE ...............

A. The Seventh Circuit Ignores the Creditor

Protection Prong of this Court's Articula-

tion of the New Value Requirements. .....

B. The Seventh Circuit Distorts the Prerequi-

sites to New Value Articulated by this Court

he PPro eee

7

TABLE OF CONTENTS - Continued

Page

Se PERRIN kvcccedinvdeceveccdccccevaves 10

2. Reasonable Equivalence ............... 11

THE APPLICATION OF THE SEVENTH CIR-

CUIT’S VISION OF NEW VALUE TO SINGLE

ASSET REAL ESTATE REORGANIZATIONS

WOULD SERVE NO PUBLIC PURPOSE, ABRO-

GATE THE PROTECTION FOR MORTGAGEES

BUILT INTO THE BANKRUPTCY CODE, AND

HAVE A SEVERE AND NEGATIVE IMPACT

ON BORROWERS, LENDERS, AND THE REAL

SEE 6 ous Wan ccdedcdvesisccatess

FED PU CONGO oes cc cvcccceesscceecss

B. Abrogation of Mortgagee Protection.......

C. Negative lmpact on the Real Estate Industry

ee ee |

iv

TABLE OF AUTHORITIES

Page

Cases

Case v. Los Angeles Lumber Products Co., 308 U.S.

BOG COBO eo cede te ceccsoussbdesedadcesees 4,5, 7, 8,9

Dewsnup v. Timm, 502 U.S. 410 (1992) ....... 0.66000 6

In re 203 N. LaSalle St. Partnership, 126 F.3d 955

Le 8 , eer Tre re rreT rT rr. passim

In re 203 N. LaSalle St. Partnership, 190 B.R. 567

Gales. BEB. GE. CORED occ uwscessccens 6, 10, 12, 16, 17

In re Coltrex Loop Central Three Partners, L.P., No.

96-5140, slip op. 7-17 (2d Cir. Feb. 19, 1988) ....... 3

In re DRW Property Co. 82, 57 B.R. 987 (Bankr. N.D.

Te, BNL kn caleure dee nee weed uy eae dens ae eileniwe 15

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

(CRR) 1478 (Bankr. N.D. Ga. 1976)............. 14, 15

In re Snyder, 967 F.2d 1126 (7th Cir. 1992)............ )

In re Woodbrook Associates, 19 F.3d 312 (7th Cir.

BOE. cnbenesscsank* os oNndnd chbueudhasabasecutcant 10

Kansas City Terminal Ry. Co. v. Central Union Trust

TF Gat Sierras ae 8, 9

Northern Pacific Ry. v. Boyd, 228 U.S. 482 (1913) ..... 11

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

GRPUED an dav cvacesndustigi ceseiieuneswusdaniatens 11, 12

STATUTES

Se Ges BS OUD bcc sdncccabaddsartbicceveuseuabace 16

CB. CRs 1 REED cusddccoccdankctis cabaupesvedsnai 15

85 USE. 6 CII. . oisicdcccidcneeR 16

v

TABLE OF AUTHORITIES — Continued

Page

Sp es Oe I 046i edd nvescdeséeéceuced 6, 14

48 Stat. 912 (Bankruptcy Act of 1898 § 77B).......... 7

MISCELLANEOUS

John D. Ayer, Rethinking Absolute Priority After

Ahlers, 87 Mich. L. Rev. 963 (1989)................. 4

Bruce Markell, Owners, Auctions, and Absolute Pri-

ority in Bankruptcy Reorganizations, 44 Stan. L.

Eee IE 6 oo h.cbuewseelios seVasendesthbinbssoese 4

Hearings on S.2266 and H.R. 8200 before the Sub-

comm. on Improvements in the Judicial

Machinery of the Senate Comm. on the Judici-

ary, 95th Cong., 853 (1977) (statement of John J.

