A Hotel That Is Not Operational and Non-Revenue Producing Is a Single Asset Real Estate Debtor
In re Source Hotel, LLC, No. 8:21-BK-10525-ES, 2022 WL 2072673 (C.D. Cal. June 8, 2022)
Article Courtesy of David Simonds of Hogan Lovells
In In re Source Hotel, LLC, the United States District Court for the Central District of California (the “District Court”), reversing a decision of the United States Bankruptcy Court for the Central District of California (the “Bankruptcy Court”), held, in an issue of apparent first impression, that a debtor’s not-yet-completed and non-operational hotel, which was not producing income, qualified as “single asset real estate” under the Bankruptcy Code’s definition.
The Bankruptcy Code defines the term “single asset real estate” as “real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto.” 11 U.S.C. § 101(51B).
The Ninth Circuit has recognized that real property must meet three elements to qualify as “single asset real estate” under this definition: (1) the property is “a single property or project, other than residential real property with fewer than 4 residential units”; (2) “the property generates substantially all of the gross income of a debtor who is not a family farmer”; and (3) “no substantial business is being conducted by a debtor [on the property] other than the business of operating the real property and activities incidental thereto.” In re Meruelo Maddux Props., Inc., 667 F.3d 1072, 1076 (9th Cir. 2012).
A debtor that files for chapter 11 whose case is a single asset real estate (“SARE”) case may designate its case a SARE case on its bankruptcy petition. Alternatively, a creditor may file a motion seeking a determination from the bankruptcy court that the case is a SARE case.
This determination has a significant impact on a chapter 11 case. In a normal chapter 11 case, the automatic stay (which prevents creditors from taking collection action against the debtor) persists for the entire chapter 11 case, unless the creditor successfully moves for relief from the automatic stay to take a specified action. The debtor also typically has an exclusive period of 120 days to file a chapter 11 plan and 180 days to obtain acceptance of such plan, with those periods subject to further extension.
In contrast, in a SARE case, the automatic stay terminates either 30 days after the court classifies the case as a SARE case, or 90 days after the bankruptcy filing on request of a secured creditor, unless the debtor files a plan of reorganization that has a reasonable chance of being confirmed or begins paying monthly interest to its secured lenders at the non-default rate.
In In re Source Hotel, LLC, Source Hotel, LLC (the “Debtor”), which in February 2021 filed a chapter 11 petition, had been developing a hotel with 178 rooms, conference rooms, an executive lounge, fitness center, restaurant, bars and cleaning services (the “Hotel”). The Hotel was financed with a $29.5 million construction loan (the “Loan”) from Evertrust Bank (“Evertrust”) and investments from EB-5 investors. The Hotel was allegedly 85% complete as of October 2019. The Debtor intended to operate the Hotel and its related businesses, including the restaurant and bars on the property.
The Loan was originally due in December 2017, but the maturity was extended to November 2017. In late 2019, Evertrust refused to issue the remaining $4 million of the Loan, claiming a cost overrun. The Debtor ceased construction activities on the Hotel. A third party, Shady Bird Lending, LLC (“Shady Bird”), purchased the Loan and filed a complaint against the Debtor in state court, seeking to take steps to foreclose on the Hotel. After the state court granted an order appointing a receiver over the Hotel, the Debtor filed for chapter 11 bankruptcy protection, but did not designate its chapter 11 filing as a SARE case. Shady Bird then filed a motion for an order designating the case a SARE case (the “SARE Motion”). The Bankruptcy Court denied the SARE Motion and Shady Bird appealed.
There was no dispute that the Hotel was a single property or project other than residential real property with fewer than four residential units, so the first element of the SARE test was clearly met. Accordingly, the first issue on appeal was the second element of the SARE test: whether property that was not income producing could qualify for a SARE case, given that the statute requires, among other things, that the property be one that “generates substantially all of the gross income of a debtor.” The District Court held that it could, noting that multiple cases had found that the term “single asset real estate” included undeveloped real property that generates no income, and included a building or buildings that were intended to be income producing, or raw land. The Bankruptcy Court had cited no contrary authority in reaching the opposite conclusion. Accordingly, even though the Hotel was not generating income, that did not preclude the case from being a SARE case. That the Debtor hoped to complete the Hotel and subsequently have it become an operational business was an argument for the Debtor to raise to seek to maintain the automatic stay after the case was designated a SARE case; it did not constitute a legal argument against a SARE designation. Applying this legal conclusion to the case at hand, there was no dispute that the Hotel, in its current state, was not producing any income and that the Debtor was not earning any gross income. Thus, the Hotel met the second element to qualify as “single asset real estate” under § 101(51B).
Finally, the court turned to the third element, that “no substantial business is being conducted by a debtor [on the property] other than the business of operating the real property and activities incidental thereto.” The District Court, applying the Ninth Circuit Bankruptcy Appellate Panel’s decision in In re CBJ Dev., Inc., 202 B.R. 467 (B.A.P. 9th Cir. 1996), held that the statute required the court to evaluate the current business activities of a property or project, rather than the current intentions of the parties. While the Debtor ultimately intended to operate the Hotel and related businesses, construction had been on hold since 2019 and the Hotel and its associated other businesses had never been in operation and remained purely within the Debtor’s intent to conduct future business. Therefore, the third element of the test was also satisfied. Accordingly, the Hotel fell within the definition of “single asset real estate” and the Bankruptcy Court erred in denying the SARE Motion.