In re SW Boston Hotel Venture: First Circuit Applies "Flexible" Approach to Limit Secured Lender's Right to Postpetition Interest | Practical Law

In re SW Boston Hotel Venture: First Circuit Applies "Flexible" Approach to Limit Secured Lender's Right to Postpetition Interest | Practical Law

The US Court of Appeals for the First Circuit in Prudential Insurance Co. of America v. SW Boston Hotel Venture, LLC (In re SW Boston Hotel Venture, LLC) affirmed a bankruptcy court's decision that a lender was entitled to a claim for postpetition interest under section 506(b) of the Bankruptcy Code, accruing from the date of the sale of its collateral rather than from the petition date.

In re SW Boston Hotel Venture: First Circuit Applies "Flexible" Approach to Limit Secured Lender's Right to Postpetition Interest

by Practical Law Bankruptcy & Restructuring
Published on 01 May 2014 • USA (National/Federal)
The US Court of Appeals for the First Circuit in Prudential Insurance Co. of America v. SW Boston Hotel Venture, LLC (In re SW Boston Hotel Venture, LLC) affirmed a bankruptcy court's decision that a lender was entitled to a claim for postpetition interest under section 506(b) of the Bankruptcy Code, accruing from the date of the sale of its collateral rather than from the petition date.
On April 11, 2014, the US Court of Appeals for the First Circuit in Prudential Insurance Co. of America v. SW Boston Hotel Venture, LLC (In re SW Boston Hotel Venture, LLC) affirmed a bankruptcy court's decision that a lender was entitled to a claim for postpetition interest under section 506(b) of the Bankruptcy Code, accruing from the date of the sale of its collateral rather than from the petition date (No. 12-9008, (1st Cir. Apr. 11, 2014)).

Background

In 2008, Prudential Insurance Company of America (Prudential) provided a construction loan of up to $192.2 million to SW Boston Hotel Venture, LLC (SW Boston) to develop a mixed-use property into the W Hotel and Residences. Prudential took a mortgage as well as first priority security interest in SW Boston's real and personal property and any proceeds thereof. Prudential also obtained additional collateral and credit support in the form of certain real estate and other property owned by SW Boston's affiliates, as well as a $17.3 million letter of credit.
In April 2010, SW Boston failed to make mandatory quarterly payments to Prudential and in June, after unsuccessful loan-restructuring negotiations, SW Boston and four of its affiliates filed for Chapter 11 relief. Prudential filed a motion for relief from the automatic stay, arguing that it was undersecured. The bankruptcy court found that Prudential was marginally undersecured with respect to SW Boston only, valuing its debt to Prudential at $154 million and its collateral at $153.6 million (valuing the hotel at $65.6 million and the condominiums at $88 million). However, with respect to the entire collateral package of all the debtors, Prudential had an equity cushion of more than $19 million. In addition, SW Boston was continually reducing the amount of the outstanding debt through proceeds from condominium sales. Therefore the bankruptcy court concluded that Prudential was adequately protected and denied its motion to lift the stay.
In 2011, SW Boston sold the hotel for $89.5 million, a price which was substantially higher than the $65.6 million value assigned by the bankruptcy court. Because the sale established that Prudential was oversecured, it filed a claim seeking postpetition interest under section 506(b) of the Bankruptcy Code, accruing from the petition date. Section 506(b) entitles an oversecured creditor to postpetition interest up to the value of its collateral. However, the debtors filed a plan of reorganization which did not provide for Prudential to receive any postpetition, pre-effective date interest.
The bankruptcy court noted that due to ongoing improvements and the resolution of various issues, the sale price did not reflect the hotel's value on any earlier date. Therefore, the court ruled that the sale price, rather than the value assigned at the lift-stay hearing, was the best indicator of the hotel's value and held that Prudential only became oversecured when the hotel was sold. The court issued an order that Prudential should only receive non-compounded postpetition interest starting on the date of the sale. The debtors modified the plan accordingly, which the bankruptcy court confirmed over Prudential's objection.
Prudential appealed the confirmation decision to the Bankruptcy Appellate Panel for the First Circuit (BAP) and filed a motion to stay the confirmation pending appeal. The BAP denied the stay motion and the plan became effective on December 1, 2011. The debtors cross-appealed the section 506(b) decision, and the BAP reversed, holding that Prudential was entitled to postpetition interest from the petition date.
The parties appealed again to the First Circuit.

Interpreting Section 506(b)

Generally, unmatured interest is not allowed after the filing of a bankruptcy petition. However, section 506(b) of the Bankruptcy Code provides an exception allowing postpetition interest to be awarded to oversecured creditors. The parties agreed that Prudential was oversecured during at least part of the bankruptcy proceeding and therefore is entitled to some amount of postpetition interest. However, the parties disagreed about how to determine oversecured status and when Prudential became oversecured.
Neither section 506(b)'s language nor its legislative history specifies the time when courts should determine secured status and collateral value. The language of the statute also suggests that Congress intended bankruptcy courts to have flexibility when making these determinations. Courts have adopted different interpretations. Under the "single-valuation" approach, the determination of oversecurity for section 506(b) purposes occurs at a fixed point in time (generally either the petition date or the confirmation date). Other courts have adopted a "flexible" approach which provides bankruptcy courts discretion to consider the circumstances of the case when determining the appropriate date on which to measure the value of collateral. Although the bankruptcy court and the BAP both employed the flexible approach, they applied it in different ways. Both courts agreed that the hotel sale price provided the best evidence of value on the sale date. However, the bankruptcy court held that the sale price was not reflective of value at any earlier point, while the BAP held that the sale price established that Prudential was oversecured during the entire bankruptcy proceeding.
Prudential argued that the First Circuit should adopt the single-valuation approach using the confirmation date as the measuring date. Under this approach, Prudential would be entitled to postpetition interest from the petition date regardless of whether it was undersecured at any earlier point. Prudential further argued that even if the flexible approach is used, the bankruptcy court erred in applying it, while the BAP's interpretation was correct and should be affirmed.

Outcome

The First Circuit agreed with the bankruptcy court and the BAP that, in this case, the flexible approach was appropriate to fairly and equitably determine section 506(b) postpetition interest. In doing so, it noted that section 506(b) of the Bankruptcy Code, which sets the amount of a creditor's allowed secured claim, says that the value of collateral "shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property."
However, the First Circuit agreed with the bankruptcy court's application of the flexible approach. In determining the correct measuring date, the bankruptcy court considered various possible dates and held that the sale closing date was the earliest that Prudential had established oversecured status. The parties ultimately agreed that it was Prudential's burden to show by a preponderance of the evidence that it was oversecured. The First Circuit agreed that the bankruptcy court had properly determined that Prudential had not met its burden to show it was oversecured before the sale closing date, and explained that a sale price at one time does not necessarily establish the collateral's value at some other time.

Practical Implications

This case is the first time the First Circuit has considered the correct approach for determining how and when a secured lender accrues postpetition interest. Its decision is important for lenders because it illustrates that a lender's right to postpetition interest can change over the course of a bankruptcy case. Even if a lender is undersecured on the petition date, it may still be entitled to postpetition interest under section 502(b) due to fluctuating collateral values during the bankruptcy proceedings.
For more information on lenders' rights to postpetition interest, see Practice Note, Postpetition Interest, Fees, Costs, and Charges in Bankruptcy.