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A Prepackaged Bankruptcy Could Be the Answer to a Mortgage Default
Chapter 11 bankruptcy has long been thought of as anathema to commercial real estate (CRE) lenders. This is due to the debtor-friendly bankruptcy forum, particularly with respect to (i) the up to 18 month exclusivity period during which only the debtor could propose a plan of reorganization and (ii) threats of a "cram-down" plan used to lever concessions from lenders. These provisions can be, and often were, abused by debtors with no real rehabilitative intent using bankruptcy only as a leverage tool. These abuses led to changes in the bankruptcy code (for example, reducing modifying deadlines in single-asset real estate bankruptcies) and also to widespread use of non-recourse carve-out guaranties that would make the sponsor guarantor fully liable for the loan if any party acting on behalf of the special purpose borrower entity files or acquiesces to a bankruptcy proceeding. These events also established a principle in CRE lending that is seldom questioned almost 30 years later: bankruptcy is to be avoided.
But for single-asset commercial properties in jurisdictions with high real estate transfer taxes, prepackaged Chapter 11 bankruptcy may offer an attractive option compared to those typically available to lenders, such as foreclosure, a deed-in-lieu of foreclosure, or a short sale.
The foremost advantage of a Chapter 11 bankruptcy lies in its exemption from transfer taxes for properties conveyed under a confirmed Chapter 11 plan of reorganization. In jurisdictions such as New York City, where state and local transfer taxes combine to reach 3.025%, and Los Angeles, which has recently adopted a "mansion" tax applicable even to commercial property sales over $5 million, these taxes can amount to millions of dollars upon property relinquishment or disposition. Furthermore, "pre-packs" can move relatively swiftly through courts.
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