Bankruptcy For The Real Estate Practitioner

These realities of today’s bankruptcy cases dictate that a business debtor must have resources to avail itself or oneself of the axiomatical protections of bankruptcy. One of those resources is a well-prepared, knowledgeable lawyer to handle the challenges facing a business debtor.

I. Introduction

Real estate is a recurring and pervasive theme in bankruptcy, as is true in most contexts of business law. But in bankruptcy, there are additional important components that require the practitioner to meet the challenges of protecting and advancing a client’s rights, whether a debtor or a creditor. These additional components include crisis management and impending forfeiture, and the loss or severe diminution of in personam or in rem rights. While these components are not necessarily unique to bankruptcy cases, they are much more pronounced and intense in bankruptcy because of the highly “result-oriented” aspects of the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure (that require, among other things, the debtor to be transparent under penalty of perjury) and the practicalities of triage (i.e., the allocation of scarce resources) in bankruptcy.

Moreover, in bankruptcy, all of a debtor’s creditors are organized in one forum. By organizing all of the creditors in one forum, the creditors have the ability to act individually or with a “strength-in-numbers” scenario, acting in concert with the other creditors and additional parties-in-interest, such as the United States Trustee, to advance agendas that might be detrimental to the debtor, and to advocate in support or opposition to the debtor’s actions. Thus, with these foundational imperatives that are often unique to bankruptcy cases, in reality, the “breathing spell” that is a central cornerstone of the protections afforded to a debtor in bankruptcy, with its paired policy of “fresh start” are often more of a myth than a reality for even the “honest debtor” (i.e., a defined term, but not necessarily a well-defined term).

These realities of today’s bankruptcy cases dictate that a business debtor must have resources to avail itself or oneself of the axiomatical protections of bankruptcy. One of those resources is a well-prepared, knowledgeable lawyer to handle the challenges facing a business debtor. While less so for creditor’s counsel, who has less “movable parts” to protect a creditor’s rights than debtor’s counsel, a lawyer representing either a creditor or a debtor in bankruptcy must be well-knowledgeable, and when called upon, act as a skilled litigator and adroit transactional lawyer. On both sides, lawyers need to be “deal makers” – where often the opportunities to make deals in bankruptcy are fleeting — and well-aware that the “fight” must be tempered by the limited resources available to both creditors (seeking affirmation of rights or distributions) and debtors (who are seeking rehabilitation, a fresh start and the ability to fairly balance the retention of assets with the rights of creditors).

But even the less experienced lawyer can find solace that real estate issues in bankruptcy are often, literally, concrete. One of these issues involve landlord-tenant relationships, with the ability to reject (i.e., terminate) an unexpired lease that is burdensome financially, with a debtor-generous cap on liability; or the ability to assume the lease, with the conditions precedent of curing pre-petition defaults within a reasonable amount of time and providing adequate assurance of future performance to the landlord.
Another common real estate issue in bankruptcy, is the attempt of a Chapter 13 debtor to “bifurcate” secured claims on the debtor’s primary residence, into partially secured claims, with the balance of the claim being unsecured. The analysis for ”bifurcation” is tied to value of the collateral, and specifically, whether there is any value to attach to the targeted secured claim. The concept of “bifurcation,” however, works poorly in Chapter 11 real estate reorganizations, where the Seventh Judicial Circuit has rejected it as means of reorganizing commercial real property in a cram-down confirmation.

One darling of the debtor’s bar is the debtor’s ability to remove a judicial lien encumbering the debtor’s principal residence because the judicial lien impairs the homestead exemption of the debtor. As in matters involving “bifurcation” of claims in a Chapter 13, the ability to remove a judicial lien encumbering the debtor’s primary residence is a “numbers game,” where the issue is whether there is any value to attach to the judicial lien. This requires a computation of fair market value of the residence versus the amount of mortgage debt versus the Illinois Homestead Exemption—ending with the question answered, “Is there any value to attach to the judicial lien?”

Another pervasive issue relating to real estate is “single asset” bankruptcy cases, where the sole asset of the debtor is one unit of real estate, like one shopping center or one hotel or one multi-family residential building. Here, the debtor is the owner of fee simple title or the owner of the beneficial interests in the land trust that owns fee simple title in the subject real estate. Typically, in this context, the precipitating events for the filing of the petition to initiate the Chapter 11 bankruptcy case (i.e., to take advantage of the automatic stay) is a foreclosure action, where the debtor is faced with loss of control of the real property by the imminent appointment of a receiver, or a judicial sale is approaching (note: if the judicial sale occurs, in this judicial circuit, the debtor has forfeited the property for bankruptcy purposes, even though the court has not entered an order confirming the judicial sale. Thus, whether in a Chapter 7, Chapter 13 or Chapter 11, the petition must be filed before the judicial sale for the debtor-fee holder to reorganize or assert bankruptcy rights using the subject real property). In a “single asset bankruptcy,” there are strict, time-sensitive requirements for the debtor to achieve a reorganization in a Chapter 11.

Perhaps the most common issues in bankruptcy center on a mortgagee or a non-consensual lien claimant (e.g., mechanic’s lien claimant, judicial lien claimant or tax lien claimant) seeking to modify, annul or vacate the automatic stay mandated by Section 362 of the Bankruptcy Code to enforce the lien claimant’s rights outside of the Bankruptcy Court. For a mortgagee, that typically means seeking an order from the Bankruptcy Court allowing the mortgagee to complete a foreclosure all the way through to confirmation of a judicial sale. For a mechanic’s lien claimant, the reception for adjudicating rights in the Bankruptcy Court is less welcoming: very often the mechanic’s lien claimant is sent back to the state court to adjudicate the extent and priority of lien rights in the subject real property, but the mechanic’s lien claimant is not allowed to proceed to judicial sale or confirmation of a judicial sale (unless the mechanic’s lien is part of a mortgage foreclosure case). Most bankruptcy judges dislike acting as the trier of facts on mechanic’s lien litigation, and correctly perceive that state court judges sitting in mechanic’s lien sections as having much greater expertise, and often greater patience, to adjudicate the fact-intensive construction issues arising in complex mechanic’s lien cases with multiple lien claimants. Thus, many mechanic’s lien claimants have their claims adjudicated in state court, and once adjudicated, they return to the Bankruptcy Court for the administration of their claims based on priorities for distribution set forth in the Bankruptcy Code.

Finally, the cornerstones of real estate reorganizations in a Chapter 11 will be discussed: namely, confirmation of a Chapter 11 Plan and sales pursuant to Section 363 of the Bankruptcy Code. Both topics present procedural and substantive complexities that should be mastered if success is to be achieved.

Download Complete Article