Bankruptcy Courts Need Tools to Help Real Estate Debtors

By Kenneth A Rosen

In the aftermath of the COVID-19 pandemic and the ensuing economic turmoil, the real estate industry is facing unprecedented challenges. As retail establishments struggle, hospitality and travel industries remain at a standstill, and the future of office occupancy remains uncertain, the commercial real estate sector is bracing for a wave of restructurings and potential bankruptcies.

Amidst this tumultuous landscape, bankruptcy and restructuring can serve as a lifeline for real estate owners and investors seeking to preserve equity, restructure debt, and emerge stronger from the crisis. However, the current Bankruptcy Code presents unique obstacles for single asset real estate (SARE) debtors, leaving them vulnerable to foreclosure and surrender at the bottom of an inordinately dislocated market.

Understanding the Challenges Faced by SARE Debtors

SARE debtors, those whose portfolios primarily consist of a single property, face significant hurdles under the current Bankruptcy Code. The 1995 amendments to the code favor mortgagees, making it difficult for SARE debtors to seek meaningful refuge in bankruptcy court.

This skewed playing field leaves SARE debtors particularly susceptible to foreclosure and surrender at the bottom of an inordinately dislocated market. The automatic stay, a temporary injunction against creditor actions triggered upon the commencement of a bankruptcy case, often proves ineffective for SARE debtors, leaving them exposed to potential foreclosure proceedings.

Empowering Bankruptcy Courts with Discretion and Creative Tools

Despite their expertise in business and financial matters, bankruptcy courts currently lack the discretion to distinguish between debtors facing genuine economic hardships due to systemic factors and those experiencing mismanagement or other localized issues. This lack of discretion can lead to unfair outcomes, particularly for SARE debtors.

To address this disparity, bankruptcy courts must be granted the authority to modify Section 362(d)(3) of the Bankruptcy Code, allowing for greater flexibility in determining adequate protection for mortgagees and providing SARE debtors with a reasonable opportunity to restructure.

Additionally, courts should utilize Section 105(b) of the code, empowering them to fashion creative equitable relief tailored to the specific circumstances of each case. This could involve requiring SARE debtors to make deferred payments or lifting the automatic stay only if the adequate protection cushion depletes below a certain threshold.

Addressing Lenders' Concerns and Enhancing Market Efficiency

While some argue that lenders should be able to obtain stay relief quickly to monetize their loans, the financial markets offer sufficient liquidity for them to sell their loans. Bankruptcy courts are capable of determining adequate protection for lenders' claims and assessing rates of depreciation and appreciation.

Moreover, the concern that unworthy debtors will abuse bankruptcy proceedings to stall lenders is unfounded. Bankruptcy judges possess the expertise to identify and address instances of bankruptcy abuse.

Conclusion: Embracing Bankruptcy as a Strategic Tool for Real Estate Revival

In the face of the ongoing economic uncertainty, bankruptcy and restructuring should not be viewed as a last resort but rather as a strategic tool for real estate owners and investors to navigate the challenges ahead. By understanding the complexities of the bankruptcy process, seeking legal counsel from bankruptcy experts, and advocating for reforms that address the unique needs of SARE debtors, the real estate industry can emerge stronger and more resilient from this unprecedented crisis.