Creedon, American Council of Life Insurance) .... 14

5 Cover ON Bankruptcy J 506.03 [4}[e], at n.58

(Lawrence P. King et al. eds. 15th ed. rev. 1997) .... 16

Report of the Commission on the Bankruptcy

ws of the United States, H.R. Doc. No. 93-137,

Part I, 93d Cong. Ist Sess. (1973), at 256-57...... 4,5

Report of the Commission on the Bankruptc

ws of the United States, H.R. Doc. No. 93-137,

Part Il, 93d Cong. Ist Sess. (1973), at 242,

Th ERS RG cep EEN ic AEE Te RR I ag 4,5

S. Rep. No. 95-598, 95th Cong. 2d Sess. 65 (1978),

reprinted in 1978 U.S.C.C.A.N. 5787 ........6600055

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

involves a debtor whose single asset is an interest in

commercial real estate that has declined in value to a

point where the debtor's real estat + is worth less than the

amount of secured debt on the property. Whether the

property securing the debt may be retained by the

debtor’s partners under a new value plan without paying

the debt is an issue of significant concern to the real

cetate industry.

' Counsel for a party did not author this brief in whole or in

part. No person or entity, other than the Amicus Curiae, its

members, or its counsel made a monetary contribution to the

preparation and submission of this brief.

This brief supports the petition of the Petitioner in

this case. Due to the background of the Amicus, its expe-

rience as counsel to lenders and borrowers, and its famil-

iarity with the confusion, costs and consequences to the

real estate industry arising from the ambiguities created

by the issues before this Court, ACREL is in a unique

position to offer its expertise concerning the adverse con-

sequences that would result from the decision below on

the availability of financing for the acquisition and devel-

opment of commercial real property in the United States.

SUMMARY OF ARGUMENT

This brief urges that certiorari be granted for the

following reasons:

1. There is no new value exception or corollary to

the fair and equitable requirement of the Bankruptcy

Code. The new value principle as articulated in dicta

prior to the adoption of the Bankruptcy Code was

rejected by Congress in favor of a more flexible and

modified absolute priority rule that obviated the need for

a new value principle.

2. The new value exception applied by the Seventh

Circuit distorts the new value corollary articulated by this

Court in its Case v. Los Angeles Lumber dicta and represents

a post-Code invention that contravenes the parameters

set by Justice Douglas in Case and threatens the very

existence of the absolute priority rule.

3. The Seventh Circuit’s decision undermines the

protection for real estate mortgages built into the Bank-

ruptcy Code and threatens to have a severe negative

impact on the real estate industry and the availablity of

real estate mortgage financing.

¢

ARGUMENT

I. THE SO-CALLED NEW VALUE EXCEPTION OR

NEW VALUE COROLLARY WAS NOT INCORPO-

RATED INTO THE BANKRUPTCY CODE.

This brief supports the conclusions and reasoning of

the brief of the Petitioner, the dissent of Judge Kanne in

the Seventh Circuit’s opinion in In re 203 N. LaSalle St.

Partnership, 126 F.3d 955, 970 (7th Cir. 1997) and the

opinion of the Second Circuit in In re Coltex Loop Central

Three Partners, L.P--No. 96-5140, slip op. 7-17 (2d Cir. Feb.

19, 1998) that there is no hold-over new value exception

or corollary to the absolute priority rule of the Bank-

ruptcy Code.

A. Confirmation of New Value Plans Prior to the

Adoption of The Bankruptcy Code Is an Illu-

sion.

The Seventh Circuit stated that “the new value corol-

lary has long been ensconced in our bankruptcy prac-

tice,” In re 203 N. LaSalle St. Partnership, 126 F.3d 955, 965

(7th Cir. 1997), and that it has been “a major source of

new funding in reorganizations for the past fifty years.”

ld. at 966. From this predicate, the Seventh Circuit con-

cluded that “one would expect that Congress would

address deliberately such a significant issue of economic

policy if it had determined to abolish it.” Id. The problem

with this conclusion is that its predicate is incorrect.

From the decision of this Court in Case v. Los Angeles

Lumber Products Co., 308 U.S. 106 (1939), to the adoption

of the Bankruptcy Code in 1978, there appears to be no

published evidence that any “shareholder was ever able

to convince a court that she contributed sufficient value

to be able to retain an interest. Indeed, until the Code’s

adoption in 1978, no reported case seems to have adopted

Justice Douglas’ dicta as its holding.” Bruce A. Markell,

Owners, Auctions, and Absolute Priority in Bankruptcy Reor-

ganizations, 44 Stan. L. Rev. 69, 93 (1991); see also, John D.

