Opinion
BANKRUPTCY NO: 16-03135-MM11
05-08-2017
In re: 8110 AERO DRIVE HOLDINGS, LLC, Debtor
WRITTEN DECISION - NOT FOR PUBLICATION
CHAPTER: 11 AMENDED MEMORANDUM DECISION ON CONFIRMATION OF SECOND AMENDED PLAN OF REORGANIZATION DATED JANUARY 17, 2017 DATE: March 30, 2017
TIME: 9:30 A.M.
CRTRM: 1 JUDGE: Margaret M. Mann
Amended for formatting purposes only.
The court conducted a four-day trial on March 30, March 31, April 14, and May 1, 2017, regarding confirmation of the Second Amended Plan dated January 17, 2017 ("Plan") filed on January 26, 2017, by Debtor 8110 Aero Drive Holdings, LLC ("Debtor"). After providing an oral ruling on April 10, 2017, on the confirmation issues tried on March 30 and 31, 2017, the court held a further evidentiary hearing on April 14, 2017 on three reserved issues: the feasibility of the Plan, Debtor's settlement with its franchisor, and the amount of attorneys' fees necessary to cure the loan default of Debtor's secured creditor Wells Fargo Bank, National Association, as Trustee for the Benefit of the Registered Holders of JPMBB Commercial Mortgage Securities Trust 2013-C14, Commercial Mortgage Pass-Through Certificates, Series 2013-C14's ("Lender"). Lender was the only objecting party to the Plan. The court then granted Lender's motion to reopen the evidence on the feasibility issue and considered limited additional testimony on May 1, 2017.
Having made certain rulings during the pretrial proceedings on confirmation of the Plan, and having considered all of the testimony and evidence presented, the court makes the following findings of fact and conclusions of law pursuant to Fed. R. Bankr. P. 7052.
To the extent any finding of fact or conclusion of law differs in any respect from the court's oral ruling, these written findings of fact and conclusions of law are intended to govern.
I. Testimony of Witnesses
The court required that all evidence be presented by declaration as part of each party's case in chief. Each declarant was required to be available for cross-examination at trial unless the opposing party waived that right. Under this protocol, the court considered the testimony of following witnesses:
1. Richard Zelle ("Zelle"), an expert witness on industry standards who testified regarding default interest, the expectations of the parties entering into the loan in question, and his fees. Doc. 228. Cross-examination of Zelle was waived.
2. Jason Everson ("Everson"), the Vice President of Operations for GF Management, an operating affiliate of FPCA Associates, LLC ("FPCA"), Debtor's management company. Everson testified regarding Debtor's budget. Doc. 227-8.
3. Kate Mendez ("Mendez"), who provided testimony regarding Debtor's operations. Doc. 227-7.
4. Nick Zigler ("Zigler"), a controller with FPCA who testified regarding Debtor's budget. Doc. 227-9.
5. Luz Burni ("Luz"), Debtor's managing member, who provided testimony regarding the history of the loan and the feasibility of the Plan.
6. Jean Heinz ("Heinz"), who represented Debtor in negotiations regarding the loan. Doc. 237.
7. David Bornheimer ("Bornheimer"), vice president of the loan servicer who testified regarding the processing of the loan and the attorneys' fees of his counsel.
8. Craig A Welin ("Welin"), the partner in charge of counsel for Lender who testified regarding his management of the representation and his firm's fees and costs. Cross-examination of Welin was waived.
9. Ron Chin ("Chin"), trustee of the Ralph Burni Trust, an insider of Debtor.
Luz is the daughter-in-law of Ralph Burni ("Ralph"), who owned and controlled a majority interest in Debtor until his death in December 2014. For clarity, the court refers to both by their first names, with no disrespect intended.
Declarations from counsel for the parties were not considered as evidence for the confirmation trial. The court's findings of fact are based upon its review of the record and the credible testimony from witnesses.
II. Background
A. Property
Debtor owns and operates a Four Points by Sheraton Hotel located at 8110 Aero Drive, San Diego, CA 92123 ("Hotel"). The Hotel was valued at $16,800,000 in Debtor's schedules, and value was not contested at the confirmation trial. The Hotel was originally purchased by The Burni Family Trust ("Burni Family Trust") and R&D Trust Properties, LLC in 2007 and was transferred to Debtor in 2010. The Hotel is operated under a licensing and franchising agreement ("Licensing Agreement") with Sheraton, LLC ("Sheraton"). Debtor leases the real property on which the Hotel is located from the City of San Diego via a ground lease set to expire in 2052 ("Ground Lease").
B. The Loan
In July 2013, Barclays PLC ("Barclays"), Lender's predecessor, extended Debtor a $9.5 million loan ("Loan") with a 5.977% interest rate secured by Debtor's interest in the Hotel and the Ground Lease. The Loan is a commercial mortgage-backed securitized ("CMBS") loan which matures on July 22, 2023. Wells Fargo is the Trustee of the trust holding the Loan among other assets, having received an assignment from Barclays on September 18, 2013. Midland Servicing ("Midland") is the special servicer for the Loan, having been appointed in December 2015.
The terms of the Loan are governed by numerous documents, including a loan agreement ("Agreement"), a Leasehold Deed of Trust and Security Agreement, and a deposit account control agreement ("Lockbox Agreement"), all of which are governed by California law. See Exs. 1-16.
The Loan was negotiated primarily by Ralph, who was in his late 80's at the time. Luz had no communications with Barclays or the mortgage broker for the transaction. Luz understood the purpose of the refinancing, however. She had discussions with Ralph, gathered documents for the mortgage broker, and served as a guarantor. As trustee of the Burni Family Trust which owned an 11% interest in Debtor, she signed off on the escrow instructions for the Loan. Ex. 12. Luz' testimony that Debtor obtained the Loan to refinance a short-term, hard-money loan with a higher interest rate of 10.75% because it was soon coming due was credible.
Heinz was retained to assist Debtor with the transaction in April 2013. She was referred to Debtor by the mortgage broker and had previously assisted other entities related to Ralph and Luz in obtaining financing from Barclays. Between April and July 2013, Heinz directly negotiated with Barclays' counsel regarding the terms of the Loan. Ultimately, Heinz issued an opinion letter dated July 22, 2013 ("Opinion Letter") regarding the Loan. Since no witness from the mortgage broker or Barclays testified, Heinz is the only witness with credible personal knowledge of the Loan negotiations.
C. Franchise Agreement
After the Loan closed, Debtor continued to work on a remodel required by its franchisor, Sheraton. In November 2013, after an inspection of the Hotel, Sheraton insisted Debtor complete a Property Improvement Plan ("PIP") and make extensive improvements to the Hotel by December 2016. Due to Debtor's inability to meet guest satisfaction score requirements, Sheraton required Debtor hire a management company from a list it provided. Debtor hired HMG, who ran the Hotel's operations from November 2014 to April 2016, when HMG was replaced by a management company selected by Lender.
Ralph died in December 2014 shortly after HMG was retained. Given his age, the months preceding his death may have contributed to Debtor's management problems. Luz then took over management of the Debtor. There is no evidence she had previous experience running a Hotel, and she was not sophisticated in commercial matters.
Luz and Ron Chin (Trustees of the Ralph Burni Trust) thereafter received regular reports from HMG regarding the Hotel. These reports reflected that under HMG's management Debtor's expenses increased by approximately 33-40% without a corresponding increase in revenue. HMG also failed to allocate money necessary for Debtor to complete the PIP. This caused the profits of the business to decline. During HMG's management, Luz's communications with Lender were limited, as HMG was receiving all statements and communications Midland sent.
D. Default
The decline in profitability of the Hotel caused the Loan to go into default when Debtor failed to make the September 2015 Loan payment. Initially, Debtor did not notice that it had missed a payment. Upon receipt of the October payment, Lender applied it to the September payment, which caused the October payment to go into default until the November payment was received. The same pattern applies to the December and January payments. Payments stopped until Debtor filed bankruptcy that May because Lender declared a default on January 14, 2016. Midland froze Debtor's bank accounts by letter sent to Wells Fargo but did not send the letter to Debtor or describe the default.
Midland sent Debtor a notice of default on February 24, 2016, declaring a default as of December 6, 2015, based upon Lender's application of payments after the September payment, the only missed payment at the time. Luz did not receive this letter, which she assumed was received by HMG. Lender demanded a cure but did not provide the amount, advising the cure amount could be obtained from Midland.
Luz did not learn of the default until March 11, 2016, when she received a call from Brent Ramsey, a Regional Manager for Starwood Hotels & Resorts Worldwide, Inc. ("Starwood," Sheraton's parent company). She immediately called Midland's representative David LaFon ("LaFon") and asked for an accounting and the cure amount. She also requested that LaFon make any missed payments from the reserve accounts and release monies to HMG for Debtor's operations. Instead of responding to these requests, Lender filed suit seeking the appointment of a received to which Luz stipulated on April 6, 2016. The receiver replaced HMG as manager of the hotel.
Lender did not provide Luz a cure amount until April 28, 2016. Ex. 33. The cure amount provided was $1,672,343, including late fees, escrow deposits, protective advances, default interest, and special servicing, legal, and workout fees. Luz was shocked at the number, which was understandable. The cure amount was over five times higher than the five missed payments for January, February, March, April, and May 2016 totaling $293,556.80, even though Lender was holding sufficient funds to make these payments twice over. When Luz received an accounting of the reserve accounts in May 2016, Lender held $385,032.80 in the FF&E reserve and $273,510.86 in the Lockbox Account, totaling $658,543.66. Ex. 31. Lender's cure calculation also did not reduce the cure amount for the money it was holding in reserve.
Section 8.1(b) allows Lender to take any action it deems advisable to protect and enforce its rights "without notice or demand" if Debtor defaults.
Lender imposed harsh consequences for Debtor's default. In addition to freezing Debtor's bank accounts so that it could not access the revenue from its business operations, Lender took the following actions pursuant to the Loan documents:
Before the Default, Section 3.1(a) of the Agreement required Debtor to maintain a Lockbox Account into which it was required to deposit "all Gross Income from Operations." Section 3.1(b) required Lender to establish a "Cash Management Account" into which Debtor was required to deposit all sums from the Lockbox Account required by the parties Agreement. Prior to a Triggering Event all monies in the Lockbox Account had to be transferred to an account specified by Debtor each business day. However, under following a Triggering Event, under Section 3.7(b), Lender could direct monies on deposit to be used to fund various reserve accounts, and under Section 3.18, upon an event of default (a) Debtor has no rights to the accounts and (b) Lender was permitted direct the bank to liquidate or transfer any amounts as Lender "reasonably determine[d] . . . necessary to perfect or protect [its] security interest."
1. Claimed a defeasance fee of $2.6 million due upon sale or refinance;
2. Applied all payments Debtor made, plus all additional cash flow to principal;
3. Charged late fees (estimated at $41,512.96 as early as May 2016);
4. Increased Debtor's interest rate from 5.977% to 10.977%;
5. Compounded interest monthly;
6. Charged Debtor additional special servicing, workout, and appraisal fees (estimated at no less than $113,084.44 as early as May 2016);Freezing the accounts had particularly severe consequences for Debtor since it could not access to its reserves which it had been using to fund the PIP required by Sheraton.
7. Charged Debtor attorneys' fees (no less than $144,000 in May 2016); and
The defeasance fee is provided for in Section 2.3.3 of the Agreement. Doc. 130-3, pg. 2 (communication to Debtor provided in connection with Debtor's efforts to sell the Hotel quantified the defeasance fee at $2.6 million due to the outstanding default).
In addition to requiring the payment of default interest, upon default, Section 2.2.4 requires Debtor pay an amount equal to the "Net Cash Flow After Debt Service" to be applied to the payment of the debt as Lender "shall determine in its sole discretion."
Section 3.18(c) provides that Lender "may apply the amounts" on deposit as it "determines in its sole discretion including, but not limited to, payment of the Debt."
Section 2.2.5 requires Debtor pay a Late Payment Charge equal to 5% of any unpaid sum "to defray the expense incurred . . . in handling and processing such delinquent payment and to compensate [Lender] for loss of the use of such delinquent payment."
