The majority on a panel of the Tenth Circuit Bankruptcy Appellate Panel ruled in a nonprecedential opinion that Section 364(d)(1) may not be used to approve exit financing for a chapter 11 plan that subordinates an existing lien.

In a so-called SARE case, the majority also held that the bankruptcy court must always decide whether the plan has a reasonable possibility of confirmation within a reasonable time when ruling on a motion to modify the automatic stay under Section 362(d)(3), if the debtor is not making payments to the moving creditor.

Bankruptcy Judge Terrence L. Michael disagreed and filed what he called a respectful but “vehement” dissent.

Exit Financing Subordinates the Existing Lender

The debtor filed a chapter 11 petition in May 2019 to restructure the financing for its half-completed condominium project in Aspen, Colo. The case was a single asset real estate reorganization, or SARE.

Just before the plan-filing deadline for the SARE, the debtor submitted a plan with exit financing from a new lender to finish construction. The exit financing would “prime” the existing first-lien lender. That is to say, the lien of the exit lender would come ahead of the lien of the existing lender.

Needless to say, the existing lender objected and filed a motion to modify the automatic stay, contending that confirmation was not possible within a reasonable time as required by Section 362(d)(3).

The debtor argued that the bankruptcy court could confirm the plan by approving exit financing under Section 364(d)(1) or by cramming down the existing lender on finding “indubitable equivalence” under Section 1129(b)(2)(A)(iii).

The bankruptcy judge denied the lift-stay motion, saying there was equity in the property for the existing lender even after the exit financing. He would decide on confirmation whether the new lender could prime the existing lender.

The existing lender appealed denial of the lift-stay motion and won a reversal and remand in a July 24 opinion for the majority by Bankruptcy Judge Robert H. Jacobvitz. The opinion is nonprecedential.

The Error under Section 362(d)(3)(A)

Judge Jacobvitz first dealt with the lift-stay motion under Section 362(d)(3)(A). Because the debtor had not begun making monthly payments to the lender, he said the lender would be entitled to stay modification unless the debtor could show a “reasonable possibility” of confirming a plan within a “reasonable time.”

Judge Jacobvitz said that finding equity in the property was an insufficient basis for denying the lift-stay motion. He said that the “SARE stay relief standard requires evidence that the debtor has a reasonable possibility of confirming a plan within a reasonable time.”

Because the bankruptcy judge “did not address whether the proposed exit financing with priming lien could possibly be approved, . . . the Bankruptcy Court did not properly apply the SARE stay relief standard.” In other words, the lower court should have decided “whether exit priming lien financing needed to fund the Plan is permissible as a matter of law.”

Ordinarily, an appellate court would remand with instructions for the lower court to make fact findings and apply the requisite legal standard. But because the issue had been “extensively argued and briefed,” the BAP exercised discretion by deciding the priming issue.

The majority exercised discretion to decide the unresolved priming issue because, as Judge Jacobvitz said, Congress “wanted to limit” a bankruptcy court’s ability to prolong a SARE case if the lender was not receiving monthly payments.

First, Judge Jacobvitz cited some lower court authority and ruled that Section 364(d)(1) may not be used for approval of exit financing. He said the section was a “mechanism” to finance operations in chapter 11, “not to finance post-confirmation operations after the property of the estate has vested in the reorganized debtor.”

On the other hand, Judge Jacobvitz said that the priming loan might be approved by cramming down on the existing lender and showing that the plan gave the lender the “indubitable equivalent” under Section 1129(b)(2)(A)(iii). He defined “indubitable equivalent” to mean that subordinating the lien would not increase the creditor’s exposure to risk.

In the case on appeal, the bankruptcy court had not made a finding about the value of the collateral for the existing lender if the priming lien were approved. Without valuation, Judge Jacobvitz said, the BAP majority could not determine whether the existing lender was being given the indubitable equivalent.

The majority therefore reversed denial of the lift-stay motion and remanded for the bankruptcy court to decide whether the plan had a reasonable probability of confirmation.

Judge Jacobvitz said that the “reasonable possibility” decision “does not require a mini-confirmation hearing.” He said that the “quantum of evidence required to establish a reasonable possibility that the Plan provides [the lender] with the indubitable equivalent of its claim falls far short of the quantum of evidence required to prove, in a confirmation hearing, that the plan satisfies the indubitable equivalent requirement.”

The Dissent

Judge Michael dissented. In his view, the bankruptcy judge “acted reasonably and prudently” by moving the case toward confirmation and making a decision about indubitable equivalence at the confirmation hearing. “That’s what we do,” he said.

With regard to the standard for Section 362(d)(3)(A), he said the “test . . . is not nearly as stringent as the majority suggests.”

On the Section 364 issue, Judge Michael said that the question had not been addressed in the Tenth Circuit, nor “anywhere” else at the circuit level. He believes the majority abused its discretion by reaching out to decide a question that had not been answered by the bankruptcy court. The three cases cited by the majority to foreclose the use of Section 364 at confirmation, in his view, do not “render the majority’s reading of the law a certainty.”

Judge Michael would have been “loath to decide unsettled issues of law as a matter of first impression” when the bankruptcy court had not addressed the question.

Believing the bankruptcy judge “acted well within [his] discretion by denying” the lift-stay motion, Judge Michael ended the opinion by saying, “I respectfully and vehemently dissent.”

Commentary

“I agree with the dissent,” Richard P. Carmody told ABI.

“It is rare to see this kind of micromanagement at the BAP level. This erosion of bankruptcy court discretion at the hands of fellow bankruptcy judges seems like a self-inflicted wound.”

Carmody, a fellow of the American College of Bankruptcy, is of counsel to Adams & Reese LLP, which maintains offices in Atlanta and Birmingham, Ala., among other locations.