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The Bankruptcy Appellate Panel for the Sixth Circuit Court of Appeals recently issued an opinion of importance in bankruptcy cases involving commercial real estate as the debtor's only asset, such as a shopping center or office building. In an appeal from an earlier decision handed down by a bankruptcy court in Kentucky, the Court held that a mortgagee of commercial real estate holding an assignment of rents as additional security for the debt was not "adequately protected" by the Chapter 11 debtor's grant of a replacement lien in after-acquired rents to permit the debtor to use those rents to pay post-bankruptcy operating and other expenses where the debtor has no equity in its property. In re Buttermilk Towne Center, LLC, 2010 Bankr. LEXIS 4563 (BAP 6th Cir. 2010).
This decision severely limits the ability of a fully liened debtor to avoid foreclosure of the mortgage and to reorganize its business under Chapter 11 of the Federal Bankruptcy Code.
Background
Commercial real estate financing in its simplest terms involves the lending of funds to a commercial real estate owner secured by a mortgage in that realty and the assignment of rents generated from that property. Most state laws establish procedures whereby the assignee of rents may perfect these assignments and enforce them upon the assignor's default. In the absence of a bankruptcy case of the owner/mortgagor, a mortgagee in a default situation will often foreclose on its mortgage lien and take action to collect the assigned rents directly from tenants.
In the recession of 1989 to 1991, many "single asset real estate" debtors, in order to stave off mortgage foreclosure and collection of assigned rents, commenced Chapter 11 cases to stay those enforcement actions and propose a reorganization plan providing for an extended payout to the mortgagee of the value of its collateral, which was in most instances a number less than the debt. Because most mortgagees were undersecured, the plans would normally provide for some distribution on the mortgagees' unsecured deficiency claims. Many of these plans were confirmed by bankruptcy courts during this time period , which resulted in much pushback by commercial real estate lenders. As a result of their lobbying efforts, Congress amended the Federal Bankruptcy Code in 1994 to require single asset real estate debtors who wished to avoid foreclosure and reorganize under Chapter 11 to do one of the following early in the case: (i) to file a reorganization plan "that has a reasonable possibility of being confirmed within a reasonable time"; or (ii) to begin making monthly payments of interest to mortgagees "at the then applicable nondefault contract rate of interest on the value" of the mortgages' liens.
Because of this statutory amendment and the general prolonged uptick in commercial real estate values after 1994, the previous wave of mortgage loan defaults receded to a trickle and the incidence of Chapter 11 filings of single asset real estate cases virtually disappeared – until now. These cases are once again coming into vogue because of the precipitous drop in commercial real estate values and the general sidelining of commercial mortgage lending after 2008.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
