Real Estate Bankruptcy Law & Pandemic Cases

Real estate bankruptcy has seen recent spikes.

The rising unemployment levels following the outbreak of the COVID-19 pandemic, and the associated implications of the economic downturn, is leading to significantly higher numbers of tenant closures and lease defaults.

Across the real estate industry, bankruptcy filings are rising, and concerns are increasing, particularly amongst landlords.

The coronavirus has caused an undeniably worrying disruption in some sectors of the real estate market leaving lenders concerned about increasing bankruptcy filings by their borrowers. Loans secured directly or indirectly by retail and lodging assets are of particular concern.

The quarantine orders that swept the country earlier this year caused the closure in almost every industry that utilizes real estate to conduct their businesses. This left a huge number of tenants unable to pay their rent, and many of those tenants may never be able to reopen the doors of their businesses.

With increasing numbers of tenants struggling or unable to pay rent, closures and lease defaults are wreaking havoc on landlords, and subsequently, on borrowers. This issue is expected to become even more relevant as government support weakens.

The expected number of medium and small Chapter 11 cases is expected to include a large number of single asset real estate debtors.

Single Asset Real Estate & Real Estate Bankruptcy

The term "single asset real estate" is defined in Title 11 of the U.S. Code, Section 101(51B) to mean

real property constituting a single property or project, other than residential real property with fewer than 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.

However, some aspects of this definition have been litigated, potentially leaving wriggle room for some pandemic cases by preventing them from self-identifying in the single asset real estate category.

How Does This Help Debtors with Real Estate Bankruptcy?

In particular, this helps with the requirement that all the debtor’s gross income must be generated by the real property. A test that uses the active or passive income approach where passive income comes within single asset real estate and active does not, finds that, for example, hotels, golf courses, and marinas are not single asset real estate.

When a debtor is filing for bankruptcy using the official Chapter 11 petition form, they must answer whether or not they are categorized as a single asset real estate. Without such self-identification, a debtor cannot be determined to be in a single asset real estate case without the ruling of a court.

This presents a loophole, as it means that if the debtor cannot self-identify in the single asset real estate category, they do not have to abide by some of the formidable deadlines and hurdles imposed on a single asset real estate debtor. This wrinkle in bankruptcy law means that many of those filing bankruptcies in the wake of the Coronavirus can greatly benefit from not identifying as a single asset real estate.

For example, debtors who are not considered being a single asset real estate case can enjoy the protections of an automatic stay against foreclose (or other actions by creditors) for a longer length of time than those who are considered single asset real estate.

Additionally, if a single asset real estate debtor either has not begun to make payments with interest or filed a plan of reorganization, a secured creditor is entitled to relief from the automatic stay.

To make matters even worse, either one of the above obstacles needs to be accomplished within 90 days from the day that the Chapter 11 petition is filed.

It is easy to see why, if possible, filing as a single asset real estate case can cause difficulties for many debtors, and should be avoided if possible. While it may work to a creditor’s advantage to have their borrower’s case designated as single asset real estate, it does not usually work well in the favor of the borrower themself.

As businesses all over the country struggle following the COVID-19 pandemic, and many of them face the reality of bankruptcy and the inability to reopen their door, this wrinkle in bankruptcy law could create breathing room and be a saving grace for many cases caused by the pandemic.

For legal guidance with real estate bankruptcy law, get in touch with a real estate attorney at Lee Scott Perres, P.C.