Opinion
Bankruptcy No. 08-21869, (Jointly administered with Case Nos. 08-21870, 08-21872, 08-22075 and 08-22077).
July 3, 2008
I. INTRODUCTION
Before the Court is the motion filed by Utah 7000, L.L.C, et al. (collectively the Debtors) seeking authority to obtain $25,000,000 of postpetition financing from Pivotal Finance, LLC (Pivotal Finance) pursuant to 11 U.S.C. §§ 105, 361, 362, 363(c) and (e), 364(c)(1) and (2), 364(d), and 364(e) (the Motion). The Motion seeks funding pursuant to the term sheet, as modified, referred to by the Debtors as the DIP Credit Agreement and as more fully set forth in the pleadings (Pivotal Financing). By the Motion, the Debtors seek funding to continue operation of their luxury master planned resort community pending filing and confirmation of a plan of reorganization. The Motion is supported by the Official Committee of Unsecured Creditors (the Committee) and the Promontory Owners and Members Group (POMG). The Motion is opposed by Credit Suisse, Cayman Islands Branch, as Agent for the First Lien Lenders (Credit Suisse) and the First Lien Lenders, and by the Ad Hoc Group of Second Lien Lenders and Wells Fargo Bank, N.A. as Agent to the Second Lien Lenders (Second Lien Lenders) (collectively the Prepetition Lenders).
All future statutory citations will refer to title 11 of the United States Codes unless otherwise indicated.
The parties have briefed the legal issues and presented evidence and argument to the Court. Following the evidentiary hearing the matter was taken under advisement. After considering the evidence, assessing the credibility of the witnesses, considering the arguments of counsel and conducting an independent review of applicable case law, the Court makes the following ruling.
II. JURISDICTION AND NOTICE
This Court has jurisdiction to hear and determine the Motion pursuant to 28 U.S.C. §§ 157 and 1334. Determination of the Motion is a core proceeding under 28 U.S.C. § 157(b). Notice of this hearing has been given to all required parties pursuant to Fed.R.Bankr.P. 2002, 4001, 9014, and Bankr. D. Ut. LBR 4001-2. All parties were given notice of the Court's scheduling order which set the parameters of the parties' briefing and hearing presentations. Therefore, the Court finds that notice is proper.
III. PRELIMINARY ISSUES
As a preliminary matter, the Court notes that none of the parties has objected to section III. C. of the Motion that requests the Court to find that the Prepetition Lenders do not have an interest in postpetition income or, in the alternative, authorizing the use of postpetition cash collateral. Based on the parties' failure to object to this relief and in light of this Court's prior rulings, the Court finds that the postpetition income referenced in section III. C. of the Motion is not subject to the Prepetition Lenders' liens, or to the extent any cash collateral exists, the Debtors are authorized to use that cash collateral under § 363(c).
IV. STATUTORY STANDARD
The Debtors are authorized to operate their business under § 1108 and, as such, are able to request Court approval of postpetition credit under § 364. In order to obtain Court approval of this Motion, which requests postpetition financing on a superpriority, secured, and priming basis under § 364(d), the Debtors must establish: (1) that they are unable to obtain credit otherwise; (2) that the transaction is within the Debtors' business judgment; and (3) that the interests of primed lienholders are adequately protected.
Section 364 provides:
(c) If the trustee is unable to obtain unsecured credit allowable under section 503(b)(1) of this title as an administrative expense, the court, after notice and a hearing, may authorize the obtaining of credit or the incurring of debt —
(1) with priority over any or all administrative expenses of the kind specified in section 503(b) or 507(b) of this title;
(2) secured by a lien on property of the estate that is not otherwise subject to a lien; or
(3) secured by a junior lien on property of the estate that is subject to a lien.
(d)(1) The court, after notice and a hearing, may authorize the obtaining of credit or the incurring of debt secured by a senior or equal lien on property of the estate that is subject to a lien only if —
(A) the trustee is unable to obtain such credit otherwise; and
(B) there is adequate protection of the interest of the holder of the lien on the property of the estate on which such senior or equal lien is proposed to be granted.
(2) In any hearing under this subsection, the trustee has the burden of proof on the issue of adequate protection.
