Small Landlords Should Consider Bankruptcy Early To Mitigate Risks
Updated: Dec 4, 2022
For more than a year now, many small landlords have been unable to collect rents. Unfortunately, some of these landlords rely on the rental proceeds to make mortgage payments. As a result, many landlords will face foreclosure in the coming months unless some relief package is crafted to compensate them for lost rents or forgive the debt. There’s been no real discussion of such a measure, however, so I anticipate a large number of filings in the coming months. Many of these bankruptcy filings will be classified as Single Asset Real Estate (“SARE”) cases. This classification will make it more challenging for such landlords to get meaningful relief in bankruptcy without significant pre-bankruptcy planning and quick actions once the case is filed.
The Bankruptcy Code defines a SARE case as one where a single property or project, other than a residential real property with fewer than four (4) residential units, generates substantially all of the debtor’s gross income. Additionally, it requires that no substantial business be conducted on the property by the debtor, other than the business of operating the real property. 11 U.S.C. § 101(51B). Multiple parcels that are part of a single project may also be designated SARE. This is a factual determination in the first instance, and the debtor must also elect to be treated as a SARE on the bankruptcy petition. A secured creditor may also file a motion to have the debtor designated a SARE.
As discussed, in addition to being a single property or multiple properties with a single intended use, the property must generate substantially all of the debtor’s gross income. A bus depot that merely provides storage for buses is a SARE, but if that property also operated a repair shop and café that generates significant income it would not be a SARE.
If a chapter 11 debtor is designated as a SARE, it generally only has 90 days to either file a confirmable plan or start making non-default rate interest payments to any creditor with a security interest in the property at issue. 11 U.S.C. § 362(d)(3). This is an abbreviated schedule from that typically allowed chapter 11 debtors to file plans.
Despite the significant impact the SARE designation carries, bankruptcy judges have alarmingly little discretion in working with such debtors to craft real relief. Due to the statute, judges cannot grant extensions of time to SARE debtors, even if the debtor’s difficulties are temporary and likely to resolve or improve significantly within a reasonable period of time. Nor does it matter that the debtor may have significant equity in the property, and thus creditors are largely protected. This is largely antithetical to the overall goal of the Bankruptcy Code that seeks, foremost, to rehabilitate viable businesses.
Many debtors file for bankruptcy when a foreclosure action is imminent, or sometimes on the eve of the foreclosure sale (but note that cases filed in bad faith, such as to frustrate a secured creditor’s ability to enforce its rights, are subject to dismissal. While forced to operate on an attenuated timeline, the automatic stay may provide a SARE sufficient time to obtain new capital, refinance, or perhaps sell the property.
I anticipate that, unfortunately, we will see a significant rise in SARE filings as a result of the pandemic. For more than a year, many landlords have been unable to collect some or all of their rental income. Due to the compressed timeline faced by SARE debtors, it’s important to consider the option of bankruptcy early to put a realistic plan in place to achieve your goals, whether that’s keeping the property by refinancing or getting new capital, or selling it under section 363 of the Bankruptcy Code. If you are a landlord who believes a bankruptcy filing is imminent, be proactive. You need skilled bankruptcy counsel sooner rather than later to protect your investments. Call us at 917.447.4321 for a free consultation.
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