Opinion
No. 892-80432-478
September 30, 1993
C. Grayden Wren, Cullen Dykman, Garden City, New York, attorneys for the creditor.
Mark Basile, Garden City, New York, attorney for the debtors.
Opinion
This matter is before the Court for confirmation of Rattandeo and Rose Dindiyal's (the "Debtors") First Amended Plan of Reorganization (the "Plan"). Greenpoint Savings Bank ("Greenpoint"), the Debtors' largest secured creditor objects to confirmation. According to Greenpoint, the Plan should not be confirmed primarily because it violates 11 U.S.C. § 1129(b) and is allegedly discriminatory and unfair as to the treatment of Greenpoint's claims. Greenpoint further alleges that it has a perfected security interest in cash collateral and objects to the Debtors' use of its cash collateral to fund the Plan. Based on the pleadings, testimony of witnesses, the memoranda submitted by the parties and oral arguments presented, this Court finds that the plan is not confirmable. Although the Plan does not discriminate unfairly against Greenpoint because other impaired classes are similarly treated, the Plan as proposed with respect to the applicable interest rate to be paid on Greenpoint's claim does not provide Greenpoint with the present value of its claim.
In addition, based on the factual information provided, the Plan is not feasible as filed.
FACTS
The Debtors are individuals who filed a petition for relief under Chapter 11 of Title 11 of the United States Code on January 24, 1992.
Since the early 1980's, the Debtors have been in the business of owning and renting residential properties, consisting of single and multi-family dwellings (four (4) to eight (8) units) in the Queens Village area. The Debtors entered this business in the hopes of cashing in on the then-robust real estate market. The Debtors purchased a total of six (6) residential properties, each time arranging for first mortgage financing with Greenpoint. The current aggregate amount due under the five mortgages is $627,285.00.
During the period of 1982 through 1991, many of the properties were in disrepair and in poor physical condition. The Debtors went into the secondary market and obtained a blanket second mortgage in the original amount of $150,000 from Harry Gertler ("Gertler") which was placed on four (4) of the Debtors' six (6) properties. Three (3) of these properties are incumbered by a first mortgage held by Greenpoint. The Debtors presently own five (5) residential properties. One is their residence which is a two family dwelling and the other four are multiple dwellings. All rentable apartments are occupied and produce a total rent roll of $7,950 (Schedule "I"). In addition, the Debtors claim to have a gross annual salary in the total sum of $33,300 or approximately $2,075 per month. Therefore, the Debtors' gross monthly income totals $10,025.
The sixth property located at 90-30 213th St., Queens Village, was sold for the purchase price of $141,000 on October 16, 1992, and is therefore not considered in this decision.
The five properties at issue in this decision are encumbered by first mortgages granted to Greenpoint, the relevant terms of each mortgage are as follows:
PRINCIPAL DATE OF INTEREST ORIGINAL AMOUNT OF PROPERTY MORTGAGE RATE TERM MORTGAGE 227-46 12th Ave. 04/13/87 11.5% 25 years $104,000 88-16 213 So. 04/23/85 13.5% 25 years 63,000 115-31 209th St. 03/17/86 9 1/2% 25 years 87,000 88-28 195th Pl. 02/06/86 13.5% 25 years 125,000 88-20 195th Pl. 01/17/90 10.75% 25 years 137,900 The last three mortgages obtained were adjustable rate mortgages.The Gertler mortgage is dated July 10, 1987 and was for a one-year term with interest accruing at sixteen (16%) percent, payable in monthly installments of $1,451.33. This was a balloon mortgage which came due on July 10, 1988. It originally encumbered four (4) properties, but one property was sold, reducing Mr. Gertler's present secured claim to $114,288.31.
Prior to the filing of the petition, many of the tenants defaulted on their rental obligations and the Debtors defaulted under their obligations to Greenpoint and Gertler.
The Debtors' Plan of Reorganization proposes to pay Class 1 Administration Claims in full or as agreed upon. There are no priority tax claims. Class 2 consists of Greenpoint's claims. The Plan proposes to pay Greenpoint its allowed claim on the effective date, the full value of their claims plus eight and one-half (8 1/2%) percent fixed interest over three hundred and sixty (360) payments (thirty [30] years).
Class 3, Gertler, is to receive on account of his claim on the effective date, the full value of his claim, plus eight and one-half (8 1/2%) percent feed interest amortized over one hundred twenty (120) payments for the first year, then eight and one-half (8 1/2%) percent fixed interest amortized over seventy-two (72) payments with a balloon payment of the then remaining principal due after thirty-six (36) months. The secured creditors are to retain their liens. The general unsecured creditors are to receive one hundred (100%) percent of their allowed claims.