A. Debtors are Unable to Obtain Financing Elsewhere
The Debtors have met their burden of showing that no alternative financing is available on any other basis. This is the third § 364 motion for financing the Debtors have presented to the Court, and each motion has been hotly contested. The Debtors have sought and noticed up hearings regarding financing from not only Pivotal Finance but also from Sorin Capital Management. Mr. Karl Polen, Executive Vice President of Pivotal Group, Inc., affiliated with Pivotal Group X, who serves as the managing member of some of the Debtors, testified that the Debtors have also sought financing from Public Safety Personnel Retirement System of the State of Arizona, the Second Lien Lenders, and the First Lien Lenders. Ongoing extensive negotiations with the First Lien Lenders and/or Credit Suisse for debtor-in-possession financing have failed to produce loan terms approved by the steering committee. Indeed, Megan Kane, Credit Suisee's representative (Ms. Kane), had no suggestions as to an alternative source of debtor-in-possession financing. In addition to these parties, Mr. Polen contacted JPMorgan Chase and another entity about providing financing but neither was interested. Both Mr. Polen and Mr. Greenfield, attorney for the Debtors, testified that the Pivotal Financing is the best financing package that has been offered to the Debtors. The evidence has also shown that the only debtor-in-possession financing offered by any lender to these Debtors would require a senior lien on the Debtors' assets and, therefore, would entail priming the Prepetition Lenders. The Court finds that there is sufficient evidence establishing that the Debtors have made a reasonable effort to seek other sources of credit and that the Debtors have been unable to obtain credit otherwise. B. The Transaction Is Within the Debtors' Business Judgment
The Debtors have also established that the decision to seek Court approval of the Motion is within their sound business judgment. Much has been made of the fact that Pivotal Finance is controlled by an insider of some of the Debtors and that Mr. Polen and Mr. Najafi, the Chief Executive Officer of Pivotal Group, Inc., are employees of Pivotal Group, Inc. and were also responsible for negotiating and approving the Pivotal Financing on behalf of the Debtors. Credit Suisse has argued that this insider financing requires the Debtors to meet a heightened standard of proof that the transaction is inherently fair and in good faith. Even if the Court agreed and adopted a heightened standard, the Court finds that the heightened standard has been met. Mr. Polen and Mr. Najafi were candid about their dual roles and the evidence shows that the parties made sufficient efforts to protect their respective interests. For example, Pivotal Finance and the Debtors retained and were advised by separate legal counsel. Additionally, Mr. Najafi testified that the Pivotal Financing was discussed with other members of senior management teams, including Richard Garner, and that these individuals were involved in the review process that led to the final decision to accept the Pivotal Financing. The Committee as well as the POMG have had extensive negotiations with the Debtors and with Pivotal Finance, and many modifications and concessions in the Pivotal Financing terms have been reached as a result. Because of this inclusive negotiation and the various modifications, both creditor groups now support the Motion.
Mr. Polen, Mr. Najafi, and Mr. Greenfield testified at length regarding both the economic and non-economic factors they all considered in deciding to accept the Pivotal Financing and why these factors weighed in favor of the Debtors accepting this financing over other financing offered by, for example, Credit Suisse. Although not an exhaustive list, some of these factors are as follows:
1. The higher interest rate in the Pivotal Financing was offset by the professional fees and the cost of the CRO as proposed in Credit Suisse's financing package. 2. The Pivotal Financing provides funding for a longer period of time and there is more money available to the Debtors. 3. The Pivotal Financing only allows the lender to seek stay relief if the Debtors are in default. 4. The Credit Suisse proposal gave Credit Suisse the ability to object to the Debtors' proposed plan of reorganization regarding its own treatment and the treatment of other creditors. The Pivotal Financing does not have a similar provision. 5. Debtors have a longer period of time to propose a plan and fewer restrictions on that proposal under the Pivotal Financing than they would under the Credit Suisse proposal. 6. After reviewing both proposals, the Debtors have found that the representations, warranties, affirmative and negative covenants, and conditions precedent to closing are generally more favorable in the Pivotal Financing. 7. The bankruptcy estate will have greater ability to assert claims and defenses against creditors under the Pivotal Financing. All parties acknowledge that the Debtors need funds to maintain business operations. The Pivotal Financing provides the Debtors with sufficient capital to operate the business for a period of time, and it allows the Debtors time to propose a plan of reorganization. Yet, it does not provide so much financing that the Debtors are able to continue to operate ad infinitum. The weight of the evidence demonstrates that the Debtors have exercised sound business judgment in accepting the Pivotal Financing.C. The Interests of the Prepetition Lenders Are Adequately Protected
