362(d)(3): Codification of Extend and Pretend?

Size: px

Start display at page:

Download "362(d)(3): Codification of Extend and Pretend?"

Amice Craig
5 years ago
Views:

1 362(d)(3): Codification of Extend and Pretend? Katharine E. Battaia and Cassandra Ann Sepanik of Thompson & Knight LLP Introduction During the real estate downturn of the late 1980s and early 1990s, commercial real estate owners often filed for bankruptcy protection to coerce the lender into settlement or to bide time as they attempted to refinance their loan. These bankruptcy filings were a method to impede the lender s foreclosure through strategic use of the automatic stay. 1 When the debtor s only asset was a single piece of real property, the lender essentially was left with no choice but to entertain negotiations and, ultimately, suffer great losses. Like the economic atmosphere in the late 1980s, the current credit crisis has dramatically decreased demand for commercial real estate space, with vacancy rates rising and prospects of new occupants limited by the constraints of the job market. In fact, 2010 was the highest default rate among commercial mortgages since By contrast, real estate bankruptcy filings have been limited in the current economic recession. 3 While hindsight may teach something different, there appear to be two overarching explanations for the comparative decrease in real estate bankruptcy filings this downturn. First, on initial financings (or, more typically, refinancings), lenders often try to bankruptcy proof the investment through the use of so called bad boy guarantees that generally make guarantors personally liable when the mortgagor files for bankruptcy. 4 Second, in 1994, Congress added the term "Single Asset Real Estate" ( SARE ) to the Bankruptcy Code, along with a new subsection, 11 U.S.C. 362(d)(3), giving SARE debtors an expedited timeframe in which they must act after filing for bankruptcy protection. 5 In making the amendment, Congress counseled that the new provision should prevent debtors from fil[ing] abusive [c]hapter 11 petitions to stave off creditors when debtors have no hope of reorganizing. 6 While the bad boy guarantees have a palpable consequence, it is far from clear that 362(d)(3) is achieving Congress intended result. This article will focus on case law interpreting 362(d)(3) and opine on whether bankruptcy court interpretations align with the intent of Congress in enacting the provision. Section 362(d)(3) Is Mandatory On Its Face Congress used mandatory language to give 362(d)(3) greater import: On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay [unless] not later than the date that is 90 days after the entry of the order for relief (A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.

2 within a reasonable time; or (B) the debtor has commenced monthly payments to each creditor whose claim is secured by such real estate in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor s interest in the real estate. 7 The expedited timeframe of 362(d)(3) only applies to a debtor whose property qualifies as single asset real estate, which is defined 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. 8 A literal reading of 362(d)(3) provides that the court must lift the stay if a SARE debtor fails to make monthly interest payments and the court finds that the plan filed within 90 days of the petition date is unconfirmable. In spite of this clear language, courts faced with enforcing a consequence as harsh as a lifting of the automatic stay have not applied the language uniformly. Specifically, courts disagree as to whether: (1) granting relief under the section is mandatory or discretionary; and (2) if discretionary, what the court s precise options are in fashioning a remedy different than termination of the stay. Few Reported Decisions; Little Guidance Offered While case law on the issue is still developing, there are courts that have addressed the issue, and the majority of decisions favor the fashioning of a less harsh remedy. For instance, in a 1999 decision out of the Middle District of Tennessee, In re Archway Apartments, the SARE debtors failed to commence making payments to the lender and filed their plans one week after the 362(d)(3) 90 day deadline (and did not formally seek to extend the period). 9 The Archway Apartments court began its analysis by paying lip service to 362(d)(3), stating, relief under 362(d)(3) is mandatory where its provisions are not strictly complied with. 10 Ultimately, however, the court disregarded the provision and denied the secured creditor s request for relief from the automatic stay. 11 The court attempted to justify its holding by implementing a drop dead provision under which the debtors were given a limited timeframe for confirming a plan or the automatic stay would lift without further order of the court. 12 While a drop dead lifting of the stay is some assurance for the secured lender, it does not save the time, expense, or effort needed to go through a confirmation battle. Prior to the advent of 362(d)(3), relief was available via 11 U.S.C 362(d)(1) and (d)(2). Section 362(d)(2) allows for stay relief if the debtor does not have equity in the creditor s collateral and the collateral is not necessary for an effective reorganization. Despite 362(d)(3) s clear language, courts faced with its mandatory terms have opted to apply the 362(d)(2) standard. 13 The 2002 Southern District of New York decision in In re 68 W. 127 St., LLC provides such an example. In that case, the SARE debtor filed a chapter 11 petition on the morning of the day that its only asset, an empty, derelict residential building, was scheduled to be sold at a judicial foreclosure sale. 14 Within 90 days of the petition date, the debtor failed to file a plan or commence payments to the bank. 15 The secured lender, Bank of New York, requested relief from the automatic stay to resume its foreclosure sale in respect of its first mortgage on the building. 16 Although the building had been empty for years and the debtor had no income from or equity in the property, the debtor alleged that it wanted to reorganize through capital infusions from its principals and rehabilitate the building. 17 The court, in considering the bank s motion, acknowledged that the building qualified as single asset real estate. The court declined to strictly apply the

