"Speed bumps" in the road to bankruptcy for hotels and resorts. Part 2

Nov 26, 08 | 1:59 am

By Jim Butler, Hotel Lawyer | Author of www.HotelLawBlog.com

Turnarounds, workouts, receiverships, bankruptcies and deeds in lieu for troubled and defaulted hotel mortgage loans. As the bad news continues from the Global Financial Crisis, and as the recession bites deeper, the hotel industry is starting to feel the pain.

In his 2-part series of articles on "speed bumps" in the road to hotel bankruptcies, my partner, Bob Kaplan, adds some valuable insight to the rich library of resources available here at www.HotelLawBlog.com on troubled hotel mortgage loans.

As Bob Kaplan said last time in Part 1 of his article, the new wave of bankruptcies will test loan structures and provisions developed since the mid 1990s and never tested before, as with the requirement for unanimous board approval for bankruptcy filing (See (Part 1).

In Part 2 of the "speed bump" series (below), Bob talks about an issue that hotels, resorts, marinas, sports facilities and other hospitality-related assets will likely present to many lenders seeking to use the expedited relief from bankruptcy stay provisions available to creditors in certain "single asset" bankruptcy cases.

By Robert B. Kaplan, Hotel Lawyer

Hotel loans are more complex and challenging

Making hotel mortgage loans and dealing with troubled hotel loans is always more complex than with other real estate assets. Some of these issues have been nicely summarized at www.HotelLawBlog.com in a current series of articles on troubled hotel mortgage loans.

As Part 1 of this article noted, the new wave of bankruptcies will test loan structures and provisions developed since the mid 1990s and never tested before, as with the requirement for unanimous board approval for bankruptcy filing (See Part 1.)

In Part 2 of the "speed bump" series (below), we look at an issue that hotels, resorts, marinas, sports facilities and other hospitality-related assets will likely present to many lenders seeking to use the expedited relief from bankruptcy stay provisions available to creditors in certain "single asset" bankruptcy cases.

One commentator argued, perhaps only half tongue-in-cheek, that every hotel should have a gift shop, if only to avoid single asset real estate status in bankruptcy.

Defaulted hotel mortgage loan bankruptcy speed bumps: Can a hotel ever be a "single asset" for bankruptcy purposes? And who cares?

Since the mid 1990s, lenders on hotels, resorts and other hospitality properties have generally required their borrowers to transfer the asset being financed into a "special purpose" entity which will own only the asset being mortgaged. Intuitively, a corporation with only one asset would seem to be a "single asset" entity, but does that work under the Bankruptcy Code, and why is it important to lenders and borrowers?

This determination has important consequences. If a bankruptcy involves a "single asset" (or "single asset real estate" as it is often called), the proceedings will tilt greatly in favor of the secured creditor. In a single asset real estate bankruptcy, the creditor will be entitled to relief from the bankruptcy stay as a matter of law, unless the debtor does one of two things within 90 days of filing.

The debtor must either:

1. file a plan of reorganization which has a reasonable possibility of being confirmed in a reasonable time, or

2. start making interest only payments at the non-default contract rate of interest

These are often difficult to accomplish unless the asset is really viable and cash flowing.

And if the bankruptcy court finds that the hotel does not involve a single asset real estate bankruptcy, the creditor will likely be delayed in more protracted proceedings and greater costs.

But, why isn't a single hotel a "single asset"? How could a borrower with a single hotel possibly avoid this single asset rule that gives creditors an expedited relief from the bankruptcy stay?

. . . creditors make take hope from a case . . . where a 126-room Comfort Inn was held to be a single asset.

When is a hotel NOT a "single asset"?

The expedited relief from stay provisions are set forth in section 362(d)(3) of the Bankruptcy Code for cases which involve "single asset real estate" or SARE as defined in section 101(51B) of the Code. The idea is that creditors should not be unduly delayed from foreclosing where there is a single real estate asset and therefore minimal chances of a successful bankruptcy reorganization.

The courts generally hold that there are certain requirements for a debtor to qualify as a SARE debtor, as follows:

1. The real property must constitute a single property or project (other than residential property with fewer than four residential units).

2. The real property must generate substantially all of the income of the debtor.

3. The debtor is not a family farmer and is not engaged in any substantial business other than operation of the real property and activities incidental thereto.

4. [a limitation of secured debt to $4 million was eliminated by the Bankruptcy Code amendments in 1994.]

The classic cases for single asset real estate involve a single office building or apartment house passively held for income. Properties involving an operating business, like hotels, are more problematic. Thus, the 9th Circuit Bankruptcy Appellate Panel (or BAP) found that at least a full-service hotel did not qualify as SARE. In the case before it, the Court said that the "hotel is sufficiently active in nature to constitute a business other than the mere operation of property." The gift shop, restaurant and bar, among other things included in the operation of a 63-room full service, constituted other "substantial business" than the operation of real property. (CBJ Dev., Inc., 202 B.R. 472-473).

