Lennar Metro DC v. McLean Square Assoc

UNPUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
In Re: MCLEAN SQUARE ASSOCIATES,
G.P.,
Debtor.
LENNAR METRO D. C. PARTNERS,
LIMITED PARTNERSHIP,
Plaintiff-Appellant,
No. 95-3161
and
J. W. FORTUNE, INCORPORATED,
Plaintiff,
v.
MCLEAN SQUARE ASSOCIATES, G.P.,
Defendant-Appellee.
Appeal from the United States District Court
for the Eastern District of Virginia, at Alexandria.
Leonie M. Brinkema, District Judge.
(CA-95-1453-A, BK-93-14161)
Argued: November 1, 1996
Decided: February 24, 1997
Before NIEMEYER, MICHAEL, and MOTZ, Circuit Judges.
_________________________________________________________________
Affirmed by unpublished per curiam opinion.
_________________________________________________________________
COUNSEL
ARGUED: William James Perlstein, WILMER, CUTLER & PICK-
ERING, Washington, D.C., for Appellant. Ann Elizabeth Schmitt,
REED, SMITH, SHAW & MCCLAY, Washington, D.C., for Appel-
lee. ON BRIEF: Lewis S. Goodman, Mark T. Womack, SHAW,
PITTMAN, POTTS & TROWBRIDGE, Washington, D.C., for
Appellant.
_________________________________________________________________
Unpublished opinions are not binding precedent in this circuit. See
Local Rule 36(c).
_________________________________________________________________
OPINION
PER CURIAM:
Lennar Metro D.C. Partners, L.P. (Lennar) appeals from the district
court's dismissal of its appeal of a bankruptcy court order confirming
the plan of reorganization of McLean Square Associates, G.P.
(McLean). Lennar argues that the district court erred by holding that
its appeal was equitably moot. We disagree with Lennar for the rea-
sons stated below and affirm the district court.
I.
McLean, a general partnership, is the appellee in this case and the
debtor in the underlying Chapter 11 bankruptcy reorganization. In
1987 McLean bought a parcel of commercial real estate known as the
McLean Shopping Center. It financed the purchase with a $5 million
capital contribution by the general partners and a $5 million nonre-
course loan from the National Bank of Washington. In 1988 the bank
loaned McLean an additional $2 million and took a new note for $7
million (the Note). McLean used the additional money to buy another
property in the shopping center. The interest rate on the Note was the
floating prime rate published in the Wall Street Journal. The FDIC
took over the National Bank of Washington in August 1990. McLean
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continued to make monthly payments on the Note, but after McLean
did not make the balloon payment due at the end of 1992 when the
Note matured, the FDIC notified McLean that it was going to sell the
Note.
In October 1993 McLean filed a voluntary petition for Chapter 11
reorganization in the Eastern District of Virginia. Appellant Lennar
bought the Note from the FDIC in December 1993 as part of a bulk
purchase of loans. McLean has continued to make the interest pay-
ments since then, but it has not made payments on the principal
amount.
McLean and Lennar both submitted plans for McLean's reorgani-
zation to the bankruptcy court. The cornerstone tenant of the redevel-
opment proposed in McLean's plan was a food store called Sutton
Place Gourmet. McLean's lease agreement with Sutton Place required
McLean to make extensive renovations to the shopping center. The
agreement also gave Sutton Place the right to terminate the lease if
the bankruptcy court did not confirm McLean's plan by June 15,
1995, or if construction was not under way by October 1995.
The bankruptcy court heard experts from both McLean and Lennar
testify as to the current value of the shopping center, its projected
value after redevelopment, the costs and amount of cash needed for
redevelopment, and the rate of interest that would accurately account
for the risk of default on the Note. Lennar's expert suggested that the
interest rate on the Note be increased to floating prime plus 2.5% to
reflect what he considered to be the undersecured nature of the loan.
At the date of the confirmation hearing this rate was 11.5%.
McLean's expert testified that the appropriate rate of interest for a
loan of similar risk would be 175 basis points over a fixed rate equal
to the six and one-half year U.S. Treasury bill rate. At the date of the
confirmation hearing that rate was about 6.50%, so McLean's pro-
posed rate was a fixed 8.25%. Both experts testified as to the pro-
jected cash flow of the shopping center and McLean's likely ability
to make the interest payments. Lennar also asserted a claim for
$357,517 in late charges.
The bankruptcy court confirmed McLean's plan at the hearing on
May 22, 1995, and entered a written order on July 17, 1995. The court
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made three modifications to the plan that are relevant to this appeal.
First, it modified the Note. It set the interest rate at floating prime (9%
at that time), which was the original rate on the Note. This rate fell
between the fixed 8.25% requested by McLean and the floating prime
plus 2.5% requested by Lennar. The court also extended the term of
the Note through the end of 2001 with principal payments starting in
1999 and a balloon payment at the end. Second, the court disallowed
Lennar's claim for late charges on the ground that Lennar suffered no
damage as a result of the delay. Third, because the plan projected an
operating deficit of $122,352, the court conditioned the plan by
requiring McLean's general partners to post a letter of credit for
$200,000 to ensure that adequate cash was on hand to finish the rede-
velopment once it began.
