Daily Development for Monday, March 15, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

Hereís another excellent report from Jack Murray. I am still in China and likely will not resume DDís until after next week, as I am at UMKC for one day only before leaving for the ACREL meeting. But I liked this one and didnít want to keep it sitting.

BANKRUPTCY; AUTOMATIC STAY; WAIVER; FORECLOSURE: Florida court narrows range of cases in which courts will honor stipulations by which a borrower in mortgage loan workout negotiations stipulates to lifting of automatic stay to permit lender to foreclose should borrower file for bankruptcy following forebearance period.

In re Deb-Lyn, Inc., 2004 Bankr. LEXIS 200 (N.D. Fla., Feb. 20, 2004)

A mortgage lender commenced pre-petition foreclosure proceedings against the borrower-debtor, Deb-Lyn, Inc. on several commercial retail properties. Prior to the entry of final judgment, the lender and Deb-Lyn entered into an "interim" workout and forbearance agreement, which provided that in consideration for the lender's agreement to abate the pending foreclosure proceedings, Deb-Lyn "would not oppose or object to the [lender's] motion for relief from the automatic stay should it should it file for bankruptcy relief in the future."

The court noted that the issue of the enforceability of pre-petition waivers had produced much litigation (especially in Florida) and that the court itself previously had upheld the enforceability and validity of such waivers under certain circumstances. In this case, the lender insisted that the pre-petition agreement entered into by Deb-Lyn, absent any "radical and new development" that drastically altered its economic position, should be enforced and constituted sufficient grounds for lifting the automatic stay. Deb-Lyn, on the other hand, asserted that prior Florida bankruptcy decisions upholding pre-petition waivers of the stay were distinguishable. Specifically, Deb-Lyn argued that they either involved the situation where the debtor was a single-asset entity (or owned only one parcel of real estate) where no reasonable possibility of reorganization existed (i.e. "bad faith" bankruptcy filings), or else the situation where the waiver was included within an agreement or bank ruptcy plan previously approved by a bankruptcy court.

Based on the facts of the instant case, the court agreed with Deb-Lyn. The court reasoned that pre-petition waivers of the bankruptcy stay are not per se enforceable (and rejected any prior Florida bankruptcy decisions that may have been deemed to support this position) and stated that this was not a "bad faith, single-asset case with no possibility of reorganization coupled with a waiver of stay previously approved by the court."

The court noted that Deb-Lyn was an active, ongoing business with almost 200 employees and substantial income, and that this was not a situation where the debtor filed bankruptcy at the last minute to thwart deliberately the lender's pending foreclosure proceeding. The court noted further that this was not a dispute between the debtor and a single creditor and that the lender's claim was only a small portion of the total claims against the debtor; in fact Deb-Lyn had four major secured creditors with a combined $9 million in debt and more than 103 unsecured creditors with more than $1.6 million in aggregate debt.

The court also pointed to another distinction in this case that weighed in Deb-Lyn's favor, i.e., the fact that the pre-petition waiver was not part of a confirmed plan of reorganization where other third-party creditors would have had the opportunity to object to or approve the plan (including waiver of the automatic stay).

Reporterís Comment 1: In an attempt to negate the effects of a subsequent bankruptcy, many mortgage modification and forbearance agreements executed during loan workout negotiations contain provisions whereby, among other things, the mortgagor agrees to waive the automatic stay, whether such proceeding is voluntary or involuntary. Lenders typically seek to include such a provision in order to implement and effectuate the enforcement of state law remedies, such as receivership, foreclosure or assignments of rents, irrespective of the bankruptcy. These provisions generally expressly provide that the borrower will not object or oppose the lender's motion for relief from the automatic stay.

Reporterís Comment 2: The Bankruptcy Code ("Code") does not expressly prohibit pre-petition waivers of the automatic stay. Section 558 of the Code, however, provides that waivers of defenses subsequent to the filing of the petition are not binding on the estate. Supporters of pre-petition waivers maintain that enforcement of such provisions is necessary in order to facilitate and effectuate pre-bankruptcy consensual workout arrangements. They also argue that such agreements are supported by new and valuable consideration in the form of forbearance in the exercise of the lender's legal rights and remedies, as well as other lender concessions and accommodations. Opponents of these provisions, however, assert that they should not be enforced because they are contrary to the rehabilitative goals of Chapter 11, usurp the authority of bankruptcy judges, and are burdensome to the estate.

Enforcement of such provisions means that the debtor is usually unable to reorganize and must liquidate, thereby leaving little, if any, available assets for distribution to unsecured creditors of the bankruptcy estate.

