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In re Madison Hotel Associates

November 6, 1984


Appeal from the United States District Court for the Western District of Wisconsin. No. 82 C 694 -- Barbara B. Crabb, Judge.

Author: Coffey

Before PELL, COFFEY, Circuit Judges, and NICHOLS, Senior Circuit Judge.*fn*

COFFEY, Circuit Judge. The debtor-appellant, Madison Hotel Associates ("MHA"), appeals the ruling of Judge Crabb of the United States District Court for the Western District of Wisconsin that MHA's Chapter 11 Plan of Reorganization impairs the claim of Prudential Insurance Company of America ("Prudential").*fn1 We reverse and remand this case to the district court with instructions to reinstate the July 14, 1982 order of Judge Martin of the Bankruptcy Court for the Western District of Wisconsin, confirming MHA's Chapter 11 Plan of Reorganization.


According to the undisputed facts, MHA is a limited partnership organized under the laws of Wisconsin and consisting of two general partners, Darrell Wild and Wild, Inc., in addition to a number of limited partners. MHA owns and operates the Concourse Hotel in Madison, Wisconsin. On December 11, 1972, MHA entered into a loan agreement with the Citizens Mortgage Investment Trust ("CMIT") to finance the construction and operation of the Concourse Hotel. Pursuant to the terms of that agreement, CMIT advanced funds to MHA for construction of the hotel. In return, CMIT received a promissory note obligating MHA to repay the principal amount of the loan and interest accued thereon. CMIT secured its loan with a first mortgage and a first security interest in MHA's realty, and, in the event of default, an "assignment of rentals" accruing from such property. The parties agreed that CMIT would finance only the construction costs and upon completion of the hotel, the promissory note, along with all of CMIT's security interests, would be assigned to Prudential who would, in turn, pay the outstanding balance of the CMIT loan and provide MHA with permanent financing for hotel operations. On September 9, 1974, CMIT asssigned to Prudential the promissory note, in the amount of $7,000,000, the first mortgage and the first security interest in MHA's realty, and the "assignment of rentals." Thereafter, under the terms of the Prudential financing agreement, MHA was obligated to pay Prudential monthly installments of principal and interest in the amount of $59,360.*fn2

Shortly after opening in the summer of 1974, the Concourse Hotel began to experience operating problems and to generate a negative cash flow. As a result, early in 1976 MHA began defaulting on the payment of its monthly loan installments to Prudential. On October 16, 1978, Prudential issued a notice of default and acceleration of the amount due. Both the promissory note and the first mortgage provided that in the event of default, the mortgagee (Prudential) could immediately accelerate the entire balance due and payable, including principal, accrued and unpaid interest, and reasonable attorney's fees. Some three-and-one-half months later, on February 1, 1979, Prudential commenced a foreclosure action in the United States District Court for the Western District of Wisconsin, seeking collection, under Wisconsin law, of the entire accelerated amount due from MHA.

In the meantime, the record reveals that in May 1976, the general partners of MHA, Darrell Wild and Wild, Inc., had filed a lawsuit in Wisconsin state court alleging that the interest rates charges by Prudential (9 1/8% per annum) were usurious in violation of Wis. Stat. § 138.05.*fn3 On July 20, 1978, the Circuit Court for Dane County, Wisconsin, granted summary judgment for Prudential ruling that there existed no issues of material fact and that, as a matter of law, the interest rates did not violate Wis. Stat. § 138.05. On February 26, 1980, the Wisconsin Court of Appeals affirmed that judgment, reasoning that the corporate exception to the usury laws applied to the MHA limited partnership. Wild, Inc. v. Citizens Mortgage Inv. Trust, 95 Wis. 2d 430, 431-32, 290 N.W.2d 567, 568-69 (Wis. Ct. App. 1980). The Federal district court reserved final disposition of Prudential's foreclosure action until the Wisconsin state courts had resolved the usury issue. However, the record reveals that on February 11, 1980, some two weeks before the Wisconsin Court of Appeals issued its decision, the district court approved a stipulation between MHA and Prudential. Pursuant to the terms of that stipulation, the parties established an escrow account into which MHA paid the amount of principal and interest due Prudential under the promissory note and first mortgage.*fn4 It is undisputed that MHA has continued to make regular monthly payments into this escrow account, and as of August 1, 1983, MHA had paid some $4,888,581.17 into the account.

