A recent case from the Sixth Circuit Bankruptcy Appellate Panel, In re Buttermilk Towne Center, LLC, 2010 Bankr. LEXIS 4563 (BAP 6th Cir. 2010), appears to have strengthened the undersecured lender’s hand in single asset real estate Chapter 11 cases. An undersecured lender is one whose collateral is worth less than the amount the debtor owes, a common scenario in today’s market. In the Buttermilk case, the Debtor defaulted on its obligation to repurchase bonds whose proceeds had funded a significant, multimillion dollar loan. The Debtor had borrowed the money to develop a commercial center in Crescent Springs, Kentucky. The Debtor leased the center from Crescent Springs, and paid its lease payments with rents generated by subleases with the center’s tenants.
The Debtor filed a single asset real estate Chapter 11 case after defaulting, and sought bankruptcy court authority to use the rents as cash collateral to pay the Debtor’s counsel’s attorney fees. The Debtor offered the lender a replacement lien in the rents (which constituted substantially the Debtor’s sole income source) as adequate protection. The Sixth Circuit Bankruptcy Appellate Panel ruled that the replacement liens did not constitute adequate protection of the lender’s secured claim because there was no equity cushion in the collateral, i.e., the lender was undersecured, and because the lender already had a security interest in the rents. Accordingly, the Debtor was not allowed to use rents to pay professional fees without the lender’s consent.
It seems apparent that the lender’s undersecured status is a key factor in the decision. The single asset real estate debtor cannot reorganize if it cannot use the rents unless the lender consents or the debtor owns unencumbered assets, which is not the case if the secured creditor is undersecured. So a practice pointer from the lender’s standpoint is to be prepared immediately upon the filing of a Chapter 11 case by a single asset debtor to prove through a valuation hearing that the lender is undersecured. If the lender succeeds, it can either cause the case to be dismissed or can use its leverage to obtain highly favorable terms in any attempted reorganization by the debtor. The single asset real estate debtor, on the other hand, needs to realistically evaluate its options upon default. If there is no equity in the property, the debtor’s principals are probably better advised to consider non-bankruptcy alternatives to retaining control of the property.