The Eleventh Circuit upheld the subordination of a $5.2 million loan that the bankruptcy court had not authorized, even though the loan enabled the bankrupt estate to pay unsecured creditors in full.
The Loan
Chief Bankruptcy Judge Wendy L. Hagenau of Atlanta had authorized the chapter 11 debtor to sell developed real property for $7.2 million. The purchase and sale agreement gave the debtor an option to repurchase the property by a specified date for about $9.3 million.
The debtor was unsuccessful in locating a lender to finance the repurchase. So, the debtor took down two loans, neither of which was disclosed to or approved by the bankruptcy court. A third-party lender provided a $4.1 million loan secured by a recorded mortgage on the property.
For the remainder of the purchase price, the debtor borrowed some $5.2 million from a commonly owed affiliate that qualified as an insider. The loan carried 12% interest and was to mature in four months. The debtor signed a mortgage to secure the $5.2 million loan, but it was never recorded.
Bankruptcy Judge Hagenau learned about the loan when another creditor mentioned the transaction in court papers in a separate litigated matter. She brought everyone into court to explain. Afterwards, her first action was to appoint a chapter 11 trustee.
The trustee later sold the property for almost $12.8 million to the lender that made the $4.1 million loan. Bankruptcy Judge Hagenau allowed that lender to credit bid the $4.1 million. The sale threw off a net of almost $8.5 million before the $5.2 million loan.
The $5.2 million lender filed a motion imploring Judge Hagenau to approve the loan nunc pro tunc. Rather than give the lender a secured claim for $5.2 million, she allowed the claim as unsecured but subordinated the claim to all unsecured claims. As a result, the $5.2 million lender recovered no interest and lost only $500,000 of principal because other unsecured claims amounted to only $2.6 million.
Subordination of the claim allowed other unsecured creditors to recover in full. Had the $5.2 million loan been given priority or even pari passu status with unsecured creditors, other unsecured creditors would have been affected negatively and significantly.
The lender appealed, but the district court affirmed. Norcross Hospitality LLC v. Glass (In re Nilhan Developers LLC), 20-3491, 2021 BL 384455 (N.D. Ga. Sept. 30, 2021). To read ABI’s report on the district court affirmance, click here.
The lender appealed again, but the Eleventh Circuit affirmed in a nonprecedential, per curiam opinion on August 11.
Substantial Contribution
The appeals court first dealt with the lender’s contention that the bankruptcy court should have allowed an administrative claim for a “substantial contribution” under Section 503(b)(3)(D).
The appeals court agreed with the lender that the list of allowable administrative claims in Section 503(b) is illustrative, not exhaustive, because the subsection says “including.” However, subsection (b)(3)(D) is different, the circuit said, because it “identifies a specific subset of administrative expense claims — those seeking reimbursement for a “substantial contribution” to the estate — and specifically identifies the types of entities that may pursue such claims: creditors, indentured trustees, equity security holders, and committees of creditors or equity holders.”
Since the “plain text limits” the entities that qualify for administrative status under subsection (b)(3)(D), and the lender was not one of them, the circuit held that the lender lacked standing to qualify for an administrative claim.
Actual, Necessary Expense
Next, the lender argued that the loan was allowable as an administrative claim under Section 503(b)(1) as an actual, necessary expense of preserving the estate. To qualify, the circuit said that a loan must pass muster under Section 364.
For allowance, the debt must have been incurred in the “ordinary course of business” under Section 364(a) or must have been approved by the bankruptcy court after notice and a hearing under Section 364(b).
The appeals courts said that Bankruptcy Judge Hagenau was correct in saying that the loan was not in the ordinary course, nor was it court-approved.
The lender submitted that Judge Hagenau should have approved the loan nunc pro tunc.
When a debtor incurs a loan without bankruptcy court approval, the circuit said that the bankruptcy court “may exercise its equitable discretion to approve the loan nunc pro tunc.”
Approval after the fact is permissible, according to the appeals court, if the bankruptcy court would have approved the loan were application made in a timely manner and if the debtor “honestly believed” that it had authority to take down the loan.
To begin with, Judge Hagenau said she would not have approved the loan if there had been a proper application because the transaction was too risky. Furthermore, the debtor could not have believed that it had authority to incur the loan. So, denial of nunc pro tunc approval was proper.
Finally, the appeals court found no abuse of discretion in subordinating the lender’s claim under Section 510(c)(1).
Again, the appeals court found no abuse of discretion because the lender took an “unfair advantage” and made a risky loan, without court approval.
The circuit affirmed the district court’s decision affirming the bankruptcy court’s order.
The Eleventh Circuit upheld the subordination of a $5.2 million loan that the bankruptcy court had not authorized, even though the loan enabled the bankrupt estate to pay unsecured creditors in full.
The Loan
Chief Bankruptcy Judge Wendy L. Hagenau of Atlanta had authorized the chapter 11 debtor to sell developed real property for $7.2 million. The purchase and sale agreement gave the debtor an option to repurchase the property by a specified date for about $9.3 million.
The debtor was unsuccessful in locating a lender to finance the repurchase. So, the debtor took down two loans, neither of which was disclosed to or approved by the bankruptcy court. A third-party lender provided a $4.1 million loan secured by a recorded mortgage on the property.
For the remainder of the purchase price, the debtor borrowed some $5.2 million from a commonly owed affiliate that qualified as an insider. The loan carried 12% interest and was to mature in four months. The debtor signed a mortgage to secure the $5.2 million loan, but it was never recorded.
Bankruptcy Judge Hagenau learned about the loan when another creditor mentioned the transaction in court papers in a separate litigated matter. She brought everyone into court to explain. Afterwards, her first action was to appoint a chapter 11 trustee.
The trustee later sold the property for almost $12.8 million to the lender that made the $4.1 million loan. Bankruptcy Judge Hagenau allowed that lender to credit bid the $4.1 million. The sale threw off a net of almost $8.5 million before the $5.2 million loan.
The $5.2 million lender filed a motion imploring Judge Hagenau to approve the loan nunc pro tunc. Rather than give the lender a secured claim for $5.2 million, she allowed the claim as unsecured but subordinated the claim to all unsecured claims. As a result, the $5.2 million lender recovered no interest and lost only $500,000 of principal because other unsecured claims amounted to only $2.6 million.