[Bank of America v. North LaSalle Street Partnership]
Facts
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Bank of America (BoA)
was the major creditor of LaSalle. It had lent $93mm, which was secured by a
non-recourse mortgage on the debtor’s principal assets, which was a building in
Chicago. Upon default, BoA started foreclosure which the debtor
responded to with a Chapter 11 voluntary petition, trying to ensure that
the partners retain title to the property, which would fall due if the
bank foreclosed. If BoA foreclosed, the debtor would incur a huge tax
liability. Generally, the debtor was driven by tax consequences while
forming the plan. The value of the property was less than the amount due
(BoA undersecured, resulting in an unsecured deficiency claim under
Sec. 506(a) and Sec. 1111(b)). The Bank wanted to quickly foreclose and
sell and not to reorganize the debtor.
The plan provided the following structure:
Repayment of 2/3 of the loan
Discharge of the rest
Contribution of $6mm by the old owners in exchange for the entire property of the partnership.
BoA
blocked the plan (it could do it because its deficiency claim was
impaired), seeking that the absolute priority rule was not recognized in
the plan. The other unsecured creditors would not object because they
would prefer to get paid without interest, but quickly. They are trade
creditors who had long term r-ship and whose payments depend on the
debtor (they just want to continue business). The debtor wants to cram
down the Bank’s deficiency claim.
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Legal Issue
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Whether
and under what circumstances can the old equity be paid over the
unsecured creditors? What are the exceptions to absolute priority rule?
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Holding
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The
old equity cannot have an exclusive right (in the absence of any
competing plan) to obtain property interest in the reorganized debtor
over the unsecured creditors, without paying full value for an option to
be able to obtain this property.
Instead
of giving such exclusive right to the old equity, a market test should
be established to assess whether the old equity offers the highest bid
for the property in the reorganized debtor, or whether there are higher
bids out there.
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Reasoning
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The court analyzed the three interpretations of the expression “on account of” in sec. 1129(b)(iii)(B)(ii):
If
on account of means “in exchange for”, there plan does not violate the
absolute priority rule as long as the equity makes a new contribution to
the new firm. This is not the case as the language of the code (“or
retaining property”) clearly shows.
Instead,
the phrase could mean “because of” as it also means in other parts of
the code, meaning that the casual relationship between holding of the
prior claim and receiving property in the reorganized debtor activates
the absolute priority rule. The question here is then, why the phrase
was not just omitted if old equity holders should just be excluded from
receiving new equity.
The
phrase thus has to be understood correctly as a reconciliation of
policies preserving going concerns and maximizing property available to
satisfy creditors (this is the correct interpretation according to the
court).
Under
the debtor’s plan, the benefit of equity in the reorganized p-ship can
be obtained only by the old equity partners. Upon the court’s approval
of the plan, the partners were in the same position that they would have
enjoyed have they exercised an exclusive option under the plan to buy
the equity in the reorganized entity, or contracted to purchase it from a
seller. At the moment of the plan’s approval the debtor’s partners
necessarily enjoyed an exclusive opportunity that was in no economic
sense distinguishable from the advantage of the exclusively entitled
offeror or option holder. While it can be argued that such opportunity
has no market value, being significant only to old equity because of
their potential tax liability, it is established that any cognizable
property interest must be treated as sufficiently valuable to be
recognized under the Code.
The
opportunity to buy in the reorganized debtor has value (like call
option). The opportunity to give value is already an asset and the old
equity has not paid for that (option to buy new equity on account on
having old equity). This is what the court claims violates the absolute
priority rule. The court has doubts why the old equity should have this
exclusive opportunity to purchase the new equity. If the price that the
new equity offers is the best, they don’t need such protection (we trust
the market to do such evaluation). Thus, the court establishes the
market test, but does not elaborate on it further.
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