Within the Chapter 11 world, a common and powerful type of Chapter 11 reorganization case is the “real estate reorganization” Chapter 11 case. These types of cases are filed by real estate management companies, by individuals who own residential or commercial real estate, by holders of “single asset” real estate projects or properties, or by entities or persons who have ownership interests in real estate. A person or business does not even need to be insolvent in order to file a case. We will discuss here some of the typical features of a real estate reorganization. It is important to note at the outset that every case is different and presents its own issues. Long experience with these types of cases have enabled us to formulate some general principles and outlines.
The major advantages of the real estate Chapter 11 case is that it gives the debtor (whether an individual or a business) the ability to change the terms of the original loans. As a debtor-in-possession, the debtor stays in charge of everything and continues to operate as the business owner. Interest rates, monthly payments, and terms of loans can be (and are) drastically altered to enable the debtor to get relief from onerous mortgage or lease terms. Properties can be sold, liens can be stripped off, and loans can even be “crammed down” to the value of a piece of real estate. Regarding “cramdown”, we can say that this is one of the most powerful features of Chapter 11 practice. It provides that a Chapter 11 plan can be confirmed by a court even when there is an objection or disagreement from one or more creditors.
If a property is “underwater”, a cramdown allows a debtor to modify drastically a mortgage loan under certain conditions. Under Section 506 of the Bankruptcy Code, a lien is secured only to the extent that there is value in the property. If the mortgage exceeds the value, the unsecured portion of the loan is “crammed down” to the value of the collateral. In order for this to happen, certain requirements must be met by the filed Chapter 11 plan and with the voting among the classes of creditors. The plan must also not be unfairly discriminatory against the dissenting class of creditors. Because these requirements are somewhat vague and open to much interpretation, it is important to have an experienced attorney handle a real estate Chapter 11 case.
In a typical real estate Chapter 11 case, the case will be filed at a time when the debtor is already behind or expected to be behind on one or more mortgage payments. When the petition is filed, the debtor normally seeks a court order to use the “cash collateral” of the business. Frequently, rent collected by a debtor will be subject to such a cash collateral order. Within 120 days, a debtor will generally decide whether to assume, assign, or reject any leases or executory contract he or she may have with other parties. It no intention is declared, the lease is assumed to be rejected. Courts can extend the period of time for assumption, assignment, or rejection for an additional period of 90 days, if needed.
A debtor may assign a lease, even if the lease had a term against this, if adequate assurances of future performance are made. There are some additional nuances if the real estate involved is a shopping center. There should be adequate assurances of sources of rent and financial condition of assignee; the percentage of rent due should not decline substantially; and assumption or assignment should not destroy the balanced tenant mix in the shopping center. There are also rent caps on claims against debtors, which limit a landlord’s possible claim for a rejection of a lease.
Within 120 days of the filing of a case, the debtor must file a disclosure statement and plan of reorganization. The disclosure statement contains information about the debtor’s assets, liabilities, and financial projections. It is designed to enable a creditor to know more about the debtor’s overall picture. A plan is also filed, and sent to the creditors along with a voting ballot. If there are enough votes in favor of the plan, and it meets the confirmation requirements of the Code, it will be confirmed. Even if it does not, the court may still confirm the plan over the objections of the creditors.
In a cramdown scenario, a real estate mortgage is restructured where the loan balance is reduced to the fair market value of the collateral, and the interest rate is changed. Cramdowns can occur in three ways: (1) the lien is retained and the creditor receives the amount of the claim, and have a value equal to the allowed secured claim; (2) the debtor sells the encumbered property free and clear of all liens, and the creditor receives in cash the allowed amount of the secured claim; or (3) the lender gets some equivalent of the preceding two claims. In cramdown scenarios, at least one class of impaired creditors must vote in favor of the plan.
In certain situations, it is to a debtor’s advantage to sell some real estate in the Chapter 11 process. This is called a “Section 363” sale. We have written about the details of such sales elsewhere in this blog. The link at the end of this article is one such example. Additionally, you can click here for more information.
The Single Asset Real Estate (SARE) Chapter 11 Case
There is a special type of real estate Chapter 11 case that is meant for single properties or single real estate projects. A “single asset real estate” is defined in 11 U.S.C. §101(51B). It is a single property or project, other than residential real property with fewer than four residential units, which generates substantially all of the gross income of a debtor (who is not a family farmer). In some situations, a debtor will be behind on a real estate loan for business real estate (e.g., investment property, warehouse, developments, office building, etc.). The filing of a SARE case can be a powerful help, as it can strip away any liens that are greater than the property’s fair market value.
With SARE cases, the automatic stay has different parameters than in a regular Chapter 11 real estate case. In a SARE case, a debtor should file a plan of reorganization or begin payments either within 90 days after the filing of the case, or within 30 days from the time the bankruptcy court determines that the debtor is subject to SARE guidelines. If this does not happen, the automatic stay may expire. There are many situations where it is unclear whether a Chapter 11 case is a SARE case. In these situations, it may be of use for a debtor to file a motion seeking a determination on this issue.
Real estate cases are complicated and present special issues. If you are an owner or an investor in real estate, and are seeking relief from financial issues, it is critical to explore what a Chapter 11 real estate case has to offer. You may be surprised to discover just how powerful the Chapter 11 process is in helping you to operate your real estate business as a going concern, and resolve issues with other creditors as well.