12/14/2015. Bankruptcy: What Every Real Estate Lawyer Should Know. Types of Cases. Purposes of United States Bankruptcy Code

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1 Bankruptcy: What Every Real Estate Lawyer Should Know PBI 19 th Annual Real Estate Institute December 11, 2015 Presented by Andrew J. Flame, Esq. and Joseph N. Argentina, Jr., Esq. Purposes of United States Bankruptcy Code > Maintain the Status Quo. > Avoid Race to the Courthouse. > Prevent piecemeal disassembling of debtor. > Ultimate Goal Maximize Return to All Creditors. Permit the Debtor and creditors to propose, discuss and approve a plan for restructuring (Chapter 11 Plan) under Court supervision, or Permit orderly liquidation of Debtor s assets and distribution of proceeds in priority set by Federal and State law. Federal Bankruptcy Andrew J. Flame December 2015 Page 2 Types of Cases > Chapter 7 Liquidation Corporate/ Individual. > Chapter 9 Municipality Reorganization. > Chapter 11 Corporate Reorganization. > Chapter 12 Farmer/Fisherman Reorganization. > Chapter 13 Individual Reorganization. > Chapter 15 Cross-Border Cases. Federal Bankruptcy Andrew J. Flame December 2015 Page 3 1

2 > Chapter 7 Trustee. Typical Players Collect/liquidate Property of the Estate and Distribute to Creditors. Investigate Financial Affairs of the Debtor. Avoid Unperfected Security Interests. Pursue Litigation. > US Trustee. Federal Watchdog. Standing to appear on almost all matters. Monitor procedural requirements. > Parties-In-Interest - Bankruptcy Code allows any party-in-interest to appear and be heard in a case. Federal Bankruptcy Andrew J. Flame December 2015 Page 4 Typical Players > Debtor-in-Possession (chapter 11 only). Continue to operate business in the ordinary course. Exception: Fraud/gross mismanagement appointment of a Trustee. Fiduciary duty to maximize estate for creditors. > Secured Creditor (bank/lender). Holds lien on debtor s assets. Bank with lien in all debtor assets. Lender on specific debtor asset (i.e. vehicle, piece of equipment). > Creditors Committee (chapter 11 only). Investigate the acts, conduct, assets, liability and financial condition of the Debtor and the operation of its business. Negotiate and participate in the formation of a plan. Federal Bankruptcy Andrew J. Flame December 2015 Page 5 What Happens When Petition is Filed? An Estate is created > All debtor s legal and equitable interests become property of bankruptcy estate. > Property is protected by the automatic stay. > Property of bankruptcy estate only includes debtor s interest in property. Automatic Stay > Purpose is maintain status quo. > Prohibits attempts to collect. > Stays litigation against the Debtor. > Prohibits termination or exercise of other rights under contracts, leases and loan documents. > Prohibits acts effecting property of the Debtor. > Violating stay compensatory and punitive damages. Federal Bankruptcy Andrew J. Flame December 2015 Page 6 2

3 Relief from the Automatic Stay > Court can terminate or modify the automatic stay. > Requires notice and a hearing. > Relief in two circumstances: (1) for cause, including the lack of adequate protection of an interest in property of such party in interest; (2) with respect to a stay of an act against property of the debtor, If (A) the debtor does not have an equity in such property; and (B) such property is not necessary to an effective reorganization. 11 U.S.C. 362(d). Federal Bankruptcy Andrew J. Flame December 2015 Page 7 Single Asset Real Estate Cases Additional Special Rules for Stay Relief > Definition: 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. 11 U.S.C. 101(51B). > Single Project requires the properties be linked together in some fashion in a common plan or scheme involving their use. The mere fact of common ownership, or even a common border, will not suffice. See, e.g., In re Alvion Props., 2015 Bankr. LEXIS 3142, *9 (Bankr. S.D. Ill. Sept. 17, 2015). > Consequences: stay relief may be granted unless (A) Debtor has filed a plan within 90 days that has a reasonable possibility of being confirmed within a reasonable time, or (B) Debtor has commenced making interest payments at non-default rate to creditors secured in the property. Source of payments may be rents from the property. 11 U.S.C. 362(d)(3). Federal Bankruptcy Andrew J. Flame December 2015 Page 8 Debts and the Petition Date Pre-Petition Debts Frozen as of Petition Date Not paid during case Restructured and paid under Plan Proof of claim process Post-Petition Debts Kept current during case Ordinary course obligations Administrative expenses Post-petition DIP financing Typically motion practice required if not paid Federal Bankruptcy Andrew J. Flame December 2015 Page 9 3

