Single Asset Real Estate Cases: 0 Is Less Than 4 – Or Is It?

In Re Kachina Village, LLC, 538 B.R. 124 (Bankr. D. N.M. 2015)

A creditor sought to have its collateral designated as “single asset real estate” in order to trigger certain special protections relating to the automatic stay. The court’s decision turned on whether the property came within the exclusion for “residential real property fewer than 4 residential units.”

Under Section 362(d)(3) of the Bankruptcy Code, a creditor whose claim is secured by an interest in single asset real estate is entitled to relief from the stay unless:

not later than the date that is 90 days after the entry of the order for relief (or such later date as the court may determine for cause by order entered within that 90-day period) or 30 days after the court determines that the debtor is subject to this paragraph, whichever is later –

(A)    the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time; or

(B)    the debtor has commenced monthly payments …

Under Section 101(51B) “single asset real estate” (SARE) is defined as:

real property [1] constituting a single property or project, other than residential real property with fewer than 4 residential units, [2] which generates substantially all of the gross income of the debtor who is not a family farmer and [3] on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto.

In this case the property was undeveloped land. It was located near a ski lift, and according to the debtor, the property was subject to restrictive covenants that required mixed-use development or multiple residential units. Originally the debtor obtained a conditional use permit allowing for commercial and residential development that included more than 4 residential units.

The original permit expired, and when the debtor reapplied its plan was to build 5 single-family homes, a 3-unit townhouse and a commercial building. Although the permit had not yet been granted, the debtor anticipated that it would be and intended to construct both residential and commercial buildings.

The bankruptcy court noted that the SARE provisions were added as part of the Bankruptcy Reform Act of 1994 in order to address perceived abuses by debtors that filed bankruptcy in an attempt to delay foreclosure even though it was unlikely that they could reorganize successfully. The debtor did not dispute that (1) the property was a single project, (2) that generated substantially all of its income, and (3) there was no business being conducted on the property other than the business of operating it.

However, the debtor claimed that the property came within the exclusion for residential property involving less than 4 units. After all, there were no units located on the property – which was less than 4 units.

The court did not agree. As a preliminary matter, it was not clear to the court that undeveloped land qualified as residential property. The most natural reading was that the exclusion referred to property zoned for residential development that was already improved with houses, condos, apartments, etc. The court did not believe that a developer with 100 residential lots should be able to avoid the SARE provisions just because it had not started construction. It also noted that this was consistent with case law that generally holds that raw land constitutes SARE.

Even if undeveloped land could come within the residential exception, the court found that it would not be appropriate in this case. If the property consisted of 3 lots that were strictly zoned for residential development and the debtor intended to build 1 to 3 houses, perhaps it could be argued that the exclusion applied. However, in this case zoning allowed commercial development, the debtor’s intention was to build 4 or more residential units and a commercial unit, and the restrictive covenants required mixed-use or multiple residences.

Consequently, the court found that the residential exclusion did not apply and the debtor was required to either start monthly interest-only payments or file a confirmable plan of reorganization.

Note that (1) the Bankruptcy Code specifically allows the debtor to use rents from the property to make the monthly interest payments, and (2) the payments are to be equal to “interest at the then applicable nondefault contract rate of interest on the value of the creditor’s interest in the real estate” – i.e. (1) the debtor is not required to obtain consent of the creditor even though the rents constitute cash collateral, and (2) if the creditor is underwater, interest is calculated based on the value of the collateral as opposed to the entire amount of the debt.

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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