Reporterís Comment 3: In another recent case involving the enforceability of a relief-from-stay clause, SouthWest Ga. Bank v. Desai (In re Desai), 282 B.R. 527 (Bankr. M.D. Ga. 2002), a Georgia bankruptcy court ruled that the automatic-lift-of-stay language contained in the Chapter 11 reorganization plan of the mortgagor-debtor, Desai, which was confirmed by the bankruptcy court in Desai's prior Chapter 11 proceeding, was not enforceable against him in his subsequent Chapter 11 case. Desai and the lender bank had entered into a mortgage-loan restructuring agreement as part of Desai's reorganization plan in the prior proceeding, which agreement contained language stating that he would not oppose, and consented to, a lifting of the automatic stay in any future bankruptcy or insolvency case or proceeding. Desai subsequently defaulted on his obligations under the plan and the lender commenced foreclosure proceedings. Desai responded by filing a new Chapter 11 bankruptcy proceeding one day before the scheduled foreclosure sale.

Desai argued that the pre-petition bankruptcy waiver he had executed as part of the plan confirmed in his first bankruptcy proceeding should not be enforced against him in the present case because such agreements are not per se enforceable and there was at least one third-party creditor whose rights would be adversely affected by enforcement of the provision. The court noted that this was an issue of first impression in Georgia and in the Eleventh Circuit. The court also noted that bankruptcy courts were divided on the issue, with some holding such provisions valid and others finding them unenforceable.

The court agreed with the holdings in prior cases with fact patterns similar to the instant case, i.e., negotiated pre-petition agreements that were part of a plan of reorganization in a prior bankruptcy case. (The court found that the facts in the following two cases were most analogous to the facts in the instant case: In re Atrium High Point Ltd. Partnership, 189 B.R. 599, 602-03, 609-7-08 (Bankr. M.D.N.C. 1995) (upholding validity of negotiated relief-from stay provision entered into as part of reorganization plan in prior bankruptcy case); and In re Excelsior Henderson Motorcycle Mfg. Co., Inc., 273 B.R. 920, 924 (Bankr. S.D. Fla. 2002) (ruling that waiver was enforceable in circumstances where (1) waiver was one incorporated into a plan and approved by a bankruptcy court and (2) debtor received valuable consideration in exchange for waiver, court would enforce waiver).) The court noted that this was not a situation where the agreement was contained in the original loan doc
uments. The court cautioned, however, that such provisions are not per se enforceable or self-executing, and stated that, "the following factors must be considered: (1) the sophistication of the party making the waiver; (2) the consideration for the waiver, including the creditors' risk and the length of time the waiver covers; (3) whether other parties are affected including unsecured creditors and junior lienholders, and (4) the feasibility of the debtor's plan." Id. at 532.

The court found that the agreement in the instant case was negotiated and executed by sophisticated parties who were represented by competent counsel, and that adequate consideration existed in the form of a five-year extension of the maturity date of the mortgage loan. The court also found that there was only one pro se creditor who appeared and objected to relief from the stay, and that that individual had a fully secured interest in other property of the estate and therefore had no interest in the property on which the lender was seeking relief from stay. The court found further that at the current stage of the instant bankruptcy case, the feasibility of the mortgagor-debtor's plan could not be determined.

But the court ruled that the lender had not met its burden of demonstrating that there was no equity in the mortgagor-debtor's real property above the amount owed to it. The court noted that the lender acknowledged that an appraisal of the property in 1997 (more than two years before the debtor filed its initial Chapter 11 bankruptcy petition) concluded that the property was worth well in excess of the debt owed to the lender. Credible and uncontradicted evidence also was introduced that Desai had made significant improvements to the property (a hotel), that the property's occupancy rate had increased, and that a purchaser had offered $400,000 more than the appraised value to purchase the property but that the deal had fallen through because the purchaser could not obtain financing. Because only some - and not all - of the factors were in the lender's favor -- and because the lender, according to the court, failed to prove that Desai had filed the second bankruptcy case in bad fai th even though it filed the day before the scheduled foreclosure sale (according to the court, "Merely because Debtor filed the current case the day before the foreclosure sale was to take place does not amount to a bad faith filing as defined in the Eleventh Circuit cases." Id. at 533) -- the court refused to grant relief from the stay "at this time."