And another case where the hotel was operated without a gift shop or restaurant, also held that the hotel business itself was more than "the business of operating the real property" and the property was therefore not single asset real estate.

In fact, some courts have declared a wide range of hospitality properties to be non-SARE, including properties involving one of the following

• a marina

• a golf and ski club

• a property with golf pro shop and golf-related services

One commentator argued, perhaps only half tongue-in-cheek, that every hotel should have a gift shop, if only to avoid single asset real estate status in bankruptcy.

But creditors make take hope from a case decided in Tennessee where a 126-room Comfort Inn was held to be a single asset.

The classic cases for single asset real estate involve a single office building or apartment house passively held for income. Properties involving an operating business, like hotels, are more problematic

What does this all mean in terms of debtor or creditor strategy?

As noted above, debtors may open gift shops if only to defeat single asset status. Otherwise, they face relatively short proceedings unless they either present a plan of reorganization within the first 90 days after the bankruptcy filing (or a court-approved extension), or start making payments o

Where it is clear that a case is a single asset case (like an office building or an apartment house), the strategy is for the lender to wait 90 days, and if the debtor has not done one of the required things (i.e. filed a plan of reorganization, or started making interest payments), then the lender would move for relief from stay.

But, when there is doubt about the single asset status -- as there will normally be with hotels, resorts, marinas, and sports facilities -- the lender should normally move quickly to file a motion for the bankruptcy court to determine if it is a single asset case. If you have a hotel, you probably need to make this motion unless there is governing law in the jurisdiction involved.

And if the bankruptcy court finds that the hotel does not involve a single asset real estate bankruptcy, the creditor will likely be delayed in more protracted proceedings and greater costs.

The lender wants a determination of the single asset status early, because if it turns out to be a single asset case, the statute gives the lender relief from the bankruptcy stay the LATER of 90 days after the petition's filing, or 30 days after court determines it is a single asset.

Another strategy that we recommend in appropriate situations is adding a provision to any workout or forbearance agreement. In substance, the lender wants to include a representation or warranty by the debtor that the debtor qualifies for single asset real estate status to be governed under the appropriate provision of the Bankruptcy Code, and acknowledging that the lender is entering into the forbearance agreement in reliance on this representation and undertaking . We don't know if this works yet, but it is worth a try, and a lot of covenants may be enforceable if made in a workout that would not have been valid when the loan was originated.


About Robert Kaplan

Robert Kaplan is a partner in JMBM's Bankruptcy, Insolvency and Restructurings Group and a senior member of the Global Hospitality Group® -- a team of 50 seasoned professionals with more than $50 billion of hotel transactional experience, involving more than 1,000 properties located around the globe.

Bob represents lenders, special servicers, hard money lenders, community banks, national banking associations, distressed debt investors, and equity investors, positioning them for the best possible outcome by acting expeditiously to preserve value and increase cash flow. His industry experience and his knowledge of the current capital markets -- where distressed assets often include complex deal structures and securitized loans -- allows him to bring creative and effective strategies to the table. When aggressive litigation is the best strategy, he is a vigorous and effective advocate for his clients.

Bob represented the securitized lender in the Chapter 11 bankruptcy case filed by the Clift Hotel in San Francisco, and in the subsequent negotiations and successful sale of the loan to a third party. The lender -- acting by and through GMAC Commercial Mortgage Corporation as special servicer -- was the holder of a $60 million loan secured by a Deed of Trust on the Clift Hotel. He has also served as counsel to JER Robert Company, AMRESCO Management Inc. and Midland Loan Servicer in their capacity as special servicers on troubled hotel loans in CMBS pools.

To read more about hotel workouts, go to www.HotelLawBlog.com and select "Workouts" For more information, contact Robert Kaplan at 415.984.9673 or rkaplan@jmbm.com.


About the author

This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $50 billion of hotel transactions and more than 100 hotel mixed-used deals in the last 5 years alone. Who's your hotel lawyer?

Our Perspective. We represent developers, owners and lenders. We have helped our clients as business and legal advisors on more than $50 billion of hotel transactions, involving more than 1,000 properties all over the world. For more information, please contact Jim Butler at jbutler@jmbm.com or 310.201.3526.

Jim Butler is one of the top hospitality attorneys in the world. GOOGLE "hotel lawyer" or "hotel mixed-use" or "condo hotel lawyer" and you will see why.

Jim devotes 100% of his practice to hospitality, representing hotel owners, developers and lenders. Jim leads JMBM's Global Hospitality Group® -- a team of 50 seasoned professionals with more than $50 billion of hotel transactional experience, involving more than 1,000 properties located around the globe. In the last 5 years alone, Jim and his team have assisted clients with more than 100 hotel mixed-use projects -- frequently integrated with energizing lifestyle elements.

Jim and his team are more than "just" great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them.

Contact him at jbutler@jmbm.com or 310.201.3526. For his views on current industry issues, visit www.HotelLawBlog.com.