In re S. Side House, LLC

474 B.R. 391

In re SOUTH SIDE HOUSE, LLC, Debtor.

No. 09–43576.

United States Bankruptcy Court, E.D. New York.

June 15, 2012.

Leo Fox, Esq., Stephanie Park, Esq., New York, NY, for South Side House, LLC.

McCarter & English, LLP, Joseph Lubertazzi, Jr., Esq., Peter Knob, Esq., New York, NY, for U.S. Bank National Association, as Trustee.

MEMORANDUM DECISION ON THE STATUS AND APPLICATION OF THE POST–PETITION RENTS GENERATED BY THE DEBTOR'S PROPERTY

ELIZABETH S. STONG, Bankruptcy Judge.

Introduction

Not every dispute concerning the nature and extent of a secured creditor's claim arises in the context of an objection to claim. In this single asset real estate case, South Side House, LLC, has used the substantial rental income generated by a mixed-use commercial property to make adequate protection payments every month to its secured creditor. Now, after a nine-day contested confirmation hearing, it is necessary to answer certain questions that arise from those payments, before the larger question of plan confirmation can be addressed. First, does this rental income belong to South Side, or did the debtor cede it to the lender when it entered into an assignment of rents? And second, how should these payments, which amount to millions of dollars, be applied to the lender's claim?

The Court first considers whether the post-petition rental income generated by the Debtor's property (the “Rents”) are property of the estate and cash collateral. To make this determination, the Court must start with New York law, which defines the property interests of borrowers and lenders under assignments of rent, and then consider whether the Debtor's prepetition property interests in the Rents meets the definition of property of the estate under Bankruptcy Code Section 541(a). These determinations also implicate the Debtor's proposed use of the Rents to pay administrative expenses and to fund its Chapter 11 plan of reorganization (the “Plan”).

The Court next considers how the Debtor's monthly payments to the Lender from the Rents should be applied to the Lender's claim. This determination requires consideration of the treatment of secured claims under Bankruptcy Code Section 506 and the security interest created by Section 552(b). It also implicates the obligations of single asset real estate debtors under Section 362(d)(3).

The Debtor owns and operates a mixed-use building with 74 residential units and two commercial units in Williamsburg, Brooklyn (the “Property”). The Lender is the Debtor's largest creditor and holds a commercial mortgage loan made to the Debtor in the principal amount of $29 million. In connection with that loan, the Debtor entered into a Note, Mortgage, and Other Security Documents (the “Loan Documents”). The Mortgage includes rent and lease assignment terms (the “Assignment of Rents”).

This case was filed on April 30, 2009. Starting in June 2009, and each month thereafter, the Debtor made monthly payments of approximately $151,000 to the Lender from the Rents, and also made a payment of $250,000 in May 2011. As of December 31, 2011, the net payments, after subtracting amounts applied to real estate taxes, exceed $4.6 million.

The Debtor argues that the Rents are property of the estate that may be used as cash collateral to fund the Plan and to pay professional fees, among other uses. The Debtor contends that it has a property interest in the Rents under New York law, that rents are treated as cash collateral under the Bankruptcy Code, that the Lender stipulated to this treatment of the Rents in the cash collateral orders entered during the pendency of this bankruptcy case, and that if the Plan is confirmed, the Lender's lien on the Rents will be modified under Bankruptcy Code Sections 1141 and 1129 and any interest that the Lender may have in the Rents will be extinguished.

According to the Debtor, the payments should be applied first to the Lender's unsecured claim, then to post-petition interest and the principal amount of the Lender's secured claim. The Debtor states that when the Rents are applied in this way, as of June 29, 2010 the Lender's unsecured claim was paid in full, and as of August 2010 the Lender became an oversecured creditor entitled to post-petition interest under Section 506(b) at the non-default contract rate. And the Debtor argues that when the payments are applied in this way, the Lender's remaining claim as of December 31, 2011 is $28,520,747.

The Lender argues that the Rents are not property of the estate, whether or not the Assignment of Rents is absolute, because its affirmative steps to enforce the assignment left the Debtor with only a “reversionary interest” or “a right to the Rents ... in the event the Loan is repaid in full.” Lender's Br. ¶ 12, ECF No. 378. The Lender contends that this interest is insufficient for the Rents to be considered property of the estate under Section 541. The Lender argues that if the Rents are not property of the estate, then it has an absolute right to them and is entitled to “dictate[ ] their use.” Lender's Br. ¶ 11. And the Lender does not consent to the use of the Rents to fund the Plan or to pay professional fees.

