Case No. 95-11924-AM (Jointly Administered), Contested Matter No. 95-769United States Bankruptcy Court, E.D. Virginia
September 14, 1995
Kevin O’Donnell, Esquire, McKinley, Schmidtlein, O’Donnell
Bornmann, P.L.C., Alexandria, VA, counsel for debtors
David R. Ruby, Esquire, McSweeney, Burtch Crump, Richmond, VA, counsel for Fannie Mae
MEMORANDUM OPINION
STEPHEN MITCHELL, Bankruptcy Judge
This matter is before the court on the motion of The Federal National Mortgage Association (“Fannie Mae”) for relief from the automatic stay in order to foreclose under a deed of trust against two apartment buildings that constitute essentially the sole asset of 1436-1438 Meridian Place General Partnership (the “debtor”), one of the debtors in these jointly administered cases. A preliminary hearing at which nearly 6 hours of testimony was taken was held on August 10, 1995. At the hearing, the chapter 11 trustee advised the court that he would not oppose relief from the stay. The debtor, however, appeared and vigorously opposed relief. At the conclusion of the hearing, the court ordered that the stay be continued in effect until a final hearing could be held on September 8, 1995. At the final hearing, the debtor orally withdrew its opposition to the
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motion. Even though there is now no party in interest before the court opposing relief from the stay, some brief discussion of the issues is nevertheless warranted because of the impact termination of the stay may have on the public interest and because debtor’s counsel has raised a separate issue as to whether the chapter 11 trustee’s decision not to contest relief from the stay should have been noticed to creditors under F.R.Bankr.P. 400 l(d) as an “agreement” to terminate or modify the automatic stay.
The debtor is a general partnership whose sole asset is a renovated two-building, 58-unit residential apartment complex known as the “Concetta Courts” apartments located at 1436-1438 Meridian Place, N.W., Washington, D.C.[1] On September 22, 1989, The Patrician Mortgage Company made a loan of $3,600,000.00 to the debtor secured by a properly recorded deed of trust against the property, by a perfected UCC security interest in all appliances, equipment, supplies and fixtures, and by a recorded collateral assignment of rents. The note bears interest at 9.5% per annum, is amortized over 30 years but due at the end of seven years, and calls for payments of $29,578.02 per month. The note has been assigned to Fannie Mae.
The debtor, having fallen behind in its payments on the note, filed a voluntary chapter 11 petition in this court on May 16, 1995. On June 15, 1995, this court ordered the appointment of a chapter 11 trustee. The chapter 11 trustee, after examining the debtor’s problematic cash flow situation and taking into account the difficulty of getting paid, advised the court at the preliminary hearing that he had made a business judgment not to oppose Fannie Mac’s motion for relief from
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stay.
The principal balance on the note on the date of the chapter 11 filing was $3,508,826.05. Accrued interest, calculated at the contract rate of 9.5%, amounted to $88,305.46, [2] and late charges totalled $4,436.70. The only dispute with regard to the note centers on the noteholder’s claim to an additional $156,095.96 as a “yield maintenance premium” — essentially a prepayment penalty — under an addendum to the note. The provision in question[3] allows the noteholder, in
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the event of a prepayment within the first seven years, to collect an additional sum based on the present value of the difference, over the remaining term of the prepayment period, between the then-current yield on a certain specified U.S. Treasury security and the contract rate of the note, but in no event less than 1% of the loan principal. The noteholder’s witness testified that the calculation of the sum in question had been made by another employee using a computer “spreadsheet program” which that employee had set up, but that he, the witness, had verified the calculation using a pocket financial calculator. The witness was unable, however, to testify as to the crucial component going into the calculation, namely, what value had been used as the applicable yield on 7 7/8% U.S. Treasury Securities due July 1996. This prevented any meaningful cross-examination on the issue and effectively precluded the court and opposing counsel from testing the witness’s conclusion by attempting to repeat, or to have the witness repeat, the calculation. Additionally, the witness was unable to point to any provision of the note that would make the prepayment provision applicable where the payments due on the note had been accelerated[4] and simply asserted that it was the noteholder’s “policy” to add such amount in the event of acceleration.
