SR Construction v. Hall Palm Springs

Supposedly nefarious facts aren’t evidence of bad faith if they were disclosed to the bankruptcy judge who nevertheless made a finding of good faith.

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Case Type:
Case Status:
No. 21-11244 (5th Circuit, Apr 17,2023) Published
The record facts, framed by the external context and circumstances, make plain that there is no error in the judgments of the able bankruptcy and district courts. The lender did not engage in fraud and was a “good faith purchaser.” AFFIRMED
Procedural context:
SR Construction held a lien on real property owned by RE Palm Springs II. The property owner is a corporate affiliate of Hall Palm Springs LLC who financed the original undertaking for a separate real estate developer. The latter requested leave of the bankruptcy court to submit a credit bid to purchase the property from its affiliate, which the bankruptcy court granted. The bankruptcy court later approved the sale and discharged all liens. The construction company appealed the bankruptcy court’s credit- bid and sale orders. Finding that the lender was a good faith purchaser, the district court affirmed the bankruptcy court and dismissed the appeal as moot under Bankruptcy Code § 363(m). Now, “[a]cting as a second review court,” the 5th Circuit Affirmed.
In November 2016, Palm Springs, LLC, a commercial real estate developer and the original owner of real property in Palm Springs, California, contracted with SR Construction to develop its Property and build a hotel, but it did not go well. Approximately a year later, the developer financed the construction with Hall Palm Springs LLC,6 securing its loan with a deed of trust. At the same time, it entered into a separate Subordination Agreement with the construction company, giving the lender priority of repayment over the construction company. The developer terminated the construction company on October 22, 2019, owing it $14,151,000 for the work completed. Nine days later, the developer and owner defaulted on loan obligations owed to the lender, and the lender gave notice that it was accelerating the debt. The construction company then filed its mechanic’s lien on the Property on November 25, 2019. In January 2020, the construction company filed suit in California state court against myriad parties, including both the developer and the lender, seeking to foreclose on its mechanic’s lien as superior to other liens and the lender’s deed of trust. On February 12, 2020, the lender’s president formed an affiliated corporate entity (the “affiliate”) and became its sole manager and organizer. Following the lender’s acceleration of the debt, the developer conveyed the Property to the affiliate pursuant to a conveyance agreement “as an alternative to foreclosure.” By its terms, the developer would be “released from [its] obligations with respect to the [l]oan and [the developer] shall be entitled to a net profits interest in the Property” in the amount of 50 percent. The affiliate intended to finish construction and develop the hotel, but more trouble came; “with the impact of the novel coronavirus COVID-19 on the hospitality industry, coupled with the filing of numerous lawsuits . . . [the lender] concluded that the sale of the Hotel to a strategic buyer would yield the maximum value for all parties.” Within the ensuing six months, the lender and its affiliate undertook several discrete actions to prepare for bankruptcy. In June 2020, the affiliate changed its name, and around the same time, the lender retained r2 Advisors (“r2”), a third-party with relevant experience, to oversee the affiliate’s restructuring. To ensure arm’s-length objectivity, as represented to the bankruptcy court, the lender “caused . . . to convey ownership of [the affiliate] to r2” such that “the entire sales process [wa]s under the control and supervision of r2.” Then, on July 22, 2020, the affiliate filed for bankruptcy in the Northern District of Texas and filed motions for leave to hire a pre-selected real estate agent, to authorize the affiliate to borrow funds from the lender (its corporate affiliate), and to approve specific bankruptcy sales and bidding procedures. The bankruptcy court held multiple hearings and on August 24, 2020 approved the retention of r2 as the restructuring organization and the bidding and sales procedures, complimenting the Parties for presenting “a game plan that could . . . get creditors paid in full quite soon,” observing it “not an unusual game plan” in high stakes financing. The bankruptcy court then approved a proposed real estate broker, finding the firm “well qualified” and lacking any conflicts or impairments. And, finally, it approved the debtor-in- possession loan from the lender as “the only game in town” with substantively “reasonable” conditions in light of the circumstances. This left the lender, as the debtor-in-possession, with the power to veto any sale. The bankruptcy judge followed with related orders formally approving the needed processes and personnel. One of the orders approved an auction and bidding process requiring a “stalking horse,”7 McWhinney Real Estate Services, Inc., to submit its bid on August 28, 2020, alongside a nonrefundable $2.5 million deposit. Other bidders in the auction were required to submit bids and deposits by October 5, 2020, the sale hearing to be held eleven days later. The marketing and sale of the Property garnered substantial interest. The real estate brokerage engaged in an aggressive marketing campaign, hosting site visits from “8 potential buyer groups” and executing approximately 268 confidentiality agreements from potential buyers seeking to perform due diligence. Several bids were proposed, though none conformed to the specified format, timing, or financial arrangements approved by the bankruptcy court. The stalking horse also submitted a proposal for $35,450,000, though it ultimately declined to make the deposit by the deadline and backed out entirely. Prior to the auction deadline but after the stalking horse had dropped out, with no outstanding bids, the lender sought leave to submit a credit bid for the Property pursuant to 11 U.S.C. § 363(k), which confers secured creditors a right to credit bid their allowed claims.8 The construction company opposed, urging that the bid was “premature.” While the construction company contested the credit bid, the auction proceeded apace, ultimately garnering only the lender’s credit bid of $37,279,365.74—almost $2 million more than the floor set by the stalking horse’s proposal. The bankruptcy court held evidentiary hearings on November 3, 5, and 6, 2020 regarding the lender’s ability to submit a credit bid and on the free and clear sale of the Property. In broad strokes, the construction company argued—as it does here—the sale should not proceed because: 1) the lender (and intended purchaser) was aware of adverse claims to the Property, namely the construction company’s adversary proceeding as well as its action in California state court; and 2) because the lender had fraudulently manipulated the bankruptcy proceedings, including rigging the bankruptcy sale process, to acquire the Property free and clear of all liens at the lienholders’ expense, including the construction company’s. At the culmination of the final hearing, the bankruptcy court approved the sale. Shortly before the hearing concluded, the construction company moved for a stay pending appeal, which the bankruptcy court denied. Three days later, the bankruptcy court issued its formal order granting the lender’s Motion to submit a bid, and on November 18, 2020, a formal order approving the sale free and clear of all liens, claims, encumbrances, and interests and, in so doing, denying the construction company’s motion to stay the sale. These orders gave rise to this appeal. Parallel to its objection, the construction company sought to bar the developer from conveying the Property to the affiliate or another non-party entity. It filed an adversary proceeding in the bankruptcy court against the lender, the affiliate, and the developer. The construction company also brought a separate action in California seeking a determination that its lien on the Property is senior to the lender’s deed of trust.
Before Higginbotham, Southwick, and Higginson, Circuit Judges. Patrick E. Higginbotham, Circuit Judge

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