4 Types of Claims & Payment Priority > Secured Claims - Paid first from proceeds/value of collateral. > Administrative Expense Claims paid during the case or pursuant to chapter 11 plan unless claimant agrees otherwise. > Priority Claims Paid before unsecured claims. > Unsecured Claims. Federal Bankruptcy Andrew J. Flame December 2015 Page 10 Proofs of Claim > Filing Proof of Claim preserves right to share in any distribution. > BAR DATE: deadline to file proof of claim (similar to statute of limitations), standard for late filed claims is excusable neglect ). > Submission to Bankruptcy Court jurisdiction and waiver of right to jury trial with respect to resolution of the claim. See Stern v. Marshall, 131 S. Ct. 2594, 2617 (2011). > Claimant retains right to jury with respect to claims not necessarily resolved as part of claim resolution process. See Desmond v. Ng, 2015 U.S. Dist. LEXIS , *12 (D. Mass. Oct. 8, 2015). > Claims objection process. Federal Bankruptcy Andrew J. Flame December 2015 Page 11 Leases and Executory Contracts > Executory Contracts = material performance by debtor and non-debtor remain unperformed. > With respect to leases and executory contracts, the Debtor in bankruptcy can: reject the contract (a court-approved breach); or assume (affirm) its obligations. > If the Debtor assumes a lease or executory contract, it can then: continue to perform, or assign the lease/executory contract to a third party. Federal Bankruptcy Andrew J. Flame December 2015 Page 12 4

5 Leases and Executory Contracts > Timing (11 U.S.C. 365(d)): Chapter 7: deemed rejected if not assumed within 60 days. Chapter 11: Generally may be assumed any time prior to confirmation of plan. Commercial lease deemed rejected if not assumed within shorter of 120 days or date a plan is confirmed. Debtor may for cause seek a one-time 90 day extension of 120 day period. Additional extensions require landlord consent. > Court can shorten deadline for assumption or rejection. > Proposed reform: debtor must assume or reject commercial lease within one year of petition date. See Final Report, American Bankruptcy Institute Commission to Study the Reform of Chapter 11 ( ABI Commission Report ). Federal Bankruptcy Andrew J. Flame December 2015 Page 13 Leases and Executory Contracts > Pending the Debtor s decision to assume or reject a commercial lease, the debtor (or trustee) must timely perform all of its obligations. 11 U.S.C. 365(d)(3). > Result: commercial lease payments and related charges for post-petition period are granted administrative priority status and must be paid. > Courts disagree on whether charges incurred prepetition but which become due post-petition are entitled to administrative priority. Third Circuit Court of Appeals has held that such charges are entitled to administrative expense priority status. CenterPoint Properties v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 268 F.3d 205, (3d Cir. 2001). > Proposed reform: rent under commercial lease for post-petition period should be calculated by accrual method (some courts currently use duedate method). See ABI Commission Report. Federal Bankruptcy Andrew J. Flame December 2015 Page 14 Assumption General Rules > Debtor may assume an executory contract that is in default (with exceptions) if it (11 U.S.C. 365(b)): 1. cures (or shows it will promptly cure) defaults, including payment defaults; 2. compensates (or shows it will promptly compensate) for actual pecuniary loss resulting from a default; and 3. provides adequate assurance of future performance. > Ipso Facto provisions (termination/modification based on filing of bankruptcy or insolvency) unenforceable (11 U.S.C. 365(e)). > Debtor cannot cherry pick provisions of contract unless parts are severable (i.e. master lease with multiple schedules each with term and rental amounts). > Upon assumption, contract becomes a post-bankruptcy obligation. Federal Bankruptcy Andrew J. Flame December 2015 Page 15 5

