Acquiring Real Estate From a Bankrupt Seller: Legal Issues Evaluating Acquisition Options and Navigating Complex Bankruptcy Court Procedures

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1 Presenting a live 90 minute webinar with interactive Q&A Acquiring Real Estate From a Bankrupt Seller: Legal Issues Evaluating Acquisition Options and Navigating Complex Bankruptcy Court Procedures TUESDAY, JULY 9, pm Eastern 12pm Central 11am Mountain 10am Pacific Td Today s faculty features: Ken Miller, Shareholder, Gorman & Miller, Santa Monica, Calif. Joseph Bolnick, Of Counsel, Gorman & Miller, Santa Monica, Calif. David K. Gottlieb, National Partner, Crowe Horwath, Los Angeles The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 ACQUIRING REAL ESTATE FROM A BANKRUPT SELLER: LEGAL ISSUES Webinar July 9, 2013 Panelists: Ken Miller Gorman & Miller kmiller@gormanmiller.com Joseph Bolnick Gorman & Miller jbolnick@gormanmiller.com David Gottlieb Crowe Horwath LLP david.gottlieb@crowehorwath.com

6 U.S. CBMS ISSUANCE (in billions) Source: CRE Finance Council 6

7 HYPO: Debtor who has just filed bankruptcy - owns commercial property encumbered by a senior mortgage loan with a balance of $40 million and a junior mortgage loan with a balance of $2.5 million. The Debtor, the Senior Lender and Junior Lender are all unrelated. Your client, an investor, wishes to acquire the Property and learns that the Senior Loan may be for sale. 7

8 Property owner files bankrutpcy. Property is sold at foreclosure to the highest bidder. YES Does Senior obtain relief from the automatic stay? NO NO Is Property included in a Plan of Reorganization? YES YES Do outstanding mortgage balances exceed the expected sale price? NO NO Does Plan call for the sale of the Property? YES Can the Trustee satisfy the requirements for a "free and clear" sale under Section 363(f)? No lien stripping is required. Senior and Junior are paid in full with sale proceeds at closing. Property is NOT sold. Sale is exempt from transfer tax under the Bankruptcy Code so long as the sale occurs after confirmation and "pursuant to the Plan". NO YES Property is sold "free and clear" of the liens. Proceeds are paid first to the lienholders in order of priority with any balance to the estate. Trustee abandons the Property to the debtor subject to the liens. 8

9 Obtaining Relief from the Stay Governed by Section 362(d) of the Code. Typically: Inadequate equity cushion Single asset real estate where debtor fails to either (a) timely file a plan of reorganization having a reasonable possibility of being confirmed within a reasonable time or (b) timely commence monthly payments meeting certain specified criteria Bankruptcy filing is a party of a scheme to defraud creditors 9

10 Foreclosure and Title Insurance Surviving coverage under ALTA Lender s Policy: coverage shall continue in force after acquisition of the Title by an Insured. (Condition 2. ALTA 2006). Coverage is limited to the unpaid loan balance plus interest, foreclosure expenses and protective ti advances. The policy does not cover defects in the foreclosure process. Trustee s s Sale Guarantees, Foreclosure Guarantees and Litigation Guarantees generally provide the name and address of the current owner of record, other lienholders and parties required by law to be notified of a trustee s t sale or named in a judicial foreclosure. They insure the lender and trustee, if applicable, against loss arising from any errors in such information. 10

11 Section 363 Sales Statutory Requirements Section 363(b)(1) of the Bankruptcy Code provides that The trustee, after notice and a hearing, may use, sell or lease property of the estate. Under Section 2002(a)(2) of the Federal Rules of Bankruptcy Procedure, the United States t Trustee and all creditors and indenture trustees must receive at least 21 days notice of a 363 Sale unless the court orders otherwise. The notice must include the time and place of any public sale, the terms and conditions of any private sale and the time fixed for filing objections. Lienholders may credit bid unless the court for good cause orders otherwise. ( 363(k)) ()) Credit bidding gjuniors must include sufficient cash to payoff the senior liens. 11

12 Asset Purchase Agreement with Stalking Horse Break-up fee? Procedures for overbids Allocation of closing costs Purchase Price and required deposit Whether mortgages will be assumed, stripped or paid off. Closing conditions: bankruptcy court approval, title insurance, etc. Free look due diligence period Representations and warranties? 12

13 Time Line: Bankruptcy Court Approval Stalking Horse and Trustee sign Asset Purchase Agreement Hearing on Motion for approval of the Bidding Procedures and any break-up fee Bidders perform due diligence and submit marked up Asset Purchase Agreements Auction Hearing on Motion for approval of the Sale, which may include a Free and Clear Order Closing of the sale to the winning bidder 13

14 Lien Stripping Section 363(f) The trustee may sell property free and clear of any interest in such property of an entity other than the estate, only if - (1) applicable nonbankruptcy law permits sale of such property free and clear of such interest; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest t is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. 14

