When secured creditors are taking haircuts to permit an out-of-court workout, the Eighth Circuit Bankruptcy Appellate Panel gave lenders comfort that receiving payment on underwater liens will not end up being a preference.
Like all workouts of sizeable companies, the deals were complicated. It amounted to this: The bank had subordinate liens on the debtor’s personal property. For the most part, the subordinate liens were worthless because the properties were not valuable enough to pay off senior liens on the collateral.
The debtor negotiated a sale with a buyer to pay $27 million for the real and personal property at 19 gasoline stations. The deal called for all of the properties to be conveyed free and clear of liens. If all of the lenders exercised their rights and refused to release liens without full payment, there would have been no sale because the secured debt exceeded the sale price.
Consequently, senior and subordinate lenders decided to take haircuts — that is, release their liens without full payment for the value of the collateral being released.
For example, the senior lender took $14 million and released its lien, despite not being paid in full. The bank (which was sued later for a preference) received a partial payment of $1.3 million and released its lien. Around the same time, the debtor paid the lender $100,000.
After the sale, the debtor filed a chapter 11 petition. The trustee for the creditors’ trust sued the bank, claiming that the payments were preferences under Section 547.
The bank raised the contemporaneous exchange/new value defense under Section 547(c). Bankruptcy Judge Dennis R. Dow of Kansas City, Mo., ruled in favor of the bank. The trustee appealed.
In a March 19 opinion by Bankruptcy Judge Barry S. Schermer, the BAP upheld Judge Dow, ruling that the new value defense held water.
Section 547(c)(1) provides that a transfer may not be avoided as a preference “to the extent that such transfer was — (A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and (B) in fact a substantially contemporaneous exchange . . . .”
The bank had the Eighth Circuit on its side, because the appeals court had previously held that a release of lien can be new value. Velde v. Kirsch, 543 F.3d 469, 474 (8th Cir. 2008).
From then on, the outcome was a matter of valuation. In that respect, the BAP upheld Judge Dow’s conclusions about value.
With regard to the $1.3 million payment to the bank, the release of the bank’s subordinate lien was worth $1.4 million in new value to the debtor. Therefore, the BAP affirmed Judge Dow by upholding the new value defense.
The $100,000 payment by the debtor to the bank was more problematic, because it came a few days before the sale closed.
Again, the BAP upheld the bankruptcy court’s findings of fact. Judge Dow had found that the $100,000 was part of the overall deal and that the $100,000 was intended as an advance payment for the sale to close a few days later.
Like Judge Dow, the BAP therefore held that the $100,000 payment was protected by the new value defense because the bank released its lien as part of the transaction.
For the BAP, Judge Schermer said that the payment prior to closing “does not change the result,” even though the $100,000 did not come from sale proceeds.
When secured creditors are taking haircuts to permit an out-of-court workout, the Eighth Circuit Bankruptcy Appellate Panel gave lenders comfort that receiving payment on underwater liens will not end up being a preference.
Like all workouts of sizeable companies, the deals were complicated. It amounted to this: The bank had subordinate liens on the debtor’s personal property. For the most part, the subordinate liens were worthless because the properties were not valuable enough to pay off senior liens on the collateral.
The debtor negotiated a sale with a buyer to pay $27 million for the real and personal property at 19 gasoline stations. The deal called for all of the properties to be conveyed free and clear of liens. If all of the lenders exercised their rights and refused to release liens without full payment, there would have been no sale because the secured debt exceeded the sale price.
Consequently, senior and subordinate lenders decided to take haircuts — that is, release their liens without full payment for the value of the collateral being released.
For example, the senior lender took $14 million and released its lien, despite not being paid in full. The bank (which was sued later for a preference) received a partial payment of $1.3 million and released its lien. Around the same time, the debtor paid the lender $100,000.