The Plan is to be funded from the rents derived from the Debtors' continuing rental operation.
The Plan contemplates modifying Greenpoint's mortgages by extending the time for repayment of the full amount of the debt, and reducing the interest rate from the original contract rate to a blanket eight and one-half (8 1/2%) percent interest payable over twenty-five (25) years. The effect of this treatment is to reduce the overall interest rates of each Greenpoint mortgage and add an average of six and one-half (6 1/2) years onto the term of the original mortgage.
Although the Plan reads thirty (30) years payable over three hundred sixty (360) months, Debtors' counsel orally acknowledged that this would be reduced to twenty-five (25) years.
The Debtors' Plan proposes to modify Gertler's claim by paying him over a three (3) year period commencing on the effective date. It should be noted that Gertler's claim is a claim for money due which claim is secured by three mortgages. The terms of all notes on these mortgages have expired by their own terms. As a result of this proposal, the overall interest rate of the Gertler debt will be reduced from the original sixteen (16%) percent to eight and one-half (8 1/2%) percent and will be fully repaid eight (8) years beyond the term of the original mortgage which had matured in 1988. Gertler has agreed to accept the modifications as proposed pursuant to the Plan.
Greenpoint has rejected the Plan and the Debtors seek confirmation of the Plan over the objections of Greenpoint via the cramdown provisions in Bankruptcy Code § 1129(b). Greenpoint objects to the Debtors' proposed cramdown on the following grounds:
(1) The Debtors have used cash collateral of Greenpoint without the consent of Greenpoint or an Order of this Court, and the Debtors' proposal to fund the Plan with such cash collateral is prohibited, and
(2) The Plan unfairly discriminates against Greenpoint because it proposes to pay Gertler, a junior lienholder three years from confirmation, whereas the Greenpoint mortgages are to be extended for twenty-five years, and
(3) The Plan is not fair and equitable with respect to Greenpoint because it proposes to greatly reduce the interest rate payable to Greenpoint and to unduly extend the term of the Greenpoint mortgages.
DISCUSSION
The Debtors are individuals who filed under Chapter 11 of the Bankruptcy Code. The Supreme Court in Toibb v. Radloff, 111 L.Ed.2d 145, 111 S.Ct. 2197, 2202 (1991), has recognized the right of individuals to file for relief under Chapter 11. The Debtors in this case are similar to a corporate debtor in that they own various investment properties, aside from their individually owned homestead where they reside. Therefore, this Court's decision in this case is applicable to similarly situated individual Chapter 11 Debtors, who have mortgages on investment properties or other commercial interests, in addition to a mortgage on their residence, and does not necessarily reflect this Court's view in cases where the debtor is attempting to cram down the rights of secured creditors who have a lien only on a debtor's homestead and the debtor has no other real property. That fact pattern is not before the Court in this case.
I. CRAMDOWN
Greenpoint's claim is less than the fair market value of the properties that secure such claim. Therefore, Greenpoint is oversecured and has a secured lien for the total amount of its claim, see 11 U.S.C. § 506, and is entitled to interest on its claim. In order to confirm a Plan of Reorganization over the objections of a class of secured creditors who have voted to reject the plan, this Court must find that all subparts of 11 U.S.C. § 1129(a), except (a)(8), have been met, and further, that the Plan satisfies the cramdown requirements of 11 U.S.C. § 1129(b). Moreover, the proponent of the Plan has the burden of producing evidence that the requirements for confirmation are met. See e.g., In re Stratford Associates Ltd. Partnership, 145 B.R. 689 (Bankr.D.Kan. 1992) (and cases cited therein).
Bankruptcy Code 1129(b) states two basic criteria for cramdown. First, the Plan must not "discriminate unfairly," and second, the Plan must be "fair and equitable," with respect to each class of claims that is impaired under, and has not accepted, the Plan.
A. UNFAIR DISCRIMINATION
In this case, the Debtors' Plan proposes to pay Greenpoint, the senior lienholder, over a period of twenty-five years whereas Gertler, the junior lienholder, will be paid within three years from confirmation. Greenpoint asserts that such treatment discriminates unfairly and therefore, the Plan cannot be crammed down pursuant to Bankruptcy Code § 1129(b)(1). For the reasons set forth below, this Court finds that the Plan does not discriminate unfairly with respect to Greenpoint's claims.
