In a case decided on May 15, 2015, the 7th Circuit Court of Appeals has declared that the existence of forbearance agreements from a creditor can, in the right circumstances, satisfy the reasonable equivalency test in order to prevail in an avoidance action brought by a debtor in bankruptcy. This is a key decision for creditor’s rights professionals, and will add another layer of protection to the workout professional’s armor. The case is 1756 W. Lake Street LLC v. American Chartered Bank and Scherston Real Estate Investments, LLC, Court of Appeals, 7th Circuit (May 15, 2015).
What are the right circumstances? Here are the circumstances that led to the decision:
1756 W. Lake Street LLC (“Lake Street”) filed for Chapter 11 bankruptcy while owing $1.5 million to American Chartered Bank (“Bank”). The obligation was in the form of a mortgage on property that now had a value of $1.7 million. Lake Street brought an adversary proceeding in the form of an avoidance action to set aside a transaction whereby the Bank took a deed to the debtor’s property as part of a structured workout, alleging that the property had $200,000 in equity as supported by an appraisal. The debtor believed that the deed was an avoidable transfer because of the equity in the property. The Bank attempted to disprove the equity with a lower value appraisal, but that did not sway the court at all. However, what did move the court was the fact that the bank’s forbearances provided reasonably equivalent value that would otherwise make up the difference.
The court found that the income produced by the asset for the four additional years that the life of the business was allowed to continue, after the event of default, stood for increased value. The court determined that the income produced over the four years far exceeded the $200,000 that now existed as equity in the property. Without this finding, the bank would have lost its deed to the property and lost a valuable asset it negotiated hard for during the workout process.