15 Section 363(m) Protection of Good Faith Purchaser According to the Senate Report on Section 363, this subsection protects good faith purchasers of property sold under this section from a reversal on appeal of the sale authorization, unless the authorization for the sale and the sale itself were stayed pending appeal. The purchaser's knowledge of the appeal is irrelevant to the issue of good faith. A notice of appeal must be filed within 10 days of the date of the entry of the judgment, order or decree appealed from. (Federal Rules of Bankruptcy Procedure, ) 15

16 Clear Channel Case Facts: Senior Lender had a $41 million mortgage that was in default. Borrower filed bankruptcy on the eve of the Senior s foreclosure Sale. Junior Lender had a $2.5 million mortgage. Senior entered into Asset Purchase Agreement as stalking horse buyer and agreed to pay Trustee an $800,000 Carve-Out Payment. When there were no overbids, the Senior credit bid its $41 mortgage. The court approved the sale free and clear of the Junior mortgage. The sold-out Junior received no proceeds; the Trustee received the Carve-Out Payment which it used to pay its fees and those of its professionals. 16

17 The Appeal The Junior appealed without seeking a stay. On appeal, the 9th Circuit BAP held: 1. It affirmed the order allowing the Carve-Out Payment to be made to the Trustee reasoning that the Carve-Out Payment was physically and logically isolated from the Senior s obligation to pay the purchase price of the Property. (Section 506(c) permits payment of reasonable costs of disposing of the property. What about the trustee s fee? Compare SPM Manufacturing Corp v. Stern, 984 F. 2d 1305 (1st Cir. 1992) with In re Goffena, 175 BR 386 (D. Mon. 1994)) 2. Section 363(m) does not apply to the lien stripping order so that reversal of the lien stripping order binds the Buyer even in the absence of astay. 3. Section 363(f)(3) allows lien stripping only when the unpaid balance of the liens is less than the sale price. 4. Remanded to allow the parties to attempt to identity a qualifying proceeding satisfying Section 363(f)(5). (391 B.R. 25 (2008)) 17

18 Judicial Reaction to Clear Channel WIDESPREAD CRITICISM a. Re 363(m) ruling b. Re 363(f)(3) ruling c. Re 363(f)(5) ruling COURTS HAVE GENERALLY DECLINED TO FOLLOW 363(m)HOLDING a. 6 th Circuit In re Nashville Senior Living b. 8 th Circuit U.S. v. Asset Based Res. Grp. c. 9 th Circuit it In re Thorpe Insulation d. EXCEPTION In re Lehigh Coal Senior Lender s foreclosure remains viable as a qualifying proceeding under Section 363(f)(5) to strip junior liens. 18

19 Closing Considerations in 363 Sale Part 1 Prepayment penalties. An over-secured lender is entitled to reasonable fees, costs, or charges provided for under its loan documents. (Section 506(b)) Most cases engage in a state law liquidated damages analysis: is the prepayment penalty a reasonable approximation of Lender s losses? Yield Maintenance Penalties (YMP) are generally approved in the Second Circuit (See, e.g., In re Financial Center Associates, 140 BR 829 (Bankr. E.D.N.Y. 1992); but may be invalidated in other circuits, particularly where projected interest shortfalls are not discounted to present value. (See e.g., In re Kroh Bros., 88 BR 997 (Bankr. W.D. Mo. 1988) and In re Skyler Ridge, 80 BR 500 (Bankr. C.D. Cal. 1987) rejecting YMPs which did not discount to present value). 19

20 Closing Considerations in 363 Sale Part 2 Title Insurance without title affidavits. (Applies also to sales under a plan.) California style closing to eliminate necessity of a GAP Indemnity, if necessary. Transfer tax. Federal exemption does not apply, but state exemption might apply. (E.g., in N.J., no transfer tax on any deed from a trustee in bankruptcy or liquidation (N.J. Stat. 46:15-10(g)) Due Diligence Review. The stalking horse bidder will typically be able to perform a thorough due diligence review; bidders will have a more limited opportunity to perform due diligence due to time constraints and the risk that they fail to win the auction. Closing. Ifany liens are being stripped, then in jurisdictions not g y g pp, j explicitly rejecting Clear Channel, closing should occur after the time to appeal has expired without the filing of an appeal. 20

21 Sale of Real Property Pursuant to a Plan of Reorganization Plan may provide for sale to be either subject to or free of any lien. (Section 1123(a)(5)(D)) Sale is exempt from transfer tax so long as the sale occurs after Plan confirmation and pursuant to the Plan. (Florida Dep t of Rev. v. Piccadilly Cafeterias, Inc., 554 U.S. 33 (2008)) Cramdown plan may not provide for sale of property free and clear of liens without allowing lienholders to credit bid. See RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065, 182 L.Ed.2d 967 (2012). Typically, the sale is conducted without court supervision. Prospective buyers typically are able to perform a relatively thorough due diligence review. 21