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The Bankruptcy StrategistFeaturesBankruptcyLitigation

Distressed Real Estate Bankruptcies Continue, Despite Interest Rate Peak

By Andrew C. Kassner and Joseph N. Argentina Jr.
January 01, 2024

Although interest rates may have peaked, we continue to expect a large volume of distressed real estate debtors to utilize the bankruptcy system over the next couple of years. This article analyzes two recent decisions regarding distressed real estate bankruptcies, both of which involve rights of real estate lenders against proceeds of collateral other than the real estate itself. One involves the right of a lender to assert a deficiency claim against proceeds of the bankrupt debtor's insurance policy, and the other concerns whether a debtor can use the rents derived from the property that were pledged as additional collateral for the loan.

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Lender Permitted to Assert Deficiency Claim Against Insurance Policy

In the first case, the U.S. Bankruptcy Court for the Eastern District of New York issued an opinion on Sept. 21 in In re Savva's Restaurant, Case No.: 22-70382-reg. According to the opinion, a mortgage lender sought to recover under the debtor's insurance policy following destruction of the property in a fire. The borrower filed a bankruptcy case and sold the property in a sale pursuant to a Chapter 11 plan. The lender entered into a stipulation consenting to the sale and agreeing its secured claim would be reduced by the amount of the net proceeds of the sale. The lender then asserted the deficiency amount against the insurance policy.

The insurer had rescinded the policy as a result of the debtor making misrepresentations in the insurance application. As is typically the case, the lender was listed as an additional insured and loss payee under the policy. The insurer argued that the lender could not assert a claim under the policy because rescission of the policy as to the insured also rescinds the policy for additional insureds. The bankruptcy court disagreed. The court reasoned that while controlling state law provided an additional insured's right to collect is derivative of the primary insured's continuing right to coverage, the lender was also a loss payee under the policy and a loss payee under an insurance policy has an independent contract with the insurer that is not dependent on an enforceable agreement between the insurer and the primary named insured.

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