Section § 364(d) also requires the Debtors to show that the interests of the primed lien holders are adequately protected. The Debtors have the burden of proof on the issue of adequate protection. In O'Connor, the Tenth Circuit wrote: "The whole purpose in providing adequate protection for a creditor is to insure that the creditor receives the value for which the creditor bargained prebankruptcy. In determining these values, the courts have considered `adequate protection' a concept which is to be decided flexibly on the proverbial `case-by-case' basis." The existence of an equity cushion is, as the Ninth Circuit has stated, "the classic form of protection for a secured debt . . ." Here, the Debtors maintain that the value of the collateral is at least $561,600,000 as reported in Joseph Calvanico's (Mr. Calvanico) expert report. Mr. Calvanico is a certified general appraiser employed as a Director of Midwest Property Tax and Valuation Services at Grant Thornton LLP. Mr. Calvanico estimated the market value of the real and personal property using a going concern valuation. Credit Suisse maintains, however, that liquidation is the appropriate valuation method. The Court has reviewed the relevant case law and finds little support for Credit Suisse's argument. Additionally, although it is early in the case, there is no indication that the Debtors, or any other party, will propose a liquidating plan or request any form of liquidation. The very purpose of the Pivotal Financing is to provide the Debtors with sufficient funds to allow them to continue to operate the business and propose a plan of reorganization. To further complicate this proposed use of a liquidation valuation, none of the parties have come forward with any evidence establishing a liquidation value of the property. There is simply no factual basis and scant legal authority supporting the use of a liquidation value.
Dallas Bank, N.A. v. O'Connor (In re O'Connor), 808 F.2d 1393, 1396-97 (10th Cir. 1987) (internal citations omitted).
Pistol v. Mellor (In re Mellor), 734 F.2d 1396, 1400 (9th Cir. 1984).
Credit Suisse has cited to the following cases in support of its position: In re Demakes Enterprises, Inc., 145 B.R. 362 (Bankr. D. Mass. 1992) (adopting liquidation value instead of fair market value to resolve the extent of adequate protection necessary to avoid relief from the automatic stay); In re Robbins, 119 B.R. 1 (Bankr. D. Mass 1990) (holding that continued operation of mortgaged property does not justify using a fair market valuation when determining adequate protection for stay relief purposes); In re Tenney Village Co. Inc., 104 B.R. 562 (Bankr. D.N.H. 1989) (discussing the appropriateness of using a liquidation versus a going concern valuation); In re THB Corp., 85 B.R. 192 (Bankr. D. Mass. 1988) (adopting a liquidation standard to value collateral for purposes of establishing whether there was sufficient adequate protection to justify the use of cash collateral); In re Phoenix Steel, 39 B.R. 218 (D. Del. 1984). It should be noted that the First Circuit criticized these opinion, with the exception of Phoenix Steel, in Winthrop Old Farm Nurseries, Inc. v. New Bedford Institution for Savings (In re Winthrop), 50 F.3d 72 (1st Cir. 1995) indicating that liquidation value should not be used in all circumstances but that a flexible approach should be adopted so that a bankruptcy court can "adopt in each case the valuation method that is fairest given the prevailing circumstances." Id. at 75-76.
The Debtors propose to provide adequate protection to the secured creditors for the priming of their liens by (a) proving that a sufficient equity cushion exists to protect the creditors, (b) providing a junior lien on an additional 244.94 acres of real property described as out parcels not previously provided as security to creditors, and (c) fixing the dates by which a plan of reorganization will be filed and confirmed.
1. Equity Cushion
To determine if an equity cushion sufficient to protect the primed secured creditors is present, the amount of the debt owed by the Debtors must be established. Solely for the purposes of this Motion and without prejudice to a later determination of the exact amount of debt owed, it appears uncontested that the following encompasses the debt owed for the purposes of establishing adequate protection:
Approximately $6,000,000 owed to the Mountain Regional Water SSD;
Approximately $500,000 owed to Brows/Stembridge and mechanics' liens;
Approximately $25,000,000 that would be owed to Pivotal Finance if the Motion is granted;
Approximately $313,000,000 owed to the First Lien Lenders projected to the end of January 2009;
Approximately $87,000,000 owed to the Second Lien Lenders projected to the end of January 2009.
The total debt therefore reaches approximately $431,500,000.
