Ravenswood Apartments, Ltd.

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF OHIO
WESTERN DIVISION
In Re
RAVENSWOOD APARTMENTS, LTD.
Debtor
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James F. O’Brien, Trustee
Claimant
vs.
Ravenswood Apartments, LTD.
Objector
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Case No. 04-15832
Chapter 11
Judge Burton Perlman
DECISION ON DAMAGES
This Chapter 11 case has to do with certain real property
This document has been electronically entered in the records of the United
States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
Dated: January 03, 2006
____________________________________________________________
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consisting of several residential apartment buildings bearing
the name Ravenswood Apartments (hereafter “the property”).
James F. O’Brien, trustee, sold the property to debtor in a Land
Installment Contract (“LIC”). O’Brien subsequently financed a
loan with Union Central on the property which provided a
prepayment penalty of $200,000.00. In a prior decision, this
court held that because the LIC was in force for more then five
years before the bankruptcy case was filed, James F. O’Brien,
trustee, was a secured creditor of the debtor. In this decision
we will hereafter refer to James F. O’Brien, trustee, as
“O’Brien”. We note that the creditor intends that Roger S.
Corbley, Glen A. Burns and Carol Burns be included within the
designation “James F. O’Brien trustee”.
Debtor has presented a plan of reorganization in the case,
which came on for hearing on confirmation. Class 3 in the plan
was for “O’Brien Secured Claim”. The plan proposes the
treatment for O’Brien at paragraph 4.3.2 as follows:
4.3.2 Payment as Secured Claim: Subject to the
filing of a proof of claim, O’Brien will be paid the
purchase price for the property as specifically set
forth in the LIC (after giving credit to Debtor for
all amounts paid by Debtor to O’Brien or Union Central
prior to or during this case, including but not
limited to the Union Central Payoff Amount (as
herinafter defined), plus all interest provided for in
the LIC accrued as of the Effective Date, plus late
charges specifically provided for under Section 9 of
the LIC, but NOT including any other amounts,
including but not limited to prepayment penalties
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and/or unearned or future interest accruing after the
Effective Date (the “Purchase Price”). The Purchase
Price shall be paid in full, in cash,
contemporaneously with closing on the Effective Date,
and shall constitute payment in full of all
obligations and amounts due under the LIC.
Simultaneously with the payment of the Purchase Price
and the Union Central Payoff Amount, O’Brien shall
transfer title to the Property to the Debtor free and
clear of all liens, claims, and encumbrances.
Unless O’Brien files a proof of claim within the
time prescribed by the Plan, the Purchase Price will
be the amount of the claim scheduled by the Debtor,
after deducting any payments made to O’Brien or Union
Central Life Insurance Company after the Petition
Date. In connection with the payment of this claim,
Union Central shall provide to Debtor a payoff
statement as of the date of the closing including any
and all amounts owed under its Note and related
mortgage, including but not limited to prepayment
penalties and late fees (the “Union Central Payoff
Amount”). At closing, Debtor shall disburse the Union
Central Payoff Amount directly to Union Central, and
Debtor shall be entitled to a credit against the
Purchase price in an amount equal to the Union Central
Payoff Amount. Upon payment of the Union Central
Payoff Amount, Union Central shall release its
mortgage, liens, claims and/or encumbrances against
the Property and the Assignment of Rents executed by
Debtor.
Payment of the Union Central Payoff Amount shall
not be deemed to act as a consent on the part of
O’Brien to the accuracy of the payoff statement or
the amount set forth therein. Payment of the O’Brien
Claim shall not be deemed a waiver of any claims that
Debtor may have against O’Brien arising out of
O’Brien’s conduct, all of which are specifically
reserved for adjudication on a post-confirmation
basis.
While recognizing that debtor was entitled, because of 11
U.S.C. §1123(b)(5), to modify the rights of O’Brien by providing
for a payoff at confirmation rather than payments over time as
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provided in the LIC, at the hearing, the court denied
confirmation. This court held that O’Brien was entitled to
damages by reason of breach of the provision that the contract
could not be prepaid. The court then set a hearing on the
amount of damages to which o’Brien was entitled.
At the hearing each party presented the testimony of two
experts.
A. O’Brien’s Witnesses
1. Jamal A. Rashed, Ph.D.
O’Brien’s first witness was Jamal A. Rashed, Ph.D, an
economics professor at Xaiver University. Dr. Rashed’s analysis
of O’Brien’s damages was based upon the future stream of cash
flow that by its terms the LIC was to provide for O’Brien. Dr.
Rashed took the future LIC payments and discounted those
payments to present value. In doing this he stated in his
report that he employed an interest rate of 4.25% “derived from
the June 1, 2005 average yield on the benchmark 10 year and 30
year treasury bonds.” Based upon this analysis, Dr. Rashed
testified that a payment of $4,512,914 to O’Brien by the Debtor
would ensure that O’Brien would receive future cash flows from
an investment in treasury bills that would equal the payments
outlined in the LIC.