3 362(d)(3) standard, however, finding that the references in 11 U.S.C. 362(d)(3)(A) and 362(d)(2)(B) were similar, if not identical in their references to an effective reorganization and a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time do not require a determination that the Debtor s plan shall be confirmed. 18 The court ultimately denied stay relief, finding that [t]he Debtor has earned the right at least to make the case for confirmation of its plan. 19 The Southern District of New York s opinion mistakenly substitutes a 362(d)(2) analysis for the heightened standard that Congress intended for 362(d)(3). As discussed infra, 362(d)(3) was designed to correct the lengthy delay and corresponding costs associated with SARE bankruptcies. Therefore, 362(d)(3) cannot afford the same flexibility provided by 362(d)(2). While the unwillingness the majority of courts have shown to strictly apply the standard will likely impede a secured creditor s arguments under 362(d)(3), a few bankruptcy courts in North Carolina have taken Congress mandate to heart. For example, in In re Carolina Commons Development Group, LP, the United States Bankruptcy Court for the Eastern District of North Carolina lifted the stay under 362(d)(3) because the SARE debtor failed to make interest payments to the creditor, and the debtor s plan, though timely filed within the 90 day window, had no realistic chance of being confirmed within a reasonable time. 20 The Carolina Commons debtor filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code, after falling more than a year behind on the note for the property. The debtor filed its plan of reorganization exactly 90 days after filing its bankruptcy petition. In arguing against the secured creditors' lift stay motion (brought under 362(d)(3)), the debtor told the court that it would amend its plan in order to make it confirmable. 21 Ultimately, however, the court declined to allow the debtor to amend and held that, in order to meet the requirements of 362(d)(3), the debtor must submit a confirmable plan or commence monthly interest payments within the 90 day period, failing which relief from stay must be granted. 22 Conclusion The perfect storm occurs where the secured lender has no bad boy guarantee (or a principal with no real assets) and the bankruptcy court declines to enforce the provisions of the SARE subsection. In that instance, the debtor maintains control of the asset and the protections of the automatic stay while the creditor is forced to weigh the costs and benefits of staging a full fledged lift stay battle. In other words, the secured lender is placed in a position nearly identical to that of the pre 362(d)(3) secured lender. Secured lenders faced with a SARE debtor should continue to argue for application of the SARE section of the Bankruptcy Code. While the provision is not strictly applied, its requirements push SARE debtors to file plans at an accelerated pace, which, if the secured creditor is ready with its lift stay motion at the expiration of the 90 day period, can at least encourage earlier negotiations. Moreover, if bankruptcy courts are more frequently faced with applying the statute, a stronger body of case law could be developed to help guide the bankruptcy bar. Katharine E. Battaia is an attorney in the Dallas, Texas office of Thompson & Knight LLP. Ms. Battaia represents clients before bankruptcy courts, federal and state trial courts, arbitration panels, and state appellate courts. She focuses her practice on bankruptcy, creditors' rights, and litigation, including representation of banks, indenture trustees, acquirers of assets from bankruptcy estates, and debtors and creditors in chapter 11, 7, and 13 bankruptcy cases in a broad range of contested matters and adversary proceedings. Ms. Battaia has represented creditors in objecting to the adequacy of disclosure statements and confirmation

