Appellate Court Upholds Lenders’ Effort to Protect Collateral in Bankruptcy

A Seventh Circuit U.S. Court of Appeals decision affirming a bankruptcy court decision represents a major victory for undersecured lenders holding distressed real estate collateral. The case, In re River East Plaza, LLC, No. 11-3263, -- F.3d -, 2012 WL 169760, involved the River East Art Center near Chicago’s Navy Pier.

“The debtor in this case defaulted on its mortgage obligations almost three years ago, using the legal system to delay the inevitable,” says Mark A. Berkoff, chairman of the Financial Restructuring & Bankruptcy Group and a partner at Neal, Gerber & Eisenberg, LLP (Chicago), which was lead counsel to the property owner’s senior secured lender, LNV Corp. “In affirming the bankruptcy court’s decisions to lift the automatic stay in favor of LNV and to dismiss River East’s bankruptcy case, Judge Posner determined that ‘LNV, having waiting years to enforce its lien, the bankruptcy judge was not required to stretch out the Chapter 11 proceeding any longer.’”

This decision, Mr. Berkoff explains, is important because it validates a secured lender’s ability to make the Section 1111(b) election to defeat a debtor’s deficient cram-down plan. The 1111(b) election is noteworthy because:

• It allows a secured creditor to “elect” to have its entire claim treated as secured.
• It allows the secured lender to retain its lien on the property until that secured claim is paid in full.
• It is appropriate when the secured creditor believes the property is undervalued and will appreciate, and when the lender believes the reorganized debtor may later default under its confirmed plan.
• However, the secured creditor, in making the election, must agree to waive its undersecured deficiency claim, which, in this case, totals approximately $25 million.

Nicholas M. Miller, also a partner at Neal Gerber who was involved in the case, points out that at the heart of this case is Section 1111(b), one of the most complicated sections of the bankruptcy code. “The wording is confusing and, therefore, rarely invoked because it has been highly misunderstood in the past. The Seventh Circuit has now provided clarity as to how and when to use that particular section.”

Ultimately, what the Seventh Circuit did was bring stability back to the lending markets, adds Mr. Miller. “The opposite result could have been disastrous. This decision adds clarity and comfort, and the Seventh Circuit did a good job of concisely explaining what is clearly one of the more complicated sections of the bankruptcy code.”

Mr. Berkoff and Mr. Miller are available to discuss the decision and its ramifications, which are likely to have wide-reaching impacts as lenders strive to clean up the distressed real estate market.   [02/07/2012]