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
Here’s another excellent report from Jack Murray. I am still in China and likely
will not resume DD’s 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 didn’t 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).
Reporter’s 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.
Reporter’s 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.
Reporter’s 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."
Reporter’s 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.
Reporter’s 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.
Reporter’s 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.
Reporter’s 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.
Editor’s 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 Murray’s 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 Jack’s 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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