In his 2-part series of articles on "speed bumps" in the road to hotel bankruptcies Bob talks about an issue that hotels, resorts, marinas, sports facilities and other hospitality-related assets will likely present to many lenders seeking to use the expedited relief from bankruptcy stay provisions available to creditors in certain "single asset" bankruptcy cases.
Hotel loans are more complex and challenging.
Making hotel mortgage loans and dealing with troubled hotel loans is always more complex than with other real estate assets.
As Part 1 of this article noted, the new wave of bankruptcies will test loan structures and provisions developed since the mid 1990s and never tested before, as with the requirement for unanimous board approval for bankruptcy filing (See Part 1.)
InOne commentator argued, perhaps only half tongue-in-cheek, that every hotel should have a gift shop, if only to avoid single asset real estate status in bankruptcy.
Defaulted hotel mortgage loan bankruptcy speed bumps: Can a hotel ever be a "single asset" for bankruptcy purposes? And who cares?
Since the mid 1990s, lenders on hotels, resorts and other hospitality properties have generally required their borrowers to transfer the asset being financed into a "special purpose" entity which will own only the asset being mortgaged. Intuitively, a corporation with only one asset would seem to be a "single asset" entity, but does that work under the Bankruptcy Code, and why is it important to lenders and borrowers?
This determination has important consequences. If a bankruptcy involves a "single asset" (or "single asset real estate" as it is often called), the proceedings will tilt greatly in favor of the secured creditor. In a single asset real estate bankruptcy, the creditor will be entitled to relief from the bankruptcy stay as a matter of law, unless the debtor does one of two things within 90 days of filing.
The debtor must either: - file a plan of reorganization which has a reasonable possibility of being confirmed in a reasonable time, or
- start making interest only payments at the non-default contract rate of interest
- These are often difficult to accomplish unless the asset is really viable and cash flowing.
And if the bankruptcy court finds that the hotel does not involve a single asset real estate bankruptcy, the creditor will likely be delayed in more protracted proceedings and greater costs.
But, why isn't a single hotel a "single asset"? How could a borrower with a single hotel possibly avoid this single asset rule that gives creditors an expedited relief from the bankruptcy stay?
. . . creditors make take hope from a case . . . where a 126-room Comfort Inn was held to be a single asset.
When is a hotel NOT a "single asset"?
The expedited relief from stay provisions are set forth in section 362(d)(3) of the Bankruptcy Code for cases which involve "single asset real estate" or SARE as defined in section 101(51B) of the Code. The idea is that creditors should not be unduly delayed from foreclosing where there is a single real estate asset and therefore minimal chances of a successful bankruptcy reorganization.
The courts generally hold that there are certain requirements for a debtor to qualify as a SARE debtor, as follows:
- The real property must constitute a single property or project
(other than residential property with fewer than four residential units).
- The real property must generate substantially all of the income of the debtor
- The debtor is not a family farmer and is not engaged in any substantial business other than operation of the real propertyand activities incidental thereto.
[a limitation of secured debt to $4 million was eliminated by the Bankruptcy Code amendments in 1994.]
The classic cases for single asset real estate involve a single office building or apartment house passively held for income. Properties involving an operating business, like hotels, are more problematic. Thus, the 9th Circuit Bankruptcy Appellate Panel (or BAP) found that at least a full-service hotel did not qualify as SARE. In the case before it, the Court said that the "hotel is sufficiently active in nature to constitute a business other than the mere operation of property." The gift shop, restaurant and bar, among other things included in the operation of a 63-room full service, constituted other "substantial business" than the operation of real property. (CBJ Dev., Inc., 202 B.R. 472-473).
And another case where the hotel was operated without a gift shop or restaurant, also held that the hotel business itself was more than "the business of operating the real property" and the property was therefore not single asset real estate.
In fact, some courts have declared a wide range of hospitality properties to be non-SARE, including properties involving one of the following:
- a marina
- a golf and ski club
- a property with golf pro shop and golf-related service.
One commentator argued, perhaps only half tongue-in-cheek, that every hotel should have a gift shop, if only to avoid single asset real estate status in bankruptcy.
But creditors make take hope from a case decided in Tennessee where a 126-room Comfort Inn was held to be a single asset.
The classic cases for single asset real estate involve a single office building or apartment house passively held for income. Properties involving an operating business, like hotels, are more problematic.
What does this all mean in terms of debtor or creditor strategy?
