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A recent decision by the 8th U.S. Circuit Court of Appeals attests to the fact that while “drop dead” provisions will often work, don’t look for them to save an otherwise unfeasible plan. In In re Danny Thomas Properties II Limited Partnershipand its companion case, In re Danny Thomas Properties III Limited Partnership, Nos. 00-1524 and 00-1626 (8th Cir., filed March 5, 2001), the court affirmed a bankruptcy court decision in which an objecting secured creditor successfully challenged the debtors’ plans of reorganization on the grounds of feasibility. In doing so, the court analyzed the effect of “drop dead” provisions in Chapter 11 plans of reorganization. The facts of the case as summarized by the court are as follows. In the late 1980s and early 1990s, the debtors, co-owners of an apartment complex, suffered a series of financial setbacks that required them to restructure their loan agreement with the U.S. Department of Housing and Urban Development (HUD). In 1995, the HUD loan was sold to Beal Bank, S.S.B., and shortly thereafter, Beal commenced foreclosure proceedings against both debtors. In response, the debtors filed voluntary Chapter 11 petitions in the U.S. Bankruptcy Court for the Eastern District of Arkansas. The debtors’ plans of reorganization called for the payment in full of the bank’s claim, proposing to pay installments (presumably of both principal and interest) on the basis of a 30-year amortization schedule, with a “balloon” payment — a payment of the full amount of principal and interest then due and owing — at the end of 10 years. The plans further provided a strategy for ensuring a successful reorganization, including the establishment of a maintenance reserve of $50,000 per year to cover any anticipated loss in value of the complex over the life of the plans. Perhaps in anticipation of the bank’s objection to confirmation of the plans, the debtors inserted “drop dead” provisions in their plans. These provisions stated that in the event that the debtors failed to cure any default in the plans after a 45-day notice period expired, the debtors would consent to the immediate initiation of foreclosure proceedings. The plans further gave the bank the right to obtain an ex parte order from the bankruptcy court granting relief from the automatic stay (of Bankruptcy Code � 362) in order to commence the foreclosure proceedings. The bank, in objecting to confirmation of the plans, in effect said that the “drop dead” provisions were not enough. It argued that based on the debtors’ own financial projections, the plans were not confirmable because they did not satisfy the provisions of � 1129(a)(11) of the Bankruptcy Code, which states that in order for a court to confirm a plan of reorganization under that subsection, a court must find that a plan “is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor….” By contrast, the debtors argued that as a matter of law, inclusion of the “drop dead” provisions made the plans feasible, because (a) the provisions amounted to liquidations, and (b) liquidations are a contemplated allowable purpose of Chapter 11 plans of reorganization. The Court of Appeals agreed with the bank. It concluded that the liquidations contemplated by the “drop dead” provisions of the plans of reorganization proposed by the debtors “do not amount to liquidations for purposes of � 1129(a)(11).” The court stated that a liquidation — whether in or out of bankruptcy — contemplates the end of a debtor’s existence ( citing Maytag Corp. v. Navistar International Transportation Corp., 219 F.3d 587, 591 (7th Cir. 2000)). The 8th Circuit noted that the “drop dead” provisions in the debtors’ plans of reorganization did not amount to or contemplate the end of the debtors’ existence, but merely the removal of a part (recognized by the court to be the significant part) of the estate. Notwithstanding the “drop dead” provisions, the debtors would continue to exist post-foreclosure. And since the plans did not provide for the liquidation of the debtors but rather a liquidation of some, but not all, of the debtors’ assets, the provisions of � 1129 (a)(11) were not satisfied as a matter of law. Perhaps more significant than the court’s direct holding is its observations regarding the effect of holding that a “drop dead” provision in this type of case satisfies the “feasibility” requirement of � 1129(a) as a matter of law. The circuit court noted that if it were to accept the proposition that any plan of reorganization, no matter how speculative, could pass the “feasibility” test by including a “drop dead” provision, such a reading “would eliminate the courts’ duty under � 1129(a)(11) to protect against visionary schemes,” citing In the Matter of Pizza of Hawaii, 761 F.2d 1374, 1382 (9th Cir. 1985). Similar cases, the court held, were distinguishable. The court noted that in other cases, such as In the Matter of T-H New Orleans Limited Partnership, 116 F.3d 790 (5th Cir. 1997), and In re Nite Lite Inns, 17 B.R. 367 (Bankr. S.D.Cal. 1982), the courts, after detailed analysis, concluded that upon liquidation under the “drop dead” provisions of a plan, the secured creditor’s claim would be paid in full. The 8th Circuit thus concluded that the “drop dead” provision in the debtors’ plans of reorganization did not make the plans of reorganization feasible as a matter of law, but rather, that such provisions are “entitled to be considered…when evaluating the prospects for success.” The court then examined the evidence presented to the bankruptcy court in support of the debtors’ contention that notwithstanding the “drop dead” provisions, the financial provisions made the plans feasible. The court recognized that while it is not necessary to demonstrate that success be guaranteed ( citing In re Monnier Brothers, 755 F.2d 1336, 1341 (8th Cir. 1985)), proponents of plans must show that it is at least reasonably likely that a plan will result in full payment. Using that standard, the court agreed with the bankruptcy court that the debtors had not met their burden. The court found first that the net operating income of the complex was simply insufficient to pay plan obligations. Second, and more particularly, the court found that there would be insufficient funds to fund the maintenance reserve that was needed in this case, since the complex would deteriorate without regular maintenance and jeopardize the value of the bank’s collateral. The court noted that without a sufficient maintenance reserve, the complex would be less attractive to tenants and thus the prospect of future plan payments would be thrown into doubt. Those findings by the bankruptcy court, the circuit court noted, were not in error. In sum, the economics of the plans of reorganization, unlike those in T-H New Orleansand Nite Lite, demonstrated that the value of the bank’s collateral would not remain steady, or increase, during the life of the plans. Feasibility, the court stated, must be firmly rooted in predictions based on objective fact ( citing In re Clarkson, 767 F.2d 417, 420 (8th Cir. 1885)). These plans of reorganization were not. The bankruptcy court’s denial was thus affirmed. Myron A. Bloom is a shareholder with the firm of Hangley Aronchick Segal & Pudlinin Philadelphia. Telephone: (215) 496-7005; e-mail: [email protected]

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