The Chapter 11 SINGLE ASSET REAL ESTATE DEBTOR

Not every entity that owns real estate is a SARE debtor. Even entities that own a single piece of real estate are not necessarily SARE debtors.  In order for a debtor to be classified as a SARE, the following elements must be met:

• The real property must constitute a single property or project
• The real property must generate substantially all of the debtor’s gross income

Both of the above factors are not as straightforward as they may seem.  They are dependent on the specific facts of the debtor’s operations, and both are highly litigated.

Generally, if the debtor owns and operates a single property, this inquiry is straightforward.  If the property is more than 4 units, whether a residential development property, or commercial property, it would presumably qualify.  However, if the multiple parcels of land are involved, the answer is not clear–determining whether the debtor is a SARE it is a fact driven question that may be argued both ways.  Generally, the question will turn on what the debtor’s plans for us of the land are.

In order for debtor to be classified as a SARE, it must generate substantially of its income from the property.  The question is, what is income generated from the property?  Courts have found that income generated from activities separate from the sale or lease of the real property does not constitute income generated from the real property.  Thus, if a debtor generates substantial revenue from business activities that are separate, incidental, or ancillary to the sale or lease of the property, the debtor is not a SARE.

As such, generally excluded from the definition of SARE debtors are hotel owners, golf course owners, and marina owners. Included in the definition are situations where a company owns only a single large office building, leases the property, and derives substantially all of its gross income from leasing the property.

The relevant inquiry into whether the business owner engaged in any substantial business other than the operation of its real property is “whether the nature of the activities are of such materiality, that a reasonable and prudent person would expect to generate substantial revenues from the operation activities – separate and apart from the sale or lease of the underlying real estate.” In re Kara Homes, Inc., 363 B.R. 399, 406 (Bankr. D.N.J. 2007). For example, if entities such as a hotel or country club generate revenue from restaurants or selling merchandise, that revenue would be separate from the owner’s income generated by leasing the real estate. On the other hand, if the owner builds homes or markets the property, these actions are considered incidental to leasing the property rather than separate income.

An “automatic stay” goes into effect as soon as a Chapter 11 case is filed and prevents creditors from taking any collection activity against the business. 11 U.S.C. § 362. However, in a SARE case, the automatic stay terminates either 30 days after the court classifying the case as a SARE case, or 90 days after the bankruptcy filing on the request of a secured creditor. To avoid this the debtor must either file a confirmation plan of reorganization or must begin monthly interest payments to its lenders at the non-default rate.

Generally, a Chapter 11 debtor has the exclusive right to file a plan during the first 120 days of a case, and may obtain extensions, for good cause shown, of up to 18 months.  For a SARE debtor, the time period is limited to just 90 days unless the debtor does one of two things:

• Begins making monthly payments at the nondefault interest rate to secured creditors

OR

• Files a plan that a reasonable chance of being confirmed.

A Chapter 11 case must be filed in good faith.  While not stated specifically in the Bankruptcy Code as being a basis for dismissal or relief from the automatic stay, this is a requirement that most jurisdictions find is implicit.  What constitutes a good faith filing is, not surprisingly, the subject of litigation.

Similarly, whether a plan has a reasonable chance of being confirmed is heavily debated.  A SARE debtor does not need to show that the plan will actually be confirmed, and the standard for surviving a motion for relief from the automatic stay is not the same as that necessary for confirmation of the plan.  Instead, the SARE debtor must show that there is a reasonable probability that the plan can be confirmed within a reasonable period of time.

Chapter 11 generally provides protections and benefits for business owners seeking reorganization. Real estate owners and developers should be mindful that some of the protections of Chapter 11 will be restricted if they fall into the definition of a single asset real estate debtor.