Says the Ninth Circuit, That Argument Isn’t Going to Get You Out of This Single Asset Real Estate Case

Contributed by Rich Mullen
Debtors can often craft arguments that will enable them to bring their “plans” to fruition.  At times, however, a debtor is left empty handed by a determination in its case that may interfere with its overarching restructuring strategy.   While debtors may advance well-thought-out arguments to support their positions, sometimes those arguments do not carry the day.  Such was the case in In re Meruelo Maddux Properties, No. 10–56128, 2012 WL 248167 (9th Cir. 2012), in which the Ninth Circuit rejected one debtor’s argument that there is a “whole business enterprise” exception to the single asset real estate provisions of the Bankruptcy Code, and affirmed the district court’s holding that those provisions applied to the several sister debtor subsidiaries.
Meruelo involved a parent company and its enterprise of subsidiaries that owned and developed real property in the Los Angeles area.  The parent company had a centralized management team that operated the business enterprise on a consolidated basis — revenues of the parent and each of its subsidiaries were swept into a single operating account used to pay all expenses, and the parent and each of its subsidiaries filed consolidated financial reports and tax returns with the SEC and IRS, respectively.
The parent company and fifty-three of its subsidiaries filed voluntary chapter 11 petitions, and the debtors’ cases were jointly administered but not substantively consolidated by the bankruptcy court.  Various competing plans of reorganization were filed and, ultimately, one was confirmed by the bankruptcy court, going effective one month after confirmation.
Before the plan was confirmed, however, one of the debtor subsidiaries moved for a determination that the cases filed by it and its sister subsidiaries were not single asset real estate cases as defined by section 101(51B) of the Bankruptcy Code, and they were, thus, not subject to section 362(d)(3) of the Bankruptcy Code.  Had section 362(d)(3) applied, the secured creditors of the various sister subsidiaries could be granted relief from the automatic stay unless the debtors filed quickly a plan of reorganization that had a reasonable possibility of being confirmed within a reasonable time or the debtors had commenced monthly payments equal to the interest at the non-default contract rate of interest.
The bankruptcy court concluded that each of the subsidiaries appeared to have the characteristics of a “single asset real estate,” but decided to not apply the single asset real estate provisions of the Bankruptcy Code citing the consolidated, interrelated nature of the business operations of the parent and its subsidiaries.  On appeal by a secured creditor of the movant subsidiary debtor, the district court reversed the bankruptcy court’s decision, holding that each of the subsidiaries should be treated as a single asset real estate debtor because there was no exception for a “whole business enterprise” in the plain language of the Bankruptcy Code.
By the time the issue reached the Ninth Circuit, the debtors’ plan had become effective, and the automatic stay was no longer in effect.  Accordingly, the Ninth Circuit first considered whether the issue was moot given that the purpose of any single asset real estate determination is to allow for relief from the automatic stay if certain conditions are present.  The Ninth Circuit concluded that the issue was not moot because it was highly unlikely that this issue, generally, would ever reach a court of appeals before plan confirmation, and, thus, the parties in Meruelo would find themselves in an identical situation if the confirmed plan were overturned on appeal.
The Ninth Circuit then turned to the heart of the matter, looking to the plain language of section 101(51B) of the Bankruptcy Code to determine if the movant debtor (and also its sister subsidiaries) fell under the definition of “single asset real estate.”  The Ninth Circuit answered this question in the affirmative, determining that the movant debtor owned (i) “a single property” that (ii) “generate[d] all or substantially all” of the movant debtor’s gross income, and (iii) the movant debtor’s “only business activities involve[d] operating and receiving rents” from its single property.  The Ninth Circuit also stated that there was no evidence that the movant debtor received funds as profit from services or labor provided to its parent or sister subsidiaries, or from its investments, that qualified as income allowing for a different outcome.
Perhaps most importantly, the Ninth Circuit held that the plain language of section 101(51B) of the Bankruptcy Code gives no basis for a “whole business enterprise” exception, and that, absent substantive consolidation, the court could not ignore the separate and distinct legal statuses chosen by the parent company and its several subsidiaries.
Meruelo is an important decision.  Many larger real estate enterprises organize their businesses in the manner in which the debtors were organized in Meruelo.  Had the Ninth Circuit come out the other way, the single asset real estate provisions of the Bankruptcy Code would apply only to those smaller business operations that have no parent or affiliated companies.  Instead, Meruelo allows the single asset real estate provisions to reach debtors of all sizes and affiliations, as long as the requirements of section 101(51B) of the Bankruptcy Code are met.  While this may appear to deliver a large blow to many debtors whose businesses are similarly organized, the Ninth Circuit’s ruling does not signify that every large enterprise comprised of smaller single asset real estate properties will be required to file a plan under the timeframe provided in section 362(d)(3) or risk forfeiting the protections of the automatic stay.  Single asset real estate debtors who wish to take longer to develop comprehensive plans for their enterprise can simply begin making the monthly interest payments described by section 362(d)(3).