The Debtors' Plan as amended on the record proposes to pay Greenpoint over a twenty-five year period commencing on the effective date, thereby extending the maturity dates on the Greenpoint mortgages as follows:
ORIGINAL TIME PROPOSED PROPOSED EXTENSION REMAINING UNTIL INTEREST TIME UNTIL OF MATURITY MATURITY RATE MATURITY DATE 227-46 12th Ave. 19 years 8.5% 25 years 6 years 88-16 213th St. 17 years 8.5% 25 years 8 years 115-31 209th St. 18 years 8.5% 25 years 7 years 88-28 195th Pl. 18 years 8.5% 25 years 7 years 88-20 195th Pl. 22 years 8.5% 25 years 3 years Based on the chart set forth above, the Debtors' Plan proposes to extend the overall payment period on the Greenpoint mortgages by an average of 6.2 years. Under the Debtors' Plan, the Gertler debt, which matured in 1988 will be paid over a three (3) year period commencing on the effective date. The Gertler debt, having matured by its own terms, is a secured debt. No regular monthly payments are due and there can be no reinstatement of the mortgage. The Plan effectively extends the repayment of this secured debt for a period of eight years beyond the original payment due date. This is not materially different than the effective repayment of Greenpoint's original mortgage.Thus, this Court finds that the claims of Greenpoint and of Gertler areboth impaired under the Plan and that the Plan does not unfairly discriminate with respect to either class of claims.
B. FAIR AND EQUITABLE
Bankruptcy Code § 1123 sets forth the requirements that a Plan must contain. In particular, Section 1123 provides in relevant part:
(a) Notwithstanding any otherwise applicable non-bankruptcy law, a Plan shall —
(5) provide adequate means for the Plan's implementation, such as —
(E) satisfaction or modification of any lien;
(F) cancellation or modification of any indenture . . .
"Indenture" is defined under § 101 to include a mortgage.
Accordingly, pursuant to Bankruptcy Code § 1123, "[t]he Bankruptcy Code permits a Chapter 11 debtor to modify both the contractual rate of interest of a secured claim and to pay a secured claim in deferred cash payments which extend beyond the original maturity date of the underlying obligation." In re Crane Automotive, Inc., 88 B.R. 81, 83 (Bankr.W.D.Pa. 1988).
However, for purposes of cramdown, Bankruptcy Code § 1123 must be read in conjunction with § 1129(b)(2)(A), which limits the lengths a debtor can go in restructuring its secured obligations over the objections of a dissenting class of secured creditors. Bankruptcy Code § 1129(b)(2)(A) sets forth the minimum requirements necessary for the plan to be fair and equitable with respect to a non-accepting impaired class of secured creditors. See In re Apple Tree Partners, L.P., 131 B.R. 380, 395 (Bankr.W.D.Tenn. 1991) ("Section 1129(b)(2) establishes the minimum standards that the plan must meet in order to be fair and equitable under § 1129(b)(1) [emphasis in original]"). Section 1129(b)(2)(A) provides that a plan does not satisfy the "fair and equitable" requirement unless the plan provides:
(1) that the secured creditors retain the liens securing their claims, and
(2) that the secured creditors receive deferred cash payments totaling at least the amount of their claims, and
(3) that the present value, as of the effective date, of the deferred cash payments is at least the value of the secured creditor's interest in the estate's interest in the property.
This language is taken from Bankruptcy Code § 1129(b)(2)(A)(i)(II) and is somewhat confusing. To clarify the language of the code section one must differentiate between oversecured and undersecured creditors. With respect to an oversecured creditor, such as Greenpoint, where the value of the collateral securing the claim exceeds the amount of the claim, the present value of the deferred cash payments must total at least the value of the claim, as of the effective date. With respect to an under secured creditor, where the value of the collateral is less than the value of the claim, the creditor will have both a secured claim and an unsecured claim pursuant to bankruptcy code § 506, unless the creditor elects to treat its claim as fully secured pursuant to Bankruptcy Code § 1111(b). Regardless of whether the creditor makes the § 1111(b) election, the present value of the deferred cash payments must total at least the value of thecollateral.
In this case, the Debtors' Plan proposes that Greenpoint will retain its liens on the Debtors' properties and therefore, the Plan satisfies the first requirement of § 1129(b)(2)(A). However, this Court finds that the Debtors' Plan fails to satisfy the remaining requirements of § 1129(b)(2)(A) because it fails to provide for a payment plan which will give Greenpoint the present value of its claim on the effective date.
In determining what is meant by "present value," the Bankruptcy Court in In re Busone, 71 B.R. 201 (Bankr.E.D.N.Y. 1987) stated:
"`Present value' or the `time value of money' is not a legal concept, but rather it is a term of art in the financial community . . . [i]t simply means that a dollar received today is worth more than a dollar to be received in the future . . . [t]o compensate the creditor for not receiving its money today, the debtor is charged an additional amount of money . . . [t]he charge is based on a rate of interest called a `discount rate' . . . [t]he discount rate is used to calculate how much the creditor should be paid so that it will have the same amount of money in the future as it would have had if it did not have to wait to be paid."