On August 17, 1981, Judge Crabb of the Federal district court considered the parties' legal and equitable arguments on the foreclosure issue, reviewed the applicable Wisconsin state law of foreclosure, see Wis. Stat. § 846.01 et seq. (1981-82), and granted Prudential's summary judgment motion to foreclosure on the MHA mortgage. According to the court, "on the present record the equities are with [Prudential] who [has] been subjected to years of protracted litigation pursued by [MHA] . . . in an obvious effort to extend [its] low cost use of the loan funds. . . ." The court rules that "because of the continuous and current default in the First Note, First Mortgage, and Security Agreement [Prudential] may foreclose the First Mortgage by judicial proceeding under the terms of the mortgage and sell the collateral of the Security Agreement." Moreover, the court ordered that Prudential "may have until August 24, 1981, in which to submit a form of judgment of foreclosure and sale of the realty described in the First Mortgage and the collateral described in the Security Agreement, to be entered by the court." On August 24, 1981, before Prudential filed its judgment of foreclosure with the district court, MHA filed a Chapter 11 petition for reorganization in the United States Bankruptcy Court for the Western District of Wisconsin. The effect of MHA's Chapter 11 petition was to stay the foreclosure proceeding, see 11 U.S.C. § 362(a) (1982), transfer it to the bankruptcy court, see 28 U.S.C. § 1478 (1982), and thereby preclude Prudential from obtaining a final judgment of foreclosure.

Some four months later, on December 22, 1981, MHA filed its proposed plan of reorganization with the bankruptcy court. On that same day, the bankruptcy court conducted a hearing to address claims by CMIT and Prudential that the court should abstain from considering MHA's Chapter 11 petition for reorganization, see 11 U.S.C. § 305(a)(1) (1982),*fn5 or, in the alternative, dismiss the entire case, see 11 U.S.C. § 1112(b) (1982).*fn6 Following the evidentiary hearing, the court ruled that "this case is not appropriate for abstention. There are claims which exist which are not and nor can be better protected in another court. I'm satisfied with the debtor as a person which may have relief under Chapter 11." The bankruptcy court added that under 11 U.S.C. § 1112(b), "there are various categories suggested as a basis for dismissal. None of those specific suggested categories fits the case nor has it been contended that it does." Nonetheless, CMIT and Prudential argues that "there is available an additional category which would be an absence of good faith." The bankruptcy court judge responded, "I'm satisfied that there has been sufficient efforts to reorganize undertaken by the debtor to rebut any contention that there would be a lack of good faith in the initial filing of the Chapter 11. As I indicated before, the debtor is an appropriate entity for relief under Chapter 11." (Emphasis added).

Throughout the pendency of the Chapter 11 reorganization proceeding, the stay remained in effect upon Prudential's foreclosure action in the district court. Prudential continued to seek relief from the stay in order that it could obtain a judgment of foreclosure on MHA's realty. Prudential claimed that it "would be delayed in the event the chapter 11 case were dismissed if it was not foreclosure judgment against Madison Hotel Associates and commence the period for equity of redemption allowed by Wisconsin law." In re Madison Hotel Associates, 18 Bankr. 218, 219 (Bankr. W.D. Wis. 1982). On March 5, 1982, the bankruptcy court ruled that Prudential lacked the "cause" required under 11 U.S.C. § 362(d)(1) to obtain relief from the stay. According to the court, "the occurrence of delay is speculative upon the failure of the debtor's effort to reorganize under chapter 11.If those efforts are successful, Prudential will incur neither delay nor economic loss. Even if those efforts are unsuccessful, there is no contention that Prudential will incur unprotected or uncompensated economic injury." Id. at 219. See also In re Madison Hotel Associates, 31 Bankr. 400, 401-02 (Bankr. W.D. Wis. 1983).

The bankruptcy court conducted additional hearings on MHA's proposed plan of reorganization on June 23, July 9, and July 12, 1982. At the July 9 hearing, Prudential presented an offer of proof that MHA had not acted in good faith when proposing its Chapter 11 Plan of Reorganization. The bankruptcy court noted that:

"Taking all of the offers of proof as proved they must be applied against the legal standard for good faith in a Chapter 11. Also considered are matters which the Court has observed or has received evidence on either in this or in prior hearings which would be counter to the matters that are proved. Among those that I am prepared to consider are the terms of the plan that is now being considered for confirmation, the history of the amendments to that plan and the conduct of the debtor and debtor's counsel throughout these Bankruptcy proceedings; the fact that the plan calls for full payment to all creditors and specifically the treatment of MHA, Inc. in the plan is considered. Also considered is the presence of an escrow fund that was created in prior proceedings."