Ayer, Rethinking Absolute Priority After Ahlers, 87 Mich. L.

Rev. 963, 1016 (1989) where Professor Ayer concludes,

“Justice Douglas’ supposed ‘exception,’ . . . is nowhere

present as a rule of decision in Chapter X cases. New

value under Chapter X, then, is an illusion.”

Thus there was no 50 year history of the new value

exception being part of bankruptcy “practice.” While the

new value theory, as expressed in dicta by this Court in

Case was known, that theory never became part of bank-

ruptcy practice until after the adoption of the Bankruptcy

Code.

B. Congress Rejected the New Value Exception

When Adopting the Bankruptcy Code.

In 1973, the Commission on the Bankruptcy Laws of

the United States in its Report, H.R. Doc. No. 93-137,

Parts | & Il, 93d Cong. Ist Sess. (1973), concluded that the

absolute priority rule had become a “strait jacket” (Part |

at 256-57) because, as applied, it did not permit old

equity to participate even with the agreement of all

classes of creditors. Its solution was to modify the abso-

lute priority rule by permitting juniors to participate on

the basis of a contribution “important to the operation of

the reorganized debtor . . . under the plan” on a basis

reasonably approximating the value of their contribution.

H.R. Doc. No. 93-137, Part I, 93d Cong., Ist Sess. (1973)

at 242, § 7-303(4). This proposal created a storm of criti-

cism and was rejected by Congress.

In its place, Congress modified the absolute priority

rule to limit its application only to dissenting impaired

classes of creditors, thus breaking the perceived strait-

jacket by freeing classes of creditors to admit junior inter-

ests by agreement. If this limited absolute priority had

been in effect under the Bankruptcy Act, the Case plan

would have been confirmed and the issue that gave rise

to the creation of the new value corollary would never

have arisen. Thus the Bankruptcy Code obviated the need

for a new value corollary. The dissent in LaSalle noted,

“the pre-Code rationale for the new value exception

makes little sense in today’s Chapter 11 environment.”

126 F.3d at 976.

Indeed Congress considered a provision that would

have incorporated new value into the Code (even includ-

ing, it would seem, alternative forms of contribution,

such as were proffered in Case), rejected it and enacted a

compromise that allowed for participation by agreement.

Although those arguing that the new value corollary

survived the adoption of the Bankruptcy Code do so on

the basis that “Congress . . . does not write ‘on a clean

slate.” Dewsnup v. Timm, 502 U.S. 410, 419 (1992), the

facts would seem to indicate either that there was nothing

on Congress's slate when the Bankruptcy Code was being

considered or, if the new value principle were on its slate,

Congress clearly erased it before it began to write.

The clear language of Bankruptcy Code § 1129(b)(2)(B)

prohibits juniors from retaining an interest on account of

their junior interest if dissenting creditors are unpaid.

Proponents of new value argue that the interest is not

being retained “on account of” the junior interest but

because the debtor has made a bid in the form of new

value. LaSalle, 126 F.3d at 964. It stretches credulity to

believe that the debtor, in control of all the information

about the property and with the exclusive right to present

a plan, is not retaining an interest on account of its junior

interest. Indeed in LaSalle the Bankruptcy Court argued

that the new value offered did not represent the intrinsic

value of the property but rather was based on the part-

ners’ need to retain the property to avoid tax consequences

arising out of their prior interest in the property, thus

acknowledging that the new value was offered, and the

property retained, on account of the prior junior interest.

See In re 203 N. LaSalle St. Partnership, 190 B.R. 567, 576

(Bankr. N.D.IIl. 1996); and infra note 6.

Il. THE NEW VALUE EXCEPTION AS ADOPTED BY

THE SEVENTH CIRCUIT DISTORTS THE NEW

VALUE COROLLARY AS ARTICULATED IN

DICTA BY THIS COURT AND ABROGATES THE

ABSOLUTE PRIORITY REQUIREMENTS OF THE

BANKRUPTCY CODE.

A. The Seventh Circuit Ignores the Creditor Pro-

tection Prong of this Court’s Articulation of the

New Value Requirements.