Section 2.2.4 of the Agreement provides that "during the continuance of an uncured Event of Default," Debtor must pay 5% above the interest rate provided under the Loan, or 10.977% (5.977%+5%) "on the outstanding principal balance of the loan . . . and other amounts due in respect of the Loan . . . calculated from the date such payment was due." Section 2.2.4 states that the default interest rate will "be computed from the occurrence of the default until the actual receipt and collection of the Debt (or that portion thereof that is then due)."
Section 2.2.4 states that the default interest rate "shall be added to the Debt" and "shall itself accrue interest at the same rate as the Loan and shall be secured by the Security Instrument."
Section 9.3 makes Debtor responsible for paying: set-up fees and costs for the appointment of any servicer; processing fees charged by the servicer; any workout fees and special servicing fees that may come due to the servicer; and the costs of all property inspection and appraisals. Section 10.13 makes Debtor responsible for all "reasonable costs and expenses" Lender incurs in connection with Debtor's "ongoing performance of and compliance with" the parties' Agreement, including "enforcing any obligations of or collecting any payments due from [Debtor]."
Sections 10.13 and 5.1.12 make Debtor responsible for Lender's "costs of collection and defense" in the event of foreclosure or bankruptcy.
Under Section 7.3.2(b) of the Agreement, Lender is not obligated to disburse funds from the FF&E Reserve if an Event of Default exists. But Section 3.7 provides that, upon the occurrence of a "Triggering Event," including an event of default, Debtor has an ongoing obligation to fund certain reserve and escrow accounts.
E. Debtor's Bankruptcy and Sheraton's Relief from Stay
Approximately a month after a receiver was appointed, on May 25, 2016, Debtor filed a voluntary Chapter 11 petition. Cash collateral use was stipulated, and Debtor continued to perform the PIP as its cash resources allowed. Debtor tried to sell the Hotel, but Lender's imposition of a $2.6 million defeasance fee rendered that strategy infeasible. On December 8, 2016, the court approved a Stipulation between Lender and Debtor. Doc. 157, which applied the funds held by Lender in the Lockbox Reserve Account, the FF&E Reserve Account, and the Ground Lease Reserve Account against the monthly payments due for the calendar months of June 2016 through February 2017 and provided for payment of the Ground Lease.
Sheraton filed a relief from stay motion on October 17, 2016, based on Debtor's failure to perform its requirements under the PIP and Sheraton's assertion that continued low levels of guest satisfaction breached the Licensing Agreement. The PIP was attached to Debtor's opposition to the stay motion filed on November 14, 2017. Doc. 137-2, p. 20. Lender reviewed the stay motion and presumably the exhibits since it filed its own limited opposition to stay relief. Doc. 136. By the January 26, 2017, relief from stay status conference, Sheraton and Debtor had entered into a tentative settlement conditioned on the timely confirmation of Debtor's reorganization plan by April 15, 2017. The time constraints were imposed because Sheraton had continuing concerns regarding diminution of its brand, and also Debtor's delayed performance of the PIP. As well as prompt performance of the PIP, guest satisfaction scores must improve by year end 2017 for the franchise agreement to continue in good standing. These deadlines created time exigencies for the confirmation process.
F. Post-Petition Financing
Debtor filed an emergency motion for post-petition financing on December 23, 2016. Doc. No. 170 ("Financing Motion"). In it, Debtor requested approval of a $100,000 unsecured line of credit ("Post-petition LOC") from Gaslamp. The express purpose of the Post-petition LOC was to make up for cash shortfalls during the slow winter months. The court granted Debtor's Financing Motion without opposition. However, the order uploaded attached a signed agreement providing a secured line of credit that was neither referenced in the motion nor approved by the court. Debtor contends this was a mistake, which is not contested by Lender. The court has approved a modified order which authorizes the unsecured line of credit attached to Debtor's Financing Motion.
G. The Plan
Debtor's Plan is a 100% payment plan that provides for the repayment of all administrative, priority, and general unsecured claims in full without interest within two years of the Effective Date, which is the 10th business day after the court enters a confirmation order.
Section 4.1.2(a) of the Plan provides that Debtor will treat Lender as unimpaired and its secured claim will receive all "protections provided by [11 U.S.C.] § 1124" applicable. Debtor initially disputed that Lender was entitled to any default interest, prepayment penalties, late fees, liquidation/special service fees, protective advances, and certain attorneys' fees as part of its cure, but some of these objections have been withdrawn. Although Lender initially asserted that Debtor is required to pay a defeasance fee as part of the cure, this argument has been withdrawn. These elements of Lender's debt are also in its proof of claim but Debtor has not brought a separate claim objection.
All further statutory references are to Title 11, United States Code, unless otherwise noted.
The Plan contemplates curing Lender's default from $1,800,000 in new value provided by Debtor's members in the form of a $500,000 capital contribution and a $1,300,000 loan to have the same terms as those approved by the court in Debtor's Financing Motion. The balance of the contribution is to be used for other Plan purposes. Under the Plan, Debtor must make $50,000 quarterly payments to priority tax claimants and $50,000 quarterly payments to unsecured creditors for 24 months.
The Plan, in Class 3, provides for the treatment of $652,558.86 of "Unsecured Claims," including claims belonging to Gaslamp. The Gaslamp claims were listed in Debtor's schedules as nonpriority unsecured lines of credit in the amounts $189,572.66 and $234,004.17. The $189,572.66 line of credit dated January 10, 2013, was the source of payment to Debtor's counsel in this proceeding, but counsel's employment application indicates this line of credit is secured. The Plan provides these insider debts "will not be paid until Plan payments on all Allowed Claims are completed."
III. Analysis
A. Confirmation Requirements
Section 1129(a)(1) requires a plan be confirmed only if it complies with applicable provisions of Chapter 11 of the Bankruptcy Code, such as § 1122, § 1123, and the thirteen subsections of § 1129(a). Spieker Props., L.P. v. MFM The SPFC Liquidating Tr. (In re S. Pac. Funding Corp.), 268 F.3d 712, 716 (9th Cir. 2001) (section 1129(a)(1) can be grounds for denial of confirmation where a plan is contrary to provisions of the Bankruptcy Code generally).
B. Impaired Consenting Class
Debtor's summary of balloting indicates all creditors entitled to vote voted in favor of the Plan, creating an impaired consenting class in satisfaction of § 1129(a)(10).
C. Impairment
Lender disputes its claim treatment is unimpaired. Under § 1124(1), a claim is unimpaired if the plan does not alter the claim holder's "legal, equitable, and contractual rights." Impairment is defined "in the broadest possible terms," and any alteration to a creditor's rights, even an improvement, makes the creditor "impaired." In re L & J Anaheim Assocs., 995 F.2d 940, 942-943 (9th Cir. 1993) (plan requiring a creditor's collateral be sold at public auction altered the creditor's prepetition contract rights and the creditor was impaired even though their rights were effectively enhanced under the plan). While any change of terms for an affected creditor renders it impaired, the Bankruptcy Code nevertheless permits defaults to be cured. As noted in Pacifica L 51 LLC v. New Invs. Inc. (In re New Invs., Inc.), 840 F.3d 1137, 1139 (9th Cir. 2016) (citation omitted):
The Bankruptcy Code incorporates the concept of cure. Chapter 11 provides that a debtor's plan of reorganization must "provide adequate means for the plan's implementation," including the "curing or waiving of any default." 11U.S.C. § 1123(a)(5)(G). This statute means that a plan of reorganization may include a provision authorizing the debtor to remedy any breach of a loan agreement with a creditor and return to pre-default conditions.
The court in New Investments, 840 F.3d at 1141, recently explained, the purpose of the right to cure provided in § 1123(a)(5)(G) is to nullify the consequences of default and deaccelerate the loan, after which the claim is to be paid under the underlying documents. Unimpaired status is thus restored. In re Taddeo, 685 F.2d 24, 26-27 (2d Cir. 1982).
Based upon certain provisions in the Plan initially, Lender appropriately contended that it was impaired since the Plan altered its rights. Debtor agreed to revise its Plan so that after the Loan is reinstated the Loan documents will control the parties' relationship. This clarification must be included in the confirmation order. Lender has advised Debtor of certain requirements it asserts Debtor must comply with post-confirmation, including that:
1. The Loan be made into a recourse loan as the loan Debtor's insiders make under the Plan violates Section 4.1.36(g) of the Agreement.
2. Debtor must comply with financial reporting covenants set forth in Section 5 of the Agreement.
3. Debtor must execute a Conditional Assignment of Management Agreement regarding its engagement of FPCA as property manager.
4. Debtor must "promptly deliver" an estoppel certificate from Sheraton pursuant to Section 5.1.13(c) of the Loan Agreement.
5. Debtor must "promptly deliver" an estoppel certificate from the City pursuant to the terms, conditions, and requirements of Section 5.1.13(d) of the Agreement.
6. Debtor must comply with the Cash Management provisions of Article III of the Agreement. Doc. 232, p. 12:24-13:28.
7. Debtor must address the fact that the guarantee of the Franchise Agreement violates Section 4.1.36 (g) of the Agreement. As to this claim, the court notes that Luz is not a "Borrower," and Section 4.1.36 applies only to Debtor, so this provision is not applicable.
Debtor intends to comply with these requirements, so the court concludes Lender will be unimpaired upon a cure of the default. Pre-petition defaults are otherwise waived, and future dealings between Debtor and Lender must comport with the Loan documents. The preclusive effect of the rulings of this court will appropriately be determined if and when they later arise.
D. No Claim Objection is Necessary Because the Plan Does Not Disallow the Claim
Debtor has not separately objected to Lender's proof of claim. Lender asserts this precludes Plan confirmation because, under § 502(a), a claim is deemed allowed unless an objection is filed. There are many aspects of Lender's claim that are not disputed: such as the perfection of the security interest, the allowance of the principal amount, or the enforceability of the documents. Debtor contends that the Plan is not a claim objection and does not need to be because the cure dispute is a separate issue.
Notably, neither § 1123(a)(5)(G), permitting a debtor to "cur[e] or waiv[e] . . . any default" in its plan, nor § 1124, dealing with impairment, expressly require a claim objection. New Investments, 840 F.3d at 1138-39 (addressing the enforceability of default interest in a Chapter 11 plan under Washington state law) held cures "need address only the individual event of default, thereby repealing the contractual consequences." New Investments, id., did not involve or require a separate claim objection to decide the default interest issue.
The court recognizes that under § 502(a), proofs of claim are "deemed allowed, unless a party in interest . . . objects." Fed. R. Bankr. P. 3007 implements § 502(a) by enacting various procedures to ensure due process before a claim is allowed. And it is true that in other contexts, where a creditor did not receive the "notice and hearing" required by Rule 3007(a), courts have held that a reorganization may not reduce a creditor's allowed claim. See, e.g., Varela v. Dynamic Brokers, Inc. (In re Dynamic Brokers, Inc.), 293 B.R. 489, 496 (B.A.P. 9th Cir. 2003) (court erred in overruling a creditor's oral objection to a chapter 11 plan which impaired creditor's claim and reduced the principal amount because of usury issues); Fireman's Fund Mortgage Corp. v. Hobdy (In re Hobdy), 130 B.R. 318 (B.A.P. 9th Cir. 1991) (bankruptcy court erred in confirming a Chapter 13 plan which reduced the arrearage in an allowed claim of $36,787.55 to $4,532 where the affected creditor claimed it did not receive notice of the plan). These cases are distinguishable from the facts here, however, because in each, the courts expressly disallowed the creditors' claims without due process. And, neither of these cases dealt with the cure provisions of §§ 1123(a)(5)(G) and 1124(2).
Most importantly, Varela, 293 B.R. at 497, specifically declined to hold that "a plan can never be used to object to a claim of a creditor" as long as "the essence of Rule 3007" is complied with. The B.A.P. only required "the creditor receive specific notice (not buried in a disclosure statement or plan provision) of at least the quality of specificity [which would be offered in a Rule 3007 claim objection]" as well as "the same opportunity to litigate one-on-one, as would be provided with a straightforward claim objection under Rule 3007." Varela, 293 B.R. at 497.