As noted above, debtors may open gift shops if only to defeat single asset status. Otherwise, they face relatively short proceedings unless they either present a plan of reorganization within the first 90 days after the bankruptcy filing (or a court-approved extension), or start making payments.
Where it is clear that a case is a single asset case (like an office building or an apartment house), the strategy is for the lender to wait 90 days, and if the debtor has not done one of the required things (i.e. filed a plan of reorganization, or started making interest payments), then the lender would move for relief from stay.
But, when there is doubt about the single asset status -- as there will normally be with hotels, resorts, marinas, and sports facilities -- the lender should normally move quickly to file a motion for the bankruptcy court to determine if it is a single asset case. If you have a hotel, you probably need to make this motion unless there is governing law in the jurisdiction involved.
And if the bankruptcy court finds that the hotel does not involve a single asset real estate bankruptcy, the creditor will likely be delayed in more protracted proceedings and greater costs.
The lender wants a determination of the single asset status early, because if it turns out to be a single asset case, the statute gives the lender relief from the bankruptcy stay the LATER of 90 days after the petition's filing, or 30 days after court determines it is a single asset.
Another strategy that we recommend in appropriate situations is adding a provision to any workout or forbearance agreement. In substance, the lender wants to include a representation or warranty by the debtor that the debtor qualifies for single asset real estate status to be governed under the appropriate provision of the Bankruptcy Code, and acknowledging that the lender is entering into the forbearance agreement in reliance on this representation and undertaking . We don't know if this works yet, but it is worth a try, and a lot of covenants may be enforceable if made in a workout that would not have been valid when the loan was originated.
Robert Kaplan is a partner in JMBM's Bankruptcy, Insolvency and Restructurings Group and a senior member of the Global Hospitality Group® -- a team of 50 seasoned professionals with more than $50 billion of hotel transactional experience, involving more than 1,000 properties located around the globe. Bob represents lenders, special servicers, hard money lenders, community banks, national banking associations, distressed debt investors, and equity investors, positioning them for the best possible outcome by acting expeditiously to preserve value and increase cash flow. His industry experience and his knowledge of the current capital markets -- where distressed assets often include complex deal structures and securitized loans -- allows him to bring creative and effective strategies to the table. When aggressive litigation is the best strategy, he is a vigorous and effective advocate for his clients. Bob represented the securitized lender in the Chapter 11 bankruptcy case filed by the Clift Hotel in San Francisco, and in the subsequent negotiations and successful sale of the loan to a third party. The lender -- acting by and through GMAC Commercial Mortgage Corporation as special servicer -- was the holder of a $60 million loan secured by a Deed of Trust on the Clift Hotel. He has also served as counsel to JER Robert Company, AMRESCO Management Inc. and Midland Loan Servicer in their capacity as special servicers on troubled hotel loans in CMBS pools.To read more about hotel workouts, go to www.HotelLawBlog.com and select "Workouts" For more information, contact Robert Kaplan at 415.984.9673 or rkaplan@jmbm.com.JMBM's Distressed Assets ExpertiseJMBM's Global Hospitality Group® includes an experienced Distressed Assets Team that mobilizes quickly to address the complex issues surrounding distressed hospitality properties and stalled developments. Whether it is a solution to a lender's troubled loan or the response to a buyer's opportunity, we work quickly to preserve value and increase cash flow.Because hotels are special assets, with operating companies, numerous issues come into play in a workout or bankruptcy scenario. Because we have represented creditors, owners and investors in the hospitality arena for more than two decades, we do not need to "get up to speed" on the special issues. Regardless of where we are in the market cycle, JMBM's Distressed Assets Team is involved, day in and day out, in restructuring and working out deals that go sideways. Our experience -- together with our knowledge of the current capital markets where distressed assets often include complex deal structures and securitized loans -- allows us to bring creative and effective strategies to the table. When aggressive litigation is the best strategy, we are effective, rigorous advocates for our clients' interests. For information about how we can help, contact one of the senior members of the team, below.Jim Butler 310.201.3526 JButler@JMBM.com
Neil Erickson 310.201.3516 NErickson@JMBM.com Robert Kaplan 415.398.9673 RKaplan@JMBM.com Guy Maisnik 310.201.3588 GMaisnik@JMBM.com David Poitras 310.201.3571 DPoitras@JMBM.com Richard Rogan 415.984.9606 RRogan@JMBM.com This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $50 billion of hotel transactions and more than 100 hotel mixed-used deals in the last 5 years alone. Who's your hotel lawyer?