Single asset actual property (SARE) is a novel classification underneath the Chapter Code with implications for each debtors and lenders. SARE classification is obvious for a property corresponding to a shopping mall, house advanced or workplace constructing the place the debtor’s earnings is generated completely from actual property operations, however is much less obvious for a hospitality property the place the debtor might present incidental providers. Though a full-service lodge with a pool, health heart and restaurant shouldn’t be a SARE property, current tendencies point out that even hourly motels providing little-to-no onsite facilities might not qualify for SARE classification. As a result of SARE classification is seen as offering lenders with distinct benefits in a chapter 11 case, property house owners searching for chapter 11 safety to reorganize usually attempt to keep away from that classification, whereas lenders search to impose it via generally expensive litigation.
What Is a SARE?
Single asset actual property is actual property constituting a single property or challenge, aside from residential property with fewer than 4 residential items, which generates considerably the entire debtor’s gross earnings and on which no substantial enterprise is carried out aside from the enterprise of working the true property and actions incidental thereto.
An actual property class probably categorized as SARE are hospitality properties. There is no such thing as a bright-line rule for when a lodge ought to be labeled as SARE, so chapter courts assess the information and circumstances to find out whether or not a lodge chapter suits throughout the SARE definition of the U.S. Chapter Code. Most courts have discovered that full-service resorts that supply onsite facilities usually are not SARE properties as a result of they have interaction in actions past mere operation of the property. For instance, offering cleansing providers, sustaining a health heart and swimming pool, working a convention heart, and offering meal, laundry, web and telephone providers are facilities and providers which have allowed resorts to keep away from SARE classification.
However what occurs when facilities and providers are stripped away? Will an hourly motel or price range lodge that provides no onsite facilities escape SARE classification?
In re Caribbean Motel: Motels Are Not SAREs, Both
The U.S. Chapter Court docket for the District of Puerto Rico not too long ago thought of whether or not a by-the-hour motel ought to be redesignated a single asset actual property debtor in In re Caribbean Motel Company, No. 21-01831 (EAG), 2022 WL 50401 (Jan. 5, 2022). The debtor operated Motel Caribbean, a by-the-hour motel, and filed for reduction underneath subchapter V of chapter 11. Out of 40 rooms, solely 22 have been operational. The debtor employed 9 to 11 workers to help with check-in, reply requests for meals, settle for cost, present routine upkeep upon checkout, clear and replenish linens, and full crucial repairs. Although the debtor’s earnings was primarily generated by room charges, 5 p.c to seven p.c of its earnings got here from meals service and the sale of choose items. Nonetheless, the motel lacked lots of the options that always render resorts exterior the scope of SARE.
The motel was encumbered by a lien in favor of OSP Consortium LLC. Specializing in the shortage of facilities and arguing that the debtor derived considerably all of its earnings from room leases, OSP sought to redesignate the debtor as a SARE debtor, which might render the debtor ineligible for reorganization underneath subchapter V—a streamlined choice in Chapter 11 for smaller companies. The debtor opposed by specializing in the revenues it generated except for room leases.
In declining to redesignate the debtor as a SARE, the court docket defined that, no matter whether or not the providers supplied by Motel Caribbean have been included within the room price, the debtor operated an lively enterprise that engaged workers, which was not incidental to merely renting or managing actual property. The court docket was not swayed by the shortage of a pool, web or continental breakfast. As an alternative, the court docket emphasised that the debtor engaged in extra providers that generated income. Collectively, these components allowed the debtor to flee SARE classification.
Why SARE Designation Issues
SARE designation can vastly tilt restructuring instances in favor of a lender secured by the SARE property via expedited timelines and reduction from the automated keep (i.e., the statutory injunction that prohibits most acts in opposition to the debtor or its property after the graduation of the chapter case). Particularly, a debtor has till the later of 90 days after the graduation of a voluntary chapter case or 30 days after the court docket determines the debtor is a SARE debtor to both file a plan of reorganization that has an affordable risk of being confirmed inside an affordable time or start month-to-month funds to the lender in an quantity at the least equal to curiosity on the relevant nondefault contract fee on the worth of the lender’s curiosity within the property, which can be tough to attain until the debtor has optimistic money circulate early within the case or a sponsor. If the debtor fails to file a plan or start funds throughout the required time, then the lender may be very prone to get hold of reduction from the automated keep to implement its rights in opposition to the property.
Regardless of its advantages for lenders, it may be expensive to litigate to impose SARE standing on a debtor. Lenders ought to anticipate to litigate over SARE classification if the debtor doesn’t make the election on the graduation of the case (and strategically, the lender might wish to be ready to rapidly transfer for SARE designation for its advantages). The lender might transfer for SARE designation in a standalone movement or as different reduction in movement for reduction from the automated keep or to dismiss the case. It will also be time consuming to litigate SARE points; in Caribbean Motel, 5 months handed between the lender’s movement and the court docket’s ruling. Even when the lender is profitable in acquiring SARE classification, litigation over the extent of the lender’s curiosity within the property or whether or not the debtor’s plan has an affordable risk of being confirmed must also be anticipated when going through a litigious debtor in want of extra time.
In sum, whereas secured lenders to distressed resorts or motels get pleasure from extra advantages in SARE instances, lenders might first face a authorized battle over whether or not the property is a SARE. When confronted with a possible hospitality chapter, lenders ought to undertake an intensive evaluation of their debtors’ actions to find out whether or not they transcend mere operation of the property and assess whether or not pursuing SARE classification is worth it.