Reporterís Comment 3: To sustain the enforceability of a waiver of the automatic bankruptcy stay, it is generally a good idea to set forth the factual circumstances surrounding the transaction at the time the documents are executed. However, several courts have expressly refused, for a variety of reasons, to enforce such waivers. It is unclear, as a result of the holdings in the various cases that have dealt with this issue, whether bankruptcy courts will uphold relief-from-stay provisions in the future. Real estate lenders should certainly be judicious in their use of relief-from-stay provisions in loan workout documents, and may wish to restrict their use and attempted enforcement to true workout situations where the following factors are present:

* Consideration (in the form of forbearance, loan concessions or modifications by the lender, etc.) is clearly established;

* Few, if any, other creditors (secured or unsecured) have or may assert significant claims against the borrowing entity (or such other creditors specifically consent in writing to the relief-from-stay provision or execute the document containing the relief-from-stay provision);

* The borrower has been represented and advised by competent counsel;

* The agreement clearly states the specific facts and circumstances that support a finding of cause for relief from the stay (i.e., the lack of need for, or appropriateness of, bankruptcy reorganization, as well as lender reliance thereon as evidenced by recitals that indicate that the borrower has no realistic chance for reorganization, has few or no employees, has few or no unsecured creditors, has no equity in the property, and has no assets other than the property); and

* The lender can conclusively demonstrate that the outstanding loan balance exceeds the value of the property.

Reporterís Comment 4: Furthermore, when drafting a relief-from-stay provision, lenders would be well advised to specifically state that the enforcement of the relief-from-stay provision is expressly subject to the approval of the bankruptcy court, in order to avoid the implication that the lender is attempting to oust the bankruptcy court of its jurisdiction and its authority to decide the enforceability of such a provision. See, e.g., In re Sky Group International, Inc., 108 B.R. 86 (Bankr. W.D. Pa. 1989), where the court held that a creditor's unilateral assertion of an automatic right to relief from the bankruptcy stay was a threat to the court's jurisdiction, and must be specifically authorized by the bankruptcy court, which the court emphasized it had no intention of doing in this case.

Reporterís Comment 5: Pre-bankruptcy waiver provisions are generally not self-executing, despite what the language in the provision may provide (e.g., that the automatic stay is automatically lifted upon the filing of the bankruptcy petition). The lender must file a motion to lift or annul the automatic stay under Section 362 of the Code, and notice the motion to creditors and parties in interest in the estate. (In Michigan, for example, the applicable local bankruptcy rules provide that such motions are filed on a 15-day notice and opportunity.) If no objections are filed within the noticing period (e.g., 15 days, plus three days for mailing), a certification of no response is filed seeking entry of the order. On the other hand, if objections to the motion are filed, the court schedules a hearing for determination and resolution of the matter.

Reporterís Comment 6: The National Bankruptcy Review Commission recommended that Section 558 of the Code be amended specifically to preclude the enforcement of all pre-bankruptcy agreements that modify the debtor's rights under the Code, unless expressly allowed under other provisions of the Code. But the most current version of the bankruptcy reform legislation pending in Congress does not address the enforcement of such agreements. The enforceability of pre-bankruptcy provisions seeking to waive the automatic stay will, therefore, continue to be subject to varying - and often conflicting - court decisions. The trend of recent case law is that automatic-lift-of-stay provisions are neither per se enforceable in bankruptcy nor self-executing in favor of the lender, and will not bind third parties not a party to the agreement where the rights of such parties would be adversely affected and cause for lift of the stay does not otherwise exist. Instead, bankruptcy courts likely wil l consider and evaluate the enforceability of such clauses in the context of the fact pattern of each individual case, including the existence -- or non-existence -- of the relevant factors set forth in recent bankruptcy cases.

The existing body of case law on this issue is still confusing and contradictory -- some courts limit enforcement of such waivers to single-asset real estate cases, and others have held that such waivers are per se enforceable, while still other courts will only enforce the provisions under specified conditions. As noted above, such waivers are generally viewed by the courts on a case-by-case basis and are subject to a review of all the facts and circumstances surrounding the giving of the waiver. A lender cannot assume, however, that a court will necessarily enforce a waiver of the automatic stay merely as a result of the parties' contractual agreement. Ultimately, the enforceability of a waiver will depend on the ability of the lender to demonstrate, to the court's satisfaction, that the proper conditions for enforcement exist.

Editorís Comment: One would expect a bankruptcy court to take seriously a waiver of the right to object to relief from stay if such waiver had been approved by a bankruptcy court in a prior bankruptcy proceeding involving the same parties. Even in such cases, it is clear that the subsequent court retains discretion, often used, to reject such a waiver. Jack Murrayís comments above, however, properly focus on the more dicey question - when there is no prior court approval, is there any hope for enforcement of such a waiver.

From Jackís report above, it appears that in fact the circumstances in which a court will approve a waiver to object to relief from a stay (absent prior court approval of the waiver) are very nearly the same as those in which the court would have granted relieve even without the waiver. Perhaps the most significant difference is that, without the waiver, the lender would also have to prove that the asset is not material to a possible reorganization. But in most of the circumstances in which the court granted relief based upon the waiver, the record of facts relied upon by the court would appear also to support the conclusion that no reorganization would be possible. It is likely, however, that the debtor, absent the waiver, would be granted a little more time to try to make the case for reorganization.

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