For the purpose of ruling on the motion for relief from stay, the court does not find that Fannie Mae has established its right to the yield maintenance premium. First, the failure to prove the yield on 7 7/8% U.S. Treasury Securities due July 1996 left the court unable to review or test in any meaningful way the noteholder’s bald assertion of the amount due. Put another way, if the noteholder’s own witness is unable on the witness stand to repeat the calculation, the court has
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little confidence in his assertion that he calculated it months ago and obtained a particular result. Second, and more to the point, the prepayment language in the note addendum specifically addresses only voluntary prepayment. The plain language of the acceleration clause in the note itself specifically makes due on acceleration “the entire principal amount outstanding and accrued interest thereon,” with no mention of the “yield maintenance premium.” To the extent that the note addendum — a printed form evidently prepared by the lender — is ambiguous regarding liability for the prepayment penalty in the event of acceleration as opposed to a voluntary prepayment, such ambiguity is properly resolved against the lender. Finally, where, as here, the debtor is proposing not to pay off but to restructure and pay the note balance, consideration of the prepayment penalty as part of the indebtedness for the purpose of establishing the debtor’s equity, or lack of equity, in the property is inappropriate. For the foregoing reasons, the court uses $3,601,568.21 as the amount of the indebtedness for the purpose of determining whether the debtor has equity in the property.[5]
The major factual issues are the value of the real estate and whether, in light of the debtor’s present and anticipated cash flow and the asserted declining character of the neighborhood in which the property is located, there is a reasonable prospect of reorganization. On the issue of value, Fannie Mae presented the testimony of an appraiser, Lee M. Cissna, III,
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who had previously appraised the property in 1988, when the loan was originated.[6] Mr. Cissna testified that in his opinion the fair market value of the property as of June 30, 1995, was $1,485,000.00 using the income approach to valuation, which he believed was the most applicable to the property in question.
Factors that heavily influenced Mr. Cissna’s valuation were that the property, although itself attractive and well-maintained, was located in a high-crime area that had been steadily deteriorating in the last several years and that a majority of the tenants occupying approximately 40 of the 58 units-were participants in the District of Columbia’s Tenant Assistance Program (“TAP”), under which a portion of the tenant’s rent was paid by the District of Columbia government. Because an impending change to the TAP program would reduce the subsidy paid from 70% to 60% of the rent — requiring the tenant to pay 40% rather than 30% — the appraiser predicted a “large exodus” of TAP tenants suddenly unable to pay their rents. As a result, the appraiser postulated that a purchaser of the property would incur approximately $236,000.00 in “conversion” costs — essentially fix-up expenses — to make the property attractive to market-rate tenants.[7] Additionally, the appraiser valued the property based on market-rate rents, which are 10 to 20% lower than the TAP rents.[8]
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The debtor’s witness testified that the reduction in the level of the TAP subsidy actually took effect in March 1993 for new tenants, with existing tenants being grandfathered until October 1, 1995. Of the 40 units now occupied by TAP-subsidized tenants, only 16 pre-date March 1993 and will be effected by the reduction taking place on October 1, 1995. In addition, the debtor’s witness testified that Concetta Courts was among the more desirable of TAP-subsidized apartments. The debtor also presented evidence that historical rent receipts were substantially higher, and historical operating expenses substantially lower, than the figures used by the appraiser in performing his income capitalization computations. What the true figures are cannot, on the evidence presented, be determined with certainty. The debtor offered an exhibit purporting to summarize income and expenses for the period from 1990 through 1994. The figures on the summary chart, however, did not entirely comport with the debtor’s year-end financial reports for the same period and were apparently extracted from the debtor’s tax returns, which were not in evidence. Additionally, the debtor’s witness did not know whether the year-end financial reports were compiled on a cash basis or an accrual basis. Nevertheless, the court, while recognizing the uncertainties, finds, based on the year-end financial reports, that the debtor’s historical rental income for the period 1990 through 1994 averaged $549,006 per year and operating expenses averaged $196,294 per year.
The court finds that there is little likelihood that the “exodus” of TAP tenants postulated by the appraiser will occur. The court further finds that the historical income and expense figures to be more probative of future income and expense than the hypothetical figures derived by the
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appraiser. Additionally, the court finds that the 12% income capitalization rate used by the appraiser is inappropriately high[9]
based on his own comparables, and that a more appropriate capitalization rate would be 11.6%. Using the historical average figures, a capitalization rate of 11.6%, and the appraiser’s assumed 10% vacancy/rent loss factor, but not deducting “conversion costs,” results, using the appraiser’s methodology, in a valuation of $2,567,340.
For the foregoing reasons, although the court does not adopt the appraiser’s $1,485,000.00 opinion of fair market value, the court finds that the fair market value does not exceed $2,500,000.00, and is probably closer to $2,200,000.00[10] Accordingly, it is clear beyond cavil that the debtor has no equity in the property. In addition to the $3,601,568.21 owed on Fannie Mae’s first deed of trust, the debtor’s schedules reflect that approximately $383,500.00 is owed on a second deed of trust in favor of the District of Columbia Department of Housing and Community Development.
Under § 362(d)(2) of the Bankruptcy Code, a secured creditor is entitled to relief from the automatic stay if the debtor has no equity in the collateral and the property is not necessary for an effective reorganization. An “effective” reorganization is one that has a reasonable prospect of occurring within a reasonable period of time United Savings Ass’n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 465, 108 S.Ct. 626, 632, 98 L.Ed.2d 740 (1988). The secured creditor has the burden of proof on the issue of lack of equity, while the party opposing
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relief has the burden of proving that the property is necessary for an effective reorganization. § 362(g), Bankruptcy Code. Some limited evidence bearing on reorganization potential was presented at the preliminary hearing, and one of the reasons the court continued the motion for a final hearing was (in addition to giving the debtor an opportunity to obtain its own appraisal) to present additional evidence as to reorganizations prospects.
