Bankruptcy Courts Need Tools to Help Real Estate Debtors Lowenstein Sandler LLP

Bloomberg Law – May 3, 2021

It has been quite a year. We are in a unique economic recession due to a pandemic, and we are not done yet. There appears to be a lag between the pandemic and its fully felt impact on real estate.

We’ve seen a retail apocalypse, hospitality and travel have come to a halt, and office occupancy rates have plummeted and we may never be able to get back to the five-day office workweek. These factors have had a negative impact on commercial real estate.

According to Moody’s The vacancy rate in the office sector is forecast to rise to 19.4% this year. Average effective office rents are not expected to reach pre-pandemic levels until 2026, according to forecasts. In addition, apartments in New York are predicted to see an effective drop in rent of 6.4% this year, compounding their decline of 12.2% last year. The physical retail sector has so far been the sector most affected by the pandemic and the resulting surge in online sales. Moody’s predicts that the shopping center vacancy rate will peak at 12.7% this year, up from 10.5% at the end of 2020.

The Federal Reserve recently warned sharp drops in commercial real estate prices. He said commercial real estate prices “appear susceptible to sharp declines” from historically high levels and that this could especially prove to be the case if the pandemic causes demand to drop in the longer term. .

We are on the verge of seeing billions (perhaps billions) of dollars in real estate go through several years of restructuring. In anticipation of the flood of pandemic-forced real estate bankruptcies, bankruptcy courts should be a place where worthy debtors who are forced to restructure due to “macro” or systemic factors that have disrupted real estate fundamentals can. seek relief to preserve equity.

Effectively out of bounds

However, bankruptcy court – the place where reorganization and preservation of value is supposed to take precedence over liquidation – is in fact prohibited for these debtors. As currently drafted, Single Asset Real Estate Debtors (SAREs) cannot seek meaningful refuge in bankruptcy court because in 1995 the Bankruptcy Code was amended in favor of mortgage creditors.

As a result, SAREs are particularly vulnerable to foreclosures and redemptions at the bottom of a disproportionately dislocated market. A SARE is a single property that generates most of a debtor’s gross income.

Savvy investors see the opportunity to leap forward. Private equity firms and hedge funds enter into commitments worth billions of dollars to invest in direct and indirect real estate assets. Owners’ equity is flushed to the bottom of the market due to widespread systemic dislocation.

Requirements for the SARE debtor

The automatic stay, which is triggered at the start of a bankruptcy case, gives the debtor a breath of fresh air from the creditors. It stops all collection efforts, all harassment and all foreclosure actions. To maintain the automatic stay (injunction against continuation of the action), Article 362 (d) (3) of the Bankruptcy Code requires a SARE debtor to either:

  • File a reorganization plan that has a reasonable possibility of being confirmed within a reasonable time; or
  • Start paying monthly interest to the lender at the initial contract rate.

These actions must be brought within 90 days of the entry of the reparation order (or at a later date as the court may determine for cause by order entered within that 90-day period); or 30 days after the court has determined that a debtor is a SARE debtor.

The voting conditions for confirming a reorganization plan also make it impossible to confirm a plan and pay the mortgagee less than the full amount of their claim. In addition, regardless of the cause of the homeowner’s difficulty or the expected time frame for recovery of the value, the Bankruptcy Code requires the debtor to begin repaying the mortgagee’s debt from 90 days after the date of payment. the request.

Bankruptcy courts need discretion

Despite the commercial and financial expertise of the bankruptcy court, it lacks the discretion to distinguish between a debtor who initiates a case due to mismanagement, lack of capital investment, or failure. changes in the local demographics of a debtor who starts a business because of a macroeconomic or systemic breakdown that passes and is likely to end in a recovery of value in “V”.

Additionally, the court cannot take into account the amount of equity or “cushion” that exists above the existing mortgage debt on the property.

In a scenario where the debtor’s mortgage constitutes only 20% of the value of the property, with no other debt attached to the property, if the debtor cannot begin payment within the time period specified under 362 (d) (3) of the Bankruptcy Code, the automatic stay can be lifted, allowing the mortgagee to seize the property. This cannot be the right outcome when there is a large cushion to protect the mortgagee from loss.

Creative Equitable Relief available

Bankruptcy courts must have the necessary tools to enable SAREs to reorganize effectively and preserve fairness where adequate protection exists, either by amending section 362 (d) (3) of the Bankruptcy Code, or by asking the court to use Article 105 (b) to grant SAREs. relief needed.

Bankruptcy courts are more than capable of fashioning a fair and creative remedy, such as requiring the SARE debtor to pay all payments that would have been required under section 362 (d) (3) to be paid on the due date. entry into force of any confirmed plan, and the automatic lifting of the forestay if the adequate protection cushion is exhausted below a certain threshold. This would give the debtor time to find alternative financing or complete the sale of the property in a commercially reasonable manner to maximize value.

The counter-argument is that lenders should be able to timely get paid or get suspended pay in order to quickly monetize their loans. The answer is that the financial markets are liquid enough for them to sell their loans. The court is able to determine adequate protection of the lender’s debt and the rates of depreciation and appreciation.

Economists agree that the current market has temporarily “jumped” lower. If the problem is that outrageous debtors keep lenders at bay for unreasonable periods of time, the answer is that bankruptcy judges are savvy enough to know when bankruptcy abuse is occurring.

Reprinted with permission from the May 3, 2021 issue of Bloomberg Law. © 2021 The Office of National Affairs, Inc. All rights reserved.

About Kristina McManus

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