6 Assignment General Rules > Upon assumption, Debtor may assign the contract to a third party if adequate assurance of future performance showing that assignee has ability to satisfy the lessee s monetary and non-monetary obligations. > Ipso facto clauses - provisions prohibiting, restricting, or conditioning assignment generally not enforceable. 11 U.S.C. 365(f)(1). Federal Bankruptcy Andrew J. Flame December 2015 Page 16 Assumption and Assignment Adequate Assurance of Future Performance > Term given a practical, pragmatic construction based upon the circumstances of each case. > Debtor must show that performance is more likely than not. > Based on a variety of factors, including the debtor s or assignee s (a) willingness and ability to fund cure payments, (b) general ability to fulfill financial obligations under the lease, (c) expected profitability by demonstrated reductions in operating costs, payroll, and inventory and increases in sales, as well as any plan provisions earmarking money exclusively for the landlord, (d) financial resources, (e) business experience, and (f) pattern or history of fulfilling obligations. > Absolute guarantee of performance such as a letter of credit is not required. Federal Bankruptcy Andrew J. Flame December 2015 Page 17 Shopping Center Leases Special Rules > Tenant-debtor in shopping center has additional hurdles to show adequate assurance of future performance. Must show: (a) source of future rent and that the assignee, if any, and any of its guarantors are in a similar financial condition as that of the debtor and its guarantor at the time of lease execution, (b) that any percentage rents under the lease will not substantially decline, (c) that assumption or assignment of the lease is subject to all lease provisions, including use, radius, and exclusivity provisions, and will not breach such provisions contained in any other lease, financing agreement or master agreements related to the shopping center, and (d) that the shopping center s tenant mix or balance will not be disrupted. 11 U.S.C. 365(b)(3). Federal Bankruptcy Andrew J. Flame December 2015 Page 18 6

7 Shopping Center Leases > Criteria in determining whether a group of stores is a shopping center : Combination of leases. Joint advertising. All leases held by single landlord. All tenants engaged in the commercial retail distribution of goods. The presence of a common parking area. The purposeful development of the area as a shopping center. The existence of a master lease. The existence of fixed hours during which all the stores are open. Contractual interdependence of the tenants evidenced by restrictive use provisions in their leases. The existence of percentage rent provisions. Right of tenants to terminate if the anchor tenant terminates. Joint participation in trash removal and other maintenance. Existence of a tenant mix. Contiguity of the stores. In re Joshua Slocum, Ltd., 922 F.2d 1081 (3d Cir. Pa. 1990). Federal Bankruptcy Andrew J. Flame December 2015 Page 19 Rejection General Rules > Rejection ends both parties obligations going forward. > Breach, but not a termination. > Rejection Damages Claim = General unsecured claim for Debtor s fictitious breach of executory contract or unexpired lease on eve of bankruptcy. Federal Bankruptcy Andrew J. Flame December 2015 Page 20 Rejection Lease Issues > Commercial landlord s Rejection Damages Claim capped at the following amount (11 U.S.C. 502(b)(6)): (1) The sum of prepetition unpaid rent, PLUS (2) the greater of (A) One year of rent, starting from the earlier of the petition date or surrender/repossession date; OR (B) 15% of rent for remaining term, not to exceed three years rent. > Rent is defined under applicable state law (i.e. include or exclude CAM, tax reimbursement and other charges in excess of base rent?). > Proposed reform: Rent would include all periodic, recurring payments. See ABI Commission Report. Federal Bankruptcy Andrew J. Flame December 2015 Page 21 7

8 Rejection Lease Issues > Courts disagree on whether cap applies to damages such as failure to maintain property, remove equipment, or perform similar duties. District of Delaware has held that the cap applies to these damages. In re Foamex Int l, Inc., 368 B.R. 383, 393 (Bankr. D. Del. 2007). Other courts have held that the cap does not apply to these categories of damages. See In re Bob s Sea Ray Boats, Inc., 143 B.R. 229 (Bankr. D. N.D. 1992); In re Best Prods. Co., 220 B.R. 673, 679 (Bankr. E.D. Va. 1998). Federal Bankruptcy Andrew J. Flame December 2015 Page 22 Rejection Lease Issues > Landlord s duty to mitigate does not affect the 502(b)(6) cap. > Proposed reforms (see ABI Commission Report): Landlord should make reasonable efforts to mitigate damages if the trustee or debtor-in-possession reject the lease under Section 365. Landlord s obligation to mitigate damages should continue through the claims objection deadline or the date of the order allowing the claim, whichever is earlier. Federal Bankruptcy Andrew J. Flame December 2015 Page 23 Rejection and Security Deposits Cash vs. Letters of Credit > Claim may be further reduced by security deposit held by the landlord and letters of credit in the landlord s favor. > Cash security deposits will reduce the claim. > Generally, letters of credit will also reduce the claim. See Solow v. PPI Enters.(U.S.) (In re PPI Enters.(U.S.)), 324 F.3d 197 (3d Cir. Del. 2003). > However, at least one court has held that a landlord may draw a letter of credit in excess of the amount landlord would have received in the bankruptcy case, provided landlord has not actually filed a claim. EOP-Colonnade of Dallas Ltd. P'ship v. Faulkner (In re Stonebridge Techs., Inc.), 430 F.3d 260 (5th Cir. Tex. 2005). Federal Bankruptcy Andrew J. Flame December 2015 Page 24 8

