The United States Court of Appeals for the Seventh Circuit recently held that numerous forbearances by a lender that allowed a single asset real estate borrower to stave off bankruptcy for four years provided value in the context of a constructive fraudulent transfer action. 1756 W. Lake St. LLC v. Am. Chartered Bank (In re 1756 W. Lake St. LLC), Case No. 14-1869 (7th Cir. May 15, 2015). The decision in Lake Street recognizes that a lender may, under certain facts and circumstances, provide real value when it extends a lifeline to the borrower in the form of forbearance. The trick, however, may be putting a price tag on that value.
The facts are straightforward and all-too-familiar to bankruptcy practitioners. Lake Street borrowed approximately $1.5 million from American Chartered Bank. Lake Street’s obligation to repay the debt was secured by a mortgage on its only significant asset: property located at 1756 W. Lake Street. Eventually, Lake Street was unable to meet its obligation to repay the debt and entered into a number of forbearance agreements with the Bank. In connection with one of the forbearances, Lake Street agreed to place the deed to the mortgaged property in escrow, to be released to an affiliate of the Bank upon an event of default. Lake Street ultimately defaulted and the Bank, through its affiliate, took possession of the deed and recorded it.
Lake Street commenced a case under chapter 11 of the Bankruptcy Code. Shortly thereafter, Lake Street filed a one-count complaint in the District Court for the Northern District of Illinois seeking to establish that the recording of the deed constituted a constructively fraudulent transfer under section 548 of the Bankruptcy Code.
Lake Street argued that the mortgaged property was worth $1.7 million when it agreed to place the deed in escrow, which was $200,000 more than its obligation to the Bank, and, therefore, Lake Street received less than reasonably equivalent value in exchange for transferring the deed to the Bank.
The Bank countered with three arguments:
- Lake Street’s appraisal was wrong. The property was worth only $1.3 million;
- Even if Lake Street’s appraisal was correct, by forgiving $1.5 million in debt, the Bank provided Lake Street with 88% of the mortgaged property’s value, which was “reasonably equivalent” value; and
- The numerous forbearances the Bank granted to Lake Street, which included loans to Lake Street affiliates, repeated extensions of maturity, and reductions in monthly payments and interest rates, were worth at least $200,000, closing the gap between the amount of debt the Bank would forgive and Lake Street’s appraisal.
The District Court granted the Bank’s motion for summary judgment. The Seventh Circuit affirmed the lower court’s decision on the grounds that the numerous forbearances the Bank granted to Lake Street were worth at least the difference between the amount of debt outstanding and the value Lake Street alleged for the property.
The Seventh Circuit rejected the Bank’s first argument because “the record compiled in the summary judgment proceeding … does not permit a confident inference as to which appraisal is more accurate.” The court also concluded that the Bank’s second argument was “no good” because reasonably equivalent “should be understood to mean not part payment but that the debtor received or will receive value for the property that he transferred that is as close to true equivalence as circumstances permit.”
The court, however, was persuaded by the Bank’s third argument. Observing that Lake Street and the Bank had negotiated eleven forbearance agreements, the court found that these accommodations eased the repayment terms of the debt and “kept Lake Street out of bankruptcy for the next four years.” The court then looked to Lake Street’s Statement of Financial Affairs and determined that Lake Street’s total gross income for three of the four years of its “extended life” equaled an aggregate amount of $435,746; more than doubling the difference between the amount of debt outstanding and Lake Street’s own appraisal amount. Thus, the court concluded that the forbearances provided Lake Street with reasonably equivalent value in exchange for transferring the deed to the Bank.
The Seventh Circuit’s decision in Lake Street embraces the maxim that everything has its own value; even an agreement not to exercise contractual remedies. Where the rubber meets the road, however, is how to determine the amount of that value. In Lake Street, the court suggested that it could determine the amount by looking to the revenue generated by the borrower during the “extended life” caused by the forbearance. The court’s reasoning turns on the cause and effect relationship between the lender’s forbearance and the borrower’s continued operation. Although that cause and effect relationship is apparent in a single asset real estate case such as Lake Street, the court’s reasoning may be difficult to apply to more complex enterprises and capital structures. Nevertheless, the Seventh Circuit’s decision makes clear that the question to be answered is how much value a forbearance provides and not whether a forbearance provides value at all.