Contributed by Kyle J. Ortiz
In Caviata Attached Homes, LLC v. U.S. Bank, Nat’l Assoc. (In re Caviata Attached Homes, LLC), NV-11-1620 (9th Cir. B.A.P. June 29, 2012), the United States Bankruptcy Appellate Panel of the Ninth Circuit held that a bankruptcy court had not abused its discretion when it granted a secured lender’s motion to dismiss a debtor’s second chapter 11 case. The BAP affirmed the bankruptcy court’s reasoning that a bad economy remaining a bad economy was not “an unforeseeable and extraordinary change” warranting the debtor’s second chapter 11 filing in contravention of the terms of the plan it confirmed in its previous chapter 11 case.
Prior to seeking bankruptcy protection, Caviata Attached Homes, LLC developed, owned, and operated a 184-unit apartment complex in Sparks, Nevada. To finance the construction of apartments on the property, Caviata obtained a construction loan that, at the time of its first bankruptcy, was held by U.S. Bank. The construction loan was secured by the property, and all rents, income, and profits generated by the property. After defaulting on the construction loan, Caviata filed its first chapter 11 petition on August 18, 2009. U.S. Bank filed a proof of claim for roughly $29 million.
Caviata proposed a chapter 11 plan in November of 2009 that sought to pay U.S. Bank 4.25% interest on the construction loan (U.S. Bank asserted that no market existed for a rate lower than 9.25%) for three years and committed to sell or refinance the loan on the property within three years to pay U.S. Bank in full. Under the terms of the plan, if Caviata defaulted, U.S. Bank could enforce its rights and foreclose on its collateral.
U.S. Bank objected to the plan, arguing that the plan was not feasible because U.S. Bank’s expert had recently appraised the property at $23 million and, thus, U.S. Bank asserted that the property could not be sold within three years at a price that would satisfy the debt owed to U.S. Bank let alone that of junior lenders on the property. U.S. Bank’s expert referred to Caviata’s plan to sell the property and pay the bank in full as a “dream” and “a fairy tale.”
Caviata, although agreeing with the $23 million appraisal, argued that market conditions would improve such that Caviata would be able to sell the property for $34 million within the three years contemplated by the plan. On April 12, 2010, over U.S. Bank’s objection, the bankruptcy court confirmed Caviata’s first plan, and Caviata began making monthly payments of $120,500 to U.S. Bank in June of 2010.
Things may not have gone according to plan (no pun intended) because fifteen months after confirmation, on August 1, 2011, Caviata filed a second chapter 11 petition. U.S. Bank quickly moved to dismiss the second case under section 1112(b) of the Bankruptcy Code (which allows a party in interest to request dismissal of a chapter 11 case for cause) as a bad faith attempt to circumvent the prohibition against modifying a substantially consummated plan under section 1127 of the Bankruptcy Code.
Caviata opposed the dismissal motion contending that the second filing was justified because finance and real estate markets had undergone significant changes that nobody could have foreseen at the time of the first plan’s confirmation. Caviata acknowledged that courts typically will not find market changes, alone, to be sufficient to warrant a second filing, but stated that such cases were based on “general” market fluctuations and not the global crises the world was experiencing at that time. Caviata pointed to case law that allows for a second filing when an “unforeseeable” economic change fundamentally alters market conditions. To support the contention that the then-current market conditions were unforeseeable at the time Caviata’s first chapter 11 plan was confirmed, Caviata noted that typical recessions “cycle and recover within 10-22 months” (as opposed to the much longer recession stemming from the 2008 financial crisis) and that at the time of the first plan’s confirmation, public figures, such as Fortune 500 CEOs and President Obama, had publicly asserted that the economy “had ‘hit bottom’ and could only improve.”
U.S. Bank responded that not only were the then-current market conditions foreseeable at the time of the first plan’s confirmation, but also U.S. Bank had explicitly warned of such conditions from the onset of the first case. Furthermore, U.S. Bank noted that the “market change” cited by Caviata wasn’t so much a downward trend in the market but, instead, was the market’s failure to rebound since Caviata’s first chapter 11 filing. According to U.S. Bank, the real estate market’s failure to improve was not only foreseeable but probable.
It likely was foreseeable that the hearing to consider the motion to dismiss was not going to go well for Caviata when the bankruptcy judge began the hearing by noting to Caviata’s counsel:
I can’t see given the objection by the secured party how [you] can say that  we had no idea that this was going to happen because [you] were fighting with somebody who [said] exactly what has happened [would] happen. It’s very difficult for me to understand how that can be a surprise, but I’m happy to hear from you.
Caviata, in addition to attempting to demonstrate the “unforeseeability” of the market conditions at the time it filed its second chapter 11, also objected to the nature of the hearing before the bankruptcy court stating that it was entitled to a full evidentiary hearing and wished to present additional testimony that Caviata had suffered due to what it alleged was the real estate market taking a turn for the worse. The bankruptcy court denied the request for an evidentiary hearing as it could not see what additional facts would be presented that would make the then-current economic climate less “foreseeable” and granted the motion to dismiss, holding that:
The debtor when they made their plan basically said, you know, our best guess that we can get confirmed is we think we can get this done in three years. They were just wrong. And I’m not saying that’s a bad faith issue in this case, but I don’t think just being wrong that the economy is worse than they thought it was going to be is a basis for filing a new plan.
Caviata appealed the bankruptcy court’s decision, arguing that (i) the bankruptcy court made a final determination knowing that the record was incomplete, (ii) Caviata was severely prejudiced and its due process rights were violated, and (iii) the bankruptcy court abused its discretion in dismissing the second case.
The Bankruptcy Appellate Panel disagreed with Caviata’s procedural objections to the motion to dismiss, noting that a motion to dismiss is a contested matter subject to Bankruptcy Rule 9014, which may be decided upon the parties’ papers. Additionally, the BAP held that “[a] full evidentiary hearing is not required under [section] 1112(b) [of the Bankruptcy Code] so long as the parties had a fair opportunity to offer relevant facts and arguments to the court and to confront their adversaries’ submissions.” It also held that the record had been sufficiently established and that it was unclear how the additional evidence that Caviata was hoping to enter (which was in the form of a declaration from an expert who would testify that the worsening economy from 2010 to 2011 was an unforeseeable event) changed anything. The BAP noted that such evidence seemed duplicative, and it was unclear how it would have aided the bankruptcy court.
The BAP also found that the bankruptcy court had not abused its discretion in dismissing Caviata’s second case because sections 1141(a) (making the terms of a confirmed plan binding on all parties) and 1127(b) (providing that a plan may not be modified after substantial consummation) impose an element of finality to chapter 11 proceedings that should not be disturbed absent unforeseeable or unanticipated changes in circumstances. The BAP held that “when an unforeseeable economic change effects a significant change in the market, a second filing may be permitted,” but that such a change did not occur in Caviata’s case. Caviata, based on the statements allegedly made by President Obama and others, mistakenly had believed the economy would improve. The BAP held that the economy’s failure to rebound in the time anticipated by Caviata was not an “extraordinary and unforeseeable change” and, therefore, found that the bankruptcy court had not abused its discretion when it held that U.S. Bank had shown cause for dismissal pursuant to section 1112(b) of the Bankruptcy Code.
Optimism is a virtue, but where a debtor’s plan is premised solely on the hope that a depressed market will rebound, the market’s failure to live up to the debtor’s expectations is not likely to be considered a sufficiently “unforeseeable event” to shield a debtor’s subsequent bankruptcy filing from dismissal.