Property Interests / Subordination: Plan Ahead, Or You May Be Stuck Behind

Scotiabank De Puerto Rico v. Brito (In re Plaza Resort at Palmas), 469 B.R. 398 (B.A.P. 1st Cir. 2012) –

In Plaza Resort at Palmas the timeshare owners asserted claims as secured creditors with liens on the resort that were senior to Scotiabank De Puerto Rico (holder of a first mortgage securing acquisition funding for the resort), while Scotiabank sought a declaratory ruling that their claims were general unsecured claims. The result turned on state law, which in turn was driven by the language used in the timeshare documents.

As background, Puerto Rico enacted the Timeshare Act and Vacation Club Act in recognition of the critical role that tourism plays.  The Act provides various protections to owners of timeshare interests, including a requirement that a “lienholder’s right, lien or encumbrance … shall not adversely affect, and shall be subordinate to, the rights of any owners of timeshares …” and that a lienholder “[s]hall hold title to such property subject to the rights of the owners of accommodations, timeshares or vacation club rights therein …”  Further, as a condition of encumbering a timeshare resort, developers are required to obtain a subordination agreement that provides that as long as a timeshare owner is in good standing, the lienholder “will honor all rights of such owner relating to the subject accommodation or facility as granted by the timeshare or vacation club documents.”

Scotiabank argued that the accommodation required by the Act was a subordination of its mortgage to the rights of the timeshare owners to use and occupy the resort, which was more in the nature of a non-disturbance agreement than the creation of a senior real property interest.  The distinction was critical because the debtor’s plan of reorganization was based on converting the timeshare resort into a hotel, which as a practical matter would cut off all rights to occupy and use the timeshare facilities.

In determining whether the timeshare owners had a real property interest, the court looked to state law.  In this case, the court agreed that there was an intent to transfer a real property interest.  Throughout the timeshare documents, the acquired interest was described as an “ownership” interest.  The purchase agreement provided for a sale free and clear of all encumbrances except taxes and assessments.  Title to the timeshare interests was transferred in perpetuity, which the court distinguished from a contractual right to use a vacation facility for a specified number of years.

In support of its argument that the required subordination was the equivalent of a non-disturbance agreement, Scotiabank cited another case in which the bankruptcy court concluded that the timeshare interests were not an interest in real property and the mortgagee’s agreement was limited to giving the timeshare purchasers a right to use the facility.  However, the court found that this case was inapplicable since the timeshare contracts included language stating “you understand that you will not have any interest in the properties or operations of the resort or any of its rooms or other facilities, or in the revenues therefrom, except the right to reserve and occupy accommodations and use certain facilities under the terms and conditions contained in this Agreement.”  Consequently, the court confirmed the status of the timeshare interests as real property interests that had priority over Scotiabank’s mortgage.

Points worth noting in this case are that (1) under the Bankruptcy Code there are a number of circumstances where the courts are required to look to state law to determine property interests, and (2) documentation often matters – even in bankruptcy.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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