Mezzanine Borrower’s Chapter 11 Case Filed on Eve of Foreclosure Sale Dismissed as a Bad Faith Filing

by Cadwalader, Wickersham & Taft LLP
Contact

Background

JER/Jameson Mezz Borrower II LLC (“Mezz II”) was formed in 2006 as part of the mezzanine financing used to acquire a chain of economy hotels. To facilitate the acquisition, JER/Jameson Properties LLC and JER/Jameson NC Properties LP, the operating companies, borrowed $175 million under a CMBS loan with Wells Fargo. Four mezzanine borrowers, including Mezz II, were formed for the sole purpose of borrowing an additional $40 million. The capital structure, typical of mezzanine financings, is as follows: Mezz I is the sole member or partner of the operating companies; Mezz II is the sole owner of Mezz I; Mezz III is the sole owner of Mezz II; and Mezz IV is the sole owner of Mezz III.

The acquisition debt matured on August 9, 2011, at which time the Debtors were unable to service the debt and the lenders at each level commenced various enforcement actions. CDCF JIH Funding, LLC and ColFin JIH Funding, LLC (collectively, “Colony”), the holder of the debt at the Mezz I and II levels, issued a notice of intention to auction Mezz II’s interest in Mezz I under Article 9 of the Uniform Commercial Code. The night before the auction was scheduled to take place, Mezz II filed a voluntary chapter 11 petition in the United States Bankruptcy Court for the District of Delaware (Mezz I and the operating companies filed for bankruptcy protection a week later). Shortly thereafter, Colony moved to dismiss the case and sought relief from the automatic stay, arguing that Mezz II had filed its chapter 11 petition in bad faith to stave off Colony’s foreclosure proceedings.

Motion to Dismiss

After conducting an objective examination of the circumstances surrounding Mezz II’s bankruptcy filing, the Bankruptcy Court granted Colony’s motion to dismiss Mezz II’s chapter 11 case with prejudice pursuant to sections 349(a) and 1112(b) of the Bankruptcy Code. Referring to the factors enumerated by the District Court for the District of Delaware in In re Primestone Inv. Partners, L.P., 272 B.R. 554, 557 (D. Del. 2002), the Bankruptcy Court concluded that the circumstances of Mezz II’s filing indicated that the filing was in bad faith. The Bankruptcy Court based its decision on a broad panoply of factors, including, among other things, that: Mezz II had only one asset, no unsecured creditors, no cash or income, no employees or ongoing business operations, no prospect of reorganization, and its petition was filed on the eve of Colony’s UCC auction. The fact that the bankruptcy case was essentially a two-party dispute between Colony and Mezz II did not go unnoticed by the Bankruptcy Court. The Bankruptcy Court found that Colony’s foreclosure would merely change the ownership of Mezz I. The only entities that would be affected, the Mezz III and Mezz IV lenders, had the right to buy out Colony’s position pursuant to an intercreditor agreement or could attend the auction and bid for an ownership interest in Mezz I. Additionally, the Bankruptcy Court found that there was compelling evidence that the filing was a litigation tactic – Mezz II had filed a bare petition on the eve of the UCC sale, it had not sought any additional relief since filing for chapter 11, and the only beneficiaries of the filing were the Mezz III and IV lenders.

The Bankruptcy Court agreed with the debtors that based on Judge Gropper’s decision in In re Gen. Growth, Props., Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009), the court must consider the debtors on a holistic basis to determine whether there is a realistic possibility that Mezz II could be reorganized. However, because the debtors were not substantively consolidated and Colony was Mezz II’s only creditor, the Bankruptcy Court found that confirmation of a plan without Colony’s consent was impossible because Mezz II would not have an impaired accepting class under section 1129(a)(10) of the Bankruptcy Code. Relying on the fact that Mezz II would be unable to confirm a plan without Colony’s consent, the Bankruptcy Court also rejected the debtors’ argument that dismissal was premature because they had not been given sufficient time to propose a plan.

While the Bankruptcy Court agreed with the debtors that a bankruptcy sale of Mezz II’s interest can be a legitimate purpose for a chapter 11 filing, the Bankruptcy Court found that there was no evidence that a sale would be more cost effective in bankruptcy rather than through a UCC sale. Because the only parties affected by the sale, the Mezz III and IV lenders, could protect their interests outside of bankruptcy, the Bankruptcy Court found there was no benefit for Mezz II to remain in bankruptcy. Moreover, the Bankruptcy Court emphasized that not only did the debtors fail to present any evidence that additional value could be realized in bankruptcy, but the debtors had failed to refinance or sell in the past, and had failed to take any action to initiate a sale process in bankruptcy.

Motion for Relief from Automatic Stay

The Bankruptcy Court also found that Colony should be granted relief from the automatic stay under sections 362(d)(1) and (d)(2) of the Bankruptcy Code. First, the Bankruptcy Court found that cause existed to lift the automatic stay under section 362(d)(1) because a de minimis equity cushion of 9%, which was eroding daily, did not constitute adequate protection of Colony’s interest. The Bankruptcy Court also rejected the debtors’ argument that excess cash at the operating level adequately protected Colony’s interest and could be used to pay administrative expenses. To the contrary, the Bankruptcy Court found that the “excess” cash had never been offered to Colony, and the debtors’ budget revealed that the cases were administratively insolvent, and there were no unencumbered assets at the Mezz II level. Next, the Bankruptcy Court determined that Colony was entitled to relief from the automatic stay under section 362(d)(2) because as Mezz II’s only creditor, Colony’s consent was required for a reorganization of Mezz II, and therefore Colony’s collateral was not necessary to an effective reorganization of the debtors.

Appeal of the Bankruptcy Court’s Order

On December 28, 2011, Mezz I, Mezz II, and the operating companies appealed the Bankruptcy Court’s decision and concurrently moved for an emergency stay pending the appeal. Judge Walrath denied the motion for an emergency stay on December 29, 2011, holding that the movants did not establish cause to justify a stay pending appeal. On January 11, 2012, Mezz I and II, the operating companies, and Colony stipulated and agreed to voluntarily withdraw the appeal, thereby permitting the Mezz II bankruptcy case to be closed.

Judge Walrath’s decision in In re JER/ Jameson Mezz Borrower II LLC will likely impact bankruptcy planning for distressed mezzanine financings. Where potential debtors are not substantively consolidated, each individual mezzanine entity will need to meet the requirements for a good faith filing, including, whether the entity can realistically confirm a plan. Mezzanine borrowers without ongoing business operations, property, or employees, and with only one creditor—which is often the case—will need to strongly consider these hurdles before deciding to file for chapter 11 relief.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Cadwalader, Wickersham & Taft LLP | Attorney Advertising

Written by:

Cadwalader, Wickersham & Taft LLP
Contact
more
less

Cadwalader, Wickersham & Taft LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.