In Re Lantana Motel

124 B.R. 252, 1990 Bankr. LEXIS 2799, 1990 WL 264587

• Court: United States Bankruptcy Court, S.D. Ohio
• Decided: November 13, 1990
• Docket: Bankruptcy 2-90-05478, 31-1211188
• Status: Published

Opinion

OPINION AND ORDER ON OBJECTION OF RESOLUTION TRUST CORPORATION AS CONSERVATOR OF COMMONWEALTH FEDERAL SAVINGS AND LOAN TO DEBTOR'S USE OF CASH OR RENTS GENERATED BY THE PROPERTY OWNED BY THE DEBTOR

BARBARA J. SELLERS, Bankruptcy Judge.

I. PRELIMINARY CONSIDERATIONS AND JURISDICTIONAL STATEMENT

This matter is before the Court upon an objection (the “Objection”) by Resolution Trust Corporation as Conservator of Commonwealth Federal Savings and Loan (“RTC”) to the use by Chapter 11 debtor, The Lantana Motel, a Limited Partnership (“Lantana” or “Debtor”) of cash or rents generated by its property. Lantana opposes the Objection and seeks, by separate motion, authority to use cash collateral. Cardinal Lodging Group, Inc. (“CLG”), itself a Chapter 11 debtor, has also responded to the Objection.

RTC and Lantana have reached an agreement on all material issues raised by these cash collateral pleadings except for an issue concerning the payment of franchise, management, bookkeeping and performance fees to CLG. The parties disagree as to whether the payment of these fees should be subordinate to the Debtor’s obligations to RTC.

The matter was originally heard on October 11, 1990, at which time CLG did not appear. On October 16, 1990, a supplemental hearing was held to permit CLG to be heard on the matter. Following that hearing, the Court took the matter under advisement.

The Court has jurisdiction in this matter under 28 U.S.C. § 1334(b) and the General Order of Reference entered in this district. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A), (K) and (0) which this bankruptcy judge may hear and determine. For the reasons stated herein, the Court holds that CLG’s right to the payment of fees is not subordinate to Lantana’s obligations to RTC.

II. FACTS AND ARGUMENTS

The Debtor is a Florida limited partnership which owns as its primary asset a motel known as the Lantana Knights Inn located in Lantana, Florida (the “Property”). In December 1987, the Debtor executed various documents designed to memorialize and secure a $3,920,000 loan to it from Commonwealth Federal Savings and Loan (“Commonwealth”). These documents included a promissory note (the “Note”) and a Mortgage and Security Agreement (the “Mortgage”) in favor of Commonwealth.

Previously, on November 1, 1987, Lanta-na had entered into a franchise agreement (the “Franchise Agreement”) with Cardinal Industries, Inc. (“CII”) relating to the Property. On December 21, 1987, Lantana and CII executed a Subordination and At-tornment Agreement (the “Franchise Subordination Agreement”) whereby Lantana and CII agreed to subordinate the Franchise Agreement to the Mortgage. On December 17, 1987, Lantana and CLG, then a division of CII, had executed a similar Subordination and Attornment Agreement (the “Management Subordination Agreement”) whereby Lantana and CLG agreed to subordinate to the Mortgage a motel management agreement (the “Management Agreement”) dated November 1, 1987 between Lantana and CLG. (The Franchise Subordination Agreement and the Management Subordination Agreement together will be referred to as the “Subordination Agreements.”) Copies of the Subordination Agreements, without exhibits, are attached hereto.

On January 12, 1988, Lantana and Commonwealth executed a certain Modification of Promissory Note and Mortgage and Security Agreement to correct a scrivener’s error concerning the commencement date for the payment of principal and interest under the Note. All references to the Note and/or Mortgage, therefore, mean the Note and/or Mortgage as modified.

In February 1989, Lantana defaulted on its obligations under the Note. Thereafter, in May 1990, RTC, as conservator for Commonwealth, instituted a foreclosure action in Florida state court in which RTC also requested appointment of a receiver. On August 10, 1990, the Florida state court entered a judgment of foreclosure and set a foreclosure sale for September 24, 1990. That sale was stayed by the Debtor’s filing of its Chapter 11 petition.