2. Michael Veneman, CPA
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O’Brien’s second witness was Michael Veneman, a Certified
Public Accountant. In his analysis, Veneman took the net
amount O’Brien would receive under the LIC after taxes if
payments were made for the life of the contract by its terms.
He then used an interest rate of 4.25% to calculate that the
total payments under the contract held a future value in the
year 2020 of $2,727,934. The interest rate was “derived from
the June 1, 2005 average yield on the benchmark 10 year and 30
year treasury bonds.” Veneman then calculated the proceeds that
O’Brien would receive if the LIC was paid in full as of July 1,
2005. By utilizing the same treasury bond interest rate he
calculated that the future value of those proceeds in 2020 would
equal $885,300. Thus, Veneman concluded that the total damages
to O’Brien as a result of an early payoff of the contract was
$1,215,930 which equals the difference between the net future
value of the LIC payments and the future value of an immediate
payoff.
B. Debtor’s Witnesses
The Debtor also relied on two experts to assess the amount
of damages suffered by O’Brien as a result of an early payoff of
the LIC. The first was an expert in real estate investments, and
the second was an expert in financial investments.
1. Barton Weprin
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Weprin is a real estate broker affiliated with Sperry Van
Ness Co. and deals exclusively in commercial real estate
investment property. For the purposes of evaluation, Weprin
assumed O’Brien would receive $1,757,993, an amount O’Brien
could then invest. The Debtor believes this is the amount that
O’Brien would receive as a result of a payoff of the LIC on
confirmation of debtor’s plan. In his report, Weprin looked at
possible investments in comparable properties. Weprin’s
analysis of the financial returns of comparable properties in
Hyde Park are based upon a series of estimates that are provided
by a subscription computer service. Weprin testified that
O’Brien could take the payment received on confirmation and
invest it in property comparable to Ravenswood. If it did this
it would receive a return equivalent to, if not greater than
the current 9% called for in the LIC.
2. Angelo A. DiMarzio, CFA, CPA, CFP
The Debtor’s second witness, DiMarzio is an expert in the
financial field. DiMarzio’s testimony was based entirely upon
possible investments that O’Brien could make in financial
markets over a 15 year time span. That is, DiMarzio’s starting
point was the assumption that O’Brien would receive a lump sum
payoff on confirmation of the plan, as provided in the plan.
O’Brien could then invest that amount. DiMarzio calculated that
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amount, utilizing the numbers provided in Veneman’s Schedule 3,
then adjusting them as shown in DiMarzio’s Table 3, to arrive at
an investable figure of $1,757,993 which would be available to
O’Brien on distribution following confirmation of Debtor’s plan.
In his analysis, DiMarzio believed that based upon the age and
risk tolerance of O’Brien, placing 45% of the amount distributed
in equity investments and 55% in bonds and treasury bills would
be appropriate. He testified that the risk level involved in
the financial investments were similar to the risk O’Brien took
in entering into the LIC with the Debtor. Based upon this asset
allocation, DiMarzio looked at two different models in
attempting to determine the likely rate of return of O’Brien.
After determining the likely rate of return to O’Brien from the
financial investments, DiMarzio then compared the difference in
the returns expected between the LIC and the investments.
The first model DiMarzio utilized to determine the likely
rate of return from an investment in the financial markets is
referred to as the historic audit method. He used this method
to analyze historical returns of investment portfolios over
rolling 15 year periods between 1926 and 2004. He found the
average return over the time period equaled 8.44%, while the
high return for a 15 year period was 13.38% and the low return
was 3.68%. In the second model, known as a simulation approach
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DiMarzio used a computer program to generate random, but
statistically possible returns. The results are accurate to a
99% probability plus or minus three standard deviations. Using
this approach, the average return was 8.23%. The highest return
under the simulation approach was 16.01% and the lowest was
.52%.
DiMarzio then took the numbers from both the historical
audit method and the simulation approach and calculated the
average return which equaled 8.34%. He then subtracted a
management fee of .25% and ended with an average net return of
8.09%. DiMarzio then compared the difference between the
interest that O’Brien would receive between the 9% LIC rate and
the 8.09% average net return estimate. He was of the opinion
that this difference was the measure of the damage to O’Brien.
He found the present value of this difference to be $195,992.00
and this in DiMarzio’s opinion is the damage to O’Brien.
DISCUSSION
As indicated on p. 3 above our task in this decision is to
determine the damages to which O’Brien is entitled. It is
fundamental that in determining that amount we must apply state
law. Unsecured Creditors Committee v. Strobach Real Estate Inc.
(In re Highland Super Stores Inc.) 154 F. 3d 573, 578 (6th Cir.
1998) That court supported its conclusion of the applicability
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of state law by reference to Vanston Bond Holders Protective
Comm. v. Green 329 U.S. 156, 67 S.Ct.237, 91 L.Ed. 162(1946) and
Butner v. United States 440 U.S. 48, 99 S. Ct. 914, 59 L. Ed. 2d
136 (1979).