As discussed above, this brief argues that no new

value principle survived the adoption of the Bankruptcy

Code. Even if this Court should conclude that new value

is still viable, certiorari should be granted and the Sev-

enth Circuit should be reversed because the supposed

“new value corollary” applied is not the corollary to

absolute priority articulated by this Court in Case v. Los

Angeles Lumber Products Co., 308 U.S. 106 (1939).

In Case, this Court struck down a plan under which

old equity? attempted to circumvent the requirement that

a plan had to be “fair and equitable,” which term requires

that interests in the debtor be distributed on the basis of

“absolute priority.” 308 U.S. at 106. The Case plan,

approved by all classes of creditors, would have allowed

old equity to retain an interest in the debtor based on a

promised contribution of expertise even though creditors

were not fully compensated.’ In dicta, this Court noted

? The term “old equity” as used herein refers to the

stockholders, partners or principals of the debtor.

* Case was decided under § 77B of the Bankruptcy Act of

1898 (48 Stat. 912). Had the Bankruptcy Code been in effect at

the time, the Case plan would have been confirmed. Under the

that it had previously stated that creditors could be pro-

tected “through other arrangements which distinctly recog-

nize their equitable right to be preferred to stockholders against

the full value of all property belonging to the debtor.” 308 U.S.

at 117 (quoting Kansas City Terminal Ry Co. v. Central

Union Trust Co., 271 U.S. 445, 454 (1926)) (emphasis

added). Justice Douglas stated that where the necessity for

tunds exists and old equity makes a fresh contribution

“and receive[s] in return a participation reasonably equiva-

lent to their contribution,” the creditors cannot object on

the ground that they were not accorded their “full right

of priority against the corporate assets.” Id.

The dicta in Case permitted old equity to obtain an

interest in the debtor only if creditors were accorded their

“tull right of priority” against the debtor’s assets. Old

equity could not participate “at the expense of the prior

rights .. . of creditors.” 308 U.S. at 116. It is this creditor

protection prong of the Case dicta that the Seventh Circuit

and cases adhering to its view, ignore. In LaSalle, old

equity was allowed to retain valuable property at the

expense of the unpaid mortgagee, which received only

16% on its deficiency claim. This would hardly seem to

accord the creditor its “full right of priority.”*

Bankruptcy Code, the fair and equitable requirement applies

only to dissenting impaired classes of creditors. Thus there was

no longer a need for a “new value corollary” to permit

uncompensated seniors to admit juniors, which was the issue in

Case.

* How the standards of the Case dicta can be achieved has

been the source of much controversy. This difficulty may be the

basis for the apparent lack of any reported cases under which a

court confirmed a new value plan over the objection of a

LS —

Thus, by not affording the creditor its full right of

priority, the LaSalle debtor's plan did not meet the

requirements of the new value corollary to the absolute

priority rule, was not fair and equitable, and should not

have been confirmed over the objection of an impaired

class of creditors. Although the Seventh Circuit refers to

new value as a “corollary” to the absolute priority rule,

its decision converts the Case corollary to a wide excep-

tion to the rule that threatens to consume the rule itself.

We respectfully urge that certiorari be granted to resolve

the extent of protection afforded by the absolute priority

rule of the Bankruptcy Code under a new value plan.

B. The Seventh Circuit Distorts the Prerequisites

to New Value Articulated by this Court in Case.

Under the dicta in Case, a plan in which old equity

retains an interest might be confirmed upon a contribu-

tion of new value in the form of money or money's worth

only if the full priority rights of creditors are preserved; if

the new value is necessary or “ ‘essential to the success of

the undertaking,” 308 US at 121 (quoting Kansas City

Terminal Ry., 271 U.S. at 454) (emphasis added); and if the

retained interest is reasonably equivalent to old equity's

contribution.®

creditor prior to the adoption of the Bankruptcy Code. This

difficulty may also explain the abrogation by some courts

(presumably unwittingly) of the creditor protection prong of

this Court's articulation of the new value principle.

5 The courts have engrafted to the Case requirements, a

further prerequisite of substantiality as either a corollary to the

requirement of necessity (/n re Snyder, 967 F.2d 1126, 1131 (7th

10

In LaSalle, the requirements of necessity and reason-

able equivalence have been so ignored and distorted that

in reality they no longer are prerequisites to confirmation

of a new value plan.

