2712 Mission Partners, L.P.

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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-1-
UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re
2712 MISSION PARTNERS, L.P.,
Debtor.
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Case No. 08-32226 TEC
Chapter 11
MEMORANDUM RE OBJECTIONS TO DISCLOSURE STATEMENTS AND SECURED
CREDITORS’ MOTION FOR RELIEF FROM STAY
On January 11, 2010, the court held a hearing regarding three
matters: the adequacy of the disclosure statement filed by Debtor;
the adequacy of the disclosure statement filed by unsecured
creditor 600 Alabama Partners LLC; and the joint motion of two
secured creditors for relief from the automatic stay. 	Scott H.
McNutt and Marianne Dickson appeared for Debtor. 	Merle C. Meyers
appeared for David Bradlow, the chapter 11 trustee of 600 Alabama
Partners LLC (600 Alabama). 	Jeanne M. Jorgensen appeared for
secured creditor Los Angeles Federal Credit Union (LAFCU). 	Henry
Lerner appeared for secured creditor Redwood Mortgage Investors
Signed and Filed: January 22, 2010
________________________________________
THOMAS E. CARLSON
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
January 25, 2010
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 08-32226 Doc# 237 Filed: 01/22/10 Entered: 01/25/10 09:57:48 Page 1 of
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-2-
VIII (Redwood Mortgage). 	Timothy J. Gorry appeared for unsecured
creditor Gorry, Meyer & Rudd, LLP (Gorry). 	Hutchinson B. Meltzer
appeared for MKA Capital Group, Inc. (MKA).
Upon due consideration, and for the reasons stated below, the
court declines to approve either disclosure statement, because
neither plan can be confirmed. 	The court conditions the
continuation of the automatic stay upon an effort to sell promptly
the affected real property.
FACTS
Debtor is a limited partnership that owns an office building
at 2712 Mission Street in San Francisco (the Property). 	The entire
building is leased to the City and County of San Francisco (the
City). 	The initial term of the lease expires in twenty months
(September 30, 2011). 	The lease affords the City the option to
extend the lease term for an additional five-year period. 	The City
must exercise that option by April 3, 2011. 	The rent payable
during the five-year extension is the greater of 95 percent of the
current market rate or the rent during the previous term of the
lease.
The Property is subject to three promissory notes secured by
deeds of trust. 	The first deed of trust, which is held by LAFCU,
currently has a balance of approximately $9.6 million. 	The second
deed of trust, which is held by Redwood Mortgage, has a balance of
approximately $1.2 million. 	The third deed of trust, which is held
by MKA, currently has a balance of approximately $14 million. 	Both
Debtor and 600 Alabama contend that the MKA deed of trust is
avoidable as a fraudulent conveyance, and it appears that MKA may
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1 Debtor objected to the $1.0 million proof of claim filed by
600 Alabama, and the dispute was settled on the day of trial with
600 Alabama to have an allowed general unsecured claim in the
amount of $850,000. 	Debtor later moved to set aside that
settlement, but the court denied that motion by order signed on
January 22, 2010.
2 Gorry now asserts a claim of $485,256, but did not file a
timely proof of claim. 	At a hearing held on or about May 22, 2009,
the court determined that the estate was estopped from objecting to
the timeliness of any claim up to $220,000, because Debtor proposed
to pay Gorry that amount in a plan filed prior to the claims bar
date.
MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-3-
agree to release its lien upon payment of $50,000. 	There is a lien
for property taxes in the amount of $200,000. 	An appraisal
obtained by Debtor indicates that the Property was worth
approximately $13.3 million in March 2009. 	An appraisal obtained
by LAFCU indicates that the Property was worth approximately $11.2
million in October 2009. 	Debtor has equity in the Property only if
the value is at least $11.1 million and the MKA deed of trust is
avoidable.
Allowed general unsecured claims total approximately $1.1
million. 	The largest of these claims are held by 600 Alabama
($850,000), 1 and Gorry ($220,000). 2
Debtor filed this chapter 11 case on November 20, 2008 to stay
a state-court action by LAFCU seeking appointment of a receiver.