Since the debtor has now withdrawn its opposition to Fannie Mae’s motion, ordinarily there would be no reason for the court to consider the issue further. There are two concerns, however, that justify an independent assessment by the court of the debtor’s reorganization prospects. The first is the public interest in decent affordable housing. Although the evidence before the court clearly established that the immediate neighborhood around Concetta Courts would charitably be characterized as dilapidated, the property itself is attractive and has been well-maintained — an “oasis,” as even one of the lender’s witnesses described it. Whether from a genuine commitment to maintaining the supply of affordable housing or from motives of simple profit — as noted above, TAP rents are typically 10 to 20 percent higher than market rents, and the debtor’s witness testified that TAP tenants remain longer — the undisputed fact is that the debtor undertook a first-class renovation of the buildings when it acquired them and has consistently made a large block of units available to tenants who could not otherwise afford decent rental housing in the District of Columbia. The court has little confidence that the lender or a bidder at a foreclosure sale would be similarly committed, and the result of granting relief from the stay could therefore potentially be the loss to the lower-income citizens of the District of Columbia of a significant number of desirable subsidized rental apartments.
Second, the debtor, although withdrawing its own opposition, has raised the issue of
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whether the chapter 11 trustee’s decision not to oppose Fannie Mae’s motion is an “agreement . . . to modify or terminate the stay” requiring notice to creditors under F.R.Bankr.P. 4001(d) and an opportunity to be heard. Specifically, the debtor complains that the lender, as part of its negotiations with the trustee, agreed at least informally that it would not oppose the payment of the trustee’s fees and that of his professionals out of its cash collateral.[11]
Viewed realistically, the debtor’s prospects for reorganization are at the very least problematical. Neither the debtor nor any party in interest has proposed a plan of reorganization. As noted above, the debtor’s only asset is currently worth no more than $2,500,000.00 and is saddled by approximately $3,955,000.00 of debt. While the value of the buildings appears stable in the short run, there is no evidence that the buildings will appreciate in value and some that they may decline if the surrounding neighborhood continues to deteriorate. The historical cash flow has just barely been sufficient to pay debt service, and debt service payments have frequently been late, due at least in part to substantial delays — in one instance, 58 days — by the Government of the District of Columbia in remitting TAP payments. Although the debtor’s witness testified that the timeliness of TAP payments had greatly improved in the last few months, the court cannot ignore the District of Columbia’s current grave fiscal crisis which has necessitated the appointment of a financial control board. Although the pro forma financial projections offered by the debtor at the preliminary hearing showed a healthy bottom line, that budget assumed a reduction of approximately $50,000 per month in debt service, achieved by lowering Fannie Mae’s interest rate from its present 9 1/2% to 8%.
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There is no suggestion that Fannie Mae would consent to the interest rate reduction. Accordingly, the debtor, if it proposed such a plan, could achieve confirmation only by satisfying the stringent “cramdown” requirements of § 1129(b) of the Bankruptcy Code. The claims, in addition to the two deeds of trust against Concetta Courts, consist of $30,343.00 in tenant security deposits, $9,642.75 in non-insider general unsecured claims, and $90,993.64 in insider general unsecured claims. If the unsecured portion of the two deeds of trust were placed in the same class as non-insider general unsecured claims, the lender deficiency claims would control that class. Even assuming that the debtor may properly classify the security deposit claims separately and were successful in getting that class to vote in favor of the plan, the debtor would still have to surmount two additional hurdles. First, it would have to show that 8% interest satisfies the requirement of § 1129(b)(2)(A)(i)(II) that Fannie Mae receive deferred payments having a present value equal to the amount of its secured claim. Second, if the unsecured claims are not to be paid in full, the debtor has to get past the bar of the absolute priority rule as embodied in § 1129(b)(2)(C)(ii). Assuming, without deciding, that the “new value” exception would allow the debtor’s general partners to retain their equity interest in the debtor in exchange for a substantial cash infusion, there is no indication that the general partners (who are themselves chapter 11 debtors) have either the resources or willingness to do so. Accordingly, although a confirmable plan of reorganization is not beyond the realm of possibility, prospects of a reorganization do not appear bright.