(1) Necessity. When Justice Douglas referred to the

“necessity, at times, of seeking new money ‘essential to

the success of the undertaking,’ ” id., he obviously was

referring to the necessity for funds to continue the opera-

tion of the enterprise, the production of its product, the

provision of its services, and the employment of its

workers. In single asset real estate cases, it_is normally

difficult to find this necessity. There is no business to be

continued, no product to be produced, and no service to

be performed that will not be continued, produced or

performed by the new owner of the real estate.

Cir. 1992)) or as a substitute for all other factors. The substitute

theory can be seen in the bankruptcy court decision in LaSalle,

where the court sees an implication in In re Woodbrook Associates,

19 F.3d 312, 320 (7th Cir. 1994) that “substantiality serves as

something of a summary of the other factors” (In re 203 N.

LaSalle Street Ltd. Partnership, 190 B.R. 567, 586 (Bankr. N.D. III.

1995)). All courts seem to agree that there is no mathematical

formula for determination of substantiality and that the

determination should be based on “common sense.” This was

the view of the Seventh Circuit in LaSalle. 126 F.3d at 967. While

the addition of another prerequisite on its face causes no harm,

given the enormous flexibility that some courts have allowed

themselves in determining whether this requirement has been

met, and their apparent conclusion that if this requirement is

met there is no need to consider the other prerequisites, it

appears that “substantiality” is but another shorthanded way to

circumvent this Court's stated conditions for confirmation of

new value plans.

= A ee -

11

Confronted with the fact that funds were not essen-

tial to the success of the undertaking in LaSalle, the Sev-

enth Circuit distorted the necessity requirement to mean

essential for confirmation of the debtor’s “plan” (“The

infusion of new capital was necessary for the successful

implementation of the plan.” 126 F.3d at 967). Since new

value is always proposed by the debtor to enable old

equity to keep the property, this switch in the meaning of

“necessary” would result in virtually every new value

plan meeting this requirement over dissenting unpaid

creditors’ objection. The approach taken by the Seventh

Circuit effectively reads necessity out of the prerequisites

for new value plan confirmation. We urge that certiorari

be granted to resolve the meaning of “necessary” or

“essential.”

2. Reasonable Equivalence. Under this prerequisite,

old equity may not receive more than the reasonable

equivalence of its contribution. In single asset cases, the

debtor usually has no equity in the property (the prop-

erty value is lower than the mortgages encumbering it, as

was the case in LaSalle). In the past, debtors have argued

that retention of the property by old equity does not

deprive the creditor of its “full right of priority” because

what the debtor-proposes to retain is worthless. This

Court has clearly rejected this “no-value” argument. In

Northern Pacific Ry. v. Boyd, 228 U.S. 482, 508 (1913), this

Court stated that “control” itself was an asset that consti-

tuted value and that such value belonged to the creditors,

not old equity. This Court again in 1988 reaffirmed that

determination in Norwest Bank Worthington v. Ahlers, 485

U.S. 197 (1988), stating that “we join in the consensus of

ES ———eeoooeere

12

authority which has rejected this ‘no value’ theory.” Id. at

207-08.

Notwithstanding these decisions, the LaSalle court

employed the no-value theory as the basis for determin-

ing whether the contribution met the reasonable equiva-

lence standard. The Bankruptcy Court stated that “the

contribution is easily the equivalent of the interests

retained by the debtor's partners. Indeed, on the market,

those interests are worthless.” 190 B.R. at 588. The Sev-

enth Circuit acknowledged that the Bankruptcy Court

had determined that the contribution was “reasonably

equivalent to the interest retained” but failed to discuss

whether the requirement had been met, apparently agree-

ing with the Bankruptcy Court’s determination. 126 F.3d

at 967.

