Mortgagee “Cramdown”: Sometimes You Just Can’t Win

Fed. Nat’l Mortgage Ass’n v. Village Green I, GP, 483 B.R. 807 (W.D. Tenn. 2012) –

Fannie Mae objected to a “cramdown” plan of reorganization, arguing that (i) the accepting class of creditors was artificially impaired, (ii) the modification of its rights under its loan agreement was not fair and equitable, (iii) the interest rate on its unsecured deficiency claim was not sufficient, and (iv) the debtor did not propose the plan in good faith based on its misrepresentations and submission of a series of unconfirmable plans.  The bankruptcy court confirmed the plan, and Fannie Mae appealed.

The debtor, Village Green I, GP, owned an apartment complex that it bought in the summer of 2005 for $10.18 million.  It assumed a Fannie Mae loan that was originally due October 1, 2013, with interest at the rate of 5.98% per annum, and with payments based on a 30-year amortization, resulting in a balloon payment due at maturity.

Village Green executed a Master Lease with EP Village Green Operator, LLC, which in turn retained a management company to manage the property.  The project experienced financial difficulties due to the economic downturn.  Village Green approached its loan servicer to discuss modification of the financing.  However, the servicer advised that Fannie Mae would not discuss modification as long as the loan was current.  In other words, Village Green would need to miss a payment in order to be turned over to “special servicing.”

However, after Village Green missed a payment, Fannie Mae still would not discuss a loan modification.  Fannie Mae accused Village Green of failing to maintain the property, and sought appointment of a receiver.  When the request for a receiver was denied, it initiated a foreclosure.  Village Green filed for protection under chapter 11 of the Bankruptcy Code in order to stop the foreclosure.

Village Green’s fifth amended plan of reorganization, as modified, proposed the following treatment of claims:

  • Class 2 was Fannie Mae’s secured claim in the amount of $5.4 million (stipulated value of the property).  The loan was to bear interest at 5.4%, with monthly payments for 10 years based on a 30-year amortization, with a balloon payment at the end.
  • Class 3 was general unsecured claims, which consisted of the debtor’s accountant and a former law firm who had claims totaling a little less than $2,400.  These claims were to be paid in two cash installments:  one payment 30 days after confirmation and a second payment 60 days after confirmation of the plan.
  • Class 4 was Fannie Mae’s unsecured deficiency claim of ~ $3.2 million, which was to receive payments of $2,000 per month for 10 years, followed by a balloon payment, with interest accruing at 5.4% per annum.

Since Fannie Mae objected to the debtor’s plan of reorganization, Village Green could obtain confirmation only through a “cramdown.”  One requirement for a cramdown is that there be at least one impaired class that votes to accept the plan of reorganization.  The Class 3 general unsecured claims were offered as the accepting class.

Fannie Mae argued that Class 3 was not entitled to vote because it was artificially impaired.  In particular, some courts have held that if a debtor could pay de minimis claims in cash at the time of confirmation, then the claims are not actually impaired.  However, the Village Green bankruptcy court disagreed.  It concluded that this line of cases was no longer valid because the 1994 amendments to the Bankruptcy Code removed cashing out claims on the effective date of plan as an exception to impairment.

On appeal the district court noted that artificial impairment normally means putting creditors into separate classes who otherwise should have been grouped together in order to artificially create a class to accept the plan.  However, Fannie Mae did not challenge the separate classification of its ~$3.2 million unsecured claim (i.e. its deficiency claim) from the general unsecured claims totaling $2,400.

It is not clear why Fannie Mae did not object to separate classification.  If all three claims had been placed in the same class, there would not have been an accepting class, since acceptance by a class requires a vote in favor by creditors holding claims that constitute both (i) two‑thirds in number and (ii) a majority in amount of the claims.  Apparently Fannie Mae did try to buy claims:  An attorney with the law firm that held an unsecured claim for $1,629.97 testified that they refused an offer to purchase the claim because they wanted to thwart “Fannie Mae’s attempts to further harm a part of the community that has suffered economically in the last few years.”

The district court went on to note that some courts have held that a debtor is not allowed to impair de minimis claims in order to create a class to accept a plan.  (This has been described as the majority view.)  Other courts have focused on artificial impairment as relevant to the debtor’s good faith in proposing the plan, as opposed to whether there is a proper accepting class.

Ultimately the district court reversed the bankruptcy court, finding that a debtor cannot impair claims without justification, and remanded for a determination of this issue.  It left open whether the bankruptcy court should consider the question in the context of (i) whether there was a proper accepting class under Section 1129(a)(10), or (ii) the requirement that a plan be filed in good faith under Section 1129(a)(3).

Fannie Mae also objected to modifications of its rights under its loan documents, contending that its treatment was not fair and equitable.  This included matters such as allowing the debtor to independently escrow funds for taxes, insurance, and capital reserves (as opposed to allowing Fannie Mae to hold the escrow), and allowing the debtor to unilaterally change property managers or the property management contract without Fannie Mae’s prior approval.

The district court found that although the bankruptcy court addressed the modifications in the context of determining whether the debtor acted in good faith, it was not clear whether it considered the impact on its finding that Fannie Mae’s treatment was fair and equitable (as required for a cramdown).  This question was also remanded to the bankruptcy court.

Fannie Mae further objected to the 5.4% interest rate on its unsecured loan.  It presented a witness that testified the proper rate should be 22% per annum, given the risk.  In particular, Fannie Mae contended that the bankruptcy court should have started with a prime rate and adjusted upward to account for risk.  The district court declined to reverse the bankruptcy court, finding that its decision was not clearly erroneous.

The court also rejected other objections, including Fannie Mae’s contentions that the insufficient interest rate meant that treatment of its claim violated the absolute priority rule since it resulted in payments with a present value less than its claim, and that the plan was not proposed in good faith because it artificially impaired a de minimis class and the debtor made several misrepresentations.

It seems surprising that a court would be willing to confirm a plan based on an accepting class of two creditors holding less than $2,400 in claims in the face of an objection by a creditor holding a secured claim of $5.4 million and an unsecured deficiency claim of $3.2 million.  This is particularly true where the supposed impairment of the accepting class consists of making payment in two installments so that the claims are paid in full within 60 days after confirmation.

Although it seems doubtful that most bankruptcy courts would approve this plan of reorganization, that is small comfort to a lender faced the decisions of a court that holds views similar to those of the Village Green bankruptcy court.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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