As an alternative basis for its ruling, the court finds that Lender has received the "the essence of Rule 3007." See Am. Gen. Fin. v. Diaz (In re Diaz), No. NV-04-1419-MaRP, 2005 Bankr. LEXIS 3356, at *10 (B.A.P. 9th Cir. Apr. 26, 2005) (citing Varela as holding that a "chapter 11 plan could affect creditor's claim only if specific notice was provided that would satisfy due process concerns"). The court concludes the Plan process provides Lender all necessary due process considerations. Debtor's first "proposed" disclosure statement filed December 9, 2016, set forth Debtor's intention to "fully reinstate" the Loan by paying far less than the amount set forth in Lender's claim. This disclosure statement noted that while Lender "may contend that Debtor owes more in defeasance fees, default interest, penalties and possibly other default related charges," Debtor was "disput[ing] the amounts asserted." The court has weighed the need to preserve the Sheraton franchise resolution against Lender's right to defend its concept of a cure by permitting expedited discovery, an expedited identification of witnesses and evidence, and multiple opportunities for briefing. To ensure Lender received due process under the time constraints, the court also bifurcated the parties' dispute regarding attorneys' fees and set an evidentiary hearing on this issue for April 14, 2017, with additional opportunities for briefing. The court also granted Lender's motion to reopen the evidence.
All of these accommodations provide adequate due process. Lender's objection to the Plan on the basis that a claim objection is required is overruled.
E. Identification of Management
Lender objected to confirmation of the Plan on the ground that Debtor had not presented evidence on several confirmation requirements such as disclosure of its management post-confirmation as required by § 1129(a)(5). This objection is overruled as Luz is identified in Section 4.3 of the Plan as Debtor's post-confirmation management serving without compensation.
F. Payment of Administrative Expenses
Lender objected to the Plan on the grounds that Debtor lacked sufficient cash flow to pay its administrative expenses on the Effective Date as required by § 1129(a)(9). This is an objection for these creditors, not Lender, to raise. Counsel for Debtor indicates his firm is willing to be flexible on the cash payment requirement of the Bankruptcy Code. Lender lacks standing for this objection, which is overruled.
G. Default Interest
The most hotly contested issue in this plan proceeding is whether the default interest due under Section 2.2.4 of the Agreement is an unenforceable penalty. Lender asserts Debtor owes $673,206.85 in default interest for the period December 5, 2015, through March 11, 2017. This number is the product of subtracting the pre-default interest Debtor paid between December 5, 2015, and March 11, 2017 (totaling $743,093.05) from the default interest Lender estimates was due during this period ($1,407,299.90).
Lender calculates the amount of default interest which came due by taking each month's per diem interest and multiplying it by the number of days in that month. For example, in January 2016 the applicable per diem rate was $1,523.8890 (5.977%/360 multiplied by the principal balance of $9,178,518.36), which was then multiplied by 31 to arrive at an accrued interest of $47,240.56. At the end of each month, the unpaid interest is then added to the principal balance and a new per diem rate is calculated. Any payments Debtor made during this time are subtracted from the principal owed, at which time a new per diem rate is calculated.
Lender estimates Debtor's ending principal balance would be $8,986,159.94 had only pre-default interest been charged and Debtor's ending principal balance would be $10,011,634.95 if the default interest was charged. In other words, the principal amount due to the consequences of default, including the compounding of the default interest, would have increased the principal balance by over $1 million in less than a year, even though regular payments were made after the bankruptcy case. This $1 million principal increase would be reversed if Debtor cures the default and reinstates the Loan per Bornheimer's testimony.
The court must consider the amount of default interest, with the other consequences of default under the Loan document, in the context of Cal. Civ. Code § 1671(b). This statute provides that liquidated damages clauses in commercial, non-consumer contracts are valid unless the party seeking to invalidate the provision establishes "that the provision was unreasonable under the circumstances existing at the time the contract was made." Id. The California Law Revision Commission Comments to § 1671(b) describe how courts should approach the issue:
[Section 1671(b)] gives the parties considerable leeway in determining the damages for breach. All the circumstances existing at the time of the making of the contract are considered, including the relationship that the damages provided in the contract bear to the range of harm that reasonably could be anticipated at the time of the making of the contract. Other relevant considerations in the determination of whether the amount of liquidated damages is so high or so low as to be unreasonable include, but are not limited to, such matters as the relative equality of the bargaining power of the parties, whether the parties were represented by lawyers at the time the contract was made, the anticipation of the parties that proof of actual damages would be costly or inconvenient, the difficulty of proving causation and foreseeability, and whether the liquidated damages provision is included in a form contract.
Debtor bears the burden of proof under the current version of § 1671, which was enacted in 1977 after Garrett v. Coast & S. Fed. Sav. & Loan Assn., 9 Cal. 3d 731, 738 (1973) was decided. The amended version of § 1671 reversed the former presumptive invalidity of liquidated damages clauses so that in commercial contexts, such as here, liquidated damages are presumed valid, not invalid. See Weber, Lipshie & Co. v. Christian, 52 Cal. App. 4th 645, 654 (1997). A noted real estate treatise, Miller & Starr 4-110 California Real Estate Law & Practice § 110.10 (2016), however, opines that only the burden of proof was changed and that Garrett remains the law despite the amendment.
1. Extrinsic Evidence is Admissible to Determine the Default Interest
"Whether the amount to be paid upon breach of a contractual term should be treated as liquidated damages or as an unenforceable penalty is a question of law." Greentree Financial Group, Inc. v. Execute Sports, Inc., 163 Cal.App.4th 495, 499 (2008). This is consistent with California law more generally, which provides that interpretation of a written contract is "solely a judicial function." McGuire v. More-Gas Invs., LLC, 220 Cal. App. 4th 512, 523 (2013). Nonetheless, before determining the legal effect of a contract provision, courts must evaluate "its true function and operation," including considering extrinsic evidence relevant to whether the contract provision is ambiguous. McGuire, 220 Cal. App. 4th at 528, 532 (summary judgment denied on whether contract provision was an unenforceable penalty where evidence as to what the parties' reasonably expected at the time of contract created factual issues regarding whether the contract provided for an alternate performance). Here as well, the court must give the most weight to the documents, but also consider evidence presented as to the reasonableness and true form and function of the default interest provision.
2. The Default Interest is a Liquidated Damages Provision
The first step in determining if Section 2.2.4 is an unreasonable liquidated damages clause is to evaluate its "true function and character," i.e., whether it operates as a liquidated damages clause or an alternative performance provision. Ridgley v. Topa Thrift & Loan Assn., 17 Cal. 4th 970, 981 (1998) (prepayment fee equal to six months of interest and applicable only if the borrowers were more than 15 days late on a payment was a liquidated damages clause because it was "plainly intended as an incentive for prompt payment of interest"); Blank v. Borden, 11 Cal. 3d 963, 969 (1974) (withdrawai-from-sale provision in an exclusive, right-to-sell contract that provided the broker 6% of the price of the property if the seller withdrew was not a liquidated damages clause because "the provision presented the owner with a true option or alternative"); Meyers v. Home Sav. & Loan Assn., 38 Cal. App. 3d 544, 546-47 (1974) (prepayment charge not conditioned upon default was not a liquidated damages provision).
To argue the default interest provided in Section 2.2.4 is an "alternative form of performance," Lender relies on Thompson v. Gorner, 104 Cal. 168, 169 (1894), contending that default interest provisions that increase interest on a "going forward" basis are enforceable alternative forms of performance and not liquidated damages clauses. Doc. 232, pg. 21. Lender also argues Debtor made a conscious choice for a lower interest rate loan with the higher default pricing. But this is not supported by the evidence. Luz did not actively negotiate the Loan, however, her testimony that there was pressure to refinance the earlier loan since it was coming due and the lending market was difficult was credible. Luz was shocked when she learned of the harsh default consequences, which indicates that neither she nor Ralph (who negotiated the loan on behalf of Debtor), accepted these consequences in exchange for a lower interest rate. This is also corroborated by Heinz's testimony that the default interest was not discussed. Zelle avers that the risks at issue here likely would have resulted in Debtor receiving a higher interest rate, but for the default interest clause. However, Zelle has no knowledge of the actual circumstances of the negotiations and ignores the effect of other provisions of the Loan documents.
The Loan documents do not support Zelle's unimpeached testimony that the default interest provision served as a pricing mechanism to provide Debtor a lower rate of interest (5.977%) until Debtor's risk profile "deteriorate[d] as demonstrated by [Debtor's] failure to make required payments." Zelle tries to justify the default interest as necessary to compensate additional risk and expenses upon default, which are "difficult to quantify at the time a particular loan is made." But the risky aspects of the Loan Zelle referenced, i.e. that the Loan was secured by a ground lease and Debtor's income relied on a franchise agreement, were not generated by the default. Rather, these risks were present throughout the Loan, even when the 5.77% interest rate applied.
Zelle also testified that the default interest:
[C]ompensat[ed] [Lender] for the added perils and overhead costs not otherwise covered by the loan documents that are necessarily triggered or incurred when a loan changes from one that is performing into one that is in default and not performing.
However, the Agreement has numerous provisions which protect Lender from "added perils and overhead costs" in the case of breach, including funding reserve and escrow accounts, late charges, a defeasance fee, and a broad indemnity clause to cover all costs incurred with securing Debtor's "ongoing performance." The only potential costs excluded from the indemnity are those incurred from Lender's gross negligence or willful misconduct, none of which are at issue here. The court can find no cost of default not covered given the breadth of the indemnity provision and the wide array of reimbursement expenses sought by Lender as part of the cure, including, for example, Bornheimer's incidental travel expenses and the inspection fee. The extent of these protections is also clear from the amount of cure Lender requested in May 2016. See Ex. 31. Excluding the $195,304.28 in default interest requested at that time, Lender asserted it was entitled to $1,477,038.72, to cover late charges, compounded interest, attorneys' fees, appraisal fees, servicing fees, and a $100,000 work out fee. Lender also has a guaranty from Luz to cover its risks.
Lender's reliance on Thompson, 104 Cal. at 169, is also misplaced in light of the California Supreme Court's later ruling in Garrett, 9 Cal. 3d at 736, which distinguished the contract provision in Thompson, 104 Cal. at 169-179. In Thompson, higher interest was assessed only after a payment came due and only on the amounts in default. Garrett, 9 Cal. 3d at 736, differentiated that clause from liquidated damages clauses like the one at issue here which assess a higher interest rate "against the whole of the unpaid balance of the principal of the note whether or not in default." Garrett, id., explained:
[W]hen it is manifest that a contract expressed to be performed in the alternative is in fact a contract contemplating but a single, definite performance with an additional charge contingent on the breach of that performance, the provision cannot escape examination in light of pertinent rules relative to the liquidation of damages.
As applicable here, Debtor agreed to repay the principal owed at the Applicable Interest Rate of 5.977%. This is a single, definite performance. In Section 2.2.4 of the Loan Agreement, Debtor then agreed that upon default it would be charged the default interest rate. This is an "additional charge contingent on the breach." Under Garrett, this provision is a liquidated damages clause, not an alternative performance. Garrett, 9 Cal. 3d at 738, elaborated:
The only reasonable interpretation of the clause providing for imposition of an increased interest rate is that the parties agreed upon the rate which should govern the contract and then, realizing that the borrowers might fail to make timely payment, they further agreed that such borrowers were to pay an additional sum as damages for their breach which sum was determined by applying the increased rate to the entire unpaid principal balance.See also Blank, 11 Cal. 3d at 970 (courts look at "the substance rather than form" of a contract provision when determining whether it is a liquidated damages clause). As Blank, 11 Cal. 3d at 971, explained, where the liquidated damages clause, like the late charge in Garrett, is calculated as "a percentage of the unpaid principal balance . . . during which [the] payment was in default," it cannot be reviewed as a mode of alternative performance because:
[The] arrangement, viewed from the time of making the contract, realistically contemplates no element of free rational choice on the part of the obligor insofar as his performance is concerned; rather the agreement is founded upon the assumption that the obligor will make the lower
payment.
