Great Western Bank v. Sierra Woods Group

Sierra Woods Group (defendant), which owned an apartment complex as its sole asset, filed for reorganization under Chapter 11. It owed $4,098,000 to Bank of America, which held a first deed of trust on the property, and $3,845,124.47 plus $103,124.47 in interest to Great Western Bank (Great Western) (plaintiff), which held a second deed of trust. Sierra Woods’ note to Great Western was fully amortized over 30 years and provided for an adjustable interest rate set at three percent over the Federal Home Loan Bank of San Francisco Eleventh District Cost of Funds Rate. Sierra Woods proposed a reorganization plan under which it would pay Great Western interest only for the first five years, with the rate set at eight percent for the first three years, allowing any excess interest to accrue and be added to principal. After five years, the note balance would amortize over the remaining term. Thus, in effect, the note would provide for negative amortization over the first three years. The bankruptcy court refused to confirm the plan on the grounds that negative amortization was not “fair and equitable” as a matter of law because it could not comport with the terms of 11 U.S.C. § 1129(b)(2)(A)(i). Sierra Woods proposed a new plan under which Great Western would receive interest only during the first five years but at the prevailing note rate. The note would then amortize over a term that was extended by 10 years. The bankruptcy court concluded that the new plan was also insufficient, notwithstanding the lack of negative amortization, because the plan still exposed Great Western to significant risk. The district court affirmed the bankruptcy court’s decision to reject the first plan without addressing the question of whether negative amortization was legally permissible. Rather, the district court concluded that the plan was not “fair and equitable” based on its findings that Sierra Woods had not abided by previous promises to Great Western, the plan required Great Western to make a 100 percent value loan to Sierra Woods, and Great Western was in a more vulnerable position than Bank of America. Sierra Woods appealed the rejection of its first plan.