Cramdown: Can “Dirt-for-Debt” Qualify as the Indubitable Equivalent of a Secured Claim?

Bate Land Co. LP v. Bate Land & Timber LLC (In re Bate Land & Timber LLC), 877 F.3d 188 (4th Cir. 2017) –

A Chapter 11 debtor sought approval of a plan of reorganization that included a partial “dirt-for-debt” treatment of the mortgagee’s allowed secured claim. The bankruptcy court confirmed the plan over the mortgagee’s objections, the district court dismissed the mortgagee’s appeal as equitably moot, and the mortgagee appealed to the Fourth Circuit.

The debtor had acquired 79 tracts of land for $65 million, paying $9 million in cash and financing the remaining $56 million. Although the debtor repaid over $60 million, it failed to pay the outstanding balance of the loan on maturity. The debtor proposed to convey two tracts to the mortgagee in satisfaction of the debt, but the proposal was rejected.

After the debtor filed bankruptcy, the mortgagee filed a secured claim for ~$13 million. The debtor had only a handful of other creditors who were owed around $200,000. The debtor filed a plan of reorganization with a partial debt-for-dirt provision that contemplated transferring two of the tracts of land to the mortgagee in satisfaction of its claim, with the debtor retaining the rest of the tracts free and clear of any liens.

Since the mortgagee objected, the debtor had to justify a cramdown. Section 1129(b)(2)(A) of the Bankruptcy Code imposes certain requirements for treatment of a secured claim in a cramdown plan. Specifically, it provides three options: (1) retention of liens with cash payments, (2) sale of the property free and clear with liens attaching to proceeds, and (3) providing for “the realization by such holders of the indubitable equivalent of such claims.”

After a series of hearings, the bankruptcy court determined that the original two tracts of land that the debtor proposed to transfer together with six additional tracts was estimated to be worth ~$13.7 million, so that the eight tracts together with a $1 million cash payment provided the “indubitable equivalent” of the mortgagee’s ~$14.6 million claim.

On a related point, the mortgagee was oversecured, and thus entitled to postpetition interest under section 506(b). In ruling on the amount of postpetition interest owing to the mortgagee, the court determined that it would be unfair to charge the debtor interest during periods of delay due to the court’s schedule or proceedings initiated by the mortgagee. Accordingly, the court disallowed 266 days of postpetition interest on equitable grounds. (For example, when it took the court more than 30 days to issue a ruling, it tolled the running of postpetition interest for the excess period.)

The bankruptcy court confirmed a plan of reorganization with the partial dirt-for-debt treatment of the mortgagee’s claim and the reduced postpetition interest.

On appeal the mortgagee questioned whether a partial dirt-for-debt plan could ever provide the indubitable equivalent of a mortgage claim given the inherent uncertainty in property valuation. It also attacked the bankruptcy court’s determination of value.

As a matter of law, the Fourth Circuit declined to hold that a partial dirt-for-debt plan could never provide the indubitable equivalent of a secured claim. With respect to the bankruptcy court’s determination of property values, the court reviewed it for clear error and held that the decision was not clearly erroneous.

The mortgagee also argued that it was entitled to postpetition interest, and the bankruptcy court erred in disallowing a portion of the interest on equitable grounds. While acknowledging that section 506(b) states that an oversecured creditor “shall be allowed” to collect interest, including postpetition interest, the court held that the right to interest continues to be subject to equitable defenses. The Fourth Circuit concluded that the bankruptcy court reasonably decided that it would be inequitable to require the debtor to pay interest that accrued through no fault of its own.

Consequently, the Fourth Circuit reversed the district court dismissal of the appeal and affirmed the bankruptcy court decision.

It seems likely that the facts of this case played a large role in the result. It was essentially a two-party dispute between the mortgagee and debtor where the mortgagee had been unwilling to release any of its collateral. Given that the original $56 million loan had been paid down to ~$13 million, the original purchase price was $65 million (suggesting value substantially in excess of the remaining secured claim), and there were 79 parcels (giving the debtor flexibility to create a package of properties with a value that matched the debt), it was inevitable that some subset of the tracts would be enough to support a finding that their value was equivalent to the remaining secured claim. In contrast, typically a bankrupt debtor would not have substantial equity, and even if the debtor has equity in a project, typically it would be difficult to carve out a portion of the project to transfer to the secured creditor.

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).
This entry was posted in Financing, Real Estate and tagged , , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s