It is hard to go an entire day without hearing or reading new stories about the “subprime” lending crisis or efforts to stem the escalating number of foreclosures. The situation is grim for both consumers and lenders. However, beyond the consumer-based issues, commercial real estate is also being affected. Developers are unable to finance ongoing and previously approved projects and lenders are less willing to enter into loan extensions, resulting in the foreclosures of more and more projects. These cases often end up in bankruptcy court in order to make one last attempt for a favorable resolution. This article provides a brief overview of the specialized “single asset real estate” bankruptcy case (“SARE”) and suggested strategies for both creditors and debtors.
Example of a SARE Case
- The Bank holds a first deed of trust securing a $4.5 million obligation, a “hard asset” lender (the “Second Lien Holder”) has a second at $3.8 million, and there is a third at $3.4 million (held by a related entity to the Developer) on a San Mateo County residential development of high-end homes recently appraised at $28 million. The Developer defaults on the Second Lien Holder’s obligation and a forbearance arrangement is entered into. The Developer is unable to overcome the lack of cash flow and soon the Bank begins foreclosure proceedings (apparently never willing to enter into any forbearance). The Second Lien Holder, believing that the project is valuable and worth preserving, reinstates the Bank’s obligation by making a payment of approximately $550,000. The Developer defaults again and the Second Lien Holder proceeds to foreclosure sale, which is stayed when the Developer owner files a Chapter 11 case on the eve of the sale. When the Developer is unable to secure a buyer or a joint-venture partner for the project, the Second Lien Holder seeks relief from the stay after the 90-day deadline expires, as permitted by the Bankruptcy Code. The Second Lien Holder is granted relief from the stay, forecloses and becomes the owner of the project only to discover that the appraisal was fraudulent (which could be in itself the subject for another article) and the project is actually worth less than the amount owed to the Bank. The Bank later refuses to refinance and forecloses on the project, wiping out the Second Lien Holder’s equity.
This situation illustrates the special provisions contained in the Bankruptcy Code for SARE cases. Those provisions provide powerful tools to lenders to quickly dispose of bankruptcy cases which its borrowers file in an attempt to gain additional time to complete a sale, refinancing or a joint venture with respect to its real property. 11 U.S.C. § 101(51B) defines a SARE case as one in which the property of the estate consists of: “Real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.”
A debtor that files a SARE case as a Chapter 11 is able to proceed as an otherwise typical debtor-in-possession under Chapter 11, with one significant exception. Section 362(d)(3) provides a secured creditor with expedited relief from the stay 90 days after the petition is filed if the debtor fails to either file a plan of reorganization that has a reasonable possibility to be confirmed or does not begin making monthly interest payments on the secured creditor’s obligation.
Thus, unless the debtor is able to secure its secured creditors’ confidence to forbear, the secured creditor will proceed to foreclose on its real property collateral 90 days after filing of the petition, unless the debtor complies with the requirements of Section 362(d)(3). Even though the debtor may attempt to secure an extension of the 90-day deadline “for cause”, the bankruptcy court will likely be reluctant to delay giving relief from the stay without a substantial showing by the debtor.
Strategies for the SARE Parties
If there is any question concerning whether or not the SARE provisions apply, the secured creditor should proceed to file a motion in the bankruptcy court for a finding that the debtor’s case is a SARE case. The secured creditor should then be prepared to enforce the 90-day deadline if the debtor is unable to file a confirmable plan or make adequate protection payments. Assuming that the Notice of Sale has already been recorded, the secured creditor can simply continue the sale for a period of 90 days and time its relief from stay motion to allow for the continued foreclosure sale. And if the debtor seeks an extension of the 90-day deadline, the secured creditor should oppose the request and insist that if the court is willing to extend the deadline that at a minimum the debtor should be required to make some type of interim adequate protection payment for delaying the resolution of the case.
On the other hand, if the debtor finds itself in this type of case, if possible, the debtor should not concede that it is controlled by the SARE provisions. See, 1 Bovitz, Personal and Small Business Bankruptcy Practice in California, Section 9.16, p. 482 [what is and what is not a single asset real estate case is unclear in the reported cases]. Otherwise, the debtor obviously will be under tremendous pressure to quickly reach a resolution with the secured creditor regarding the real property collateral. If the secured creditor’s own appraisal indicates that the real property collateral is substantially less the current amount of the outstanding obligation, and market conditions are uncertain, it might be easier for the parties to reach a resolution. It then may be possible to seek the dismissal of the bankruptcy case and the debtor allowed to continue to develop the project. Short of that, the debtor will need to be ready to provide adequate protection payments or proceed to file a plan of reorganization. That plan might also provide for the “cram down” on the secured creditor’s reduced real property collateral, i.e., a forced modification of the loan obligation.
Given current market conditions in Northern California, it is expected that more and more developers will be forced to resort to the bankruptcy court but find themselves faced with compliance of the strict SARE requirements. Proper planning and decisive action will be necessary to be successful for either the secured creditor or debtor in these type of bankruptcy cases and/or workouts.