Debtor’s Dream Home Becomes Nightmare: Bankruptcy Court Grants Relief from the Automatic Stay to Permit Foreclosure

The automatic stay is one of the most important protections a debtor has in bankruptcy.  Upon the filing of a bankruptcy case, section 362(a) of the Bankruptcy Code automatically stays a number of actions that may adversely affect a debtor’s estate, including the commencement of an action to foreclose on the debtor’s property.  A secured creditor seeking to foreclose on a debtor’s property may be entitled to relief from the automatic stay if it can be shown that the debtor has no equity in the property and that the property in question is not necessary for a successful reorganization.  In In re Denny A. Ryerson, the United States Bankruptcy Court for the District of Idaho explained that the debtor’s burden of showing a successful reorganization changes depending on the timing in the case.
In 2003, the debtor, a successful real estate developer, had begun development of his dream home on Lake Coeur d’Alene in Idaho.  The debtor used funds from a line of credit to purchase over two acres of contiguous lakefront land, and, over a period of years, constructed an 11,000 square foot home, which included a movie theater, wine cave, sports bar, and 300 feet of lake front access.  A second residence for a caretaker and a 900 square foot three-car garage were also constructed on the property.
The debtor’s obligations under the line of credit were restated and evidenced by three promissory notes secured by liens on the property, totaling more than $6 million.  Notwithstanding a series of loan modifications to extend the maturity dates of the notes, significant amounts remained due, and a default under the notes was declared in 2013.  The debtor filed his petition for chapter 11 relief less than one week prior to the scheduled foreclosure sale for the property.
Unbeknownst to the debtor, the bank had assigned its interests in the debtor’s loans and security thereof to Anaconda, a limited liability company whose principal had an interest in purchasing the property.  Anaconda had intended to exercise credit bid rights pursuant to the assigned notes at the foreclosure sale to obtain the property.   Anaconda filed a timely proof of claim in the debtor’s bankruptcy case and then requested relief from the automatic stay to pursue foreclosure on the property.
Anaconda’s motion sought relief from the automatic stay pursuant to section 362(d)(2) of the Bankruptcy Code, which provides that relief may be granted if (i) the debtor does not have any equity in such property and (ii) such property is not necessary to an effective reorganization.  Section 362(g) of the Bankruptcy Code establishes that the party requesting stay relief bears the burden on the issue of equity and that the debtor has the burden on all other issues.
The court first examined the value of the property and the various claims secured by the lakefront estate to determine if the debtor had any equity.  The court sided with Anaconda and found that after taking into account Anaconda’s secured claim, claims for unpaid real property taxes, and various judgment liens, the debtor lacked any equity in the property.
The burden then shifted to the debtor to show both a “reasonable possibility of successful reorganization within a reasonable time” and “if there is conceivably to be an effective reorganization, this property will be needed for it[.]”  Following the Ninth Circuit Bankruptcy Appellate Panel in In re Sun Valley Newspapers, Inc., the court acknowledged that the “effective reorganization showing is a moving target which is more difficult to attain as the chapter 11 case progresses” and that the “debtor’s burden increases from showing a successful reorganization is ‘plausible’ early in the case, to showing reorganization is ‘probable’ near the expiration of the exclusivity period, and finally to showing reorganization is ‘assured’ after the exclusivity period expires.”
Although the exclusivity period had run by the time the court heard Anaconda’s motion and the debtor already had filed a proposed plan of reorganization, Anaconda had filed its stay relief motion a mere 26 days after the debtor filed his voluntary petition.  The court ultimately punted on which standard applies after determining that even under the less stringent “reorganization is possible” standard, the debtor had not carried its burden.  The debtor’s proposed plan failed to address key issues, including, among others, Anaconda’s ability to credit bid and the logistics of payment of claims from the sale of the property in question while simultaneously attempting to reserve funds to later attack Anaconda’s claim.  In addition, the proposed plan was premised on using proceeds of the sale of the property to pay other creditors; however, the evidence established that the property would not generate value beyond the amount of the secured claims.
The court granted the stay relief because Anaconda carried its burden of establishing that the debtor had no equity in the property and the debtor failed to meet even the lowest standard of showing that the reorganization is possible.  In opposing relief that seeks to foreclose on secured property, a debtor must be cognizant of the burden it must meet to prevail and must keep in mind that timing may mean everything.