As real estate project lenders continue to decline the extension of maturity dates for their loans to single purpose LLCs in today’s credit-challenged environment, debtors will continue to seek protection under Title 11 of the United States Code. As most sophisticated lenders and borrowers know, however, the protections under a Chapter 11 bankruptcy case are limited if the debtor’s sole asset is the real property collateralizing the loan, and bankruptcy courts are empowered to dismiss the Chapter 11 proceeding very quickly upon motion. This is an important factor that can render the strategic value of a bankruptcy filing problematic, and it can reduce a borrower’s leverage in workout negotiations substantially. To counter this risk of an early dismissal or relief from the automatic stay, borrowers are becoming increasingly aggressive at formulating arguments that the borrower has other assets beyond the real estate. To the extent that these arguments are convincing to the Court, which has wide discretion in deciding the issue, or perhaps more importantly, to the extent the arguments have facial appeal so as to increase the risk that a lender motion will be denied, a full understanding of the parameters of the “Single Asset Real Estate” doctrine is important to both lenders and borrowers.
One of the critical elements is the definition of what it means to have a single real estate asset, and that is located in Bankruptcy Code § 101(51B). Essentially, the “Single Asset Real Estate” (“SARE”) rule, applies if the debtor’s sole asset is real property whose income generates substantially all of its cash flow from operations at the property. The principal battleground is whether there are other assets which can be distinguished from the real property which generate income greater than property operations do. Somewhat obviously, one key to that equation is what constitutes a property operation. The resolution of this issue will determine if the debtor is allowed to reorganized within the typical time limits of a Chapter 11 case, or be required within the next 30-days, to either propose a confirmable plan of reorganization or restart making payments to the secured lender.
Debtors have successfully argued that restaurants, golf courses, hotel cleaning services and adjacent boat marinas, even though owned by the debtor and associated closely with real property operations, are nonetheless assets outside of real property operations, hence removing the debtor’s business from the SARE exception. In the case of In re Scotia Development, LLC, 375 B.R. 764, 778 (Bkrtcy.S.D.Tex.,2007), a company that held timberland and also harvested timber was not a SARE. See also In re Kkemko, 181 B.R. 47, 51 (Bankr. S.D.Ohio 1995) (finding that the operation of a marina does not fall within the purview of § 101(51B), given that the “business of the marina is something more than simply rental of moorings”). See also Centofante v. CBJ Dev., Inc. (In re CBJ Dev., Inc.), 202 B.R. 467, 473 (B.A.P. 9th Cir.1996) (concluding that a full service hotel does not qualify as single asset real estate since the operation of a restaurant, bar, and gift shop constituted significant other business); and In re Kara Homes, Inc., 363 B.R. 399 (Bkrtcy. D.N.J. 2007) (where the court found that businesses other than operating the debtor’s real property e.g. marinas, golf courses and hotels, were not SAREs since these operations generated additional income separate from its real property). Accord: In Re CBJ Development, Inc., 202 B.R. 467 (B.A.P. 9th Cir.1996); and In re CGE Shattuck, LLC, L 33457789, 7-8 (Bkrtcy.D.N.H. 1999) (running a golf course is a substantial business other than the operation of the real property itself); and In re Perry Hollow Management Co., Inc., L 33679447, 1-2 (Bkrtcy.D.N.H. 2000).
Some debtors have been more aggressive in arguing that project completion guarantees from third parties are not property assets, similarly removing the debtor’s business from the SARE exception to the right to continue a Chapter 11 proceeding. Experience teaches that though there is no law on this point, the matter can be heavily influenced by the particular personal orientation of a given bankruptcy judge. Many bankruptcy judges are known, correctly or otherwise, as being creditor-friendly or debtor-friendly, and those with creditor leanings seem increasingly frustrated by deteriorating marketing conditions that result in a lender being unable to foreclose upon and then sell the collateral for its loan. Nonetheless, performance guarantees (as opposed to loan guarantees) may pose a convincing alternative to the single asset model, particularly where a guarantor is an affiliate of the borrower and there is commingling of funds. The commingling of debtor funds with those of other projects owned by the guarantor-affiliate arguably creates a condition either of a constructive trust (legally empowering the debtor to claim rights of repayment from the guarantor’s other assets) or conditions of alter ego liability (legally equating the debtor’s business with all the other businesses of the completion guarantor). It is well established in California that under certain circumstances two or more business entities, though nominally separate, may be treated as one single business entity—that is, alter egos of each other. Upon such a finding, the assets and liabilities of the respective parties become the assets and liabilities of each other. Associated Vendors, Inc. v. Oakland Meat Company (1962) 210 Cal.App.2d 825, 837, with the added consequence that the debtor would not be a SARE. In any case, the debtor should always look for opportunities for an early business solution for restructuring their loans, or be prepared to begin making “adequate protection” payments to the lender. Otherwise the debtor, especially in SARE cases, risks an early adverse outcome in the bankruptcy case, or will be faced with a contested confirmation trial on its proposed plan.
As the real estate market continues to deteriorate, debtors will become increasingly creative and potentially successful in fashioning these anti-SARE arguments and assessing the risks for both sides will become increasingly more challenging. Perhaps, as with most uncertainty, this will enhance the prospects of resolutions to avoid adverse results in court.