United States: Navigating Single-Asset Real Estate Status In Bankruptcy

Among the different policy tensions embedded in the Bankruptcy Code is the balancing act between affording a debtor sufficient time to reorganize versus the impact upon creditors - especially secured lenders - from the delays imposed upon exercising remedies.

While the Bankruptcy Code provides certain protections for a secured creditor for potential impacts of delay - e.g., adequate protection - real estate lenders have a specific remedy in the form of single-asset real estate, or SARE, cases.

To obtain - or conversely from the debtor's vantage point, to be burdened by - these protections, a threshold issue is whether the debtor meets the criteria for being treated as a SARE case.

In Shady Bird Lending LLC v. The Source Hotel LLC (In re: The Source Hotel LLC) in June, the U.S. District Court for the Central District of California adopted the majority view that a non-income-producing property could be a SARE debtor.¹

The district court held that the hotel, which was not yet producing income, nonetheless met the definition of a SARE.²

Relevant Bankruptcy Code Provisions

By way of background, the Bankruptcy Code defines single-asset real estate as

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 thereto.³

Whether a debtor is designated as a SARE is relevant to requests for relief from the automatic stay and the debtor's enhanced burden regarding a proposed plan. Specifically, a SARE designation allows for a quick termination of the automatic stay under Section 362(d)(3) of the Bankruptcy Code.⁴

That subsection provides that after notice and a hearing, the court "shall grant relief from the stay" in the case of a SARE debtor where the moving creditor's claim is secured by an interest in the real estate, unless within 90 days of the filing - or within 30 days of the court making a SARE determination if the designation is contested - the debtor "filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time," or the debtor commenced monthly payments to the secured creditor at the nondefault contract rate of interest.⁵

It is not sufficient for a debtor to file a placeholder plan - as may be done in non-SARE bankruptcy cases. Rather, SARE debtors must file a plan that has a "reasonable possibility of being confirmed within a reasonable time."⁶

Courts have found that the debtor's burden under Section 362(d)(3) is a lesser standard than that required at plan confirmation.⁷

In In re: RYYZ LLC in 2013, the U.S. Bankruptcy Court for the Eastern District of New York stated that it requires the debtor's plan "delineate a credible path to reorganization," and that hurdles to confirmation are more likely than not to be overcome promptly.⁸ While less than a confirmation burden, it nonetheless requires more than merely filing a plan to prevent the loss of exclusivity prior to the applicable deadline.

One of the issues that has come up in a SARE dispute is whether the debtor must be producing income from the real estate to qualify.

Factual Background

Since 2014, The Source Hotel had been developing a hotel and intended to operate the hotel and its related businesses, including a restaurant and bars on the hotel property.⁹

To finance construction, it obtained a $29.5 million loan from Evertrust Bank.¹⁰ In 2019, The Source Hotel stopped construction.¹¹ In December 2020, Shady Bird Lending purchased Evertrust's interests in the loan.¹²

Shady Bird then filed a complaint against The Source Hotel in state court and took steps to foreclose. The state court appointed a receiver to take possession of the hotel and a few days later, The Source Hotel filed for Chapter 11 bankruptcy. In its voluntary petition, it did not designate itself as a SARE debtor.

Shady Bird Lending moved to designate the debtor's bankruptcy case as a SARE. The U.S. Bankruptcy Court for the Central District of California denied the motion and Shady Bird Lending appealed.

On appeal, the district court found that the bankruptcy court had erred in its interpretation of Section 101(51B) and its finding that The Source Hotel did not satisfy the test for a SARE case, and reversed the bankruptcy court's order, remanding for further proceedings.

District Court Opinion

The district court analyzed the second and third elements of the SARE definition - element one was not disputed.

To view the full article click here

Originally published by Law360.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.