As the support provided by government measures during the pandemic begins to weaken, the expected wave of medium and small Chapter 11 cases will undoubtedly include a fair number of single asset real estate debtors.
This will occur even though interest rates will remain at historic lows because vacancy rates and rental rates have been hammered by the confluence of electronic commerce, work-from-home alternatives and pandemic concerns. By far the majority of these debtors, judging from past experience during the Great Recession, will be debtors with assets of a value from $1 million to $10 million and will be concentrated in New York, California and Texas.
Single asset real estate cases are difficult cases from the debtor's perspective. The single asset real estate provisions dating from 1994 arose because of a perception of abuse by debtors and to correct relative unfairness of lengthy delay burdening lenders.
Indeed, one could argue that single asset real estate cases are a type of "bad faith-light" cases where the debtor has few employees, few unsecured creditors, a single encumbered asset, a failed history of attempts at out-of-court restructuring and has filed bankruptcy on the eve of foreclosure to obtain the benefit of the automatic stay.
What is usually missing in a good faith single asset real estate case is the intent by the debtor to frustrate the legitimate efforts of the secured creditor without any possibility of emerging from bankruptcy.
In any event, just as any other Chapter 11 case, a single asset real estate case can be dismissed for bad faith and in this type of case many of the bad factual predicates are obvious and undisputed. That may be why, according to a recent study, the majority of single asset real estate cases end up being dismissed. Therefore, counsel for a prospective single asset real estate debtor should carefully consider the hurdles and deadlines that will need to be overcome to reach a happy conclusion to the case.
What Is Single Asset Real Estate?
The term "single asset real estate" is defined in Title 11 of the U.S. Code, Section 101(51B) to mean
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.
Several of the elements of this definition have been litigated. Perhaps the most analyzed is the requirement that substantially all the debtor's gross income is generated by the real property.
Courts have created a test using the active or passive income approach where passive income comes within single asset real estate and active does not. Using such analytics courts have concluded that, for example, hotels, golf courses, and marinas are not single asset real estates.
Another frequently litigated element of the definition is whether the real property constitutes a single project. The test most commonly used by courts focuses on the debtor and whether the debtor treats the multiple properties as linked under one common business operating plan.
The official Chapter 11 petition form, form 201, used to begin a Chapter 11 case has a question, number 7, regarding the nature of the debtor's business and asks whether the debtor is a single asset real estate.
Without such self-identification, a debtor does not fall in the single asset real estate category absent a court's determination. As discussed below, if the debtor can in good faith not self-identify in the single asset real estate category, it may soften some of the onerous deadlines and hurdles imposed on a single asset real estate debtor.
The Automatic Stay
The principal benefit for a single asset real estate debtor in filing a Chapter 11 case is to get the automatic stay against foreclosure or any other action by the secured creditor. However, unlike other debtors that can enjoy the protections of the automatic stay for many months, single asset real estate debtors have a limited period of stay protection and several high hurdles to preserve that protection.
Under Title 11 of the U.S. Code, Section 362(d)(3), a secured creditor of a single asset real estate debtor is entitled to relief from the automatic stay unless the debtor has either begun making payments with interest at the nondefault rate under the secured creditor's note or has filed a plan of reorganization which has a reasonable possibility of being confirmed within a reasonable period of time.
Either one of these difficult hurdles must be accomplished within the later of 30 days from the court's determination that the debtor is a single asset real estate debtor or 90 days from the filing of the Chapter 11 petition. Failing that, and unless the court extends the 90 days for cause by an order entered within the 90 period, relief will almost certainly be granted.
Since the time limits of Section 362(d)(3) do not begin to run until the later of 90 days from the petition date or 30 days from the court's determination of single asset real estate status, it is in the debtor's interest to delay such a determination as long as possible.
If single asset real estate status is admitted in the petition, then the debtor will have no choice but to start making payments or filing a reasonably confirmable plan within 90 days of commencing the case.
Single asset real estate debtors have sometimes attempted to change their self-designation claiming that they were ill-advised or misinformed. While a debtor may amend its petition and change its designation as permitted by the Federal Rules of Bankruptcy Procedure, the court may regard the initial designation as an admission and may consider it as evidence in its determination. The court may also give such determination retroactive effect to the date of the petition.
If at all possible, single asset real estate self-designation should be avoided. It is not by chance that most single asset real estate cases end up dismissed and not as successful reorganizations or even sales. The diligent secured creditor, on the other hand, should, unless the debtor has self-designated, move as soon as possible for a single asset real estate designation and move that it be retroactive as of the petition date.