In re Busone, 71 B.R. at 204 (quoting, In re Fisher, 29 B.R. 542, 543 (Bankr.D.Kan. 1983)).
Accordingly, to determine the present value of a future stream of payments, a discount rate must be used. The discount rate should equal the prevailing market interest rate for a comparable loan, taking into full consideration the risk of non-payment and default by the debtor and the quality of the security." In re 266 Washington Associates, 141 B.R. 275 (Bankr.E.D.N.Y. 1992), aff'd 147 B.R. 827 (E.D.N.Y. 1992) (emphasis added).
According to the Debtors, this Court should adopt 8.5% as the appropriate discount rate used in determining present value for purposes of § 1129(b)(2)(A)(i). Although the Debtors urge the Court not to take into account the risks involved in determining the appropriate interest rate, such failure to do so could greatly prejudice the mortgagee, and is inconsistent with prevailing case law.
The proper rate for interest pursuant to Section 1129(b)(2)(A)(i) of the Bankruptcy Code is a base rate, augmented by a factor representing any additional risk entailed in lending in the particular situation. In re 360 Inns. Ltd. 76 B.R. 573, 593 (Bankr.N.D.Tex. 1987); In re Sherwood Square Assoc., 107 B.R. 872, 883, et. seq. (Bankr. Md. 1989); In re Westwood Plaza Apartments, 147, B.R. 692, 701 (Bankr.E.D.Tex. 1985). The base rate may be a market rate, a prime rate or a treasury bond rate. Sometimes an additional factor representing risk is included in order to reflect that the market rate to be applied is for the particular type of loan proposed by the debtors' plan. In re Wilkinson, 33 B.R. 933, 937 (Bankr.S.D.N.Y. 1983).
In considering the rate to be applied, the Court must determine on a case-by-case basis what interest rate the reorganizing debtor would have to pay a creditor in order to obtain a loan on equivalent terms on the open market. In re Camino Real Landscape Maintenance Contractors, Inc, 818 F.2d 1503 (9th Cir. 1987). The lender is entitled to include in his return "a significant element to compensate for the risk of default", depending upon the creditworthiness of the reorganized debtor. Id. at p. 1506. There are additional factors that concern the market rate which should be considered beyond the simple quotation of market interest. The Court may consider the debt to value ratio, the competitive charges between lenders, the cost of funds, the condition of the local economy, the term of the loan.
It is also appropriate to take into consideration the factors in the real estate market as they exist at this time. It is evident to this Court that the interest rates on real property within the last several years has fluctuated from extremely high rates to the present low interest rates. Lenders in the last few years have been reluctant to make long term loans at low interest rates on non-owner occupied properties as is evidenced by the fact that the last three mortgages granted by Greenpoint were adjustable rate mortgages. That economic uncertainty continues at this time. It is unclear whether the present low interest rates will continue for any extended period of time. It is therefore appropriate that a lender which is asked to take the risk of repayment at a reduced interest rate and on an extended term, be granted the right to have the newly revised terms revisited every three years so that the rate could be adjusted to reflect the actual market.
The Debtors did provide testimony to support adoption of a discount rate of 8.5%. However, Greenpoint provided compelling testimony that the actual interest rate charged by lenders for non-owner occupied similar rental properties was nine (9%) percent. In addition, the Court recognizes that certain risk factors are inherent in the Debtors' Plan which this Court cannot ignore, despite the Debtors' entreaties to do so. For example, the Debtors propose to pay Greenpoint over a period of twenty-five years, which substantially lengthens the time period which the Debtors must pay Greenpoint's claims. If the premises need major repairs or several of the premises remain unoccupied for a certain length of time, additional non-rental funds would be necessary which the Debtors may not be able to provide over the duration of the Plan. The Debtors' "outside" income appears to be limited and unable to support additional funds being provided to the investment property. This could lead to a deterioration of the condition of the properties and corresponding difficulty in keeping the properties rented. Therefore, a risk factor of 1% will be added to the base rate of 9%. Thus, this Court holds that in determining the present value of the mortgage payments the appropriate discount rate is 10% and is to be adjusted every three (3) years if it is to be fair and equitable.
II. FEASIBILITY
Pursuant to 11 U.S.C. § 1129(a)(11), the Court shall confirm a plan only if:
[C]onfirmation of a plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.