The bankruptcy court added that "essentially a reorganization plan is proposed in good faith when there is a reasonable likelihood that the plan will achieve a result consistent with the objectives and purposes of the Bankruptcy Code." Based upon these considerations, the court rules that sufficient evidence existed to find that MHA's plan of reorganization was proposed in good faith.

The record reveals that all of MHA's creditors, except Prudential, affirmatively accepted the plan of reorganization. Following the July 12 hearing, the bankruptcy court ruled, from the bench, that MHA's plan satisfied the statutory requirements of 11 U.S.C. § 1129(a) and thus the court confirmed the plan.*fn7 Specifically, the bankruptcy court found that, in compliance with 11 U.S.C. § 1129(a)(3), MHA proposed the plan in good faith. According to the court:

"This issue was disposed of in the prior ruling on Prudential's offer of proof to the contrary. That ruling concluded that on the basis of the whole record in this case the good faith of the debtor in proposing this plan to the standards required under this subsection and articulated in the case of In re Nite Lite Inns, [17 Bankr. 367, 370 (Bankr. S.D. Cal. 1982)], . . . that standard was sufficiently evidenced. . . ."

The bankruptcy court further found that in accord with 11 U.S.C. § 1129(a)(8), all classes of creditors either affirmatively accepted MHA's plan of reorganization or their claims were "not impaired" by the plan. In particular, the court found that Prudential was not impaired as that term is defined in 11 U.S.C. § 1124 because MHA's plan of reorganization cures the default of Prudential's accelerated loan, reinstates the maturity of such loan as it existed before the default, compensates Prudential for damages incurred as a result of reasonable reliance, and does not otherwise alter legal, equitable, or contractual rights between MHA and Prudential. On July 14, 1982, the bankruptcy court entered a written order confirming MHA's plan of reorganization.

Prudential appealed the bankruptcy court's order to the United States District Court for the Western District of Wisconsin. The case was assigned to Judge Crabb, the same judge who some two years previous granted Prudential's motion for summary judgment to foreclose, under Wisconsin state law, on MHA's mortgage. MHA filed a motion pursuant to 28 U.S.C. § 455(a), asking Judge Crabb to disqualify herself due to her apparent lack of impartiality on the issue of foreclosure and her statement that the case involved "many years of delay and legal skirmishing" on the part of MHA. Judge Crabb denied the motion, summarily responding that "it is inevitable that judges will come to some evaluation of the merits of protions of the case. It does not follow from this, however, that the judge will be unable to remain neutral about other aspects of the case." Following this terse and unsupported treatment of the impartiality question, Judge Crabb overruled the bankruptcy court's holding that Prudential was not impaired under MHA's plan of reorganization. According to the district court:

"MHA's plan impairs Prudential's claim because it does not restore Prudential's judicially-recognized right to proceed with foreclosure of the real and personal property of the Concourse Hotel. And, because Prudential's right to foreclosure does not arise merely from a contractual provision or applicable law but is created by court order and is not simply a right to accelerated payments which can be cured, Prudential's claim does not fall within the exception created by § 1124(2). Therefore, Prudential cannot be deemed to have accepted MHA's plan under 11 U.S.C. § 1126(f) and this matter must be remanded to the bankruptcy court for a determination of the plan's validity under 11 U.S.C. § 1129(b)."

In re Madison Hotel Associates, 29 Bankr. 1003, 1009 (W.D. Wis. 1983) (emphasis original) (footnote omitted). The district court further stated that "there are indications that MHA's filing for reorganization may have been motivated by the sole purpose of hindering and delaying its creditors." Id. at 1010. The court thus reasoned that:

"The indications of misuse of the bankruptcy court are sufficient to require an evidentiary hearing by the bankruptcy court to determine whether MHA's prefiling conduct demonstrates by a preponderance of the credible evidence that its sole purpose in filing for Chapter 11 reorganization was to hinder or delay its secured creditors, Prudential and CMIT. The determination should not be limited to deciding only whether there is a reasonable likelihood that the plan will achieve a result consistent with the objectives and purposes of the Bankruptcy Code."

Id. On appeal, MHA claims that the district court erred in ruling that Prudential's claim is not impaired for purposes of 11 U.S.C. § 1129(a)(8). MHA further contends that the district court improperly construed the good faith requirement of 11 U.S.C. § 1129(a)(3).


We initially address the legal issue of whether Prudential's claim against MHA is impaired for purposes of 11 U.S.C. § 1129(a)(8), ...

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