All parties apparently agree that CLG is the successor-in-interest to CII under the Franchise Agreement and the Franchise Subordination Agreement. RTC is also the successor to Commonwealth for all purposes.

RTC contends that the Subordination Agreements entitle it to payment in full before CLG may receive any payments under the Franchise Agreement or the Management Agreement. RTC urges that such a broad construction of the concededly vague language of the Subordination Agreements best implements what must have been the intention of the parties at the time of the loan.

CLG, on the other hand, maintains that RTC misinterprets the intent and scope of the Subordination Agreements and that the Subordination Agreements do not subordinate CLG’s right to receive payments under the Franchise Agreement and the Management Agreement. Instead, argues CLG, the Subordination Agreements serve merely to insure the superiority of the Mortgage and to resolve any incongruities between the provisions of the Mortgage and the provisions of the Franchise Agreement and the Management Agreement. Lantana joins in this position.

III. ISSUE PRESENTED

The issue before the Court is whether the Subordination Agreements subordinate CLG’s right to payment under the Franchise Agreement and the Management Agreement to the Debtor’s obligations to RTC.

IV. LEGAL DISCUSSION

Poorly drafted documents often make for spirited litigation. Here, the Court is asked to construe the intent and scope of Subordination Agreements which are so unskillfully crafted that meaningful interpretation approaches the impossible.

Aside from the general lack of clarity, a glaring inconsistency in the Subordination Agreements prompted some initial discussion among the parties as to their enforceability by RTC. Particularly, Commonwealth is a named party to the Subordination Agreements and in the fourth paragraph of each such agreement “covenant[s] and agree[s]” to the substantive provisions of the document. However, there are no signature lines for Commonwealth and Commonwealth did not execute the Subordination Agreements. Upon consideration, the Court finds that the Subordination Agreements are valid and enforceable without Commonwealth’s signature and RTC may enforce them. See, e.g., Johnson v. Florida Bank at Orlando, 153 Fla. 120, 13 So.2d 799 (1943) (subordination agreement enforced although mortgagee not a party thereto). Since the Subordination Agreements are enforceable under nonbankrupt-cy law, they are enforceable in this Chapter 11 case. 11 U.S.C. § 510(a).

More pressing and difficult is the parties’ disagreement as to the meaning of the Subordination Agreements. The Court is called upon to divine the intent of documents that are, as counsel for RTC puts it, “what we’ve got and we have to work with.” Record at 31 (October 11, 1990 hearing). Before the Court proceeds to its task, however, a general discussion of subordination agreements is appropriate.

A. Subordination Agreements Generally

“A subordination agreement is an agreement by which a party having a superior right of some sort agrees with someone having an inferior right that, as between the two of them, the inferior right shall be treated as if it were superior.” Feinstein and Kayles, Foreclosure: Subordination, Non-Disturbance and Attornment Agreements, Prob. and Prop., July/August 1989, at 38. In the context of commercial financing, subordination agreements may be generally classified as being one of two types: debt subordinations or property interest subordinations. 1

In a debt subordination, the agreement provides that the subordinated creditor’s right to payment and collection will be subordinate to the rights of another claimant. If the debt subordination is “complete,” the, subordinated creditor is barred from receiving payments until the superior debt is paid in full.

Debt subordinations are routinely utilized when a corporate or partnership borrower seeks financing from a commercial lender. The commercial lender will insist that all indebtedness of the corporation or partnership to management or other insiders be subordinated to the lender’s proposed financing. The lender demands subordination for reasons more than just security; the lender wants its loans to be used as working capital in the borrower’s business and not just to repay insider debts.

Debt subordination should be contrasted to property interest subordination. In a property interest subordination, the agreement affects only the relative rights of parties in particular real or personal property. Property interest subordination does not concern any rights the parties may have to receive payments.

The most common type of property interest subordination is lien subordination. By executing a lien subordination agreement, the subordinating party agrees to demote the priority of its lien to that of another secured creditor, thereby delaying its recourse to the identified collateral until the other party’s secured claim has been satisfied. See, U.C.C. § 9-316. In a pure lien subordination, the subordinating party’s right to receive payments is not limited.

