Third Time Was Not the Charm for This Debtor: After Failing to Confirm Two Plans, Debtor Loses Bid to Confirm Third Plan after the Seventh Circuit Rejects Treasury Bonds as “Indubitable Equivalent” to Building Lien

Contributed by Laura Napoli
Convincing a judge that you have a reorganization plan worthy of confirmation can be a tricky business.  Yet, as one debtor recently learned, convincing a judge who already thinks you’re untrustworthy is even harder.  In In re River East Plaza, LLC, No. 11-3263, 2012 WL 1697690 (7th Cir. Jan. 19, 2012), the debtor submitted three potential plans to the bankruptcy judge.  After the judge found that the first two plans did not comply with the law, he lost patience and threw out the third plan without even considering it.  On appeal, the Seventh Circuit concluded that the bankruptcy court acted properly in denying confirmation of the debtor’s plans.
River East involved a single-asset real estate chapter 11 case that came to the Seventh Circuit directly on appeal from the United States Bankruptcy Court for the Northern District of Illinois.  River East Plaza LLC, the debtor, owned River East Plaza in downtown Chicago.  In 2009, River East defaulted on the building’s mortgage, and LNV, the mortgagee, began foreclosure proceedings in state court.  Just hours before the foreclosure sale was to take place, River East filed for chapter 11, and the automatic stay kicked in, preventing the sale.
At the time of the chapter 11 filing, River East owed LNV, its sole creditor, $38.3 million; by River East’s estimate, however, the building was worth only $13.5 million.  LNV was thus an undersecured creditor: it had a secured claim for the value of the building ($13.5 million) and an unsecured claim for everything else.  LNV decided to exercise its rights under section 1111(b)(1)(B) of the Bankruptcy Code and exchange its two claims for a single secured claim equal to the face amount of the unpaid balance of the mortgage.  Thus, LNV converted its two claims—a secured claim of $13.5 million and an unsecured claim of $24.8 million—into one secured claim for $38.3 million.
When it became a party to the bankruptcy proceeding, LNV ran the risk that the judge might approve a plan of reorganization that would affect its lien.  Although a mortgage lien normally remains on the mortgaged property until the mortgage is paid off, the lien can be removed if a bankruptcy judge confirms a plan of reorganization that removes it.  River East proposed just such a plan, and LNV objected.  River East then attempted to “cram down” the plan despite LNV’s objection using subsection (iii) of section 1129(b)(2)(A), which allows the lien to be exchanged for an “indubitable equivalent.”  Specifically, River East decided to seek confirmation of a reorganization plan that would replace LNV’s $38.3 million mortgage lien with a lien on $13.5 million of 30-year U.S. Treasury bonds.  River East claimed that the bonds were “substitute collateral” because, it argued, at current interest rates the bonds would grow to $38.8 million, thus guaranteeing that LNV would be paid in full 30 years from now.
This was River East’s second attempt at confirmation of a plan.  The bankruptcy judge threw out the first plan River East submitted because it did not comply with the cramdown statute once LNV chose to waive its unsecured claim in exchange for a larger secured claim.  The bankruptcy court denied confirmation of the second plan, concluding that a secured creditor cannot be forced to accept substitute collateral if the creditor has chosen to convert a combination of a secured and unsecured claim into a secured claim equal to the total debt that it is owed.  After River East filed its third proposed plan, which allowed LNV to retain its lien on the building,  the bankruptcy judge declined to consider it, vacated the automatic stay, and ordered that the foreclosure sale proceed.  River East appealed to the Seventh Circuit, which stayed the sale pending resolution of the appeal.
The Seventh Circuit Decision
In an opinion written by Judge Posner, the Seventh Circuit held that the bankruptcy judge had not erred in rejecting River East’s second plan.   River East claimed that it was exchanging LNV’s lien for an “indubitable equivalent” in the form of the 30-year Treasury bonds.  According to the court, to qualify as an indubitable equivalent, substitute collateral cannot be more volatile than the collateral the creditor currently has.  In this case, the Seventh Circuit found that if LNV kept its lien on the building, it could foreclose and be paid in full immediately if River East defaulted a second time.  In contrast, if River East could transfer LNV’s lien to the Treasury bonds, LNV would have to wait another 25 years to recover the money River East owed it.  Because inflation was almost certain to occur over that 25-year period, the court found that the substitute collateral would be worth less than the lien on the building.  For this reason, the court concluded that the Treasury bonds were not the “indubitable equivalent” of LNV’s building lien.
The Seventh Circuit was equally unsympathetic with River East’s third attempt at a plan.  The court held that the bankruptcy judge did not abuse his discretion by refusing to consider this third plan because this plan, which allowed LNV to retain its lien on the building, still left the chapter 11 case unresolved.  Disputes over the value of the building and the proper interest rate could keep the proceeding open for some time, and LNV had already waited years to enforce its lien.  Additionally, the court found that River East had “compromised its credibility” by submitting two plans that did not comply with the Bankruptcy Code.  Because giving River East a third chance at a plan would only stretch out the proceedings to LNV’s detriment, the court affirmed the bankruptcy judge’s decision and vacated the stay, allowing the foreclosure sale to proceed.