Debtor was in default under the first deed of trust, because it
fell behind in its monthly mortgage payments, and because it
breached a covenant prohibiting additional encumbrances.
The central facts of this case are these. 	The current lease,
executed during the 2000-2008 real estate boom, provides sufficient
rental income to make debt service payments to the first and second
deeds of trust at the non-default rate. 	All parties agree that
following the real estate crash of 2008, the rent specified in the
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-4-
current lease is substantially above the current market rate. 	The
initial term of the current lease expires in less than two years.
All parties agree that if the Property is leased at a market rate
at that time, the rental income will not be sufficient to pay debt
service on the first and second deeds of trust. 	The City has an
option, which it must exercise by April 3, 2011, to extend the
current lease for five years at the current rent. 	Debtor and 600
Alabama suggest that the City will exercise this option, because of
the expense and inconvenience of moving to a new location. 	An
economist would suggest that the lessor and tenant will likely
share whatever savings the City would enjoy by avoiding a move, and
that at the end of the current term, the parties will negotiate a
rent between the current above-market rent and the market rent. 	In
the face of such logic, Debtor and 600 Alabama could show that the
City will exercise the option to extend a lease requiring it to pay
above-market rent only through a statement to that effect from City
officials, which those officials have no interest in providing.
LAFCU and Redwood Mortgage moved for relief from stay on the
basis that: (1) Debtor has no equity in the Property; and (2) that
the Property is not necessary to an effective reorganization,
because Debtor is unable to confirm a plan under which it retains
the Property. 	Debtor has previously filed three chapter 11 plans,
none of which have been confirmed. 	The court determined that
sufficient time had passed since the filing of the petition that
relief from stay should be granted unless a plan was promptly
confirmed. 	Debtor and 600 Alabama each filed a chapter 11 plan and
accompanying disclosure statement within the deadline set by the
court.
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-5-
The chapter 11 plan filed by Debtor provides for the infusion
of $1.7 million, which will be used to reinstate the first and
second deeds of trust, extinguish the third deed of trust for an
agreed-upon payment of $50,000, and pay $520,460 to general
unsecured creditors (less than 50 percent of the allowed claims).
The plan and disclosure statement provide that LAFCU and Redwood
Mortgage are unimpaired, and that Debtor therefore need not pay the
default rate of interest specified in the promissory notes. 	See In
re Entz-White Lumber & Supply, Inc., 850 F.2d 1338, 1342 (9th Cir.
1988).
The chapter 11 plan filed by 600 Alabama provides for the
eventual sale of the Property. 	LAFCU and Redwood Mortgage are to
retain their liens on the Property, but the plan does not provide
for them to retain their liens on all rents and profits. 	Rental
income is to be used to pay debt service to LAFCU and Redwood
Mortgage at a market rate to be determined by the court at some
later date. 	The plan is to be administered by a Plan Committee,
whose expenses are to be paid from unencumbered assets (which
include rental income not necessary to pay current debt service).
The Committee has five years from the date of confirmation to sell
the Property.
DISCUSSION
A. 	Debtor’s Plan and Disclosure Statement
LAFCU, Redwood Mortgage, 600 Alabama, and Gorry object to
approval of Debtor’s disclosure statement on numerous grounds.
Among the objections is that Debtor’s chapter 11 plan cannot be
confirmed. 	Although at least some of the other objections may have
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3 The sole equity holder in Debtor, Mr. Kilroy, would retain
an interest in Debtor (and thereby in the Property) “in respect of”
his current equity interest, because under Debtor’s plan, Mr.
Kilroy alone has the right to make the proposed “new value”
interest and thereby retain ownership of Debtor and the Property.
See Debtor’s 4th Am. Disc. Stmt. at 19.
MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-6-
merit, the court need not address those objections, because it is
apparent that Debtor’s plan cannot be confirmed.