Lender attempts to distinguish Garrett by arguing that the provision at issue there was a "late charge formulated as interest based on a percentage of the total unpaid principal balance remaining." Doc. 238, pg. 13. But the court is not convinced the provision at issue in Garrett and the provision at issue here are factually distinguishable. The provision in Garrett provided for 2% per annum interest to be charged "on the unpaid principal balance of this note from the date unpaid interest started to accrue until the close of the business day upon which payment curing the default is received." 9 Cal. 3d at 735. Similarly, the default interest here allows Lender to charge a higher interest on any unpaid principal and accrued interest during the period of default. The clause at issue in Garrett is nearly identical to the default interest here, except that Lender's provision charges a higher interest rate and provides that the default interest will be charged against interest accruing during the default period (i.e., it includes compounding interest), while the default interest in Garrett was charged only against unpaid principal on a per annum basis. The default interest provision here left Debtor with no practical cure right because the amount to cure was magnified by over five times the actual payments missed. The court, therefore, concludes the default interest was included to coerce timely payment. See also Garrett, 9 Cal. 3d at 737.
Since Lender was otherwise compensated for any expenses resulting from Debtor's default and had numerous protections against any additional risk, it is a reasonable inference that the default interest had nothing to do with covering expenses or compensating for any additional risk but was instead intended to increase revenue. See Hitz v. First Interstate Bank, 38 Cal App 4th 274, 289-90 (1995), review denied, 1995 Cal. LEXIS 7511 (1995); Poseidon Dev., Inc. v. Woodland Lane Estates, LLC, 152 Cal. App. 4th 1106, 1115 (2007) (provision charging 10% of the amount overdue was an unreasonable penalty and was not intended to compensate creditor for administrative expenses despite language in the contract to the contrary because the late charge varied based on the amount due, but the lender's administrative loss for the breach could not reasonably be said to vary depending on the amount of the overdue payment).
Since the evidence does not support a finding that the default interest rate provision was intended to provide Debtor a "free rational choice" as to how to perform its obligations when the Loan was made, the court concludes it is a liquidated damages provision. As such, the default interest is unenforceable unless it is reasonable.
3. The Default Interest is an Unreasonable Penalty
Under Ridgley, 17 Cal. 4th at 981, the primary factors the court must consider to determine whether the liquidated damages provision is an unreasonable penalty are (1) whether the provision is disproportionate to the actual losses suffered by the lender as a result of the default and (2) whether the interest was the result of a reasonable endeavor to approximate the reasonably anticipated harm at the time of the making of the contract. While other factors are identified in the legislative history to Cal. Civ. Code § 1671(b), these must be considered of secondary important since neither of the two Supreme Court cases discussing liquidated damages clauses after the 1977 amendment even mentioned them. See Ridgley, 17 Cal. 4th at 977; Perdue v. Crocker Nat'l Bank, 38 Cal. 3d 913, 930 (1985) (remanding case to determine whether charges for checks returned for non-sufficient funds were valid under § 1671 as "a reasonable endeavor . . . to estimate a fair average compensation for any loss . . . sustained"); see also Arciniega v. Clark (In re Arciniega), Case No. 5-1123-KiGD, 2016 Bankr. LEXIS 343, at *32-33 (B.A.P. 9th Cir. Feb. 3, 2016) (analyzing the two primary factors identified in Ridgely).
a. The Default Interest is Not Proportionate to Lender's Losses
The first factor is whether the default remedies are disproportionate to the anticipated damages. Indeed, this is the "characteristic feature of a penalty." Ridgley, 17 Cal. 4th at 973-74; see also Cellphone Fee Termination Cases, 193 Cal App 4th 298, 321-22 (2011), cert. denied sub nom., Sprint Spectrum, L.P. v. Ayyad, 565 U.S. 1014 (2011) (liquidated damages clause was not reasonable as it was not a fair estimate of the actual damages for any loss but was designed to generate a profit). The default interest of $673,206.85 plus the late charge of $64,997.50 is a 151.47% increase over the $293,556.80 in missed payments, even ignoring the other consequences of default. The default interest is not proportional to Lender's losses, and this factor is easily met.
b. The Default Interest Was Not the Result of a Reasonable Endeavor to Approximate Harm
Turning to the second primary factor, Debtor presented uncontradicted evidence in Heinz's declaration that the parties did not discuss the reasonably anticipated damages. Heinz stated:
In my contact with [Barclays' attorney], we never endeavored to anticipate or pre-estimate the range of damages that Barclays could have incurred if Debtor defaulted on the Loan and/or to determine whether the default interest rate would compensate Barclays for any damages it anticipated incurring at the time the Loan was executed.
No other witness, including Zelle, Bornheimer, or Luz, had any personal knowledge of what was actually discussed at the time the Loan was made. The court finds that Debtor met its burden of proof that the parties made no reasonable endeavor to quantify the damages.
c. Other Circumstances Surrounding the Loan Do Not Outweigh the Punitive Nature of the Default Interest
Because of the strength of the evidence supporting the two primary factors for assessing the liquidated damages provision as a penalty, the other factors identified in the statute's legislative history are less important. While Lender was more sophisticated than Debtor, Debtor was represented by counsel in the negotiation of the Loan. There is also no evidence that the Loan documents were form contracts, and the parties were of relatively equal bargaining strength (Heinz testified the Loan terms were negotiable). However, these facts do not change the court's determination that the default interest is a penalty.
That default interest is common in the industry also does not save it from being considered a penalty. As the Supreme Court noted in Garrett, 9 Cal. 3d at 740 n.8, while invalidating a default interest provision, "such charges are not unusual in the savings and loan industry." This fact, however, does not make such provisions enforceable under California law. The court thus gives little weight to the testimony that Sheraton's license agreement, Debtor's prior loans, and other commercial loans charge higher default interest.
Finally, the fact that the Loan is a commercial loan does not prevent the default interest from being considered a penalty as the loan in Ridgley was not a consumer loan. 17 Cal. 4th at 974; see also Dye v. Sachs (In re Flashcom, Inc.), No. CC-13-1311-KuDaKi, 2014 Bankr. LEXIS 4215, at *30 (B.A.P. 9th Cir. Oct. 1, 2014) (citing Ridgley, 17 Cal.4th at 981 n.5; Harbor Island Holdings v. Kim, 107 Cal.App.4th 790, 799 (2003)) ("California courts have made it clear that sophisticated parties engaged in commercial transactions are not exempt from the protections afforded under Cal. Civil Code § 1671(b).").
The court finds the default interest provision in the Loan is an unenforceable penalty.
H. Estoppel
The parties each make estoppel arguments without identifying which of the three recognized estoppel doctrines (equitable, promissory, or judicial) actually apply. Lender contends that Debtor is estopped from contesting the default interest due to Debtor's counsel's opinion letter and testimony. It also contends that Debtor is judicially estopped from contesting its 5% default interest rate because it recommended the court approve insider financing that itself had a 3% default interest rate. Debtor, for its part, contends that Lender is estopped from claiming a default because it held sufficient funds to keep the payments current.
1. The Opinion Letter Does Not Estop Debtor From Asserting that the Default Interest Violates California Law
In the Opinion Letter, Heinz opined:
The Loan does not violate the usury laws or laws regulating the use of forbearance of money of the State of California and the operation of any term of the Loan Documents, including, without limitation, the terms regarding late charges and default interest rate or the lawful exercise of any right thereunder, shall not render the Loan Documents unenforceable, in whole or in part, or subject to any right of rescission, set-off, counterclaim or defense.
Heinz also opined that each of the Loan documents was a "valid and legally binding obligation" of Debtor "subject to (i) applicable bankruptcy, insolvency, reorganization, moratorium and other similar laws affecting the rights of creditors generally, and (ii) the exercise of judicial discretion in accordance with general principles of equity (whether applied by a court of law or of equity)."
Without citing to the elements of any of the legal theories, Lender argues that "whether analyzed under the lens of contractual estoppel, promissory estoppel, or equitable estoppel" Debtor is estopped by the Opinion Letter from asserting the default interest is unreasonable.
Debtor contends that the Opinion Letter does not issue an opinion as to the enforceability of the Loan and excludes from its analysis the enforceability of the Loan terms in the event of bankruptcy. When the Opinion Letter was signed, Debtor notes, the controlling law at the time was Great W. Bank & Tr. V. Entz-White Lumber & Supply, Inc. (In re Entz-White Lumber & Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988), which held that a debtor that cures a default in bankruptcy is entitled to avoid all consequences of the default, including higher post-default interest rates. Heinz's testimony also referenced the equity exception to the Opinion Letter, and the invalidity of liquidated damages is based in equity. Ebbert v. Mercantile Tr. Co., 213 Cal. 496, 499-500 (1931).
No party has cited any authority that an opinion letter signed by a borrower's counsel can be relied upon by a lender to invalidate an unenforceable provision of the loan, and the court cannot find any such authority. While the Opinion Letter is an admission by an agent of the borrower, it can only support a claim for equitable estoppel if the following requisite elements are met: (a) there was a representation or concealment of material facts; (b) made with knowledge, actual or virtual, of the facts; (c) to a party ignorant, actually and permissibly, of the truth; (d) with the intention, actual or virtual, that the ignorant party act on it; and (e) that party was induced to act on it. Simmons v. Ghaderi, 44 Cal. 4th 570, 584 (2008) (citing 13 Witkin, Summary of Cal. Law (10th ed. 2005) Equity, § 191, pp. 527-528.)); see also United States v. Hemmen, 51 F.3d 883, 892 (9th Cir. 1995). There can be no estoppel if one of these elements is missing. Ghaderi, 44 Cal. 4th at 584.
In re Perry, 425 B.R. 323, 374 (Bankr. N.D. Tex. 2010), has the most similar facts, although it dealt with an estoppel challenge to usury instead of default interest. Perry, id., found no equitable estoppel because there was no knowledge of the facts at issue being wrong. This is also the missing element here. Debtor did not know that the default interest might violate California law and Heinz thought it reasonable. The court rejects Lender's attempts to distinguish Perry on grounds it improperly conflated equitable estoppel and promissory fraud, because Perry, 425 B.R. at 374 expressly applied the elements of equitable estoppel. The court also notes there was no evidence at trial that Barclays was "ignorant" of the law. Indeed, the evidence was uncontroverted that Barclays had its own counsel to rely upon. The reliance element is, therefore, also lacking.
Promissory estoppel is equally inapplicable. It is an equitable doctrine which allows enforcement of a promise that would otherwise be unenforceable. Barroso v. Ocwen Loan Servicing, LLC, 208 Cal. App. 4th 1001, 1016 (2012). Its elements are: (a) a promise clear and unambiguous in its terms; (b) reliance by the party to whom the promise is made; (c) a finding that that reliance was reasonable and foreseeable; and (d) the party asserting the estoppel was injured. Id. Promissory estoppel does not apply to the Opinion Letter since Barclays was a sophisticated party with its own counsel. Barclays was also not injured by any assertion that the agreement complied with California law. Mark Twain Kan. City Bank v. Jackson, Brouillette, Pohl, & Kirley, P.C., 912 S.W.2d 536 (Mo. Ct. App. 1995) (attorneys' incorrect representations regarding the debtor's authority to enter into in the loan were not sufficient to form a basis for negligent liability because the lender could not have reasonably relied on the letter); see also Trans-World Int'l v. Smith-Hemion Prods., 972 F. Supp. 1275, 1284 (C.D. Cal. 1997) ("[I]t is implicit in the equitable principles underlying the doctrine of promissory estoppel that unreasonable reliance cannot be compensated.").
Lender alternatively cites Giacommazi v. Rowe, 109 Cal.App.2d 498, 502 (1952), for the principle that "contractual estoppel is fairly easy to find" and is applicable here. Giacommazi stands alone in advancing a contract by estoppel theory. It cites no authority for its contract by estoppel theory and has not been followed by any case espousing this theory. The court does not find it persuasive here as its precedential weight pertains only to community property issues. Id.
All of Lender's estoppel theories relating to the Opinion Letter are rejected.
2. Debtor is Not Judicially Estopped From Asserting the Default Interest Rate is Unreasonable Under California Law
Lender argues Debtor is judicially estopped from asserting the default interest of 5% is unreasonable under California law because Debtor's insiders loaned Debtor money with a 3% default interest rate under the Pre-petition and Post-petition LOCs, which the court approved. Judicial estoppel is an equitable doctrine that precludes a party from gaining an advantage by asserting one position and then later taking a clearly inconsistent position. Ah Quin v. Cty. of Kauai DOT, 733 F.3d 267, 270-71 (9th Cir. 2013); Hamilton v. State Farm Fire & Cas. Co., 270 F.3d 778, 782 (9th Cir. Cal. 2001).
