Bank of America National Trust v. 203 N. LaSalle St. Partners (05/03/1999)

By: Roxana Saberi, Medill News Service

Questions presented

Whether the exclusive right that was accorded to the debtor's old owners violated a provision of the bankruptcy code that provides that if a class of dissenting unsecured claims will not receive property that has a present value equal to the full amount of its claim, no junior claims or equity interests can receive anything under the plan on account of those junior claims and interests.

Brief

In 1987, the Bank of America National Trust began lending 203 N. LaSalle Street Partnership, a real estate partnership, about $92 million to build and maintain 15 floors of a Chicago office building. Business eventually declined, and the partnership was unable to pay the note when it was due on Jan. 3, 1995. The bank started foreclosure action later that month.

In March 1995, 203 N. LaSalle filed for Chapter 11 bankruptcy, under which a debtor may remain in control of its business and assets. At that time, 203 N. LaSalle owed the bank about $93 million.

In December 1995, a bankruptcy court found the value of the property to be $55.8 million. The court approved a plan that divided the $93 million debt into two parts: a $54.5 million secured claim, which was based on the value of the property, and a $38.5 million unsecured claim, which would be paid to the bank later if the property were sold or refinanced.

Under the plan, the debtor's partners could maintain ownership rights if they contributed new capital of more than $6 million. They could do this even if the bank would not be paid the full value of its claim.

The bank objected to the plan, alleging that the bank could recoup as little as $55 million on its $93 million claim. Despite the bank's objections, the bankruptcy court approved the plan.

The bank appealed in federal district court, raising 14 objections to the plan, including the contention that it cheated the bank out of its claims while allowing the company's shareholders to keep their ownership rights.

The bank argued that as the creditor, it should have had the power to veto the reorganization plan. The plan violated the absolute priority rule in the Bankruptcy Code, according to the bank. This rule states that if the creditor does not receive property equal in value to the claim, junior claims and equity holders cannot receive anything, either. Therefore, the bank argued, owners and shareholders should not be able to maintain ownership until the creditor is fully satisfied.

In this case, the bank claims it has $38.5 million in unsecured claims that will not receive value equal to that amount. The district court affirmed the plan in its entirety.

A divided 7th Circuit Court of Appeals affirmed, holding that the absolute priority rule of the Bankruptcy Code permits an exception for new value.

The ""new value corollary"" allows shareholders to maintain ownership if they help the ailing business by investing more capital in it. They can do this even if the plan does not fully pay the claims of unsecured creditors.

The appeals court held that even if the bank had not been paid back yet, the shareholders of 203 N. LaSalle could retain ownership because they were investing capital in the company.

""The new value corollary still serves as a significant source of new funding for the ailing entity, ... and one would expect that Congress would address deliberately such a significant issue of economic policy if it had determined to abolish it,"" the appeals court ruled, though noting that there is disagreement among lower courts.

In his dissent, Judge Michael Kanne argued that the new value concept should not be included in the Bankruptcy Code.

The U.S. Supreme Court granted certiorari on May 4, 1998, and allowed the U.S. Solicitor General, American College of Real Estate Lawyers and American Bankers Association to file amicus briefs.

On May 3, 1999, the Court sided with the bank and reversed. In an 8-1 decision written by Justice David Souter, the Court called the reorganization plan ""doomed"" because it allowed shareholders, over the objection of unsecured creditors, to contribute new capital and receive ownership interests in the reorganized entity, when that opportunity was given exclusively to the old equity holders under a plan adopted without consideration of alternatives. The Court noted that because the property must have had some value, it was unacceptable to allow the shareholders to obtain it exclusively at potentially ""no cost whatsoever.""

Justice John Paul Stevens was the lone dissenter.