The law applicable in the State of Ohio regarding damages
for breach of contract is stated at 30 O Jur 3d, Damages Section
18:
Generally, a party injured by a breach of contract is
entitled to their expectation interest, which is the
injured party’s interest in having the benefit of the
bargain by being put in as good a position as that
party would have been in had the contract been
performed. The purpose behind granting a party
contractual “expectation interest” damages is to give
the aggrieved party benefit of its bargain and to put
it in as good a position as performance would have
done. Indeed, the sole purpose of contract damages is
to compensate a nonbreaching party for the losses
suffered as a result of a breach. Generally speaking,
a party whose contract has been breached is not
entitled to more than a party would have been entitled
to had the contract not been breached. The damages
awarded must be the natural and probable consequence
of the breach or those damages that were within the
contemplation of the parties at the time of making the
contract. A party’s recovery is limited to the loss
actually suffered, and a party is not entitled to be
placed in a better position than if the contract had
not been breached.
The starting point in a consideration of damages in this
case is the treatment of O’Brien in debtor’s plan. That
treatment consists of a lump sum payment to O’Brien upon
confirmation of debtor’s plan. That is, debtor has modified the
rights of O’Brien under the LIC by presently giving him a lump
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sum instead of annual payments thru the life of the LIC. The
experts for both parties, and hence, the parties themselves,
have agreed that the way to give O’Brien its “expectation
interest” is to compute a total amount which would give O’Brien
the means to receive what it would have received under the LIC.
The difference between that amount and the plan payment would be
O’Brien’s damages. That is, the parties agree that by this
means the requirements of state law for damages is met. They
disagree, however, in how that total amount should be computed.
This Court holds that DiMarzio’s computation and method is
correct.
In addition, the basis for the rate of return ought to
incorporate the same degree of risk which O’Brien bore in
entering into the LIC. While the LIC gave O’Brien an
expectation interest in an annual income, that expectation
interest was subject to all the risks inherent in any commercial
transaction. Here the damages must be computed to put O’Brien
in as good a position as he would have been in had the LIC been
performed. A proper measure of damages, then, would be the
short fall that would have accrued to O’Brien if that lump sum
paid to him pursuant to the plan were invested, and the expected
return accumulated.
Debtor’s witness, DiMarzio, testified that the risk level
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involved in the financial investments he considered were similar
to the risk experienced by O’Brien in entering into the LIC.
With that in mind, DiMarzio testified as to an appropriate
investment plan for the distributed lump sum based upon the age
and risk tolerance of the individuals comprehended by the term
O’Brien. His opinion was that the risk tolerance in his program
was similar to that which O’Brien accepted entering into the
LIC. DiMarzio then developed an expected rate of return based
upon his assumptions. In conclusion, he arrived at a measure of
damages in the amount of $195,992.00, representing the
difference between what O’Brien would receive following the
program of DiMarzio as against what O’Brien would have obtained
had the LIC been fully performed.
This Court holds that the bases employed by DiMarzio in
reaching his conclusion are valid and that his opinion as to the
damages to which O’Brien is entitled is sound.
In reaching this conclusion, we hold that the opinions of
both of O’Brien’s witnesses, Rashed, and Veneman, must be
rejected. Both utilized in their computations an interest rate
derived from U.S. Treasury Bonds. Such a rate is consistent
only with a totally risk free investment. O’Brien when he
entered into the LIC did not have a risk free investment. And
it is a matter of state law that O’Brien “is not entitled to be
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placed in a better position than if the contract had not been
breached.” This is what the computation employed by Rashed and
Veneman would have given O’Brien, and this would not be allowed
under state law.
In addition Veneman charged the debtor $200,000.00, a
prepayment penalty required to be paid to O’Brien’s mortgager
Union Central when O’Brien refinanced its loan with Union
Central. The debtor’s only liability, however, is for “damages
resulting from the breach that were within the contemplation of
both parties at the time of the making of the contract.” The
Toledo Group, Inc. V Benton Industries Inc. 87 Ohio App. 3d
798,806 (Ct. App. Ohio 6th District, Lucas County). It is
undisputed that the $200,000.00 penalty arose from an agreement
between O’Brien and Union Central entered into well after the
date of the LIC. The prepayment due Union Central does not give
rise to a liability for debtor.
Debtor may present a further amended plan consistent with
this decision.
Copy to:
J. Michael Debbeler, Esq.
Graydon Head & Ritchey, LLP
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1900 Fifth Third Center
511 Walnut Street
Cincinnati, OH 45202
John J. Schmidt, Esq
Dinsmore & Shohl
1900 Chemed Center
255 E. Fifth Street
Cincinnati, OH 45202
Louis Solimine, Esq
Thompson Hine LLP
312 Walnut Street
Cincinnati, OH 45202
Office of the U.S. Trustee
36 E. Seventh Street
Cincinnati, OH 45202
# # #
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