Single Asset Real Estate Tightening the Noose for Developers

By: Anna Drynda

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

Recently, the United States Bankruptcy Court for District of New Jersey in In re Kara Homes, Inc. held that affiliated Chapter 11 debtors, each owning separate real estate development projects for the construction of single family residences and condominiums, qualified as single asset real estate (“SARE”) cases, a holding that allowed the lenders expedited relief from automatic stay.

[1]

  The case focused on whether the debtors conducted “substantial business” other than operating the real property sufficient to exclude them from the SARE provisions.

[2]

  Adopting a “pragmatic approach,” the Court held that even if the business activities would qualify had the debtors performed them for third parties, such activities when performed for the debtor itself, or one of its affiliates, do not constitute substantial business.

[3]

  The residential home building business, although involving real estate, arguably has more similarity to a manufacturing operation than to the on-going property management operations of many SARE debtors.  The Kara Homes approach makes it very difficult for real estate developers to reorganize in bankruptcy.

Kara Homes, a large New Jersey home builder who owns a ninety percent interest in each of the thirty-two affiliated debtors, and its affiliates filed a petition for relief under Chapter 11 and sought a declaratory judgment that they were not SARE cases as defined by 11 U.S.C. § 101(51B) and 11 U.S.C. § 362(d)(3) because each separate affiliate operated a business “sufficiently active” to be excluded from definition of SARE under section 101(51B).

[4]

In a case involving a SARE debtor, the lender may be granted expedited relief from the stay under section 362(d)(3) unless the debtor files a plan of reorganization within 90 days of the filing of the case or commences monthly payments to the lender.

[5]

 

Although the original focus of the SARE provisions were created to address bankruptcy abuse by single asset partnerships and corporations that typically acquired and managed a single developed property such as an apartment house or office building intended to produce income,

[6]

the decision of Kara Homes brings large residential development companies within the statutory scope even though their activities are not primarily passive investment.  The affiliated debtors in Kara  Homes claimed “each affiliate researches and purchases developable land, conducts planning and construction of homes, markets and sells the homes and maintains each development” which constituted substantial business not related to the business of operating the real property.

[7]

Relying on these substantial quasi-manufacturing activities, Kara Homes argued that the third requirement of section 101(51B), which states the real property or project could not have any other substantial business conducted on the property other than the business of operating the real property and activities incidental to such operation, excluded it from the SARE provisions,

[8]

but the court disagreed, finding a reasonable business person would not anticipate significant revenue from such activities without the eventual sale or lease of the real estate.

[9]

 

Although current market conditions are creating difficulty for real estate developers, the Kara Homes approach makes it very difficult for them to reorganize in bankruptcy.  Since the debtors own the underlying land, they qualify as SARE debtors even if their operations are substantial business because those operations are tied to the ultimate sale of the land.

[10]

Possibly a developer could avoid SARE treatment by performing contracting services for unaffiliated developers in order to satisfy the conditions of the footnote in the Kara opinion that requires services be provided to unaffiliated third parties.