United States: Bankruptcy Sales: Sometimes The Mortgagee Wins

Last Updated: March 5 2014
Article by Vicki Harding

In re CPJFK, LLC,496 B.R. 290 (Bankr. E.D.N.Y. 2011) –

A chapter 11 trustee sought court approval of a Section 363 sale of the debtor's hotel to its secured creditor for a credit bid of ~$13.8 million.  The debtor raised a number of objections, including that the bid was too low, the property was not adequately marketed and the court did not have jurisdiction.

The debtor filed a chapter 11 bankruptcy in Georgia.  A month later the case was transferred to New York, where the debtor's hotel was located.  Shortly after the transfer, the debtor's secured creditor asked the court to appoint a chapter 11 trustee based on various allegations of mismanagement of the hotel.

After the court appointed a trustee, he sought (1) authorization to use the secured creditor's cash collateral to operate the hotel, and (1) approval of sale procedures and terms for a sale of substantially all of the debtor's assets under Section 363 of the Bankruptcy Code.  The trustee contended that a prompt sale was necessary because there was no realistic possibility of reorganizing and the property did not generate sufficient revenue to pay current obligations.  The court approved use of cash collateral and the sale procedures, including use of a broker to market the property.

The trustee and secured creditor reached a settlement of various claims that resulted in an agreement that $410,000 of the secured creditor's proceeds from the sale could be used to pay administrative expenses and an additional $100,000 could be used to pay unsecured claims and US trustee fees.  In addition, the secured creditor agreed to cause an affiliate to reinstate a lease of an adjacent parking lot for use with the hotel so that it could be offered as part of the sale.  It also agreed to limit its credit bid to no more than $14.5 million (as opposed to its asserted claim of ~$15.7 million) and to use its mortgagee position to assist in transferring the ground lease of the property where the hotel was located as part of the sale.

The day before a hearing on the settlement motion, the debtor filed a plan of reorganization and disclosure statement, and sought to stay the sale of the hotel and the hearing on the settlement motion.  The trustee, secured creditor and various other creditors opposed the debtor, pointing out numerous impediments to confirmation; and the debtor's request for relief was denied on both procedural and substantive grounds.

Consequently, the trustee proceeded with his request for approval of the sale of the debtor's assets.  He reported that the secured creditor's bid of $13,850,000 was the highest and best bid, and that the second highest bid was $13 million.  The debtor filed the only objection to the sale, which included contentions that the broker did not properly advertise the sale, it should have obtained an appraisal, the sale price of $13,850,000 "shocks the conscience" because it was well below the value in an appraisal obtained by the debtor, etc.  It also challenged the court's jurisdiction to approve the sale given the debtor's appeal of the order approving the settlement, and contended that the hotel could not be sold because the ground lease of the property on which the hotel was situated was rejected by operation of law.

With respect to the debtor's contention that the property was not adequately marketed and the sale price was inadequate, the court took detailed testimony from the broker.  Among other things, the broker testified that:

  • He sent email blasts to 4,826 addresses in the broker's database and 9,004 email addresses in the database of a national organization.
  • He sent and received 990 emails from parties relating to the sale.
  • Approximately 104 parties received a letter giving them access to a website with marketing and due diligence materials.
  • Approximately 70 recipients of the letters executed confidentiality agreements and entered the website.
  • 50 parties engaged in additional discussions.
  • Some visited the hotel for a formal tour and 25 to 30 indicated they would visit the hotel on their own.
  • In response to a call for offers to the 104 parties, he received two offers:  one for $3 million and one for $13 million.  After the secured creditor made its credit bid, the broker approached the $13 million bidder to encourage it to increase its bid, but was unsuccessful.

On the issue of value, a principal of the debtor testified that he thought the property was worth $30 million, and the debtor produced an appraisal with a value of $20 million.  However, the principal had no basis for his opinion, and the appraisal assumed the hotel had a plan for improvement and had re-converted to a Crowne Plaza hotel at the time the bankruptcy was filed – which was not the case.

According to the broker, the fact that the hotel did not have a franchise agreement was a major negative factor, which was of particular concern given that this was an airport hotel "because of the 'high transient activity' which generally requires 'global connectivity and [a] reservation system.'"  He also testified that the hotel employee union agreement was a negative factor because " 'the buying public' does not 'want to buy union hotels, because they perceive their operating costs, and labor, and [cost of] benefits [for workers] to be hired.' "

The court rejected the debtor's arguments that the sale price was too low or that the hotel was not adequately marketed.

In determining whether to approve the sale, the court cited a Second Circuit decision, Comm. of Equity Sec. Holders v. Lionel Corp. (In re Loinel Corp.), 722 F.2d 1063 (2d Cir. 1983), for the proposition that there is a "balancing test which is applied to determine when assets may be disposed of in chapter 11 prior to confirmation of a plan of reorganization: '[t]here must be some articulated business justification, other than appeasement of major creditors.'"

The 2d Circuit decision included a list of factors to consider, such as the likelihood of reorganizing and whether the asset is increasing or decreasing in value.  A New York bankruptcy court decision in the General Motors case was cited for supplementing the list with factors such as whether there is "a material risk that by deferring the sale, the patent will die on the operating table."

Not surprisingly, after reviewing all of the Lionel factors the court concluded that under the circumstances of this case there was "ample" business justification for the sale.

On the issue of jurisdiction, the bankruptcy court acknowledged that a court is without jurisdiction to modify an order that is under appeal.  However, it retains jurisdiction to implement or enforce that order.  In this case, approval of the sale was simply implementing the prior order.

As for the argument about rejection of the ground lease, Section 365(d)(4) does provide that a lease is deemed rejected and a trustee is directed to surrender the property if the trustee does not assume or reject an unexpired nonresidential real estate lease by the earlier of 120 days after the bankruptcy filing or confirmation of a plan.  However, that deadline can be extended; and more importantly, a landlord can waive the automatic rejection.  In this case, the trustee reached an agreement with the ground lease landlord such that the Section 365(d)(4) deemed rejection was waived.

In this case the fact that the hotel was operating at a deficit and the authority to use cash collateral was about to run out was a critical factor.  The dire financial situation in combination with the fact that there was a lot of marketing activity with relatively little result suggested that further delay would likely mean an even worse outcome for creditors.

There is always a tension when substantially all of a Chapter 11 debtor's assets are sold in a Section 363 sale prior to going through the plan of reorganization confirmation process.  On the one hand, it is argued that a sale does not provide all of the protections that interested parties are entitled to in connection with confirming a plan.  On the other hand, it is argued that there are practical reasons to go with an immediate sale that gives a better return to creditors rather than requiring conversion to a Chapter 7, particularly when the assets are deteriorating in value.  The trend seems to be in favor of allowing Section 363 sales.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Vicki Harding
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