4 of chapter 11 plans of reorganization and parties involved in preference and fraudulent transfer litigation. She routinely represents investment banks, commercial banks, and other lenders who originate commercial mortgage loans in various litigation, bankruptcy, and insolvency matters involving real estate and CMBS, with particular experience in multi family, retail development, and other income producing properties. Ms. Battaia can be contacted at Cassandra A. Sepanik is an attorney in the Dallas, Texas office of Thompson & Knight LLP. Ms. Sepanik s practice focuses on representing creditors, debtors, and equity holders in complex corporate reorganizations and bankruptcy litigation. Ms. Sepanik has represented creditors in objecting to the adequacy of disclosure statements and confirmation of chapter 11 plans of reorganization and parties involved in preference and fraudulent transfer avoidance actions. In addition, Ms. Sepanik has experience advising on a range of bankruptcy and other insolvency related issues, including lender liability litigation and the implications of seeking bankruptcy relief. Ms. Sepanik can be contacted at Cassandra.Sepanik@tklaw.com. 1 Upon a debtor s filing for bankruptcy, the automatic stay prevents the commencement or continuation of a foreclosure action. See 11 U.S.C Reuters.com, Ilaina Jonas, Commercial Property Troubles U.S. Bank Study, May 24, 2010, property banks idusn (last visited April 27, 2011). 3 The average number of business bankruptcy filings for the period from 1987 through 1994 was 19,788 per year. In contrast, the average number of business bankruptcy filings for the period from 1995 through 2009 was 10, Fiscal Year Bankruptcy Filings by Chapter and District, aspx (last visited April 27, 2011). 4 These provisions have generally been held to be enforceable. See, e.g., Bank of Am., N.A. v. Lightstone Holdings, LLC (In re Extended Stay, Inc.), 418 B.R. 49 (Bankr. S.D.N.Y. 2009) (lender may pursue action against guarantor triggered by borrower s bankruptcy filing.); Blue Hills Office Park LLC v. J.P. Morgan Chase Bank, 477 F. Supp. 2d 366 (D. Mass. 2007) (holding that a borrower s transfer of parts of the mortgage property without the prior consent of the lender violated the nonrecourse carve out guaranty and, thus, the guarantor became liable for the deficiency); Federal Deposit Insurance Corporation v. Prince George Corporation, 58 F.3d 1041 (4th Cir. 1995) (guarantor liable to lender based on the borrower s bankruptcy filing) U.S.C. 362(d)(3). See also In re Heather Apartments L.P., 366 B.R. 45, 47 (Bankr. D. Minn. 2007). 6 Ad Hoc Group of Timber Noteholders v. Pac. Lumber Co. (In re Scotia Pac. Co.), 508 F.3d 214, 223 (5th Cir. 2007); Nationsbank, N.A. v. LDN Corp. (In re LDN Corp.), 191 B.R. 320 (Bankr. E.D. Va. 1996) ( [T]here is no doubt that section 362(d)(3) addresses the concern that debtors with little hope of successfully reorganizing delay the bankruptcy process while secured creditors are left helplessly on the sidelines. ). See also S. Rep. No. 168, 103d Cong., 1st Sess. (1993) ( This amendment will ensure that the automatic stay provision is not abused, while giving the debtor an opportunity to create a workable plan of reorganization. ) (d)(3); see also Ad Hoc Group of Timber Noteholders v. The Pacific Lumber Co. (In re Scotia Pacific), 508 F.3d 214, 225 (5th Cir. 2007) U.S.C. 101(51)(B) B.R. 463, 466 n.5 (Bankr. M.D. Tenn. 1997). While most courts that analyze 362(d)(3) insist that the section has meaning, the majority of them do not apply it as Congress intended. See, e.g., Riggs Bank, N.A. v. Planet 10, L.C. (In re Planet 10, L.C.), 213 B.R. 478, 481 (Bankr. E.D. Va. 1997) (applying 362(d)(3) to chapter 7 but holding that lifting the stay is not mandatory and that the court could fashion a different remedy); In re Kkemko, Inc, 181 B.R. 47, 49 (Bankr. S.D. Ohio 1995) ("[T]he consequence of not meeting [the 362(d)(3)] requirement is that the automatic stay of 362 may be lifted without further ado.") (emphasis added); In re Hope Plantation Group, LLC, 393 B.R. 98 (Bankr. D.S.C. 2007) (acknowledging that a SARE debtor clearly has to expedite its efforts and follow the requirements of the Code and Rules or face the probability of an order granting relief from the stay, but refusing to lift the stay when the hearing would be held more than 90 days after the petition date because the motion was filed prior to the 90 day deadline) B.R. at 465, n.4.