The Supreme Court identifies three factors to consider in applying judicial estoppel, but notes the doctrine is not suitable for a precise test: (a) the party's later position must be "clearly inconsistent" with its earlier position; (b) the party persuaded a court (either an earlier court or the same court) to accept that position in some way; and (c) that party would derive an unfair advantage or impose unfair detriment if not estopped. New Hampshire v. Maine, 532 U.S. 742, 750 (2001); see also Reed Elsevier, Inc. v. Muchnick, 559 U.S. 154, 170 (2010). Judicial reliance may occur in a number of ways, such as the discharge of a debtor, lifting of a stay, or approval of a reorganization plan. Hamilton, 270 F.3d at 784.
The court must analyze each Lender's claims of judicial estoppel separately as to each of the Pre-petition LOC and the Post-petition LOC.
a. The Post-petition LOC
The first factor of the judicial estoppel test is clear inconsistency. The Post-petition LOC and the Loan have some similarities and some differences. Both the Post-petition LOC and the Loan provide for default interest on the principal balance and include late charges based on the amount of a missed payment. Both were negotiated in times of financial difficulty for Debtor and there is no evidence that either situation involved the negotiation of liquidated damages. Nonetheless, the Post-petition LOC default interest rate is 3%, while the Loan default interest rate is 5%, and the terms of the Loan are, overall, far more onerous than the terms of the Post-petition LOC. The greatest difference between the two financing arrangements, however, is that the Post-petition LOC will be subordinated under the Plan and the Loan is secured and will be cured on the Effective date. This difference dissuades the court from finding Debtor's position regarding the default interest is clearly inconsistent. MK Hillside Partners v. Comm'r, 826 F.3d 1200, 1207 (9th Cir. 2016) (counsel's statement in oral argument did not estop a party from asserting a clearly inconsistent position in a later proceeding because the court's two holdings did not conflict).
The second factor of the judicial estoppel test is whether approving the Plan without a cure of Lender's default interest would create a perception that Debtor misled the court in approving the Post-petition LOC. In requesting the court approve the Post-petition LOC, Debtor represented to the court that its terms were enforceable under California law. See In re Tristar Fire Prot., Inc., 466 B.R. 392, 404 (Bankr. E.D. Mich. 2012) (court was required to find that union claim was "enforceable against the [d]ebtor" before treating it as an administrative expense). However, since Debtor did not specifically reference the default interest in its application, no perception was created that it misled the court.
The third factor is whether Debtor gained any unfair advantage in approving the Post-petition LOC claim and challenging the default interest as the cure obligation to the Lender under the Plan. Given the subordination provisions of the Plan for the Post-petition LOC, and the amendment effect of the Plan order, the court finds no unfair advantage.
b. The Pre-petition LOC
In its application to employ G&R, Debtor asserted that Gaslamp's payment of G&R's $100,000 retainer under the terms of the Pre-petition LOC did not create a conflict of interest which would prevent G&R from representing Debtor in this proceeding. This is not in any way inconsistent with Debtor's position that the 5% default in the Loan is unreasonable under California law. Debtor made no representation about the enforceability of any provision of the Pre-petition LOC in the application on which the court could have relied to create an impression the court was misled. None of the elements of judicial estoppel are met here and judicial estoppel will not be found.
3. Lender Is Not Estopped From Asserting Default Because of Reserves
Debtor argues that Lender is estopped from claiming a default because when the five payments of $293,556.80 were missed, Lender could have paid itself in full from the $273,510.86 in a Lockbox Account and $385,104.24 in Debtor's FF&E Reserve Account. These funds were not released until December 2016, when Lender used them to cover other defaults.
While these facts may be germane to the reasonableness of the default interest, Debtor fails to identify upon which estoppel theory Debtor is relying. It cannot be judicial estoppel since no judicial act was requested or undertaken. It cannot be promissory estoppel since no promises were made. The only doctrine left is equitable estoppel, which requires proof of the four elements noted above. As with Lender's equitable estoppel regarding the opinion letter, the element that is missing here is a misrepresentation, since Lender's conduct was consistent with the Loan documents. As Lender's actions in connection with the reserve accounts were consistent with the parties' Agreement, the court cannot find that Lender is equitably estopped from asserting a default.
I. Reserve Accounts
The court must resolve whether the following four reserve amounts must be included in the Plan cure of the default in the Loan:
| Tax Escrow | $ 172,778.52 |
| FF&E Reserve | $ 811,592.56 |
| Ground Rent Reserve | $ 63,515.00 |
| Protective Advances —Inspection fees and costs | $ 1,484.18 |
| TOTAL DISPUTED AMOUNT | $1,049,370.26 |
|---|
1. Tax Escrow
As to the Tax Escrow, Bornheimer admits in his declaration, Doc. 231, p. 13:17-21, that Debtor is not obligated to replenish the Tax Reserve if the payment is timely made on April 10, 2017. Debtor has confirmed this payment had been made, and only ongoing payments are required as Bornheimer concedes.
2. FF&E Reserve
The Loan document requires the establishment of an FF&E Reserve under Section 7.3 to provide a fund for "repair[s] required . . . to keep the Property in a condition consistent with a full Service hotel" [sic]. Section 7.3.2 requires Lender make disbursements from the FF&E Reserve "to reimburse [Debtor] . . . for the costs of . . . Replacements." Replacements, in turn, is defined in Section 7.3.1 as "furniture, fixtures and equipment, and replacements and repairs required to be made to the Property during the calendar year."
Debtor intends to satisfy the FF&E reserve requirements with its separate funding of the PIP. Bornheimer concedes that performance of the PIP is likely a proper use of the FF&E reserves generally, but asserts that Lender has not been able to specifically approve payment of PIP repairs from the FF&E reserve because it does not have details on the repairs to be made under the PIP. Bornheimer also states that to use FF&E reserve monies, Debtor must satisfy the administrative obligations set forth in the parties' Agreement. However, Bornheimer concedes that Debtor has no obligation to maintain a minimum balance in the FF&E reserve and agrees that Debtor is not required to use the FF&E Reserve to fund the PIP, although this is the Lender's preference.
It is mystifying to the court why Lender claims not to have the details of the PIP expenses, as a detailed list totaling $886,283.69 was attached as Exhibit B to the Second Amended Disclosure Statement filed on January 13, 2017. When credited to the $811,592.56 Lender requests be funded to the FF&E Reserves, Debtor has more than enough to offset its FF&E Reserve requirements and no further cure is required here. Of course, Debtor must fund the FF&E Reserve on an ongoing basis.
3. Ground Rent Deposit
Debtor states it will be current on the Ground Rent as of the Effective Date, and will then make deposits into the Ground Rent Reserve 10 days before each next payment is due. No further cure is necessary.
4. Inspection Fees
As to the Inspection fees and costs, Bornheimer at Doc. 231, p. 15:27-16:3, avers:
As a result of the defaults set forth above, in the Spring of 2016, a representative of the Lender visited the Property for a site inspection, which resulted in costs to the Lender of $1,484.18. Pursuant to section 9.3 of the Loan Agreement, the fees and costs incurred in the site inspection are recoverable to Secured Creditor.
While Debtor contends Lender's failure to provide an invoice, the date of the inspection, or its purpose requires these expenses be denied reimbursement, Debtor has the burden of proof. As there is nothing to refute Bornheimer's declaration, this item is required as part of the cure amount.
J. Sheraton Settlement
As part of the Plan confirmation, Debtor seeks approval of its Stipulation with Sheraton to approve: (1) Debtor's assumption of the License Agreement and PIP under § 365; (2) its settlement of Sheraton's motion for relief from stay; and (3) its cure of defaults and provision of adequate assurances of future performance under the License and PIP. Essentially, Sheraton is extending the deadlines to perform the PIP and increase guest satisfaction. While Lender initially objected to the settlement, it later withdrew its objection.
To approve a settlement, the bankruptcy court must find it fair and equitable, based upon the following four factors:
(a) The probability of success in the litigation; (b) the difficulties, if any, to be encountered in the matter of collection; (c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; (d) the paramount interest of the creditors and a proper deference to their reasonable views in the premises.
In re A & C Properties, 784 F.2d 1377, 1381 (9th Cir. 1986), cert. denied sub nom, Martin v. Robinson, 479 U.S. 854 (1986). These findings must be supported by the evidence and must be examined in light of the circumstances present at the time the settlement is considered. Id.; Reynolds v. C.I.R., 861 F.2d 469, 473 (6th Cir. 1988). The burden of persuading the court that the compromise should be approved falls on its proponent. A & C Properties, 784 F.2d at 1381; see also In re HyLoft, Inc., 451 B.R. 104, 109-10 (Bankr. D. Nev. 2011). Based on the evidence in the record relating to the Plan and the Sheraton relief from stay, the court finds these factors are met. Debtor cannot operate profitably without the franchise agreement in place and the cure is expected to increase revenues. The reasons why the franchise agreement went into default and which party is to blame are complex and litigation would risky and expensive.
The court will approve the settlement.
K. Attorneys' Fees
As part of Lender's cure, Lender seeks to recover its attorneys' fees and costs incurred in enforcing its rights in this bankruptcy case, in a prior receivership proceeding, and in a guarantee action Lender is pursuing against Luz. In total, Lender requests the following:
| Fees & Costs Requested | Fees | Costs |
|---|---|---|
| Period ending on February 28, 2017 ("FirstPeriod") (Doc. 230 ¶ 3) | $351,840.50 | $21,014.62 |
| March 2017 ("Second Period")(Doc. 283 ¶ 22) | $159,519.50 | $29,716.73 |
| April 2017 ("Third Period") Fee Estimate(Doc. 283 ¶ 24) | $45,000.00 | |
| Total | $556,360.00 | $50,731.35 |
Lender also requests fees of $2,210.57 to reimburse its client, Bornheimer, his expenses for attendance at the trial totaling $2,210.57 (including a $1,580.60 flight, a $510.67 hotel, and $119.30 in incidental charges).
Lender asks Debtor pay these fees and costs pursuant to Section 10.13(a) of the Agreement, entitled "Indemnity." This indemnity provision requires Debtor pay "reasonable costs and expenses (including reasonable and actual attorneys' fees and disbursements)" that Lender incurs "in connection with" Debtor's performance under the Agreement, including:
[E]nforcing any obligations of or collecting any payments due from [Debtor] under [the] Agreement . . . in connection with any refinancing or restructuring of the credit arrangements provided under [the] Agreement in the nature of a 'work-out' or of any insolvency or bankruptcy proceedings; provided, however, that [Debtor] shall not be liable for the payment of any such costs and expenses to the extent the same arise by reason of the gross negligence, illegal acts, fraud or willful misconduct of Lender.
There are several other attorneys' fees provisions in the Agreement. See Section 5.1.12 ("Costs of Enforcement"). However, since Lender does not rely on those provisions, the court will not address them.
Attempting to determine how much of Lender's attorneys' fees and costs must be included in the cure amount has been a challenge for the court and the parties. Not only is the total a moving target as additional proceedings regarding the Plan are held, but also the award is affected by the court's determination of the prevailing party under applicable law. Before the court gave its oral ruling on the Plan, Debtor objected to about 40% of Lender's fees and costs for the period ending on February 28, 2017, arguing that only $187,848 were reasonable. Debtor's initial objections claimed certain of Lender's fees and costs were not reasonable because the fees were unnecessary, duplicative, or administrative, or that that the descriptions were vague. Debtor's objection that some of the fees were unnecessary was based upon its categorization of the fees into 13 groups. Some of these categories did not relate to the bankruptcy and were contested on this ground.
The vagueness objections were justified because Lender had redacted many entries as it asserted attorney-client and work product privileges. These objections were later resolved by Lender serving on Debtor's counsel and filing under seal some of the un-redacted entries. Lender responded to the duplication charge by favorably comparing its counsel's charges with those of Debtor for the same time period and asserted it employed a staffing technique to avoid duplicative work. Lender also argued its expert witness, Zelle's, fees are reasonable because he provided a discount. Lender noted Zelle's testimony was not challenged and was critical to the resolution of the challenging issues in this proceeding.