First, Debtor’s plan does not satisfy the absolute priority
rule. 	The plan does not provide for payment in full of the allowed
claims of general unsecured creditors. 	Because the claim of 600
Alabama represents more than one-half in amount of the allowed
general unsecured claims, and because 600 Alabama objects to
confirmation of the plan, general unsecured creditors do not accept
the plan. 	11 U.S.C. § 1126(c). 	Because general unsecured
creditors do not accept the plan and are not paid in full, and
because the plan provides that the sole equity holder retains an
interest in Debtor and the Property in respect of his existing
equity interest, the plan does not satisfy the absolute priority
rule. 3 	11 U.S.C. § 1129(b)(2)(B).
Second, Debtor’s plan cannot be confirmed because it
improperly classifies LAFCU as unimpaired. 	To leave LAFCU
unimpaired, the plan must cure all defaults other than those
specified in section 365(b)(2). 	11 U.S.C. § 1124(2)(A). 	Debtor’s
plan does not propose to cure Debtor’s breach of the covenant in
the LAFCU note barring junior encumbrances. 	Debtor argues that
section 365(b)(2)(D) excuses the cure of virtually all non-monetary
defaults, including the due-on-encumbrance clause at issue here,
citing In re Bankvest Capital Corp., 360 F.3d 291 (1st Cir. 2004).
Debtor’s reliance on Bankvest is misplaced and represents a
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4 The Claremont decision was overruled by statute to excuse
non-curable, non-monetary defaults regarding non-residential real
property leases. 	11 U.S.C. § 365(b)(1)(A). 	That amendment has no
effect upon the present case.
MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-7-
significant breach of Debtor’s counsel’s duty of candor to this
court.
Bankvest did find that section 362(b)(2)(D) excused a debtor
from curing most kinds of non-monetary defaults. 	The court
construed the statutory language excusing the cure of any “penalty
rate or provision” to mean in substance: any penalty rate, or any
provision regarding non-monetary default. 	Id. at 300-01. 	Under
Bankvest, Debtor would not be required to cure the due-on-
encumbrance provision to satisfy section 1124(2)(A).
The problem is that Bankvest acknowledges that the Ninth
Circuit had ruled otherwise, and that Bankvest has since been
overruled by statutory amendments applicable to the present case.
The Bankvest decision expressly noted that the Ninth Circuit had
construed the language of section 362(b)(2)(D) to mean in
substance: any penalty rate, or any penalty provision regarding a
non-monetary default. 	Id. at 296-98 (citing In re Claremont
Acquisition Corp., Inc., 113 F.3d 1029 (9th Cir. 1997)). 4 	Claremont
also held that the term penalty rate means a default rate of
interest, and that penalty provision means a liquidated damages
provision. 	Claremont, 113 F.3d at 1034. 	The due-on-encumbrance
clause at issue here is not a penalty rate or penalty provision
within the meaning given to those terms in Claremont. 	Any question
as to whether Claremont or Bankvest is controlling was resolved in
the 2005 amendments to the Bankruptcy Code. 	Section 365(b)(2)(D)
now provides that Debtor is excused only from curing a “penalty
rate or penalty provision,” expressly adopting the Ninth’s Circuit
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5 The amendment to section 365(b)(2)(D) is applicable to all
cases filed after October 17, 2005. 	The present case was filed on
November 20, 2008.
6 The court will address this apparent ethical violation
through a separate order to show cause.
MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-8-
Claremont decision. 5 	Thus, following the amendments, section
1124(2)(A) requires the cure of almost all non-monetary defaults.
In re Empire Equities Capital Corp., 405 B.R. 687, 690-91 (Bankr.
S.D.N.Y. 2009).
The discussion of impairment in the Debtor’s disclosure
statement cited only Bankvest. 	It did not in any way acknowledge
Claremont or the subsequent amendment to section 365(b)(2)(D).
This appears to be a serious breach of counsel’s duty of candor. 6
The practical effect of the rejection of Debtor’s plan by
general unsecured creditors and the plan’s failure to leave LAFCU
unimpaired, is that Debtor must raise substantially more than $1.7
million to confirm its plan. 	To satisfy the absolute priority rule
by paying 600 Alabama in full, Debtor would have to raise an
additional $575,000. 	To leave LAFCU unimpaired by curing the due-
on-encumbrance clause, Debtor would have to raise yet another $1.2
million to repay the second deed of trust.
