RGW Properties of Beaver County, Inc., 564 B.R. 489 (Bankr. W.D. Pa. 2017) –

A Chapter 11 debtor sought confirmation of its plan of reorganization over the objection of its primary secured creditor. The mortgagee argued that (1) the property that was its collateral, which was acquired by the debtor in tax sales, was not even part of the bankruptcy estate, and (2) the cramdown payment terms in the plan could not be confirmed.

The debtor was a single asset real estate entity. It acquired title to its real estate subject to a mortgage as a result of two upset tax sales. (The debtor had an opportunity to buy the property because the mortgagee failed to pay the delinquent taxes or intervene at the tax sales.)

The day the debtor filed bankruptcy it also filed a plan of reorganization, which proposed to pay the mortgagee’s partially secured claim at 4% interest amortized over 10 years. The plan also provided that the debtor would commence an adversary proceeding to determine the value of the property (and thus the amount of the secured claim), which the debtor claimed was $20,000.

As a threshold matter the mortgagee contended that the property was not part of the bankruptcy estate. It claimed that the tax sales were defective and void since it did not receive adequate notice. However it never took any steps to challenge the sales – in either state court or bankruptcy court.

The bankruptcy court noted that although federal law governs whether property is part of the bankruptcy estate, generally the underlying property interests themselves are created and defined by state law. Under applicable state law there was a presumption that a tax sale is valid when it is confirmed and acknowledged in open court. There was also a deed confirming title in the debtor, which triggered the additional presumption of validity for a deed that has been executed and recorded.

Given these presumptions, in combination with the mortgagee’s failure to take any affirmative steps to attack the sales or deed or to produce any contrary evidence, the court felt compelled to consider the debtor to be the owner of the property. Consequently the property was part of the bankruptcy estate.

Although an impaired class of creditors holding secured real estate tax claims accepted the plan, it was rejected by the mortgagee (which was in a separate class). So the court next examined whether the proposed treatment of the mortgagee’s claim was confirmable.

In its proof of claim the mortgagee contended that its claim in the amount of ~$156,000 was fully secured. Thus, among other things, it objected that its secured claim was not going to be paid in full (since the debtor indicated that it intended to seek a determination in that the secured claim was $20,000).

However, subsequently the mortgagee advised that it obtained an appraisal indicating that the property value (and thus the amount of its secured claim) was $24,000. The debtor agreed to accept this value in lieu of its proposed $20,000.

The next issue was the proper interest rate. In a cramdown generally a class of secured claims that does not accept the plan must receive “cash payments totaling at least the allowed amount of such claim, with a value, as of the effective date of the plan, of at least the value of such holder’s [collateral].” In other words, the creditor is entitled to a stream of cash payments with a present value equal to the value of its collateral.

With respect to the interest rate used to determine the present value of the cash payments, under Supreme Court precedent (from a chapter 13 case, Till V. SCS Credit Corp.) the appropriate discount rate is determined by using a formula that starts with the “national prime rate” and then adds a risk adjustment – since a bankrupt debtor typically poses a greater risk of default than a credit worthy commercial borrower. Courts generally approve risk adjustments of 1% to 3%.

In this case the parties agreed that the prime rate was 3.5%. The mortgagee suggested in its pleadings that 2% was a reasonable risk adjustment, resulting in a 5.5% rate. Although the debtor originally proposed 4%, it agreed to use 5.5% instead.

The final issue was the 10 year amortization period proposed. Apparently in court the mortgagee’s counsel “alluded to the fact that [the mortgagee] may
have an issue with the ten-year repayment term,” but the mortgagee failed to raise any written objection or provide contradictory evidence. So the court concluded that 10 years was reasonable.

In sum, the court determined that the mortgagee held an allowed secured claim in the amount of $24,000 to be paid over a 10-year term at an interest rate of 5.5%, and concluded that this treatment satisfied applicable plan confirmation requirements. Since there were no other outstanding issues, the court approved confirmation of the plan.

Given the way the case evolved, one wonders whether the mortgagee felt that the results justified the expense of raising its objections. The debtor proposed paying $20,000 at 4% interest over 10 years. The mortgagee countered with $24,000 and 5.5% interest – which the debtor accepted – and effectively did not address the ten-year repayment. So, after almost a year of litigation, there was only a relatively minor improvement in treatment of its claim. This meager result is probably due in large part to the fact that it appears the mortgagee was not very effective in raising issues. To object it is almost always important to speak early and often.

Vicki R Harding, Esq.