After the court's oral ruling on April 10, 2017, Debtor filed a supplemental objection, arguing that Lender is not entitled to any attorneys* fees and costs because it is not the prevailing party under Cal. Civ. Code § 1717. It contends this objection could not have been made previously since the parties were unaware of the outcome of the confirmation proceeding prior to the court's oral ruling. Debtor also asserts Lender bears the burden of proof, and that Zelle's site inspections were unnecessary. Debtor attaches a spreadsheet to its supplemental objection as Ex. A, which withdrew some objections to Lender's un-redacted entries but asserted new objections to others. Debtor's Ex. B set forth objections to fees and costs Lender claimed for March 2017, which was filed with the court on April 11, 2017. Doc. 283.
The court then analyzed both parties' submissions on the attorneys' fees issue as is set forth below.
1. Attorneys' Fees Analysis
"[S]tate law governs an award of attorney fees if 'state law and not federal bankruptcy law provides the rule of decision in a contested matter.'" Krommenhoek v. A-Mark Precious Metals, Inc. (In re Bybee), 945 F.2d 309, 315-16 (9th Cir. 1991). California law is applicable to this dispute. Although § 506(b) normally applies to the consideration of a secured creditor's post-petition fees and costs, in this proceeding, the court is determining a cure under § 1124. As state law applies to the determination of Lender's cure, § 506(b) is inapplicable. Entz-White, 850 F.2d at 1343 n.7, reversed on other grounds, New Investments, 840 F.3d at 1141.
Under the American Rule, recognized in California at Cal. Code Civ. Proc. § 1021, litigants must pay their own attorneys' fees unless a statute or contract provides otherwise. Baker Botts L.L.P. v. ASARCO, LLC, 135 S. Ct. 2158, 2161 (2015). California law, through Cal. Civ. Code § 1717, recognizes that "parties may validly agree that the prevailing party will be awarded attorneys' fees incurred in any litigation . . . ." Tompkins v. 23andMe, Inc., 840 F.3d 1016, 1024 (9th Cir. 2016) (citing Santisas v. Goodin, 17 Cal. 4th 599, 608 (1998)). The parties agree that § 1717 applies to this action, which permits awards of "reasonable" attorneys' fees and costs where (1) an action is "on a contract"; (2) there is a contractual provision stating attorneys' fees and costs will be awarded to either of the parties; and (3) the fees and costs are requested by the "prevailing party." AmeriCredit Fin. Servs. v. Penrod, 611 F.3d 1158, 1087-88 (9th Cir. 2010).
Under California law, Lender bears the burden of proof of the reasonableness of its fees. Civic W. Corp. v. Zila Indus., Inc., 66 Cal. App. 3d 1, 16 (1977) ("It is elementary that attorney fees must be reasonable, and that the party claiming [attorney fees] must establish (1) not only entitlement to such fees but (2) the reasonableness of the fees claimed."). The court has discretion to "fix the fee at the fair market value for the legal services provided." PLCM Group v. Drexler, 22 Cal. 4th 1084, 1095 (2000); see also MeInyk v. Robledo, 64 Cal. App. 3d 618, 622-23 (1976) ("[D]etermination of what constitutes reasonable attorney fees is committed to the discretion of the trial court . . . .") (fee request for enforcing a deed of trust reduced from $71,825 as a $25,000 fee award was "ample for the services rendered").
Applying the elements of § 1717 to Lender's fee request, it is undisputed that all of the fees and costs requested arise from actions on the contract. The Ninth Circuit has specifically held that plan proceedings constitute an action on a contract. Penrod, 802 F.3d at 1087 (fees recovered by the debtor in post-petition litigation as the prevailing party and resolution of objections to a plan of reorganization is an action on the contract). Second, there is no dispute that the Indemnity authorizes an award of the attorneys' fees to Lender. The third element, however, is disputed: whether Lender is a "prevailing party." Debtor also generally disputes the reasonableness of the fees requested, which is required under both § 1717 and the parties' Agreement.
To determine the prevailing party, the court is guided by the Ninth Circuit authority of Berkla v. Corel Corp., 302 F.3d 909, 920 (9th Cir. 2002), which applied the California Supreme Court standard for identifying the prevailing party articulated in Hsu v. Abbara, 9 Cal. 4th 863, 876 (1995):
[I]n deciding whether there is a "party prevailing on the contract," the trial court is to compare the relief awarded on the contract claim or claims with the parties' demands on those same claims and their litigation objectives as disclosed by the pleadings, trial briefs, opening statements, and similar sources. The prevailing party determination is to be made only upon final resolution of the contract claims and only by "a comparison of the extent to which each party ha[s] succeeded and failed to succeed in its contentions."
The Ninth Circuit in Berkla, 302 F.3d at 920, found it appropriate to deny a request for attorneys' fees where the moving party recovered only $23,502 in compensatory damages after requesting more than $1.2 million. This outcome was found to be insufficiently successful to deem that party a prevailing party. Id.; see also DeaneGardenhome Assn. v. Denktas, 13 Cal. App. 4th 1394, 1398 (1993) ("Typically, a determination of no prevailing party results when both parties seek relief, but neither prevails, or when the ostensibly prevailing party receives only a part of the relief sought."). Both inside and outside the bankruptcy context, the applicable law defining a prevailing party requires each aspect of the dispute be separately evaluated.
The court conducted its prevailing party analysis of Lender's fees and costs on a category by category basis for the first two applicable periods. The court then applied its prevailing party analysis to Lender's April 2017 fee estimate. The court then conducted a review of Debtor's technical objections to Lender's fees in each allowed category. Finally, costs were separately considered.
2. Categorical Review
In conducting its categorical review, the court considered Debtor's Exhibit 1 to Rathbone's March 16th declaration, which provided a list of all the fees Lender requested for the First Period, ending on February 28, 2017, with Debtor's own categorization of the fee request and a brief description of any technical objection Debtor asserted. Although Lender agreed to provide un-redacted entries for the First Period and filed two supplemental declarations under seal which attached some un-redacted entries (see Docs. 271 and 297), some fee entries remain un-redacted for the First Period, which limited the court's categorical review as is set forth more fully below. After examining fees for the First Period, the court added to its review Lender's fees for the Second Period, which Lender filed under seal with the court April 11, 2017, and to which Debtor responded in its Exhibit B filed on April 13, 2017.
While Debtor categorized Lender's fees into 13 different categories, the court found only some of the categories Debtor identified to be helpful. Instead, the court found it appropriate to divide Lender's fees into the following 6 categories:
1. The state court action (including Lender's default loan analysis and the receivership);
2. The Luz guarantee action;
3. The Chapter 11 administration (including cash collateral negotiations and filings and proceedings related to Debtor's business operations);
4. The proposed sale in this bankruptcy proceeding;
5. The Starwood relief from stay and settlement;
6. The Plan and Disclosure Statement.
As to the First Period, the court evaluated whether the fees were reasonable considering which party was the prevailing party for each category as is set forth more fully below. As to the Second Period, the court found all of the fees and costs but $288 relate to category 6.
a. Category 1 - State Court Receivership Litigation
Given the breadth of the Indemnity, Lender contends that its cure is not limited to the bankruptcy matters and that the fees and costs relating to the guaranty and the receivership should be included. The court agrees. The court also finds credible Lender's explanation for maintaining the receivership matter even after the bankruptcy was filed.
Debtor's general objections to this category of fees are overruled.
b. Category 2 - Guarantee Litigation
As to the guarantee litigation, the court finds that the actions taken on the guarantee against Luz are within the scope of the attorneys' fees provision on which Lender relies, since the Guaranty is identified as a Loan Document in the Agreement and any enforcement actions undertaken regarding any Loan document are subject to the attorneys' fees provision. This is similar to In re Hyer, 171 B.R. 67, 70 (Bankr. W.D. Mo. 1994) (rejecting the notion that fees attributed to an action against a non-debtor guarantor cannot be recovered against the debtor where the creditor is oversecured but where the attorneys' fees provision expressly covered actions on the guaranty); cf. In re Woods Auto Gallery, Inc., 379 B.R. 875, 892 (Bankr. W.D. Mo. 2007) (distinguishing guarantee for that reason).
The court nevertheless will disallow all of the fees in this category because the court is in no position to determine who is the prevailing party in a matter pending before another court, as to which the outcome is not yet determined. Under California law, the court cannot award fees without a determination of the merits of the action. Liu v. Moore, 69 Cal App 4th 745, 755 (1999) ("the issue of the right to attorneys' fees for the successful appeal is deferred until the final resolution of the merits of the case"); Brosio v. Deutsche Bank Nat'l Tr. Co. (In re Brosio), 505 B.R. 903, 912 (B.A.P. 9th Cir. 2014) ("we could not locate, a single case with a procedural posture such as this one where nothing was adjudicated by the court and yet it considered a party's motion for attorneys' fees under [] § 1717").
Fees Lender incurred in connection with the enforcement of the Guaranty are also not reasonable because Debtor has been trying to cure the default to Lender and reinstate the Loan in this case. As stated in In re Southeast Co., 81 B.R. 587, 592-593 (B.A.P. 9th Cir. 1987), aff'd, In re Se. Co., 868 F.2d 335, 340 (9th Cir. 1989): "Courts have shown considerable reluctance to award attorneys' fees for such post-petition litigation, where the secured creditor's interest is not threatened." See also In re Masnorth, 36 B.R. 335, 339 (Bankr. N.D. Ga. 1984) (court reduced attorneys' fees requested by more than half where post-petition litigation was primarily motivated by a desire for an increased interest rate and a $100,000 equity cushion protected secured creditor's interest).
Having disallowed the fees in this category, the court need not determine if requiring Debtor to pay attorneys' fees and expenses incurred in prosecuting an action outside the court post-petition would be a violation of the automatic stay, or if awarding Lender fees associated with the guarantee action could lead to double recovery. All fees regarding the guaranty are disallowed without prejudice to Lender's rights in that suit.
The fees disallowed in this category for the First Period are set forth in Appendix A and total $26,884. The court was unable to identify any fees related to the guarantee action for the Second Period.
c. Category 3 - Ch. 11 Administration
Lender's fees and costs incurred in connection with the administration of Debtor's Chapter 11 case are generally reasonable. Debtor's bankruptcy required Lender to monitor the case and prevent the use of cash collateral. These fees were reasonable since Lender was successful in negotiating Debtor's use of cash collateral and protecting its rights in this case. See, e.g., In re Melbell Assocs., 99 B.R. 31, 35 (Bankr. E.D. Cal. 1989) (fees in case administration awarded as reasonable where there was "no evidence to support a finding that any of the fees and costs described therein were not directly related to the protection of [the bank's] rights as the beneficiary under the [] deed of trust"). While § 506(b) was the statutory authorization for the fees in Melbell, id., instead of § 1717, both statutes require a review for the reasonableness. See Kord Enters. II v. Cal. Commerce Bank (In re Kord Enters. II), 139 F.3d 684, 689 (9th Cir. 1998) (although state law is not determinative in § 506(b) analyses, the reasonableness of the fees must be considered).
Debtor's objections to this category are overruled.
d. Category 4 - Proposed Sale
This category involves Debtor's efforts to sell the Hotel to pay creditors, which were thwarted by Lender's assertion of the defeasance fee of $2.6 million. The court will disallow these fees as unreasonable because Lender did not later assert the defeasance fee as part of the cure right. Lender cannot be viewed as the prevailing party in an action where it abandoned the issue that gave rise to the fees. In Countrywide Home Loans, Inc. v. Hoopai (In re Hoopai), 581 F.3d 1090, 1102-03 (9th Cir. 2009), applying a similar Hawaii state law, the Ninth Circuit reversed the finding of the bankruptcy court that the lender was the prevailing party because it was paid the amount of its lien as "the overarching disagreement between the parties concerned how payment would be made, with [the bank] pushing for recognition of its foreclosure sale [], and [the debtor] seeking to sell the property . . . ."