It is inappropriate to afford Debtor additional time to amend
its plan and disclosure statement. 	The current plan is Debtor’s
fourth. 	Debtor was unable to confirm its first three plans. 	The
case has been pending for fourteen months. 	To confirm a plan in
which Debtor retains the Property, Debtor would have to raise
substantially more than it proposed to do in its current plan, and
the current plan and disclosure statement provide no credible
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-9-
detail regarding the source of the $1.7 million investment proposed
in the current plan.
B. 	The Plan and Disclosure Statement filed by 600 Alabama
LAFCU, Redwood Mortgage, and Gorry object on numerous grounds
to approval of the disclosure statement filed by 600 Alabama.
Among the objections is that the chapter 11 plan filed by 600
Alabama cannot be confirmed. 	The court agrees, and determines that
the disclosure statement should not be approved because the plan
cannot be confirmed.
Secured creditors LAFCU and Redwood Mortgage do not accept the
600 Alabama plan. 	The plan can be confirmed over their objection
only if the plan is “fair and equitable” with respect to LAFCU and
Redwood Mortgage. 	Section 1129(b) states only the minimum
requirements that must be satisfied for a plan to be fair and
equitable. 	A plan may fail to be fair and equitable in a more
general sense even if it satisfies the requirements of section
1129(b). 	In re D & F Const. Inc., 865 F.2d 673 (5th Cir. 1989).
I determine that the 600 Alabama plan is not fair and equitable in
that more general sense.
First, the 600 Alabama plan unduly delays full payment of
LAFCU and Redwood Mortgage. 	The plan provides that the Property
need not be sold for five years, without curing even the monetary
defaults under the LAFCU and Redwood Mortgage notes. 	It is not
inappropriate for the plan to provide for the sale of the Property.
If the third deed of trust is avoidable, there might be some
proceeds after payment of property taxes, LAFCU, Redwood Mortgage,
and costs of sale, even at a sale price close to the value
indicated by the LAFCU appraisal. 	The 600 Alabama plan, however,
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-10-
seeks not to secure the full value of the Property in the current
real estate market, but to hold the Property until the real estate
market rises. 	It is unknowable when, or whether, such a rise will
occur. 	I determine that any plan (or sale procedure outside of a
plan) must provide for the sale of the Property as promptly as is
commercially reasonable.
Second, the 600 Alabama plan deprives LAFCU and Redwood
Mortgage of some of their collateral without providing a
replacement lien or other adequate protection.
All parties acknowledge that the rent payable under the
current lease is above the current market rate. 	The value of all
income-producing real property is determined by discounting to
present value the expected cash flow from the property. 	The value
of 2712 Mission is enhanced to the extent that the rent from the
current lease is above-market. 	As the above-market portion of the
rent is collected, however, some of that value is turned into cash
and the value of the real property collateral declines
correspondingly.
LAFCU and Redwood Mortgage currently have a lien on all
rents, including the above-market portion of the current rent. 	The
600 Alabama plan proposes to strip the lien on the current above-
market rental income to the extent that this current rental income
exceeds the amount necessary to pay current debt service. 	600
Alabama Plan: §§ 5.2; 7.3.4; 7.5; Exh. A, ¶ 6. 	Thus, the plan
would deprive the secured creditors of some of the value of their
collateral, without providing a replacement lien or other adequate
protection.
There can be no assurance that LAFCU and Redwood Mortgage
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-11-
ultimately will be paid in full from the sale of the Property.
Counsel for 600 Alabama acknowledged at the hearing that if the
City does not exercise its option to extend the lease, and rent is
reduced to market rate, rental income will not be sufficient to pay
debt service on the first and second deeds of trust, and the
secured creditors will have to be allowed to foreclose. 	Because
any purchaser will determine the value of the Property from its
discounted expected cash flow, 600 Alabama’s acknowledgment is
tacit recognition that if rental income reverts to market, it is
unlikely that the Property could be sold at a price sufficient to
pay off the first and second deeds of trust.