Lennar did not seek a stay of the confirmation order because it
feared that Sutton Place might terminate the lease if the redevelop-
ment did not begin on time. Lennar nevertheless appealed the confir-
mation order to the district court in October 1995. Lennar objected to
the confirmation order on the following grounds: (1) the late charges
should have been included, (2) the plan left Lennar undersecured, (3)
the interest rate was too low, and (4) the plan was not feasible. Lennar
asked the district court to reverse the bankruptcy court and enter an
order denying confirmation of the plan.
The district court did not reach the merits of these objections. On
November 6, 1995, McLean filed a motion asking that the court dis-
miss Lennar's objections as moot. McLean argued that there was no
practical way for a court to grant the relief requested because the plan
was substantially consummated, major construction had begun, and
third parties had relied on the plan and entered into contracts with
McLean (the debtor). McLean provided an affidavit from one of its
general partners describing the various contracts entered into and
describing the construction work that was already under way.
Lennar responded by asking for less relief. In its response it asked
that the district court order the bankruptcy court to modify the plan
so that McLean would pay the late charges and a market rate of inter-
est. Lennar described these two elements as the"key portions" of its
appeal. Lennar argued that no third parties would be adversely
affected by the more limited relief and that the additional interest
4
would not jeopardize the plan because McLean's partners (as general
partners) were obligated to make additional capital contributions to
cover any shortfalls.
The district court held a hearing on Lennar's appeal on December
1, 1995. At the hearing Lennar again asked for the limited relief of
late charges and a market rate of interest. McLean pointed out that if
the court granted the relief requested, the plan would have a real cash
flow problem, with a projected operating deficit (using Lennar's num-
bers) of $336,750 in 1996 and $132,028 in 1997. The district court
sided with McLean and granted its motion to dismiss under the doc-
trine of "equitable mootness." It found that"to allow these appeals to
be heard would effectively run significant risks to seriously affecting
third parties in that there are other tenants, other businesses planning
to do business there, and that would not be fair to them." The court
also noted that Lennar had declined to seek a stay even though it
could have, that the plan had been substantially consummated, and
that there had been "reasonable reliance upon the finality of the Bank-
ruptcy Court's decision [confirming the plan]." Lennar appeals the
decision of the district court.
II.
We turn to the only question before us -- whether the district court
erred in dismissing Lennar's appeal on the ground of"equitable moot-
ness."
The equitable mootness doctrine allows a reviewing court, in cer-
tain circumstances, to refrain from reviewing the merits of a bank-
ruptcy court order. The doctrine applies to cases where the court finds
that it should not grant relief on equitable and prudential grounds
even if the party seeking relief might win on the merits.
This circuit previously applied the equitable mootness doctrine in
Central States, Southeast and Southwest Areas Pension Fund v. Cen-
tral Transport, Inc., 841 F.2d 92 (4th Cir. 1988). In Central States,
we stated the test for applying the doctrine as follows:
[D]ismissal of the appeal on mootness grounds is required
when implementation of the plan has created, extinguished
5
or modified rights, particularly of persons not before the
court, to such an extent that effective judicial relief is no
longer practically available. The court should reach a deter-
mination upon close consideration of the relief sought in
light of the facts of the particular case.
Id. at 96 (citations omitted).*
Lennar argues on appeal that the district court misapplied the
Central States test because the relief sought would not affect the
rights of third parties. As mentioned above, in district court Lennar
requested an order increasing the interest rate on the Note and adding
late charges. Lennar argues that these changes could be made to the
plan without substantially affecting the rights of third parties.
We disagree. The relief Lennar requests would adversely affect the
cash flow and financial stability of the shopping center. The bank-
ruptcy court heard expert testimony that McLean could not make the
payments that Lennar requested:
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*In fashioning a test for equitable mootness, other circuits have con-
sidered additional factors including (1) whether the reorganization plan
has been substantially consummated, (2) whether a stay has been
obtained, (3) whether the relief requested would affect the success of the
plan, and (4) the public policy of affording finality to bankruptcy judg-
ments. See, e.g., In re Continental Airlines, 91 F.3d 553, 560 (3d Cir.
1996) (en banc); Manges v. Seattle-First Nat'l Bank (In re Manges), 29
F.3d 1034, 1038-39 (5th Cir. 1994); In re UNR Indus., 20 F.3d 766, 769
(7th Cir. 1994); In re Chateaugay Corp., 988 F.2d 322, 325 (2d Cir.
1993); Rochman v. Northeast Utils. Serv. Group (In re Public Serv. Co.
of N.H.), 963 F.2d 469, 471-72 (1st Cir. 1992); First Union Real Estate
Equity and Mortgage Inv. v. Club Assoc. (In re Club Assoc.), 956 F.2d
1065, 1069 (11th Cir. 1992); In re AOV Indus. , 792 F.2d 1140, 1147
(D.C. Cir. 1986); Trone v. Roberts Farms, Inc. (In re Roberts Farms
Inc.), 652 F.2d 793, 796-97 (9th Cir. 1981). Lennar argues that Central
States, which places primary focus on how the relief requested would
affect third parties, is the proper test. We note that applying the other fac-
tors listed above would not help Lennar, so we need not decide which
other factors may apply in this circuit.
