The Bottom Line:
An important part of structuring real estate transactions relates to maintaining the separate nature of special-purpose real estate entities. In part, this is done to best assure that, in any potential bankruptcy filing, the secured creditors’ rights would be subject to certain provisions of the Bankruptcy Code affecting single asset real estate (“SARE”) debtors. Notably, these provisions put SAREs onto a fast-track in bankruptcy and do not allow the debtors to remain in bankruptcy without debt service or prospects of a confirmable Chapter 11 plan. In this context, determining who is a SARE debtor can be key. Recently, in Meruelo Maddux Properties-760 S. Hill Street, LLC v. Bank of America, N.A. (In re Meruelo Maddux Properties), 667 F.3d 1072 (9th Cir. 2012) (“MMPI”), the Ninth Circuit Court of Appeals affirmed that there is no “whole business enterprise” exception to the SARE provisions of the Bankruptcy Code (11 U.S.C. §§ 101(51B), 362(d)(3)). In this case, the debtors argue that the court should look at the entire integrated operation of the debtor and its affiliates to determine if the SARE provisions – which focus on income being generated from ownership of the real estate – are implicated. The Ninth Circuit, focusing on the plain language of the Code, held that the Debtor did, in fact, meet the requirements for SARE treatment. The Court rejected the debtor’s reliance upon its participation as part of a “whole business enterprise.”
MMPI is a firm comprised of approximately fifty subsidiary companies (one of which is MMP Hill), which own and develop real property in California. See id. at 1074-75. MMPI has a centralized management team that operates MMP Hill and its subsidiaries. MMPI operated on a consolidated basis (i.e., revenues from all subsidiaries are swept into a single operating account each day). MMPI also filed consolidated financial reports with the SEC and consolidated tax returns with the IRS. Id. MMP Hill owned a 92-unit apartment complex known as the “Union Lofts.” Id. In 2006, to renovate Union Lofts, MMP Hill obtained a $28.72 million loan from Bank of America and granted a security interest in the real estate. Id.
In March 2009, MMPI and its subsidiaries, including MMP Hill (the “Debtors”) each filed chapter 11 and were jointly administered for procedural purposes only. Id. MMP Hill filed a motion in the Bankruptcy Court for a ruling as to whether it was a covered by the SARE provisions of the Code. Id. Bank of America opposed the motion. Section 101(51B) of the Bankruptcy Code defines “SARE” as real property that has the following characteristics: (i) single property or project, other than residential real property with fewer than four units; (ii) the owner (that is not a family farmer) generates all of his/her gross income from the property; and (iii) no substantial other business is conducted on the property other than the operation of the property and related activities to such operation. See 11 U.S.C. § 101(51B). The Bankruptcy Court found that the SARE provisions did not apply to MPP Hill because of the “consolidated, interrelated nature of the companies and the business operations” of the Debtors, id. at 1074, and for that reason applied an un-codified “whole business enterprise” exception to the SARE provisions.
Bank of America appealed the Bankruptcy Court’s decision finding that MMP Hill was not a SARE. Id. The District Court reversed the Bankruptcy Court, finding that under the plain language of the Bankruptcy Code SARE provisions, MMP Hill qualified as a SARE entity, and that no such “whole business enterprise” exists in the Bankruptcy Code. Id. The District Court decision was appealed by MMP Hill and the Ninth Circuit affirmed the District Court decision. Id.
While the appeals were pending, competing plans of reorganization were proposed which covered MMPI and all of its subsidiaries. Id. at 1075. In June 2011, the Bankruptcy Court confirmed one of the plans. MMPI’s former managers were removed from their positions at MMPI and appealed the confirmation order. Id. The Bankruptcy Court denied the motion to stay the confirmation order pending appeal, and the plan of reorganization became effective in July 2011. Id. The automatic stay was lifted on plan confirmation. Id.
Dispute Not Moot: “Capable of Repetition, Yet Evading Review”
As a preliminary matter, the Ninth Circuit considered whether the dispute was mooted by plan confirmation. Id. at 1075. The purpose of a SARE determination under 11 U.S.C. § 101(51B) is to allow a party to obtain relief from the automatic stay under 11 U.S.C. § 362(d). However, in this case, the automatic stay was lifted after the Bankruptcy Court determined that the Debtor did not qualify as an SARE and confirmed the plan of reorganization. See 667 F.3d at 1075. This left no stay in place from which the Court could grant relief, raising a question of mootness. Id. The Ninth Circuit concluded that the case was not moot because “it is capable of repetition yet evading review.” Id. at 1075 (citing Meyer v. Grant, 486 U.S. 414, 417 n.2 (1988)). The Court noted that bankruptcy is a situation where pending appeals may not be resolved by the time a plan is confirmed and that in this situation Bank of America continued to be a secured creditor. See 667 F.3d at 1075. It was possible that MMP Hill could be in a situation where the plan confirmation was overturned or the Debtors could again file for bankruptcy. Id. Therefore, the Ninth Circuit determined that the SARE determination should be adjudicated to avoid the waste of judicial resources and the potential re-litigation of the issue. See id.
The Plain Language of the Bankruptcy Code’s SARE Provisions
The Ninth Circuit looked to the plain language of the statute to determine whether MMP Hill is a SARE debtor because if plain language is present, the Court must enforce according to the terms of the statutory provision. See id. at 1076 (citing Int’l Ass’n of Machinists & Aerospace Workers v. BF Goodrich Aerostructures Grp., 387 F.3d 1046, 1051 (9th Cir. 2004)). Applying the elements of the definition of SARE set forth in section 101(51B), the Ninth Circuit found that Union Lofts met the requirements because it was single property, that is the source of all of MMP Hill’s gross income collection of rent, and collection of rents and operation of the property are the only business activities of MMP Hill. See id. The Court noted that the result might have been different if MMP Hill received income from MMPI or other subsidiaries, or if the entities were substantively consolidated, but that was not the case. Importantly, a consolidated management team and cash management system was insufficient. See id. at 1075-76.
While MMP Hill contended that it was part of a complex financial and organizational enterprise, the Ninth Circuit focused upon the plain language of the SARE provisions and noted that if Congress had intended to incorporate a “whole business enterprise” exception, the legislators would have expressly done so. See id. at 1077.
Why the Case is Interesting:
It is not unusual for businesses to be structured with specific real property holding companies and separate operating entities. There may often be a centralized management and cash management system in place. Each real property owning debtor may be viewed, pragmatically, as part of an overall business. However, if the businesses file for bankruptcy protection, each case – absent substantive consolidation – is a separate “estate”. To the extent that a specific debtor individually meets the SARE requirements, MMPI authorizes the application of the SARE provisions of the Code – irrespective of the individual debtor’s overall place in the “whole business enterprise”. This could require those SARE debtors to service prepetition secured claims during the case or, importantly, proceed on a more expedited basis to propose a confirmable plan. MMPI requires careful planning for debtors and creditors on the costs and timing of a bankruptcy case for the specific real estate entity, and cautions against an assumption that the specific entity can be lumped together with the other debtors.