In the Matter of Sunnyslope Housing Limited Partnership

Ninth Circuit Court of Appeals, No. 12-17241 ((April 8, 2016)
For purposes of valuation of a senior lender's interest under section 506(a), restrictions on the debtor's use of the property that would be extinguished in a foreclosure do not apply to limit the value of the senior lender's interest. Appeal was not equitably moot because the key party affected by the unraveling of the plan, the new equity investor, was not an innocent third party the doctrine of equitable mootness doctrine was intended to protect.
Procedural context:
Appeal from order of district court upholding bankruptcy court confirmation of a reorganization plan cramming down senior secured creditor after valuation hearing.
Debtor had financed development of an apartment complex through a senior loan guaranteed by HUD and junior loans from local government entities. All of the loans contained restrictions requiring the apartments to be used for affordable housing, but the senior loan provided that the restrictions would not apply in the event of a foreclosure. The debtor defaulted on the senior loan, HUD paid on the guarantee, and then sold the loan to a third party, which then sought to foreclose. A bankruptcy was filed and the debtor proposed a cramdown plan that valued the senior lender's secured claim at $2.6 million, which was the value based upon the restrictions limiting the use to affordable housing. The senior lender argued that the secured claim should be over $7 million, which was the value free of the restrictions. The bankruptcy court agreed with the debtor and confirmed the debtor's plan, which confirmation was affirmed by the district court. In a 2-1 decision, the Ninth Circuit reversed, holding that the secured value of the senior lender's claim should not be suppressed by use conditions that would be extinguished in a foreclosure. The majority opinion held that the Supreme Court's opinion in Associates Commercial Corp. v. Rash does not require a valuation based upon the debtor's particular proposed use of the property and cannot be read to permit a valuation based upon the debtor's continued use that is less than the foreclosure value. The dissent argued that the majority misread Rash and the valuation should be based upon the debtor's specific proposed use of the property. The Ninth Circuit also held that the appeal was not equitably moot. The secured creditor diligently sought a stay from both the bankruptcy and district courts, the new equity investor was not an innocent party because it was intimately involved in preparation of the plan and knew the risks, and the transactions contemplated by the plan were not that complex.
Kozinski, Paez and Clifton

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