5 11 Id. at Id. (citing In re Kkemko, Inc, 181 B.R. at 49). 13 See, e.g., In re Windwood Heights, Inc., 385 B.R. 832, 837 (Bankr. N.D. W. Va. 2008) (holding that the standard for interpreting 362(d)(3)(A) is nearly identical to the standard for determining, whether or not property is necessary for an effective reorganization in 362(d)(2) and, although the SARE debtor s plan was patently unconfirmable, allowing the debtor additional time to file its plan because the creditor had a substantial equity cushion. ) (quoting In re Deep River Warehouse, Inc., No (Bankr. M.D.N.C. March 14, 2005)); In re 68 W. 127 St., LLC, 285 B.R. 838 (Bankr. S.D.N.Y. 2002) (finding that the standards of 11 U.S.C. 362(d)(2)(B) and 362(d)(3)(A) are similar, if not identical... ) B.R. 838 (Bankr. S.D.N.Y. 2002). 15 In re 68 W. 127 St., LLC, No (S.D.N.Y July 7, 2002). 16 Id. 17 See id. at In re 68 W. 127 St., LLC, 285 B.R. at 842, n Id. at No (Bankr. E.D.N.C. May 17, 2010). See also NationsBank, N.A. v. LDN Corp. (In re LDN Corp.), 191 B.R. 320, 327 (Bankr. E.D. Va. 1996) (lifting the stay when, by the 90th day after the petition date, the SARE debtor failed to commence payments or file a plan). 21 No (Bankr. E.D.N.C. May 17, 2010). 22 Id. (emphasis in original) (citing In re Highway 751 Partners, LLC, No , 2010 BL 9195 (Bankr. E.D.N.C. January 15, 2010); see also No , 2010 BL (February 22, 2010) (although the debtor attempted to cure deficiencies that precluded the court from confirming the first plan it filed, it did so more than 90 days after it declared bankruptcy and, because the case was a single asset real estate case and the debtor had not made monthly payments that adequately protected the bank s interests, 362(d)(3) required the court to grant the bank's motion for relief from the automatic stay)).

UNITED STATES BANKRUPTCY COURT DISTRICT OF NEW MEXICO MEMORANDUM OPINION

UNITED STATES BANKRUPTCY COURT DISTRICT OF NEW MEXICO In re: KACHINA VILLAGE, LLC, Case No. 15-10140-t11 Debtor. MEMORANDUM OPINION Before the Court are a secured creditor s motion to designate its collateral