The only appraisal presented to the Court to establish the value of the Debtors' assets was that received from Mr. Calvanico. Mr. Calvanico valued the current market value of the Debtors' high-end second home subdivison that is 40% sold and with substantial infrastructure in place at $560,000,000, and also valued the Debtors' personal property at $1,600,000 for a total valuation of $561,600,000. Included in that valuation are 244.94 acres of property previously unencumbered by the First Lien Lenders' security interest, which Mr. Calvanico valued at $13,000,000.
Mr. Polen testified that in addition to the property appraised by Mr. Calvanico, the Debtors have an additional income stream from Utah 7000 Realty, the sale of cabin construction services, and from notes receivable at a net present value of between $32,500,000 and $42,500,000. Ms. Kane, Credit Suisse's representative, testified that Credit Suisse has no opinion regarding the value of the Debtors' assets.
Credit Suisse, although not presenting a competing appraisal of the Debtors' assets, provided evidence that disputed various aspects of Mr. Calvanico's and Mr. Polen's valuation estimates. Credit Suisse's witness, Ronald Greenspan (Mr. Greenspan), an attorney employed as Senior Managing Director in the Corporate Finance and Restructuring practice of FTI Consulting, disputed five areas of Mr. Calvanico's appraisal and suggested that each alleged error could be quantified by a specific amount that would result in a reduction of the proffered values of the Debtors' assets.
The first error alleged by Mr. Greenspan related to lot pricing. The Count finds, based on the credible testimony supplied by Richard Sonntag (Mr. Sonntag), the Managing Director of the Debtors, and Mr. Calvanico's testimony regarding lot valuation, expected sales prices of lots, his valuation methodology, and sales incentives that were accounted for in the costs of sale, that reducing the Calvanico appraisal because of alleged errors in lot pricing is inappropriate.
Likewise, Mr. Greenspan's criticism based upon an alleged calculation error because 2% lot price inflation was erroneously applied in 2008 was credibly explained by Mr. Calvanico, and the Court makes no reduction in the appraisal on account of alleged improper lot price inflation.
Mr. Greenspan challenged assertions regarding a valuation projected from conversion of the current type of club memberships to equity memberships. The Court finds Mr. Calvanico's assumptions and model projecting the amount to be realized from future conversion of memberships into equity in order for members to preserve anticipated appreciation in the memberships, and the calculations included in the appraisal, to be credible and, therefore, makes no reduction in the valuation on account of equity conversion of club memberships.
Mr. Greenspan also disputed Mr. Polen's representations regarding the present value of the revenue stream from the realty operation of Utah 7000 Realty, the sale of cabin construction services, and of various notes receivable. The Court finds Mr. Polen's testimony regarding the value of these assets to be credible and no adjustment will be made.
The appropriate discount rate to be applied was raised by Mr. Greenspan, challenging the discount rate Mr. Calvanico applied to projected cash flow to reduce it to net present value. Mr. Calvanico applies a discount rate of 8.75% plus 1% for the effective property tax rate totaling 9.75%. Mr. Greenspan asserts an improper discount rate was applied because Mr. Calvanico utilized the discount rate for first-class and substantially leased office buildings, shopping malls, apartments, and industrial buildings, and that such a rate is inapplicable to the Debtors' speculative land development. Had the proper rate been used, Mr. Greenspan asserts, the appropriate discount rate would be an average of 17.21% causing an adjustment of $91.6 million. However, the Court finds that such an adjustment fails to take into account the substantial infrastructure already built into the development, the entitlements already granted, and the 40% sold-out status.
Mr. Calvanico's calculations considered the highest and best use for the property, a 15-year absorption rate for the Debtors' development, that the development is partially completed with substantial infrastructure and entitlements in place, and that a portion of the development is still raw land. Using a composite of several different criteria, he selected a blended discount rate of 8.75% + 1%. Mr. Calvanico did acknowledge that a $40,000,000 correction may be appropriate to adjust for the appropriate convention to arrive at net present value. Based on this testimony, the Court finds that an upward adjustment in the discount rate of 1% is appropriate. Therefore, the Court finds that the applicable total discount rate is 10.75%. Applying that rate, the Court finds the value of the Debtors' real property to be $526,000,000. Together with the Debtors' personal property valued at $1,600,000 and additional income streams from Utah 7000 Realty, the sale of cabin construction services, and notes receivable totaling a net present value of $32,500,000, the total current market value of the Debtors' assets at this time, and valued for this purpose, is $560,100,000.