While legislative suggestions have been made for

dealing with new value, none appear to have addressed

solutions to the fundamental issues involving compliance

with the holdings of this Court discussed in this part of

the brief. It is respectfully urged that if we are to remain

subject to the rule of law, certiorari should be granted to

undo what appears to be an obvious attempt to evade

decisions of this Court.

et

13

Ill. THE APPLICATION OF THE SEVENTH CIR-

CUIT’S VISION OF NEW VALUE TO SINGLE

ASSET REAL ESTATE REORGANIZATIONS

WOULD SERVE NO PUBLIC PURPOSE, ABRO-

GATE THE PROTECTION FOR MORTGAGEES

BUILT INTO THE BANKRUPTCY CODE, AND

HAVE A SEVERE AND NEGATIVE IMPACT ON

BORROWERS, LENDERS, AND THE REAL

ESTATE INDUSTRY.

A. No Public Purpose.

The confirmation of new value plans is often urged

as a matter of public policy on the ground that the funds

are needed to keep the debtor in business, preserve the

going concern value, keep people employed, and pre-

serve the performance or production of needed services

or products. Whether or not such arguments make sense

in the case of a manufacturer or service provider, these

laudable objectives are wholly inapplicable to single asset

real estate cases. In the single asset real estate transaction

the operation of the real estate will continue 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 infu-

sion of new value. The only thing that may fail is the

attempt by old equity to keep the debtor’s property with-

out paying its just debts.

If the debtor’s plan cannot be confirmed and the

property goes to foreclosure, the mortgagee or other pur-

chaser at the sale will operate the property. The question

is not whether the business will continue. The question is

only who will own the property - the debtor’s old equity

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

or the creditors who have not been paid. The decision

14

below opts for the former with old equity given the

property and 84% of the creditors deficiency claim wiped

out. No public purpose can be served by such a result.

B. Abrogation of Mortgagee Protection.

Section 1129(b)(2)(B) of the Bankruptcy Code pro-

hibits confirmation of a plan over the objection of an

impaired class of unsecured creditors if old equity is

permitted to retain an interest in the property on account

of its junior interest. A major reason for this provision

was to overcome the so-called Pine Gate line of cases that

treated nonrecourse mortgagees as the Seventh Circuit

now treats all mortgagees. In In re Pine Gate Associates,

Ltd., 2 Bankr. Ct. Dec. (CRR) 1478 (Bankr. N.D. Ga. 1976),

and its progeny, decided under chapter XII of the former

Bankruptcy Act, the bankruptcy courts allowed debtors

to retain the mortgaged property upon payment to the

non-recourse mortgagee of the depressed (due to the

mid-70’s recession) value of the collateral. In direct

response to the perceived inequity of the Pine Gate line of

cases, Congress was asked to restore absolute priority to

real estate arrangements under the new chapter 11 of the

Bankruptcy Code. See, e.g., Hearings on $.2266 and H.R.

8200 before the Subcomm. on Improvements in the Judi-

cial Machinery of the Senate Comm. on the Judiciary, 95th

Cong., 853, 855-56, 864-76 (1977) (statement of John J.

Creedon, American Council of Life Insurance).

Congress enacted a package of protection insuring

that the mortgagee may have an unsecured claim for the

deficiency and providing absolute priority for each dis-

senting impaired class of creditors, including the

a

15

unsecured class. It was this absolute priority for the

unsecured class, including the mortgagee’s deficiency

claim, that provided the protection afforded by Congress.

If the unsecured class rejected the plan (and normally in

single asset cases the mortgagee’s deficiency claim is the

only major unsecured claim) the debtor would not be able

to retain the property without paying the creditors. The

plan could not be confirmed.

New value as applied in LaSalle and many post enact-

ment Bankruptcy Code cases would abrogate this protec-

tion by restoring the Pine Gate rule - in a much more

sinister form. In both situations the debtor would keep

the property. The difference is that in Pine Gate, the

mortgagee would receive an immediate payment of cash

equal to the court determined value of the collateral

whereas in the new value cases after the enactment of the

. Bankruptcy Code, the mortgagee would receive only a

mor ,age with a face amount equal to the court deter-

mined value of the collateral. This retention of the prop-

erty by old equity when portions of, or all of the

mortgagee’s deficiency claim is wiped out is clearly the

opposite of what Congress intended. See S. Rep. No.

