Non-Income Producing Properties that Never Operated can be Single Asset Real Estate Under the Bankruptcy Code

Paul Spagnoli

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

            

            Title 11 of the United States Code (the “Bankruptcy Code”) contains certain provisions addressing “single asset real estate” or “SARE.”[1] For example, section 362(d)(3) of the Bankruptcy Code provides that relief from the automatic stay as to single asset real estate may be granted upon a request by a creditor with an interest in such property, unless, no later than 90 days after the entry of the order for relief (or such later date as the court may determine) or 30 days after the court determines that the debtor is subject to the SARE provision, the debtor (a) files a Chapter 11 plan that has a “reasonable possibility of being confirmed within a reasonable time,” or (b) commences certain monthly payments.[2]Consequently, the designation of a debtor as a SARE may have significant ramifications in a case.  Under the Bankruptcy Code, a SARE is defined as: 

[r]eal 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.[3]

In In re The Source Hotel, the United States District Court for the Central District of California held that a developing, non-income producing property that was never in operation was a SARE.[4]  The Source Hotel, LLC ( “The Source Hotel”) obtained a $29.4 million construction loan from Evertrust Bank (“Evertrust”) to build a hotel.[5]  Because Evertrust refused to fund $4 million on the loan, The Source Hotel halted construction.[6] Shady Bird Lending LLC (“Shady Bird”) subsequently purchased Evertrust’s interests in the loan and initiated a foreclosure action on The Source Hotel–which was 85% completed and was not generating any income.[7] Thereafter, The Source Hotel filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court of the Central District of California, which resulted in an automatic stay that generally enjoined all actions against the debtor and its assets, including Shady Bird’s foreclosure action on the hotel.  Shady Bird filed a motion to designate the hotel as a SARE.[8] On April 28, 2021, the bankruptcy court denied Shady Bird’s motion because The Source Hotel was not in operation.[9] Shady Bird appealed the bankruptcy court’s decision.[10]  On appeal, the District Court for the Central District of California reversed the decision of the bankruptcy court and held that The Source Hotel was a SARE, thereby not entitled to seek protection of the automatic stay.[11]

            The California district court relied on the United States Court of Appeals for the Ninth Circuit’s SARE analysis in In re Meurelo Maddux Prop.[12]  According to the Ninth Circuit, the Bankruptcy Code’s definition of SARE can be divided into three components: 

The property must be (1) a single property or project, other than residential real estate property with fewer than [four] 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 buy a debtor on the property other than the business of operating the real property and activities incidental thereto.[13]

Here, according to the district court, the first element was undisputed.[14] As to the second – the court was persuaded bythe bankruptcy decision in In Re Oceanside, where the court opined that a SARE “‘includes undeveloped real property which generates no income.’” [15] The district court, likewise, reversed the bankruptcy court’s analysis regarding the third element because unlike the bankruptcy court’s business intent analysis, Congress’ “present tense” phrasing “is being conducted” meant that a court should “evaluate the current business activities” of the hotel, not the “intentions.”[16] In this case, construction of the hotel was at a standstill because Evertrust withheld the remaining portion of the loan in 2019, and therefore, the hotel’s current state of business operation amounted to nothing more than “operating the real property.”[17] The Source Hotel, therefore, met all three elements of SARE.[18]  

            Courts are split on whether developments that are not generating revenue at the time of the bankruptcy filing are SAREs.[19] According to the California district court, a development on real property that does not generate any revenues may be “single asset real estate” under the Bankruptcy Code.[20] The determination as to whether a debtor is a SARE will thus depend on the jurisdiction in which the debtor’s case is pending.




[1] See 11 U.S.C. § 101(51B); 11 U.S.C. § 362(d)(3).

[2] 11 U.S.C. § 362(d)(3).

[3] See id. at *2 (citing 11 U.S.C. § 101(51B)).

[4] See id. at *8 (citing 11 U.S.C. § 101(51B)).

[5] See id. at *1. 

[6] See id.

[7] See id.

[8] See id. at *2.

[9] Id. at *7.

[10] Id. at *2.

[11] See id. at *7

[12] See id. at *1 (citing Meruelo Maddux Prop. v. Bank of Am. (In re Meurelo Maddux Prop.), 667 F.3d 1072, 1076 (9th Cir. 2012).

[13] Id.

[14] See id. at *3,*6 (analyzing issues two and three of the Ninth Circuit’s SARE test).

[15] Id. at *4 (quoting In re Oceanside, 192 B.R. 232, 236 (Bankr. S.D. Cal. 1996).

[16] See id. at *7 (citing In re CBJ Dev., Inc., 202 B.R. 467, 473 (B.A.P. 9th Cir. 1996) but distinguishing on the grounds that the debtor in In re CBJ had previously operated other businesses on the property).

[17] Id. at *8. 

[18] See id.

[19] See id. at *8 (discussing how the Bankruptcy Court’s opinion about non-income producing properties qualifying as SAREs is likely the “‘minority view’” and “disagreed with the rulings of other courts”).

[20] See id. at *6.