9 Rejection Lease Issues > Assumption and later rejection of a lease gives rise to an administrative expense claim for breach. Landlord s administrative damage claim is limited to two years of debtor s financial obligations under the lease. 11 U.S.C. 503(b)(7). > For this reason, Debtors are loathe to assume leases before required to do so under the Bankruptcy Code. Federal Bankruptcy Andrew J. Flame December 2015 Page 25 Tenant s Rights When Debtor Is Landlord > If debtor landlord rejects a lease, the tenant may either: (1) Treat the lease as terminated, or (2) If the term has commenced, retain its rights under the lease, including staying in possession of the property during existing lease term and renewal terms. > Landlord need merely provide possession of premises to tenant. > If tenant elects to stay in possession, (1) Tenant must continue to pay rent and perform under lease, but (2) Tenant may offset from rent payments costs to cover services no longer provided by debtor landlord. 11 U.S.C. 365(h). Federal Bankruptcy Andrew J. Flame December 2015 Page 26 Tenant Risks in Section 363 Sales > Debtor can sell some or substantially all of its property during case. > Sale can be and typically is free and clear of all liens, claims, encumbrances and interests. > Purchaser typically obtains benefit of injunction. Federal Bankruptcy Andrew J. Flame December 2015 Page 27 9

10 Tenant Risks in Section 363 Sales > Courts disagree on whether a 363 sale divests tenants of 365(h) possessory rights under a lease. Some courts have held that a debtor may sell property free and clear of a lessee s 365(h) post-rejection possessory rights. See Precision Industries Inc. v. Qualitech Steel SBQ LLC, 327 F.3d 537 (7th Cir. 2003) (tenants lose rights under 365(h) after 363 sale). Other courts have held that a debtor may not sell property free and clear of a lessee s 365(h) possessory rights. See IDEA Boardwalk LLC v. Revel Entertainment Group LLC (In re Revel AC), 2015 Bankr. LEXIS 2090 (Bankr. D.N.J. June 24, 2015) (tenants retain possessory rights under 365(h) after 363 sale). Federal Bankruptcy Andrew J. Flame December 2015 Page 28 Chapter 11 Plan > Debtor exclusive period to file Plan and solicit acceptances. 120 days from filing date unless extended by the Court. Court may not extend exclusive period beyond 18 months. > Plan will classify similarly situated creditors (i.e. like claims). > Plan will propose treatment of creditors claims and equity interests. > Disclosure Statement to provide adequate information about the plan for voting purposes. Federal Bankruptcy Andrew J. Flame December 2015 Page 29 Chapter 11 Plan (Continued) > Plan must satisfy a number of criteria in order to be "confirmed" by the Bankruptcy Court. Plan must give each creditor at least the equivalent of its distribution in a chapter 7 liquidation. May not unfairly discriminate against similarly situated creditors. Absolute Priority Rule : May not distribute to creditors/interest holders until creditors with senior right to payment are paid in full (unless otherwise agreed). > Plan voting and approval. Each class requires 2/3 in amount, majority in number to accept the plan. Cram down possible if at least one impaired class (nonbankruptcy rights modified by plan) votes to accept. Federal Bankruptcy Andrew J. Flame December 2015 Page 30 10

11 Chapter 11 Discharge > A bankruptcy discharge effectively releases the debtor from personal liability for certain specified types of debts. > The discharge is a permanent injunction prohibiting the creditors of the Debtor from taking any form of collection action on discharged debts, including legal action and communications with the Debtor, such as telephone calls, letters, and personal contacts. Federal Bankruptcy Andrew J. Flame December 2015 Page 31 Avoidance Actions > Adversary Proceeding a lawsuit within the bankruptcy case. Preference (11 U.S.C. 547). Fraudulent Transfer (Bankruptcy Code and/or applicable state laws) (11 U.S.C. 544 & 548). Unauthorized post-petition transfers (11 U.S.C. 549). > Return assets to the estate to be distributed equitably among all creditors. > Designed to remedy preferential treatment of certain creditors and/or unlawful transfer of Debtor s assets. Federal Bankruptcy Andrew J. Flame December 2015 Page 32 Andrew J. Flame, Esq. (215) Joseph N. Argentina, Jr., Esq. (215) One Logan Square, Ste. 2000, Philadelphia, PA CALIFORNIA DELAWARE ILLINOIS NEW JERSEY NEW YORK PENNSYLVANIA WASHINGTON, D.C. WISCONSIN LONDON 2015 Drinker Biddle & Reath LLP All rights reserved. A Delaware limited liability partnership Federal Bankruptcy Andrew J. Flame December 2015 Page 33 11