Article Contributed by Christopher Linden
In 1994 Congress enacted various real estate-specific provisions of the Bankruptcy Code. These new provisions were applicable to single asset real estate (commonly referred to as “SARE”) cases, as defined in section 101(51B). As part of the 2005 amendments to the Bankruptcy Code, Congress amended section 101(51B) to remove the language that limited its applicability to cases with total debts of $4 million or less. The legislation was a belated attempt to address the problems that arose in the real estate downturn of the mid-1990s, when many developers turned what essentially were two-party disputes with their lenders into chapter 11 cases, often on the eve of foreclosure. By 2005, however, the commercial and residential real estate markets were booming, and few gave much thought to the new provisions or the amended section 101(51B). Then the 2008 financial crisis hit, and the real estate industry sustained heavy body blows. As developers once again turned to chapter 11, investors and lenders alike took a closer look at the real estate-specific provisions of the Bankruptcy Code, including section 101(51B). Designation as a SARE under section 101(51B) significantly limits a debtor’s ability to avail itself of one of the most protective provisions of the Bankruptcy Code, the automatic stay imposed by section 362. Potential SARE designation should factor heavily into strategies developed by both debtors and lenders faced with a real estate bankruptcy.
A decision by the Bankruptcy Court for the Eastern District of New York, In re JJMM International Corp., No. 11-76540-AST (Bankr. E.D.N.Y. Feb. 15, 2012), provides insight into how courts apply the Bankruptcy Code’s definition of a SARE in the multi-property context. The debtor in JJMM, owned three neighboring parcels, which were leased to two tenants, each of which operated separate businesses on the premises. Interestingly, the debtor’s principal — through two non-debtor entities — owns and controls the two tenant-businesses. The debtor filed for chapter 11 in September of 2011, indicating on the petition that it was not a SARE. Disagreeing with the debtor’s characterization of its business, Asia Bank, which held a first mortgage on the three parcels, filed a motion requesting that the bankruptcy court either grant relief from the automatic stay or designate the debtor as a SARE.
In response to Asia Bank’s motion, the debtor argued that it was a “hybrid asset case” because the debtor’s principal also owned and controlled the two non-debtor tenants, which operate businesses (a restaurant and a preparatory school) on the property leased from the debtor. As such, the debtor argued that it was engaged in “substantial business” other than the leasing and operation of the real estate and therefore fell outside the definition of a SARE contained in section 101(51B) of the Bankruptcy Code. At a hearing on the motion, debtor’s counsel conceded that the real property was debtor’s only asset, the debtor is not engaged in any substantial business other than owning and operating the real estate, and the debtor (as opposed to its principal) does not legally own or control the two tenant businesses.
Although section 101(51B) was added as part of the 1994 amendments to the Bankruptcy Code as part of an effort to limit perceived abuses relating to single asset real estate cases, its $4 million debt limitation restricted its relevance to many real estate projects. Following the 2005 amendments, section 101(51B) now defines a SARE as follows:
Real property consisting of a single property or project, other than residential real property with fewer that 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.
In this case, by its own admission, the debtor satisfied all but one of these requirements: debtor’s property was commercial real property, the debtor derived substantially all of its gross income from leasing the real property, the debtor was not a family farmer and the debtor was not engaged in substantial business other than passively owning and leasing the property. The only remaining question was whether the three adjoining parcels owned by the debtor constituted a “single property or project.”
Although neither party addressed this issue in their respective pleadings, the court took it upon itself to address the issue. The generally accepted test for determining whether a property consisting of multiple parcels constitutes a single project focuses on the debtor’s intent or purpose. The bankruptcy court made clear that the single project analysis has nothing to do with the nature of the businesses operated by the tenants, noting that section 101(51B) focuses entirely on how the debtor treats its property. Applying this rather straightforward test, the court held that the debtor satisfied the strictures of section 101(51B) because it had a common plan for the three contiguous parcels (i.e., own the three properties and lease them to its related businesses).
JJMM reminds us that the “single” in “single asset real estate” is sometimes deceiving; what most business people would characterize as distinct assets, when operated together, can constitute a single asset for purposes of SARE designation.