As applied here, Lender was not the prevailing party on the defeasance issue, even though the sale was aborted due to its assertion of this claim. As with Hoopai, id., the focus must be on the issue in dispute, not necessarily the outcome of the proceeding. Just as the bank in Hoopai was not the prevailing party simply because it was paid, here, Lender is not the prevailing party simply because the property was not sold. The main issue in dispute was whether Debtor was required to pay Lender a defeasance fee. Since Lender abandoned this position it cannot be found to be the prevailing party on this issue. See Teece v. Kuwait Fin. House, 667 F. App'x 931, 932 (9th Cir. 2016) (attorneys' fees are not available after a voluntary dismissal without prejudice involving claims under Cal. § 1717).
The fees disallowed in this category for the First Period are set forth in Appendix B and total $7,403.50. The court did not identify any fees for the Second Period associated with the proposed sale.
e. Category 5 - Sheraton Relief from Stay and Settlement
This category involves Lender's involvement in the Sheraton matters in this case. Lender separately opposed Sheraton's relief from stay and withdrew its opposition to the settlement later reached between Sheraton and Debtor after receiving information which resolved its concerns. This constructive conduct is similar to In re Melbell, 99 B.R. at 35, where fees for reasonable efforts in the case were awarded to the lender.
Debtor's objections to this category are overruled.
f. Category 6 - Plan
It is impossible to determine a prevailing party for issues litigated in connection the Plan. See Hoopai, 581 F.3d at 1102-03. Debtor has successfully reorganized, but Lender will ultimately have its default cured and the Loan reinstated. The Plan that will be confirmed is significantly different from than the one Debtor initially proposed due to some of Lender's objections. As to the quantification of the cure amount, Debtor sought to pay Lender $650,000, Lender demanded $2,745,754.52, and the court has determined $911,163.82 to be the proper amount. Because each party achieved some of their ultimate goals, there is no clear winner. See Berkla, 302 F.3d at 920. A lopsided outcome such as this prevents the court from clearly identifying who prevailed. Kytasty v. Godwin, 102 Gal. App. 3d 762, 774 (1980) (no prevailing party where each party prevailed on a different claim under an option and a lease); see also Megasoft Comput. Corp. v. Domico (In re Megasoft Comput. Corp.), 1994 U.S. App. LEXIS 17110, at *4 (9th Cir. July 7, 1994) (no prevailing party where the plaintiff's recovery was "better characterized as good news and bad news").
Each party also prevailed on different issues. Nasser, 156 Cal. App. 3d 52, 60 (1984) (no clear "prevailing party" in the litigation and the court declined to allow attorneys' fees under § 1717, either for trial or appeal, where easement rights were affirmed for one party but the other party prevailed as to size of the easement); Hoopai, 581 F.3d at 1102-03 (looking to the issues that were litigated to determine prevailing party status). Lender prevailed on the definition of impairment requiring Debtor to amend the Plan. It prevailed on the feasibility of the Plan requiring Debtor's insider to provide additional cash and further assurances. Lender also prevailed on the issue of judicial estoppel until Debtor clarified the scope of the subordination of the insider debt.
On the other hand, Debtor prevailed on resisting the necessity for a claim objection to establish Lender's cure, that the opinion letter did not estop it from challenging the default interest, that the default interest was an unreasonable penalty, and that the reserve accounts need not be replenished. Mathematically calculated, Debtor prevailed on 57% of the issues in the case and Lender prevailed on 47%. The outcome for each was "good news and bad news," with no clear prevailing party. The court must, therefore, disallow all of Lender's fees incurred in connection with the Plan.
The fees disallowed in this category for the First Period are set forth in Appendix C and total $119,226.50. The court also finds that all of Lender's fees for the Second Period, except the $288 set forth in Appendix D, relate to this category and are disallowed.
g. Fees Which the Court was Not Able to Categorize
Because Lender did not provide unredacted entries for all the fees requested for the First Period, the court was hindered in its efforts to categorize them. To the extent possible, the court relied upon Debtor's categorization since Debtor had knowledge of the nature of the dispute. The court also relied on its own knowledge of what occurred when in this bankruptcy proceeding. Nonetheless, there were approximately thirty-one entries which the court was not able to categorize. With no context to assess these fees, the court could not determine who was the prevailing party or whether the fee was reasonable. Lender failed to meet its burden of proof, and these fees are disallowed.
The fees which the court was not able to categorize are disallowed in the total amount of $11,052 as is set forth in Appendix E.
h. Fees for April 2017
In his declaration filed April 11, 2017, Welin estimates that Lender will be entitled to fees of between $35,000 and $45,000 for April 2017, including fees for:
[P]reparing the response to the Debtor's objections to the [Lender's] fees and costs . . . finalizing the objection to the Debtor's motion to approve the stipulation with Sheraton, attending the hearing on the Court's oral ruling on confirmation, and negotiating the form and language of the confirmation order.
The court has determined that there is no prevailing party on the Plan issues. Using the standards discussed above, the court similarly cannot determine who was the prevailing party on the fee issue, since the outcome was mixed. For this period, the court can only allow fees relating to the Sheraton settlement. No specific time entries were provided so the court cannot perform precise calculations, however, since Category 5 (relating to the Sheraton settlement) represents 4.59% of the total fees requested for the First Period, the court will allow 4.59% of the $45,000 in fees requested for this period, for a total award of $2,065.50.
3. Technical Objections to Fees
Having conducted a categorical review of the fees requested, the court next examined Debtor's technical objections relating to the reasonableness of the fees which the court categorically allowed. The court reviewed fees for the First Period in categories 1, 3, and 5 (relating to the receivership litigation, case administration, and Starwood) from this technical perspective. The court did not review Debtor's technical objections to fees for the First Period in categories 2, 4, and 6, as it was not necessary to review objections to fees that had been categorically disallowed. The court also excluded from its analysis fees to which Debtor initially objected to and then later withdrew its objection based on Lender's redaction and fees to which Debtor objected that did not include a charge.
After reviewing Debtor's technical objections to fees for the First Period, the court reviewed Debtor's objections to the four non-Plan related fee entries allowed for the Second Period.
The reasonableness inquiry begins with a lodestar calculation; i.e. hours reasonably expended and a reasonable hourly rate. PLCM Grp., Inc. v. Drexler, 22 Cal. 4th 1084, 1095 (2000); Gisbrecht v. Barnhart, 535 U.S. 789, 802 (2002). The court finds that Lender's counsel's rates were appropriate and the hours were accurately recorded. As is set forth more fully in Appendix F, with a few exceptions, for fees for the First Period the court finds that the time descriptions are adequate. The court also, generally, has no concerns regarding staffing and duplication in light of the various collection efforts Lender undertook. The court thus finds that Lender's fees which Debtor objected to as "client contact" are reasonable, and overrules the vast majority of Debtor's technical objections. However, the court sustains some of Debtor's technical objections where the fees were unreasonable because they were obviously duplicative, administrative, or the fee entry did not provide sufficient detail for the court to assess the technical objection Debtor asserted. Finally, for the allowed fee categories, the court reduced some of Lender's fees, even where the Debtor did not assert a technical objection, where the fee related, in part, to a category of fees that was disallowed.
For the First Period, as is set forth in Appendix F, the court disallows fees totaling $2,715.50 that would otherwise be allowable on a categorical level based on Debtor's technical objections. The court, however, overrules all of Debtor's technical objections to the fees allowed for the Second Period, as is reflected in Appendix D.
4. Cost Objections
In his March 2, 2017, declaration, Welin testified that Lender incurred $21,014.62 in costs for the First Period ending on February 28, 2017. In his April 11, 2017, declaration, Welin testified Lender incurred $29,716.73 in costs for the Second Period. While the record is not entirely clear, the court assumes that included in these costs is a total of $30,750 in fees and $353.19 in costs paid to Lender's expert, Zelle. While Lender provided separate testimony from Zelle on the reasonableness of costs associated with Zelle's expert testimony, the court will not assume that the amounts set forth in Zelle's declaration filed on April 11, 2017, are separately requested, as at least some expert costs are identified in Lender's invoices filed on April 11, 2017 (see Doc. 277, pg. 52). Lender, does, however, separately request $2,210.57 to reimburse its client for travel expenses for trial and, as the court was unable to locate these costs in the invoices provided, they will be separately considered.
Because Lender is not the prevailing party on Categories 2, 4, and 6 above, it is not entitled to costs which relate to these categories. Since it is not possible on the record for the court to conduct a cost-by-cost analysis of what costs are attributable to what categories, the court instead will allow the costs in the same proportion as fee awards for each period. For the First Period, the court awards Lender $184,419.50 of the $351,840.50 fees requested or 52.42%. The court will, therefore, award Lender 52.42% of the costs requested, or $11,015.86. For the Second Period, the court awards only $288 of the total $159,519.50 in fees requested. This represents a total fee award of 0.18%. The court will, therefore, award Lender 0.18% of the costs requested or $53.49.
Lender's separate testimony from Zelle regarding the reasonableness of his fees does not change the court's analysis. While Zelle's testimony was not controverted, Lender was not the prevailing party on issues regarding the Plan and so it is appropriate for the court not to award costs on this issue, including expert fees.
Finally, the court will add to the total cost award the costs Bornheimer incurred. While these costs were incurred in connection with the trial on the Plan, they are not attorneys' fees and costs subject to the § 1717 prevailing party analysis. Instead, they are simply cure amounts owed under the breadth of the Indemnity. Nonetheless, the court will reduce Bornheimer's travel by $1,000 since no explanation was provided for the plane fare which was significantly more than even the short-term rate. The additional $2,210.57 requested by Bornheimer will be allowed in the amount of $1,210.57 as the amount requested is not reasonable. No costs will be awarded for April 2017 as Lender provided no support for any costs incurred.
Finally, the court notes that of the total $50,731.35 in costs requested, Debtor asserted specific objections to less than $5,000. The court reviewed these specific objections but was not able to locate any objection to any specific cost that was not either withdrawn by the Lender or subsumed by the court's categorical disallowance of Lender's costs discussed above.
Lender's total cost award will be $12,279.92.
5. Total Fees and Costs
As is set forth more fully in Appendix G, the court will award Lender $186,773 in fees and $12,279.92 in costs for a total award of $197,842.35.
L. Summary of Cure Amount
The court's ruling on the cure amounts owed to Lender is summarized in the following chart:
| Fees and CostsNecessary to Cure | AmountRequested | CourtRuling | CureAmount |
|---|---|---|---|
| Five missedmonthly paymentsfrom 1/6/2016through 5/6/2016 | $293,556.80 | Undisputed | $293,556.80 |
| Default Interest | $673,206.85 | Disputed | $0.00 |
| Fees and CostsNecessary to Cure | AmountRequested | CourtRuling | CureAmount |
|---|---|---|---|
| from 12/5/15through 3/11/17 | |||
| Late Charges | $64,997.51 | Undisputed | $64,997.51 |
| Attorneys' fees andcosts | $607,091.35 | Disputed | $195,842.35 |
| $172,778.52 | Disputed | $0.00 | |
| Insurance Escrow | $153,974.85 | Undisputed | $153,974.85 |
| FF&E Reserve | $811,592.56 | Disputed | $0.00 |
| Ground RentReserve | $63,515.00 | Disputed | $63,515.00 |
| ProtectiveAdvances —TaxAdvance 3/31/16 | $133,749.53 | Undisputed | $133,749.53 |
| ProtectiveAdvances —Insurance Advance2/29/16 | $4,043.60 | Undisputed | $4,043.60 |
| ProtectiveAdvances —Inspection fees andcosts | $1,484.18 | Disputed | $1,484.18 |
| TOTAL | $2,745,754.52 | $911,163.82 |
As is set forth more fully above, the court notes that the escrow amounts Debtor will be required to pay to effectuate Lender's cure are subject to change. The parties' agreement requires Debtor to make payments into these escrow accounts (including the tax escrow, the insurance escrow, and the ground rent reserves) based on the amount of upcoming payments due to various third parties. Prior to the Effective Date (which will be 10 business days after the court enters its order confirming the Plan), Debtor will be required to make payments into these accounts sufficient to fund upcoming payments due. However, Debtor will not be required to make payments into the accounts in the exact numbers provided to the extent that any payments due to third parties have been paid from other sources. For example, Section 7.5 of the Agreement requires Debtor to pay Lender the amount due under the Ground Lease for the month 10 days before the payment is due. If the Effective Date falls more than 10 days before the rent is due, Debtor will not be required to pay the $63,515 until it comes due in the order course of the parties' Agreement. However, if the Effective Date falls less than 10 days before the rent is due, Debtor will be required to pay the rent due for the month into the reserve account. --------
M. The Plan is Feasible
Section 1129(a)(11) establishes the "feasibility" standard by requiring the court to determine that "confirmation of the plan is not likely to be followed by the liquidation, or [the] need for further financial reorganization of the debtor." The purpose of the feasibility test is to ensure that the plan offers a reasonably workable prospect of success and is not a visionary scheme. See In re Acequia, Inc., 787 F.2d 1352, 1364 (9th Cir.1986) (citing In re Merrimack Valley Oil Co., 32 B.R. 485, 488 (Bankr. D. Mass. 1983)).