A Bankruptcy Court, in determining the feasibility of a proposed plan of reorganization should `scrutinize' the plan carefully to determine whether it offers a reasonable prospect of success and is workable.
In re Johns-Mansville Corp. 68 B.R. 618, 635 (Bankr.S.D.N.Y. 1986) (quoting In re Monnier Brothers, 755 F.2d 1336, 1341 (8th Cir. 1985)).
Based on the Court's decision that the applicable interest rate with respect to Greenpoint's claim is to be increased from 8 1/2% to 10%, and the Debtors' agreement to reduce the payout term by five years to a total of twenty five years, it is clear that the Debtors have insufficient excess cash to make the increased payments. In the first year after confirmation, the Debtors estimate an excess cash reserve of approximately $2,500. However, the Plan as amended by this Decision would increase the payments to Greenpoint by approximately $800 per month. Therefore, the Debtors must come up with an amount far greater than its excess cash reserve to make the increased interest payments over the shorter term.
In addition, the Debtors' projected expenses are extremely low, inaccurate and unrealistic to the point of incredibility. Even if the interest rate of the Greenpoint Mortgage were kept at 8 1/2% and the payments were made over thirty years, the Plan would be unfeasible. The Debtors' estimated monthly expenses as shown on page 39 of their First Amended Disclosure Statement indicate the aggregate monthly proposed payments to Greenpoint and Gertler total $6,086.00, provided that the proposed interest rate of 8 1/2% is utilized. The Debtors' other projected monthly expenses for food, transportation, clothes, insurance, taxes and utilities total $2,739.83. The Debtors have made no provision for expenses related to repairs and maintenance of the investment properties, nor for any contingencies or emergencies either to the properties or for their own support. Therefore, the Debtors' total projected monthly expenses, which this Court finds to be greatly deflated, total $8,825.83. If the Debtors' were to figure in the funds necessary to maintain all of the rental properties, the amount would most likely exceed the Debtors' cash reserve even if Greenpoint's interest rate remained unchanged. Therefore, it is abundantly clear that there are insufficient funds to make the required Plan payments once the interest rate on the Greenpoint mortgage is adjusted to 10%, the payment terms are reduced to twenty-five years, and the Debtors' true and actual expense are included.
III. CASH COLLATERAL
Greenpoint seeks a determination that the post-petition rental income is cash collateral, and therefore, pursuant to Section 363 of the Bankruptcy Code, the Debtors' use of such collateral is conditioned upon obtaining an Order of this Court. In this case, the assignment of rents clauses in the various mortgage agreements gave Greenpoint a security interest in the rents. Greenpoint perfected its security interest by recording the assignment of rents clauses. See Financial Center Assoc. v. The Funding Corp. (In re Financial Ctr. Assoc. of East Meadow, L.P.), 140 B.R. 829, 831 (Bankr.E.D.N.Y. 1992) (Under New York law, perfection of security interest in rents is accomplished by recording the assignment of rents clause). Where, as here, a mortgagee has a perfected security interest in the rents, the bankruptcy courts in this district have recognized rents as cash collateral, pursuant to §§ 363(a) and 552(b) of the Bankruptcy Code, even if prior to bankruptcy, the mortgagee took no action to enforce its right to collect the rents. In re Northport Marina Associates, 136 B.R. 911 (Bankr.E.D.N.Y. 1992). Therefore, this Court holds that the post-petition rental income constitutes cash collateral.
It is true that the Debtor was obligated to obtain permission to use the lender's cash collateral. However, in this case, a large equity cushion in the encumbered property exists. The property in question is valued at $1,010,000.00, while Greenpoints' indebtedness amounts to $605,916.43. Such a large equity cushion clearly constitutes adequate protection in this case. To deny the use of the cash collateral, which is the major source of the Debtors income, as a source for funding the Plan would preclude the Debtor from availing itself of the protections afforded by the Bankruptcy Code. Therefore, this Court finds that Greenpoint's interest in the rental income is adequately protected, and therefore, the Debtors are authorized to use Greenpoint's cash collateral to fund the Plan.
CONCLUSION
Although Greenpoint has a cash collateral interest in the post-petition rental income, the Debtor can use such collateral to fund a Plan. However, this Court finds that the Plan does not provide Greenpoint, a secured creditor, with the present value of its claim. Further, this Court cannot confirm the Debtors' Plan because it is not feasible and therefore violates 11 U.S.C. § 1129(a)(11). Therefore, the Debtors are denied confirmation of the proposed Plan without prejudice to file an Amended Plan within twenty (20) days of the date hereof.
Settle an order in accordance with this decision.