Therefore, in consideration of the approximate total debt of $431,500,000, the Court finds that a substantial equity cushion exists. The Court further finds that such an equity cushion presents a significant protection for the Prepetition Lenders. 2. Additional Real Property Collateral
As stated in O'Connor, "value is the linchpin of adequate protection, and since value is a function of many factual variables, it logically flows that adequate protection is a question of fact." O'Connor, 808 F.2d at 1397 (emphasis added). This Court has engaged in such a process by reviewing the credibility of the witnesses and the evidence presented. In addressing this fact-intensive process, one court has summarized the factual findings of numerous other courts indicating that "[a]ccording to the wellresearched case of In Re McKillips , case law almost uniformly concludes that: (1) an equity cushion of twenty percent (20%) or more constitutes adequate protection; (2) an equity cushion of less than eleven percent (11%) is insufficient; and (3) a range of twelve percent (12%) to twenty percent (20%) has divided the Courts." In re C.B.G. Ltd., 150 B.R. 570, 573 (Bankr. M.D. Pa. 1992) (citing to In re McKillips, 81 B.R. 454 (Bankr. N.D. Ill. 1987)).
The Court need not determine whether this equity cushion alone is sufficient to provide the Prepetition Lenders adequate protection because the Debtor is providing additional adequate protection. The Prepetition Lenders will be granted a lien on the 244.94 acres of previously unencumbered property. Credit Suisse argues that the Debtors have consistently maintained at prior hearings that this property was only worth $1,400,000 and that the Debtor should be judicially estopped from asserting any other valuation. The Court has reviewed the transcript of the prior hearings and notes that the $1,400,000 valuation was based on the sale price of the property and that this was the only information available to the Debtors regarding its value at the time. But now, the Debtors have provided to the Court the expert report of Mr. Calvanico who has valued the out parcels at approximately $13,000,000. Even when this amount is discounted by an additional 1% from Mr. Calvanico's appraisal, it still provides the Prepetition Lenders with significant additional collateral to protect their interests. The Prepetition Lenders will be granted a security interest in this property providing them even more adequate protection.
3. Additional Adequate Protection
The Prepetition Lenders will also maintain liens on their collateral. The Prepetition Lenders will be given replacement liens in the collateral. The Prepetition Lenders will be granted a priority administrative expense claim. The Debtors have also provided that a plan of reorganization will be filed and confirmed by a fixed date. Should this not occur, the Prepetition Lenders may move for a determination that they are no longer adequately protected. Collectively, the Prepetition Lenders are receiving measurable additional protection to adequately protect their interests.
4. Additional Adequate Protection for the Second Lien Lenders
The Second Lien Lenders have requested that their attorney fees related to this filing, which they initiated as to certain of the Debtors as an involuntary petition, not only be added to their claim, but paid from the $25,000,000 sought by this Motion. The Court finds no factual or legal reason to do so, and the objection of the Second Lien Lenders to the Motion on this basis is overruled.
D. Good Faith
The Court finds that the Debtors have shown that Pivotal Finance has extended credit to the Debtors in good faith pursuant to § 364(e). There has been no evidence provided to the Court that Pivotal Finance has engaged in fraud, has attempted to take unfair advantage of other potential lenders or the Debtors, or that Pivotal Finance has colluded with the Debtors. The evidence is to the contrary and actually shows an arm's-length transaction between the parties. The parties employed separate legal counsel to advise them. Furthermore, the Debtors and Pivotal Finance have not been the only parties involved in producing this final financing package such that collusion might be a concern. Mr. Polen and Mr. Najafi testified that both the Debtors and Pivotal Finance made concessions after the Committee and the POMG objected to the original terms of the financing. Mr. Greenfield testified that this is the most debtor-favorable DIP financing he has ever seen. It is also telling that the Committee and the POMG, both comprised of unsecured creditors, support the Pivotal Financing.
V. CONCLUSION
For the reasons set forth herein, the Court hereby
OVERRULES the objections to the Motion asserted by Credit Suisse and the Second Lien Lenders;
GRANTS the Debtors' Motion for $25,000,000 in debtor-in-possession financing according to the term sheet, as amended; and
ORDERS the Debtors to submit a separate Order consistent with this Memorandum Decision.