Lender asserts the Plan is not feasible because the evidence at trial did not establish that there was sufficient cash on the Effective Date to meet the confirmation standards. It also objects that Debtor's cash flow projections do not accommodate the payments required under the Plan.
1. Amounts Necessary to Fund the Plan
On April 12, 2017, based on the evidence in the record at the time, the court posted a ruling on the amount Debtor's insiders would need to be prepared to contribute to the Plan to be feasible:
| Lender's Cure | $903,169.47 |
| Administrative Payment to Professionals | $175,000.00 |
| Effective Date Payment to UnsecuredCreditors | $100,000.00 |
| PIP Performance | $913,284.00 |
| Effective Date Priority Tax Claim Payment | $100,000.00 |
| Minimum Effective Date Cash Contribution | $2,191,453.47 |
|---|---|
| April Tax Payment unless made | $170,222.36 |
| Quarterly Payments Under Plan | $400,000.00 |
| Disputed Attorneys' Fees if awarded | $185,007.12 |
| Required Guarantee Subtotal | $755,229.48 |
| Total Insiders Must Make Available | $2,946,682.95 |
The confirmation proceedings afterward required the court to adjust these initial numbers for several reasons:
1. The Plan does not require Debtor to make a $100,000 payment to unsecured creditors on the Effective Date; payments to unsecured creditors begin after
confirmation.
2. Debtor's counsel agreed to be paid out of cash flow rather than in cash on the Effective Date.
3. The April tax payment was made.
4. The court's ruling on Debtor's attorneys' fees objections changed the cure amount.
5. Certain payments under the PIP were funded in advance of confirmation. At the reopened bifurcated trial held on May 1, 2017, Debtor provided evidence as Exs. B and C admitted at trial that Debtor made two payments from its cash flow towards the PIP in the amounts $33,481.10 and $119,950.13 on April 26 and April 28, 2017. While this funding was not with the Lender's consent or authorized by court order, the PIP needs to be reduced to $759,852.77.
6. While Debtor sought to pay only $450,000 of the total $913,284 PIP on the Effective Date, the Plan provides the PIP will be fully funded from the new cash contribution provided for under the Plan. Based upon this provision of the Plan, the court ruled that the FF&E reserve did not need to be funded on the Effective Date to effectuate Lender's cure. If the PIP is not funded in full on the Effective Date, then the cure amount would need to be increased by the unpaid amount. In either event, the court's feasibility analysis must provide for the payment of the full PIP amount on the Effective Date.
These adjustments are quantified in charts below.
| Effective Date Payments | |
|---|---|
| Lender's Cure | $911,163.82 |
| PIP Performance | $759,852.77 |
| Priority Tax Claim Payment | $100,000.00 |
| Total | $1,771,016.59 |
| Plan Payments After the Effective Date | |
|---|---|
| Deferred Administrative Payment toProfessionals | $175,000.00 |
| Total Quarterly Payments Under Plan | $400,000.00 |
| Total | $575,000.00 |
For the Plan to be feasible, the court must determine if Debtor has a reasonably workable prospect of making these payments. As Debtor did not provide cash projections or other evidence which would indicate it could make the payments from its operations, Luz provided testimony regarding the willingness and ability of Debtor's insiders to fund any shortfall at the two bifurcated hearings on April 14 and May 1, 2017. After Luz's April 14 testimony, Lender discovered documents that it contended indicated the Luz did not testify truthfully about the ownership of two properties which Luz stated Debtor's insiders would use as collateral for financing to fund the Plan. Based on these inaccuracies, Lender argued that evidence must be reopened. The court provided May 1, 2017, as another trial date to consider additional testimony on the collateral Debtor claimed its insiders held to obtain additional financing.
2. Effective Date Payments
Luz testified that the insiders have available $1,585,916 in cash to make the $1,773,018.03 in Effective Date payments. This leaves a shortfall of $185,102.03. However, Debtor contends there are two assets that insiders could borrow against to get additional sums to complete the Plan. First, is a commercial building located at 1405-1407 University Ave., San Diego, CA ("University") valued at $1.2 million and encumbered by a first mortgage in the amount of $329,000. Second, Luz testified she could borrow against her home located at 9911 Fuerte Dr., La Mesa 91941 ("Fuerte") valued at $1.3 million and encumbered by a first mortgage in the amount of $330,000.
Luz testified on April 14 that she managed these assets, which she stated were owned the Ralph Burni Trust. However, Lender obtained title records which reflected the properties were not owned by this trust. Lender also provided evidence that the encumbrances on both properties had due on sale clauses, and that University had a second encumbrance of $750,000 dated August 10, 2011 (and recorded on August 15, 2011) owed to the Attisha Family Trust ("Attisha TD"), leaving it with no equity.
As to Luz's authority to encumber the properties, Chin, trustee of the Ralph Burni Trust, confirmed on May 1 that he had conveyed title to these properties to subtrusts of the Ralph Burni Trust, which was consistent with the title report Lender provided. Chin testified that the beneficiaries of these subtrusts are Luz's children and that she is each subtrust's trustee. While Luz's testimony that the properties were owned by the Ralph Burni Trust is inaccurate, Chin testified that he had no recollection of advising Luz of the transfers of title, since it was done in the ordinary course of the trust administration. Chin, however, confirmed that as trustee of the subtrusts Luz has discretion under the trust documents to control these assets, including borrowing against them as necessary to protect the beneficiaries' interests in the Debtor.
Luz testified that the Attisha TD, which was cross-collateralized against two other properties, had been reconveyed. In support, she provided a "Substitution of Trustee and Full Reconveyance" dated October 27, 2012, in which the Attisha Family Trust purported to reconvey a deed of trust dated August 10, 2011, that was recorded on August 15, 2011 ("Reconveyance"). While Lender pointed out that the recording number and legal description on the Reconveyance indicated that it related to a deed of trust recorded against another property, Luz was steadfast that the Attisha TD's presence on title was in error because the obligation had been paid.
Ultimately, the court believes that the Reconveyance (and Luz's credible testimony) demonstrate that the Note underlying the Attisha TD recorded against University has been paid in full and that, to the extent that the deed of trust remains on title, this is a recording error that is being corrected. The court is not persuaded by the errors in the Reconveyance because, as a matter of law, if there is no underlying obligation the Attisha TD is a nullity. Yvanova v. New Century Mortg. Corp., 62 Cal. 4th 919, 927 (2016) (citing Cal Civ. Code § 2936; Cockerell v. Title Ins. & Trust Co., 42 Cal.2d 284, 291; U.S. v. Thombur, 82 F.3d 886, 892 (9th Cir. 1996)) (a deed of trust is inseparable from the note it secures). The court, therefore, concludes that there is sufficient equity in University for insiders to borrow against this property to fund the Plan.
Luz also testified that the due on sale clauses in the existing encumbrances would not affect feasibility. In fact, she has already contacted Home Bank which holds the first deed of trust against University to borrow against it. Luz testified that she expected to receive authorization from Home Bank to refinance the property and borrow up to 60% of the value. This would make another $391,000 available on the Effective Date. An appraisal is being prepared and the advance may be more.
Because Debtor could borrow another $391,000 from its insiders before the Effective Date, it can fund the shortfall of $185,102.03 identified. This evidence demonstrates that Debtor has more than a "workable prospect" of making the $1,773,018.03 in Effective Date payments required under the Plan.
3. Post Confirmation Payments
As is set forth above, under the Plan, Debtor will also be required to make payments of $575,000 over two years. However, Debtor's cash flow projections and budget (Exs. 25 and 38) did not factor in either the quarterly payments required under the Plan or the deferred attorneys' fees Debtor will be required to pay. In addition, Everson's testimony indicated that Debtor would have only $12,562 in net cash flow by the end of 2017. There is, therefore, insufficient cash in Debtor's projections to make the post-confirmation payments required under the Plan. Nonetheless, Mendez testified that she expects Debtor's cash flow to increase after the completion of the PIP in 2017, and Luz noted that summer revenues tend to be seasonally higher. The court finds Debtor's expectation that the remodel of the Hotel will increase revenues is reasonable and notes that Mendez and Luz's expectation of higher revenues is corroborated by the $100,000 positive variance for 2017 even before completion of the PIP. During the course of this case, Luz's management of Debtor's operations, assisted by the court-approved operator, has been effective and there is no reason this trend will not continue. For this reason, the court believes Debtor's expectation to pay $575,000 from its cash flow over two years is not a "visionary scheme" and has a reasonably workable prospect of success.
Corroborating this conclusion of feasibility is the ability and willingness of Debtor's insiders to contribute additional money to make Plan payments after confirmation. Luz credibly testified that she would borrow money from other insider entities to fund the balance of the Plan. Even if Luz has exhausted the $871,000 in equity in the University property after making the Effective Date payments, she also has authority to borrow against the $970,000 in equity in the Fuerte property. It is unlikely that Debtor's insiders would walk away from a $1.8 million initial investment in the Hotel, particularly when the valuation of the Hotel in Debtor's schedules reflects sufficient value for them to recoup their investment even after repaying Lender. Although Lender, paraphrasing Gertrude Stein, claims there is "no there, there" under the Plan, the court disagrees.
Debtor's increased revenues and the adequate assurances provided by the insider entities are sufficient to support the court's finding that it is more likely than not that Debtor will be able to make the $575,000 in payments required under the Plan. Since Lender will not receive any of the $575,000 payments that are due to unsecured creditors and counsel, it is also in a poor position to complain. Lender is unimpaired and the Agreement protects Lender's interests if Debtor does not perform under the Plan.
N. Ex Parte Emergency Motion for Appointment of a Chapter 11 Trustee and Conversion
At the bifurcated trial held on May 1, 2017, Lender made an oral motion for appointment of a trustee and/or conversion based on Debtor's misuse of cash collateral. At that time, Lender advised the court that the parties' cash collateral stipulation expired at midnight on April 30, 2017 and that Debtor was currently using cash collateral without authority to do so. Lender also argued that Debtor breached the parties' prior cash collateral stipulation by making two payments from Debtor's operating funds for the payment of PIP expenses. Debtor contended that it had paid the PIP from available funds several times earlier in the case and expected to negotiate another stipulation for use of cash collateral as has been the practice in this case.
The court treated Lender's ex parte motion as a request to shorten time on its trustee motion and set a hearing for May 9, 2017. In the meantime, the court found that Lender was adequately protected and the use of the funds for the PIP was in the ordinary course of business even if this use was a technical violation of cash collateral order. The court extended the use of cash collateral through the May 9, 2017, hearing date in any event, regardless of Lender's lack of consent.
Having ruled that the Plan is confirmable, however, this motion is moot and will be taken off calendar. Use of cash collateral will be continued through the Effective Date of the Plan on the terms of the existing Stipulation, and the parties are directed to meet and confer regarding the budget during the interim.
IV. Conclusion
Based upon these findings of fact and conclusions of law, the court will confirm the Plan. The parties are directed to meet and confer regarding the terms of the Plan order, which Debtor must upload an order within seven days, specifying any unresolved objections to form by the Lender.
IT IS SO ORDERED. Dated: May 8, 2017
/s/_________
MARGARET M. MANN, JUDGE
United States Bankruptcy Court
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