Another common type of property interest subordination is mortgagee-tenant subordination. With this type of subordination, the mortgage lender insists that, as a condition to its lending money to the landlord, the tenant subordinate its lease to the lender’s mortgage. In modern commercial mortgage lending, both lien subordination and mortgagee-tenant subordination are frequently seen as a part of the mortgage lender’s effort to give its mortgage priority over all other property interests.

B. The Subordination Agreements In This Case

The parties' interpretations of the Subordination Agreements can best be examined in the context of the debt subordination/property interest subordination dichotomy. RTC unquestionably views the Subordination Agreements as documents of debt subordination. CLG and Lantana, to the contrary, see the Subordination Agreements as being more in the nature of property interest subordinations.

For several reasons, the Court believes that the intent and scope of the Subordination Agreements are as CLG and Lantana suggest. First, the language of the Subordination Agreements, when considered in its totality, does not indicate that CLG intended a debt subordination. While the words “and the debt secured thereby” contained in the first numbered paragraph of each of the Subordination Agreements might be construed to effect a debt subordination, the remaining provisions of the documents, especially those found in numbered paragraphs two through four, indicate that the Subordination Agreements were intended only to grant to Commonwealth, now RTC, certain rights, including superior rights in the Property, in the event of foreclosure. The admittedly vague language of the Subordination Agreements is no more than a variation of the lien subordination and mortgagee-tenant subordination agreements discussed above; it serves to resolve in the nervous lender’s mind that, in the event of foreclosure, the mortgage will have priority over all other property interests. The Court is cognizant that any property interests which were arguably transferred by Lantana pursuant to the Franchise Agreement and the Management Agreement are tenuous at best and can affect only the relationship between the signatories and Commonwealth, since the Franchise Agreement and the Management Agreement are not documents that normally would be recordable in state real property records. Nevertheless, the Court views the Subordination Agreements as purely precautionary documents that were included in Commonwealth’s loan package. The Subordination Agreements, in their entirety, do not evidence an intention of debt subordination.

Second, the holding that the Subordination Agreements provide for only property interest subordination is more consistent with CLG's history of receiving payments from Lantana. As indicated above, property interest subordinations do not affect the subordinated party’s right to receive payments. Debt subordinations, on the other hand, typically postpone the subordinated party’s right to payments until the senior creditor is fully paid, unless payments are permitted under the provisions of the agreement. There are no provisions in the Subordination Agreements for permitted payments to CLG, yet such payments have been made. Interpreting the Subordination Agreements as only property interest sub-ordinations best comports with this fact.

Finally, the Subordination Agreements were executed in a context atypical of debt subordinations. As previously discussed, lenders, when making commercial loans to corporate or partnership borrowers, often require the subordination of all obligations the borrower may have to insiders, such as officers, directors, stockholders, partners or venturers. Commercial lenders require such debt subordination to prevent their commercial loans from being used to repay insider debt. Here, although CLG is now an affiliate of the Debtor’s general partner, the payments due CLG under the Franchise Agreement and the Management Agreement can hardly be considered as being of the nature of dividends, draws, distributions, bonuses or loans- payable — those sort of insider payments typically subordinated to the lender’s rights. Instead, the Debt- or’s obligations to CLG under the Franchise Agreement and the Management Agreement are more in the nature of pay-ables incurred in Lantana’s ordinary course of business for services performed immediately prior to the payment.

V. CONCLUSION

In sum, the language of the Subordination Agreements as well as the nature of the loan and subordination support only one construction of the documents: payments due CLG under the Franchise Agreement and the Management Agreement are not subordinated to payment in full by the Debtor of its obligations to RTC.

Based upon the foregoing, the Court finds that the Subordination Agreements do not subordinate CLG’s right to payment under the Franchise Agreement and the Management Agreement to Lantana’s obligations to RTC. The Debtor and RTC represented to the Court at the hearing that a stipulated cash collateral agreement would soon be submitted. That agreement should reflect this holding.

IT IS SO ORDERED.

APP IDIX

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1 . For a general discussion of subordination agreements in the context of commercial financing, see, Nimmer, Commercial Asset-Based Financing § 8.38 (1990); Rude, Asset Based Financing: A Transactional Guide § 13.01 et seq. (1990).