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CRE Finance World, Summer 2013

Closing The Bankruptcy Court’s Doors typically significant, and payments to them can be stretched out over a period of years in accordance with a confirmed plan. Ultimately, through bankruptcy, the lender can take control of the real property the same as through foreclosure. The title of the property would not be in the lender’s name — rather, title would already be in the name of a pre-established special purpose entity. The benefits of filing for bankruptcy (i.e., writing down the debt, reducing interest rates, and extending loan payout) are meaningless if the CRE owner is unable to control the property and business post-bankruptcy. In many situations, the Seventh Circuit’s opinion may take the ability to control away from the owners. CRE Finance World Summer 2013 72 Alternatively, if the lender does not want to own the real property, the lender can just force the real estate owner to bid a much higher amount for the new equity interests. As the cost of the equity interests rises, the reorganized CRE owner will have more capital. With increased capital, the lender can move for higher distributions and/or quicker payouts. Even if the lender does not take control, the Seventh Circuit opinion may eliminate the option of the debtor/owner to unilaterally set an artificially low price for the equity interests to the detriment of other creditors. V. Impact of Ruling on CRE Lending The impact of this decision on CRE cannot be ignored. Following the Castleton Plaza opinion, CRE owners may want to carefully evaluate the potential pitfalls before filing for bankruptcy. No longer is there any certainty that an owner can file bankruptcy and retain ownership of the property. For single asset real estate owners, the filing of bankruptcy may mean that the owner has to turn title over to a senior secured lender. This alone may act as a substantial deterrent to filing for bankruptcy. If the Castleton Plaza decision does not prohibit borrowers from filing bankruptcy, it may modify borrowers’ proposed plans in bankruptcy. To avoid a lender’s ability to enforce the absolute priority rule, borrowers may propose that lenders are fully secured. As fully secured creditors, lenders would not have the ability to assert that the absolute priority rule is being violated. At the same time, as a fully secured creditor, the lender would be entitled to recover the full amount of its debt, and potentially recover all attorneys’ fees and costs. For lenders, the Castleton Plaza decision can be a boon, reducing investment risk in commercial real estate. Without the ability to control the debtor after emergence from bankruptcy, owners should be more reluctant to invest the significant costs associated with filing for bankruptcy and fighting lenders through the reorganization process. The result may be the same with or without bankruptcy: the lender will take title and/or control of the real property. By discouraging owners from filing bankruptcy, the resulting costs to foreclose on commercial real estate should diminish. Decreasing costs to lenders may result in decreasing risk for lenders to invest in the sector. While the Castleton Plaza opinion may not open the floodgates of CRE lending to pre-2007 levels, the opinion can provide some assurance that bankruptcy is not a meaningful alternative for underwater single asset real estate owners. For more information, visit btlaw.com. 1 707 F.3d 821 (7th Cir. 2013). 2 Typically, appeals from bankruptcy courts must first proceed to the local district court before proceeding to a circuit court of appeal. Here, the bankruptcy court and the Seventh Circuit each granted their approval for a direct appeal, allowing the lender to bypass the district court. 3 In re Castleton Plaza, L.P., 707 F.3d 821, 821–22 (7th Cir. 2013). 4 Id. 5 Id. 6 CRE loans originating prior to 2007 most always have an unsecured claim, where the value of the real estate has depreciated to a value less than the loan balance. “As a result of this opinion, a bankruptcy case often may be similar to a foreclosure process for single asset real estate entities.”


CRE Finance World, Summer 2013
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