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Q. In your opinion, . . . if the rate of prime plus 2 1/2% is
incorporated into the Debtor's plan, what would be the
effect on the feasibility of the plan?
A. I believe there is not sufficient cash flow to make the
payments called for in the plan.
Transcript of May 22, 1995 hearing at 94. If the plan was modified
by increasing the interest rate on the loan to prime plus 2.5% and by
reinstating the late charges, McLean would likely suffer significant
operating deficits. This could then upset the interests of the tenants
and other third parties who have relied on the confirmed plan with the
cash flow projections in that plan.
The record contains evidence indicating third party reliance. In its
brief to the district court McLean attached an affidavit of one of the
shopping center managers who described some of the commitments
made to and by third parties after confirmation. For example, Sutton
Place Gourmet paid $49,938 on behalf of McLean as partial commis-
sion due to a broker under the lease agreement. Sutton Place made
this payment and proceeded to satisfy its obligations under the lease
on the assumption that the plan had the unconditional approval of the
bankruptcy court and would be implemented as approved. McLean
entered into contracts with a construction company (Jack Bays, Inc.)
and other contractors who began demolition and redevelopment of the
center in September 1995. As of October 31, 1995, McLean had just
$90,000 cash left on hand. Increasing the interest rate on the Note and
adding late charges would upset the carefully crafted plan and would
increase the risk that third parties would not be paid or would lose
monies already expended.
Lennar counters this reasoning by noting that the plan already pro-
vides for an operating deficit. An operating deficit in a general part-
nership can require a new capital contribution by the partners. But the
bankruptcy court, aware that the plan projected an operating deficit
of $122,352, required that the McLean general partners post a
$200,000 letter of credit to provide for this shortfall. Thus, in the
bankruptcy court's judgment, the implied obligation of the general
partners was not enough, and it required the letter of credit to ensure
that redevelopment would be completed. The bankruptcy court con-
7
firmed the plan in part on the finding that McLean"will have suffi-
cient cash with which to complete the proposed redevelopment."
Increasing the interest payments and imposing late charges would
increase the projected operating deficit over the $200,000 secured by
the letter of credit. This would mean that capital contributions beyond
those provided for (and guaranteed) would likely be required.
We realize, as Lennar stresses, that general partners in a partner-
ship do have a legal obligation to make any necessary capital contri-
bution. But the ability of third parties to get paid if contributions were
called for would turn on the wherewithal of the general partners. The
third parties here entered into their contracts with McLean on the rea-
sonable assurance that the cash projected in the plan would be avail-
able. The letter of credit posted by the partners played a significant
role in the bankruptcy court's decision to confirm:
Based on the estimates of cost . . . and the revenue sources
available to the Debtor, specifically the cash on hand, future
rental income, advances from Sutton, sale proceeds from the
sale of the residential property and the letter of credit from
the general partners, the Court finds the Plan to be feasible.
Supplemental Appendix at 50 (emphasis added). There were ques-
tions raised about the financial status of the general partners. For this
reason the bankruptcy court required a letter of credit to guarantee
additional capital contributions by the general partners. Increasing the
interest payments to Lennar and granting it late charges would signifi-
cantly increase the likelihood of calls for capital contributions that
were not secured. This prospect, in turn, increases the risk to third
parties that there will not be sufficient cash to complete the redevel-
opment. So we agree with the district court that granting the relief
requested by Lennar would impair the rights of third parties who
relied on the confirmed plan.
Lennar argues in the alternative that even if cash flow is a problem,
the district court could have effectively fashioned relief by using a
"split accrual" interest rate. Under this approach, as we understand it,
the court would increase the interest rate and reinstate the late
charges, but the monthly interest payments to Lennar would remain
the same until the Note matures. The increased interest charges would
8
be capitalized and come due, along with the late charges, when the
Note matures and the balloon payment is due. Thus, the operating
cash flow of the property would not be affected. The only change
(according to Lennar) would be a decrease in the projected profits of
the general partners. But this relief would still impair the stability of
the plan to a significant extent. Lennar's loan to McLean is a nonre-
course loan. If the value of the shopping center was to drop below the
remaining liability on the loan, the general partners would have a
strong financial incentive to walk away from the property, allow Len-
nar to foreclose, and leave third parties unpaid. By increasing the lia-
bility, this "split accrual" relief increases the risk that the general
partners might default, thereby impairing the rights of third parties.
We would not grant "split accrual" relief in any event because Lennar
did not request this relief in its brief to the district court or at oral
argument before that court.
In sum, because the relief requested by Lennar significantly affects
the rights of third parties, the district court was correct in dismissing
Lennar's appeal based on the equitable mootness doctrine. The order
of the district court is therefore
AFFIRMED.
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