Single-Asset Rule Two Edged in Bankruptcy Law

October 1, 2006

The Bankruptcy Abuse Prevention and Consumer Protection Act (Pub. L. 109-8), which went into effect Oct. 17, 2005, was intended to lessen abuses of bankruptcy statutes by some financially troubled debtors. However, one significant new provision puts added pressure on the owners of single-asset real estate who face credit problems and makes it more difficult for them to prevent the foreclosure of their real estate.

Under Section 101-51B of the Bankruptcy Code, “single-asset real estate” is defined as a single commercial property or project — other than residential real estate with fewer than four units — that’s used for rental purposes and provides all of the income for the owner, as would be the case when the property is owned in the name of a partnership or limited liability company.

To help protect troubled debtors from foreclosure, Section 362 of the Bankruptcy Code contains an automatic stay provision. This provision temporarily prevents litigation to foreclose on a mortgage or other lien against a property owned by a debtor in bankruptcy.

Previously, an automatic stay was generally limited to 90 days after the commencement of a bankruptcy case for owners of a single property valued at $4 million or less. If the property owners who are debtors continued to pay debt service to their secured creditors or proposed a reasonable plan for reorganization, the stay could be extended. Owners of single assets valued at more than $4 million, however, weren’t limited in how long a stay could remain in effect. As a result, property was often tied up for long periods.

With the passage of the 2005 Bankruptcy Code amendments, all single-asset properties, regardless of value, are subject to the 90-day limitation of the automatic stay. This change puts more pressure on an owner of a property in Chapter 11 to find a buyer for the property, work out new financing with the lender, or attract new investors who can provide cash to prevent losing the property to foreclosure.

The amendments do provide some options for extending the 90-day stay. A property owner can extend the stay by filing a plan for reorganization with the bankruptcy court. The plan must have a reasonable chance of being confirmed and must demonstrate how the owner will use an additional 90-day stay to restructure property debt (through refinancing, sale, or infusion of new funds).

An owner may also extend the stay by making payments to secured lenders at the then-applicable rate of interest on the debt. Previously, the debtor had to pay interest on the current market value of the property. In either case, there’s the possibility that the amount of payment or value of the property could be subject to litigation. In addition, if the Bankruptcy Court finds that the bankruptcy filing was part of an ongoing scheme to delay, hinder, or defraud the lender, the stay period may be shortened. Another way a debtor can prevent rapid foreclosure is to have enough cash flow from the asset to pay the debt service to secured lenders.

Because of these new amendments, owners of single-asset real estate who file for Chapter 11 bankruptcy protection must now act quickly to prevent their mortgage lender from proceeding to foreclosure after 90 days.

More real estate Bankruptcy provisions

Other changes relating to real estate in the new amendments to the Bankruptcy Code impose limitations on debtors’ ability to extend the time to assume or reject leases for nonresidential real property, often for years. In the past, these extensions left landlords hanging as to whether the debtors would remain on the premises, reject the leases and return the vacant space, or sell the lease to a third party.

Historically, debtors’ 60-day period to assume or reject leases was routinely extended. Letting debtors keep possession of their leases without having to make a permanent commitment to the landlord or having to pay rent created severe problems for property owners. Retail debtors with many locations were also able to package their leases creatively and sell the leases’ designated rights, which gave the purchasers the right to designate which leases were ultimately assumed or rejected during the extension period.

Under the amendments, debtors now have only 120 days (with one 90-day extension) to either assume or reject a nonresidential lease. As a result, debtors lose substantial flexibility in seeking to recover the upside from selling undermarket leases at close to current rates and profiting from the difference. This shorter period also reduces the value of the lease’s designated rights. On the other hand, commercial landlords will now know sooner whether a debtor tenant will retain the lease or they’ll be able to relet the space at market rent rates.

Michael Brownstein is a senior partner in the restructuring and bankruptcy group of Blank Rome LLP in New York City. He’s practiced for more than 30 years in all facets of insolvency, workouts, and bankruptcy. You can reach him at mbrownstein@BlankRome.com or 212/885-5520.

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