95-598, at 65 (1978), reprinted in 1978 U.S.C.C.A.N. 5787,

5851 (stating that a precursor of present § 1111(b), which

affords a deficiency claim to nonrecourse mortgagees,

“answers the nonrecourse loan problem and gives the

creditor an unsecured claim for the difference between

the value of the collateral and the debt in response to the

decision in” Pine Gate); see also In re DRW Property Co. 82,

57 B.R. 987, 990 (Bankr. N.D. Tex. 1986) (stating Congress

enacted section 1111(b) “to alleviate the Pine Gate

problem and to attempt to restore the benefit of the

bargain to nonrecourse secured creditors”).

16

Indeed the statutory language prevents the debtor in

single asset cases from ever retaining the property when

the mortgagee’s deficiency claim is unpaid. Section 506(a)

provides that a claim is secured only to the extent of the

value of the collateral. Section 1129(b)(2) requires that the

secured claim be equal in amount and value to the collat-

eral value as of the effective date of the plan. Any new

value offered represents a bid by old equity for the single

property in an amount in excess of the amount of the

mortgage. Such a bid represents the value of the property

and, under § 1129(b)(2), requires that the secured claim

be increased to that value. As a result no plan under

which the property will be acquired for less than the full

amount of the mortgage balance before bifurcation into

secured and unsecured portions can be confirmed over

the objection of the secured creditor class.°

© In LaSalle, the Bankruptcy Court attempted to deflect this

argument by finding that the bid was not based on the

“intrinsic” value of the real estate “but because of the tax

consequences that flow from their loss.” 190 B.R. at 588.

However the price paid for property is normally considered

determinative of value without an examination of the

motivations of the purchaser. “[I]f the collateral is actually sold

during the course of the bankruptcy proceedings or pursuant to

a confirmed plan, the consideration received from the sale will

almost always resolve the question of value.” 5 Coitirr ON

Bankruptcy J 506.03[4][a] at n.58 (Lawrence P. King et al. eds.

15th ed. rev. 1997). Indeed, in LaSalle the bankruptcy court itself,

in referring to what would be paid on the deficiency claim,

stated that the creditor will receive “50% of the net value of the

property either as realized in a sale, or as appraised at the time of

any refinancing.” (emphasis added). The price paid indicates

value. The motivation of the purchaser is irrelevant.

i ne

ee eee

17

It should be apparent that new value as interpreted

by the Seventh Circuit would undo the absolute priority

protection afforded by Congress to mortgagees. This

would represent a major change in the treatment of credi-

tors in bankruptcy. We respectfully request that certiorari

be granted to resolve this issue.

C. Negative Impact on the Real Estate Industry.

The decision below will have a severe adverse impact

on the real estate industry. Literally billions of dollars

have been loaned to real estate developers by institutions,

including insurance companies and pension plans that

insure and protect millions of ordinary citizens, on the

strength of real property collateral and the protection for

realization on that collateral built into the Bankruptcy

Code.

The decision below will result in the reduction of the

availabilty of funds for real estate development, as

lenders, faced with the uncertainties of the decision

below, channel funds away from real estate investments

to other forms of lending. For those funds that are avail-

able for real estate investment, the decision below will

result in tighter credit standards and higher interest rates

to reflect the greater risk involved. The failure to resolve

the issues raised by LaSalle will mean the continuation of

the present uncertainty and extensive future litigation in

real estate bankruptcies. Thus LaSalle not only threatens

existing mortgage debt held by lenders, but also

threatens the future of the real estate industry, which

relies so heavily on mortgage financing.

>

18

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

cases in the United States. If Courts are permitted by

judicial legislation to undermine the foundations of the

protection afforded to real estate mortgagees, the real

estate industry and the national economy will be severely

and adversely affected.

CONCLUSION

For all the reasons set forth herein, the American

College of Real Estate Lawyers respectfully urges this

Court to grant certiorari.

Respectfully submitted,

~~ Of Counsel Counsel of Record

Car J. Senexer, II Pror. Rosert M. ZINMAN

President, American St. John’s University

College of Real School of Law

Estate Lawyers 8000 Utopia Parkway

Jamaica, New York 11439

THomas C. HoOmMBURGER

Co-Chair, Amicus Briefs

Committee, American College

of Real Estate Lawyers

(718) 990-6646

CHrRIsToOPHER F. GRAHAM

THACHER, Prorritt & Woop

—o >see enti

_