April 11, 2008

When negotiating forbearance agreements, real estate lenders consider including a provision waiving the automatic stay in the event the borrower later files bankruptcy. A new decision from the U.S. Bankruptcy Court for the Southern District of Florida addressed the enforceability of just such a pre-bankruptcy waiver of the automatic stay. As the discussion below illustrates, the case involved a real estate project in financial trouble.

The real estate workout: forbearance with a price

The owner of a troubled real estate development is about to default on a loan secured by the real property. On the eve of foreclosure, the lender agrees to forbear from foreclosing for two months to give the developer time to refinance and save the project. However, in exchange the lender insists that the developer agree that, in the event of bankruptcy, the lender would have relief from the automatic stay to foreclose. The developer agrees and the forbearance agreement is executed.

The bankruptcy aftermath

Unfortunately, the hoped-for financing falls through and the developer files a Chapter 11 bankruptcy for the project just before the rescheduled foreclosure sale. The lender quickly files a motion for relief from stay, asking the bankruptcy court to enforce the pre-bankruptcy relief from stay waiver included in the forbearance agreement. The motion is opposed by the developer, now a Chapter 11 debtor in possession, as well as the official committee of unsecured creditors and junior lienholders.

Is the waiver of the automatic stay enforceable?

This was the question answered by Bankruptcy Judge John K. Olson in a decision issued on February 12, 2008, in the In re Bryan Road, LLC Chapter 11 bankruptcy case. The facts were essentially as described above, but a few additional details help put the issue in context.

• The real estate project involved a 210-unit dry stack boat storage facility in Dania Beach, Florida.
• The lender, which commenced a judicial foreclosure proceeding against the 191 units still owned by the debtor, had been awarded final judgment setting a foreclosure sale.
• On the morning of the foreclosure sale, the debtor and the lender entered into a forbearance agreement that was approved by the court in the foreclosure proceeding. The forbearance agreement provided for a two-month continuance of the foreclosure sale in exchange for the debtor’s agreement that the lender would have relief from the automatic stay to foreclose in the event of a bankruptcy.
• The day before the continued foreclosure sale was to take place, the debtor filed its bankruptcy petition.

The Bankruptcy Court’s analysis

In his decision on the lender’s stay relief motion, Judge Olson first noted that prepetition waivers of the stay will be given “no particular effect as part of initial loan documents” but the “greatest effect if entered into during the course of prior (and subsequently aborted) chapter 11 proceedings.” After concluding that a confirmed Chapter 11 plan was not required, the Bankruptcy Court looked to four nonexclusive factors, drawn from In re Desai, 282 B.R. 527 (Bankr. S.D. Ga. 2002), in considering whether stay relief should be granted based on the prepetition waiver: (1) the sophistication of the party making the waiver; (2) the consideration for the waiver, including the creditor’s risk and the length of time the waiver covers; (3) whether other parties are affected including unsecured creditors and junior lienholders; and (4) the feasibility of the debtor’s plan.

As to the first two factors, the Bankruptcy Court found that the debtor’s counsel was very sophisticated and, although the forbearance period was short, it was sufficient consideration. On the third and fourth factors, the Bankruptcy Court first noted the existence of junior lienholders and approximately $1 million of disputed unsecured claims. However, the Bankruptcy Court then engaged in a detailed analysis leading to the conclusion that the debtor’s plan simply was not feasible. As such, there likely was no value for unsecured creditors in the boat storage project beyond the secured debt and the junior lienholders could protect their own interests under state law. Putting these factors together, the Bankruptcy Court concluded that the forbearance agreement — including the waiver of the automatic stay — should be enforced and the stay was lifted.

A few observations

With economic conditions continuing to strain a variety of real estate developments, workouts in the shadow of foreclosure may become more common. Generally, bankruptcy courts are wary of enforcing prepetition waivers of the automatic stay for the benefit of one secured creditor. The debtor’s other creditors have a right to be heard and object to the granting of such relief. Although the In re Bryan Road, LLC, decision was based upon the specific facts of that case, it shows that in the right case a bankruptcy court may be willing to enforce prepetition stay relief agreements.

• The chances of enforcement go up when the debtor is a single asset real estate entity, it signs an agreement on the eve of foreclosure and it has few unsecured creditors. In fact, the more the bankruptcy appears to be just a two-party dispute between the debtor and lender, the more likely the prepetition automatic stay waiver will be enforced.
• On the other hand, when a troubled real estate project has a real chance of reorganizing, and substantial unsecured creditor claims are involved, these agreements more likely will be rejected in favor of traditional relief from stay analysis under Section 362 of the Bankruptcy Code.

Conclusion

Prepetition stay relief agreements involve complex issues. As with most bankruptcy questions, real estate owners and lenders should get advice from bankruptcy counsel on their specific situation when considering whether to include such a waiver of the automatic stay in any forbearance agreement.

If you have any questions about this alert, please contact one of the attorneys listed below.

Robert Eisenbach - San Francisco, CA
Tom O'Connor - New York, NY
Adam Rogoff - New York, NY