ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY. (D.C. Civil No. 91-04361).
Before: Greenberg, Alito, and Aldisert, Circuit Judges.
This is an appeal by a creditor, John Hancock Mutual Life Insurance Company ("Hancock"), that seeks to foreclose on a mortgage on property owned by Route 37 Business Park Associates ("debtor"), which has filed a voluntary Chapter 11 petition. The bankruptcy court denied Hancock's motion for relief from the bankruptcy automatic stay, and the district court affirmed. We hold that Hancock's motion was incorrectly denied because the debtor's proposed plan contains an impermissible classification scheme for unsecured claims and thus has no reasonable prospect of confirmation. We will, therefore, reverse the order of the district court.
The debtor is a New Jersey partnership with three partners, all individuals. The partnership's main asset is an industrial and commercial park located on Route 37 in Toms River, New Jersey. In 1989, the debtor obtained a loan of $5,700,000 from Hancock to refinance the park. The loan is secured by a non-recourse first mortgage on the park.*fn1 The debtor failed to make several interest and tax payments, and in November 1990 Hancock began foreclosure proceedings in state court. A short time later, the debtor filed a petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of New Jersey. Pursuant to 11 U.S.C. § 362(a) (1988), the petition operated as a stay of the foreclosure proceedings.
In March 1991, Hancock moved for relief from the stay under 11 U.S.C. § 362(d)(1) and (2) (1988). The first provision on which Hancock relied, Section 362(d)(1), requires a bankruptcy court to grant relief if the creditor would not otherwise have "adequate protection" of an interest in the property in question. Hancock contended that its interest in the business park was not adequately protected, but this argument was rejected by the bankruptcy and district courts and is not before us in this appeal. The other provision on which Hancock relied, Section 362(d)(2), requires a bankruptcy court to grant relief from the automatic stay if the debtor has no equity in the property and the "property is not necessary to an effective reorganization." The debtor stipulated that it had no equity in the property, and therefore the critical question was whether the property was "necessary to an effective reorganization."
Before the district court ruled on Hancock's motion, the debtor filed a proposed plan of reorganization*fn2 and a disclosure statement. The disclosure statement listed Hancock's claim as approximately $5.9 million and listed the book value of the property as approximately $2.4 million and the liquidation value as $2.2 million. Since Hancock's claim was undersecured, the plan treated that claim in accordance with 11 U.S.C. § 506(a) (1988),*fn3 dividing it into a secured claim of $2.2 million and an unsecured deficiency claim of $3.7 million. The plan stated that this treatment would be modified if Hancock elected under 11 U.S.C. § 1111(b)(2) (1988) to have its entire claim treated as secured.*fn4
The plan proposed to create three classes of claims that are relevant for present purposes. Class Two consisted of the secured portion of Hancock's claim. Class Three was made up of all the unsecured claims other than Hancock's; these were estimated to total about $492,000. Class Four consisted of Hancock's unsecured claim of approximately $3.7 million. The plan called for identical payments on the Class Three and Four claims. Specifically, the plan stated that, unless Hancock made the election under 11 U.S.C. § 1111(b)(2) (1988), all of the holders of these claims were to receive 2.5% of their claims without interest 12 months after the effective date of the plan and another 2.5% without interest 12 months after that.
The plan also called for formation of a new, limited partnership called "Newco" to execute the plan. Newco's general partner was to be a corporation, and one or more of the debtor's partners were to be limited partners. The limited partners were to receive equity interests in Newco "in consideration, among other things, for the infusion of funds and other new value." The plan did not specify the amount that any of the partners would contribute.
Hancock argued that it was entitled to relief from the stay under 11 U.S.C. § 362(d)(2) (1988) because the plan improperly placed Hancock's unsecured claim and the other unsecured claims into two separate classes and consequently could not be confirmed. At a hearing in July, however, the bankruptcy court ruled that there was a reasonable possibility that the classification would be sustained at a confirmation hearing.
After a hearing in late August, the bankruptcy court ruled on Hancock's additional argument that the absolute priority rule set out in 11 U.S.C. § 1129(b)(2)(B)(ii) (1988) also prohibited confirmation of the plan because the plan allowed holders of junior claims (the debtor's partners) to receive or retain property (equity interests in Newco). The debtors responded that this feature of the plan was permitted by the "new value exception" to the absolute priority rule. Ruling in favor of the debtor, the bankruptcy court held that this exception had not been eliminated by the enactment of the Code and that there was a reasonable possibility the plan could satisfy this exception.
On appeal, the district court affirmed. It refused to disturb the bankruptcy court's ruling regarding the classification of unsecured claims, but it expressed skepticism "whether the classification proposed by the partnership would pass muster at a confirmation hearing." The district court stated that "the plan does present the appearance of classifying ...