The Lender agrees that when the Rents are turned over to it, they must be applied to the debt. But according to the Lender, the Rents should first be applied to the post-petition interest due on its claim and not to its unsecured claim. The Lender argues that it was entitled to post-petition interest before the August 2010 date designated by the Debtor, and that the monthly interest on its claim is roughly equivalent to the monthly payments from the Rents, so that those payments do not reduce its claim. The Lender contends that the Debtor's argument creates a “perverse incentive” for single asset real estate debtors to delay their cases to the detriment of mortgagees and in contravention of the purposes of Section 362(d)(3). Lender's Br. ¶ 32. Finally, the Lender argues that it is entitled to pendency interest at the default rate provided in the Loan Documents.

Based on the entire record, and for the reasons stated below, the Court finds that the Rents are property of the estate and the Lender's cash collateral. The Court also finds that the payments made from the Rents during the pendency of the bankruptcy case should be applied first to the Lender's unsecured claim until it is reduced to zero, and then to the post-petition interest, fees, costs, and charges allowed under Section 506(b), and finally to principal.

Jurisdiction

The Court has jurisdiction pursuant to 28 U.S.C. §§ 1334(b) and 157(a). This is a core proceeding pursuant to 28 U.S.C. §§ 157(b)(1) and 157(b)(2)(K) and (M).

Background

The loan at issue in this proceeding has been the subject of litigation for several years. The Debtor defaulted under the Loan Documents by not making the full monthly payments due from September 10, 2008 through December 10, 2008, and in January 2009, the Lender accelerated the debt and brought a foreclosure action in the United States District Court for the Eastern District of New York. The District Court entered an order appointing a receiver on February 11, 2009, granted the Lender's motion for summary judgment on April 24, 2009, and scheduled a conference to address the appointment of a referee. On April 30, 2009, the Debtor filed for relief in this Court under Chapter 11 of the Bankruptcy Code. As a result of the Debtor's bankruptcy case, the foreclosure proceeding was automatically stayed under Bankruptcy Code Section 362(a), and a referee was not appointed.

The Debtor has operated its business and managed its property as a debtor in possession since the petition date. In its bankruptcy schedules, the Debtor lists two secured creditors, the Lender and Broadway Bank, which holds a second mortgage on the Property. The Debtor schedules the Lender's claim as $29 million, and Broadway Bank's claim as $1.5 million. The Debtor also schedules two unsecured nonpriority claims totaling $24,200.

Six creditors filed proofs of claim, including the Lender, Broadway Bank, the receiver, and the receiver's counsel. The unsecured creditors listed on the Debtor's schedules did not file proofs of claim, but voted in favor of the Plan. The claims of the receiver and his counsel were resolved by Order dated September 22, 2009. And Broadway Bank's claim of some $1.5 million is treated without objection as unsecured under the Plan. As such, the Debtor's principal creditor, and the only creditor to oppose confirmation of the Plan, is the Lender.

The Debtor and the Lender have engaged in extensive litigation throughout this case. Among other things, the Lender objected to the use of the Rents as cash collateral and moved for relief from the automatic stay and to dismiss this case, and the Debtor objected to the Lender's claim. The Debtor's objection to claim is addressed in a Memorandum Decision of the Court. See In re South Side House, LLC, 451 B.R. 248 (Bankr.E.D.N.Y.2011), aff'd sub nom. U.S. Bank Nat'l Ass'n v. South Side House, LLC, 2012 WL 273119 (E.D.N.Y. Jan. 30, 2012). In addition, the Lender brought an action against the Debtor's principals to enforce a guaranty of the Debtor's obligations under the Loan Documents, and that action was referred to the Court for proposed findings of fact and conclusions of law. See U.S. Bank Nat'l Ass'n v. Perlmutter (In re South Side House, LLC), 470 B.R. 659, 2012 WL 907758 (Bankr.E.D.N.Y. Mar. 16, 2012).

Cash Collateral

At the outset of this case, the Debtor sought authorization to use the Rents as cash collateral pursuant to Bankruptcy Code Section 363 and a direction to the receiver to turn over all leases and rents in its possession pursuant to Section 543. On May 5, 2009, the Court entered an Order directing the receiver to turn over the Rents and authorizing the Debtor to collect the Rents and manage the Property. That Order also granted interim approval to use the Rents as cash collateral.

As a...