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      Insolvency News and Analysis - Week Ending October 17, 2014
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    Posts Tagged ‘property’

    A Formula for Confusion

    Monday, January 23rd, 2012
    Inc

    Image by Guudmorning! via Flickr

    Thanks to an active lobby in Congress, commercial landlords have historically enjoyed a number of lease protections under the Bankruptcy Code.  Even so, those same landlords nevertheless face limits on the damages they can assert whenever a tenant elects to reject a commercial lease.

    Section 502(b)(6) limits landlords’ lease rejection claims pursuant to a statutory formula, calculated as “the [non-accelerated] rent reserved by [the] lease . . . for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease . . . .”

    This complicated and somewhat ambiguous language leaves some question as to whether or not the phrase “rent reserved for . . . 15 percent . . . of the remaining term of such lease” is a reference to time or to money:  That is, does the specified 15 percent refer to the “rent reserved?”  Or to the “remaining term?”

    Many courts apply the formula with respect to the “rent reserved.”   See. e.g., In re USinternetworking, Inc., 291 B.R. 378, 380 (Bankr.D.Md.2003) (citing In re Today’s Woman of Florida, Inc., 195 B.R. 506 (Bankr.M.D.Fl.1996); In re Gantos, 176 B.R. 793 (Bankr.W.D.Mich.1995); In re Financial News Network, Inc., 149 B.R. 348 (Bankr.S.D.N.Y.1993); In re Communicall Cent., Inc., 106 B.R. 540 (Bankr.N.D.Ill.1989); In re McLean Enter., Inc., 105 B.R. 928 (Bank.W.D.Mo.1989)).  These courts calculate the amount of rent due over the remaining term of the lease and multiply that amount times 15%.

    Other courts calculate lease rejection damages based on 15% of the “remaining term” of the lease.  See, e.g., In re Iron–Oak Supply Corp., 169 B.R. 414, 419 n. 8 (Bankr.E.D.Cal.1994); In re Allegheny Intern., Inc., 145 B.R. 823 (W.D.Pa.1992); In re PPI Enterprises, Inc., 324 F.3d 197, 207 (3rd Cir.2003).

    For more mathematically-minded readers, the differently-applied formulas appear as follows:

    Rent-Based Formula: Maximum Rejection Damages = (Rent x Remaining Term) x 0.15
       
    Term-Based Formula: Maximum Rejection Damages = Rent x (Remaining Term x 0.15)

    Earlier this month, a Colorado bankruptcy judge, addressing the issue for the first time in that state, sided with those courts who read the statutory 15% in terms of time:

    “In practice, by reading the 15% limitation consistently with the remainder of § 502(b)(6)(A) as a reference to a period of time, any lease with a remaining term of 80 months or less is subject to a cap of one year of rent [i.e.,15% of 80 months equals 12 months] and any lease with a remaining term of 240 months or more will be subject to a cap of three years rent [i.e., 15% of 240 months equals 36 months].  Those in between are capped at the rent due for 15% of the remaining lease term.”

    In re Shane Co., 2012 WL 12700 (Bkrtcy. D.Colo., January 4, 2012).

    The decision also addresses a related question:  To what “rent” should the formula apply – the contractual rent applicable for the term?  Or the unpaid rent remaining after the landlord has mitigated its damages?  Under the statute, “rents reserved” refers to contractual rents, and not to those remaining unpaid after the landlord has found a new tenant or otherwise mitigated.

    Colorado Bankruptcy Judge Tallman’s decision, which cites a number of earlier cases on both sides of the formula, is available here.

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    Is The Shortest Way Up . . . Straight Down?

    Sunday, August 16th, 2009

    “There’s a cement slab on Ridge Lane, topped with a few pipes, an electrical box and a porta-john.  Nearby, an empty house, a large sign in the driveway declaring ‘inventory home.’  Around the corner, a few muddy lots, rimmed with construction fences … ‘If [the developer] is gone,’ [Kathy] Koss [a resident in the neighborhood] said, ‘what is going to happen to these houses?'”

    This quote from a story in March 15’s Charlotte Observer opens an extensive and intriguing study assembled by Sarah P. Woo, entitled “A Blighted Land: An Empirical Study of Residential Developer Bankruptcies in the United States – 2007-2008.”  Woo is an independent risk management consultant and doctoral scholar at Stanford University with prior experience as a research manager at Moody’s KMV London and a background in corporate finance at White & Case LLP.  She offers a simple premise as the basis for her 194-page work, which also serves as her dissertation:

    Until the housing sector is stabilized, there will simply be no recovery in America.  And as financially distressed residential developers and home builders are forced into liquidation or foreclosure, the unfinished projects they leave behind affect not only the immediate community, but area housing prices as well.

    Woo is not alone in her assessment of the persistent weakness of the US residential housing sector.  A Deutsche Bank study released in early August and briefly summarized in a CNN-Money article last Wednesday indicates that home prices may fall another 14% before hitting a bottom, leaving as many as 48% of mortgage holders “underwater” by 2011.

    Ouch.

    Among Woo’s findings on developers who have filed Chapter 11 cases over the last 2 years:

    – Only 5.3% were able to successfully reorganize.  In fact, the majority of cases were actually dismissed or converted to Chapter 7 – leaving real estate to be foreclosed or liquidated in forced sales.

    – 72% of the cases sampled involved at least one request by a secured lender to lift the stay for purposes of foreclosure.  In such instances, relief was granted approximately 90% of the time.  However, foreclosure may not always have been the best outcome for the bank.  According to Ms. Woo, “[i]n one case, the bank which repossessed the property not only had trouble with the remaining development process but also found itself in a position where it could not necessarily sell the property as a going concern . . . .  In [another] case, the bank which repossessed the property was seized by regulators 2 months later for being insufficiently capitalized, raising the issue of the extent to which a bank’s own financial problems might have contributed to its preference for liquidation during bankruptcy proceedings.”

    – Where properties were disposed of through “363 sales,” Woo “uncovered a pattern of winning credit bids where secured lenders acquired the properties . . . at low prices.”

    – Access to DIP financing appears to have been severely impaired for developers (as it has been for many Chapter 11 debtors this cycle, regardless of industry).  Even where DIP financing has been available, such financing often occurred in cases where the debtor was ultimately liquidated or packaged for sale (again, a common scenario this cycle regardless of the debtor’s industry).

    Is the near-certain prospect of liquidation or sale facing struggling residential home developers a good one for the sector?

    On the one hand, Woo’s study appears to suggest that the control available to lenders through mechanisms such as DIP financing and stay relief litigation, employed by highly regulated and troubled US banks desperate to raise capital by seizing and liquidating collateral, puts housing developers who might reorganize in Chapter 11 on a very slippery slope with little prospect of survival.  On the other, it suggests that the industry may be ridding itself of weak performers very quickly, leaving only the strongest to survive as the residential housing sector struggles back to prior levels.

    Where real estate development and the residential housing sector are concerned, is the shortest way up . . . straight down?

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