Below are the comments of Prof. Dan Schechter (from my alma mater, Loyola Law) to the 9th Circuit’s en banc ruling in In re Sunnyslope Housing Ltd. Partnership, 818 F.3d 937 (9th Cir. 2017). The due date for the petition for cert is now September 22, 2017. The bank’s attorney is Craig Goldblatt from the Wilmer Hale firm in Washington DC.
My thoughts on why the 9th Circuit got Sunnyslope right are here, here and here. The en banc decision is here.
Prof. Schechter commented on the Insolvency Law e-Bulletin:
AUTHOR’S COMMENT: This decision is shockingly wrong. If the lender in this case seeks and obtains certiorari (a big “if”), I predict reversal by the Supreme Court. (As long as I am making rash predictions, I also predict a 6-3 decision, with Justice Breyer joining the majority.)
Here is why this decision is so wrong: unlike Rash, this case is not really about valuation at all. It is about lien priority, an issue not involved in Rash. There were two relevant encumbrances (i.e., property interests) attached to the debtor’s property: the senior lien of the secured creditor, and the subordinate right of the housing authority to enforce its covenants. The covenants were expressly subordinated to the lien of the mortgage, pursuant to an agreement. Under §510(a), that subordination agreement is per se enforceable:
(a) A subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law.
In holding that the property would remain subject to the covenants, the Ninth Circuit necessarily reversed the priorities of those two encumbrances, stripping the senior lien of its senior status. The Ninth Circuit failed to mention §510(a). I know of no authority that permits §506(a) to trump §510(a). I predict that a majority of the Supreme Court will hold that Rash does not authorize a bankruptcy court to completely reverse priority rights in real property.
On a much less cosmic scale, I am also troubled by the court’s reasoning with respect to the discount obtained by the assignee of the senior lien. The original senior lender held a claim valued at $8 million. The assignee purchased that claim at a discount for around $5 million. The majority then held that the discount showed that the assignee “consciously undertook” the risk that its senior position would be destroyed.
This reasoning is disturbing because it punishes parties who purchase debt at a discount precisely because they have negotiated a discount. In turn, this discourages the secondary market in debt. That means that the originating lender is either (1) forced to hold onto paper that it wants to sell for cash or (2) forced to discount the paper even more severely, precisely in order to compensate the assignee for the extra risk resulting from a discount. (Ironically, the steeper the discount, the greater the risk that the assignee will be punished for buying at a discount.) If the doctrine of freedom of contract depends in part upon the free alienability of assets, the court’s use of the discount as an excuse to subordinate an assignee is a tax on alienability and an interference with freedom of contract.