With respect to the debtor’s argument that further notice is required, the record reflects that Fannie Mae’s motion for relief from the automatic stay was served on all the parties entitled to notice under F.R.Bankr.P. 4001(a). Those same parties are also entitled under
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F.R.Bankr.P. 4001(d) to notice of any “agreement” to modify or terminate the automatic stay, unless the court finds that notice of the motion for relief from stay given under Rule 4001(a) was “sufficient to afford reasonable notice of the material provisions of the agreement and opportunity for a hearing” and waives further notice. F.R.Bankr.P. 4001(d)(4). As one leading treatise explains, the exception to notice applies “when the parties whose interests would be affected have already received notice of a proceeding that can be expected to lead to relief similar to that embodied in the agreement.” 8, King et al., Collier on Bankruptcy, ¶ 4001.08 (15th ed.) The same authority notes that the purpose of Rule 4001(d)(4) is to eliminate the necessity of giving notice of an agreement
where the specified parties have already received notice of and had an opportunity to object to the relief provided for in an agreement because a motion seeking that relief was previously served upon them. Thus, for example, when a motion seeking relief from the automatic stay has been served pursuant to Rule 4001(a)(1), an agreement granting relief from the stay to the movant need not be the subject of a separate motion to approve the agreement. Presumably, any party who opposed relief from the stay would have opposed the initial motion and thereby either prevented the relief from being granted or become a party to litigation who would be aware of any settlement.
Id. (emphaisis added).
Assuming, therefore, that the chapter 11 trustee’s decision not to contest Fannie Mae’s relief from stay motion is an “agreement” as contemplated by Rule 4001(d), the circumstances simply do not require further notice. First, the relief being decreed — the termination of the stay to permit Fannie Mae to foreclose — is the same relief prayed for in the motion for relief from the stay. Second, notice of that motion, and of the hearing thereon, was given to all parties entitled to notice under Rule 4001(d). Third, no such party, with the exception of the debtor, appeared or
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filed any pleadings in opposition to relief from the stay. Fourth, the debtor did appear and vigorously participated in the preliminary hearing, at which the court heard nearly six hours of testimony from a number of witnesses, several of whom were called in opposition to the motion. Finally, the trustee’s decision not to contest relief from the stay was not binding on the debtor, and the debtor was given full opportunity to oppose the requested relief. That the debtor has now determined it cannot successfully carry its burden and has withdrawn from the fray does not create a requirement for further notice to creditors where the relief being granted is the same relief sought in the motion and where a full evidentiary hearing was held.
The focus of the debtor’s argument over notice is not the relief being granted — termination of the stay — but rather the gentlemen’s agreement between the chapter 11 trustee and Fannie Mae concerning the trustee’s fees and expenses. Essentially, under the current cash collateral agreement, Fannie Mae has consented to a reduction of its debt service in order to fund a reserve for reorganization expenses and has told the trustee that it would not oppose payment of approved fees and expenses for the trustee and his professionals from that reserve. The debtor argues that such an agreement prejudices other administrative creditors (including, presumably, debtor’s counsel), since approved administrative expenses may well exceed the funds available to pay them. The issue of who gets paid, however, is conceptually distinct from the question of whether Fannie Mae is entitled to relief from the automatic stay. Furthermore, any payment to administrative claimants, including the trustee and his professionals, may only be made with court approval after notice to creditors and a hearing. The court has not been asked to approve any such payment, and granting relief from the automatic stay does not silently constitute such approval. Until a motion is filed to approve the fees and expenses of the trustee and his
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professionals and to authorize payment out of Fannie Mac’s cash collateral, or until a motion is filed to surcharge Fannie Mac’s collateral, there is simply no issue for the court to decide. For the foregoing reasons, the court will grant Fannie Mae’s motion for relief from the automatic stay. The court finds that the notice given under F.R.Bankr.P. 4001(a) was sufficient to advise creditors of the essential terms of the chapter 11 trustee’s agreement not to contest the motion, and the court determines that further notice under F.R.Bankr.P. 4001(d) is not required.
A separate order will be entered on presentation terminating the automatic stay.
(a) The product obtained by multiplying (1) the difference obtained by subtracting from the interest rate on the Note the yield rate on the 7-7/8% U.S. Treasury Security due July 1996 (the `Yield Rate’), as the Yield Rate is reported in the Wall Street Journal on the fifth Business Day preceding the date notice of prepayment is given to Lender, times (2) the present value factor calculated using the following formula
1 — (1 + r)-n
r
[r = Yield Rate n = the number of years, and any fraction thereof, remaining between the prepayment date and the expiration of the Yield Maintenance Period] times (3) the entire unpaid principal balance of the Note at the time of prepayment, provided, however, than in no event shall the prepayment premium be less than 0; plus
(b) If the amount of the prepayment premium due under subparagraph (a) above is less than 1% of the entire unpaid principal balance of the Note, then an additional prepayment premium equal to 1% of the entire unpaid principal balance of the Note at the time of prepayment, less any prepayment premium due under subparagraph (a) above.” A(1), Addendum to Multifamily Note, Pltf. Ex. 1.