I determine that any plan (or program for sale of the Property
without a plan) must sequester and hold for LAFCU and Redwood
Mortgage all rental income that is not paid to those lenders or
expended on necessary maintenance.
C. 	Secured Creditor’s Motion for Relief from Stay
There may be equity in the Property from which unsecured
creditors may be paid in part or in full. 	The circumstances
suggest MKA may release its third-priority deed of trust for
$50,000. 	The sum due for property taxes and on the first and
second deeds of trust is approximately $11 million. 	LAFCU’s
appraisal indicates that the Property had a value of $11.2 million
in October 2009. 	Debtor’s appraisal indicates that the Property
was worth $13.3 million in March 2009. 	The proceeds of sale
available for secured and unsecured creditors would, of course, be
reduced by cost of sale.
The value of the Property can reliably be determined only in a
sale. 	A market transaction is always a more accurate indication of
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-12-
value than a court determination made on the basis of appraisals.
Romley v. Sun Ntl. Bank (In re Two “S” Corp., 875 F.2d 240, 243
(9th Cir. 1989); Takisaki v. Alpine Group, Inc. (In re Alpine
Group, Inc.), 151 B.R. 931, 935 (9th Cir. BAP 1993). 	That is
especially so here, where the value of the Property depends heavily
upon: (1) whether the City will exercise its option to extend the
lease at a rent that all parties agree is above-market; or (2)
whether the City will instead attempt to negotiate an amended lease
under which the owner and the City share the expenses the City
would incur in moving to another location; and (3) what such a
negotiated rent would be. 	At the same time, there is little reason
not to determine the value of the Property via sale. 	Debtor has
been unable to confirm a plan under which it would retain the
Property, despite ample opportunity to do so. 	The current rent is
sufficient to pay taxes, maintenance, and debt service to LAFCU and
Redwood Mortgage pending a prompt sale.
Sale of the Property without confirmation of a chapter 11 plan
would reduce cost and delay, without sacrificing creditors’ rights.
A mechanism can be fashioned whereby unsecured creditors, as well
as the Debtor, can move to have the estate accept an offer to
purchase. 	Creditors and the Debtor can be heard at the hearing on
any such motion. 	Secured creditors would enjoy the right to credit
bid at any sale. 	The process of confirming a liquidating plan in
this case would be very expensive and would provide creditors
little corresponding benefit.
The Property should be sold promptly. 	A third-party purchaser
or foreclosing lienholder should obtain the Property with
sufficient time to negotiate with the City regarding the extension
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MEMO RE DISC. STMT. OBJECTIONS
AND STAY-RELIEF MOTIONS 	-13-
of the lease before the City must exercise its option on April 3,
2011. 	To afford the new owner sufficient time to evaluate the
situation and negotiate with the City, any sale must close before
the end of 2010. 	Such a deadline should afford the estate
sufficient time to market the Property in a commercially reasonable
manner.
Therefore, the court at this time denies the secured
creditors’ joint motion for relief from stay, on condition that the
Property be marketed actively and sold promptly, which condition is
set forth in greater detail in the accompanying order.
**END OF MEMORANDUM**
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Court Service List
Scott H. McNutt, Esq.
Marianne Dickson, Esq.
McNutt Law Group LLP
188 The Embarcadero, Suite 800
San Francisco, CA 94105
Merle C. Meyers, Esq.
Meyers Law Group, P.C.
44 Montgomery Street, Suite 101
San Francisco, CA 94104
Jeanne M. Jorgensen, Esq.
Page and Jorgensen LLP
1101 Dove Street, Suite 220
Newport Beach, CA 92660
Henry Lerner, Esq.
Allen Matkins Leck Gamble
Mallory & Natsis LLP
Three Embarcadero Center, 12th Floor
San Francisco, CA 94111-4074
Timothy J. Gorry, Esq.
Gorry, Meyer & Rudd LLP
2049 Century Park East, 21st Floor
Los Angeles, CA 90067
Hutchison B. Meltzer, Esq.
Weiland Golden Smiley Wang
Ekvall & Strok LLP
650 Town Center Drive, Suite 950
Costa Mesa, CA 92626
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