Real estate bankruptcies may occur despite personal guaranties because Bankruptcy Courts have demonstrated a willingness to enjoin collection on guaranties when the guarantor is important to the restructuring and offers to make a financial contribution.
In some cases, lenders may be better served securing a guarantor’s cooperation and controlling a bankruptcy process that allows for speedy disposition of their collateral.

This is the fourth in a series of alerts on insolvency topics affecting real estate. In this alert, we evaluate whether the existence of personal guaranties are likely to deter property owner bankruptcies—a question raised during Pillsbury’s recent “Real Assets Roundup – Real Estate” webinar.

In the wake of COVID-19, default rates for commercial real estate loans, including those supported by personal guaranties, will likely accelerate. Inevitably, borrowers will consider seeking bankruptcy protection to implement a restructuring of debt or a sale of real property collateral, and lenders should not assume that personal guaranties will prevent borrower bankruptcies. Given the current economic climate, lenders should instead assess the likelihood of their borrowers filing for bankruptcy and consider whether they are better off supporting a controlled bankruptcy process to accelerate favorable collateral disposition, as opposed to litigating on both the bankruptcy and guaranty fronts.

In some cases, debtors may be able to obtain an injunction from the Bankruptcy Court barring the lender from suing the guarantor (or staying collection efforts on the guaranty). For example, the debtors in Bray & Gillespie owned 24 hotels and other real estate assets in Daytona Beach, Florida, that were encumbered with over $350 million in guaranteed mortgage and mezzanine debt. On the petition date, the debtors sought a temporary restraining order (TRO) and other injunctive relief barring the lenders from suing the guarantors for at least 90 days. The debtors argued that without such relief, their bankruptcy cases were doomed because the guarantors would be distracted by the guaranty litigation and would be unable to focus on the debtors’ reorganization. The debtors also linked the injunctive relief sought to the guarantors’ willingness to voluntarily contribute $1 million of their personal funds to supplement distributions contemplated under the debtors’ plan. Finally, they argued the lenders were oversecured (which later turned out to be incorrect as to some lenders), and therefor unharmed by the injunction. Ex parte the bankruptcy judge issued a TRO four days later, which ripened into a preliminary injunction for the duration of the bankruptcy cases.1 While diminishing the lender’s leverage, the imposition of the injunction afforded the debtors and the guarantors several months to negotiate a global solution with the lenders without the pressure and cost of concurrent guaranty litigation.

In other cases, it may behoove the lender to refrain from pursuing the guarantor in exchange for the guarantor’s cooperation in disposing of the property through a bankruptcy process. The Stellar GT TIC case involved the Georgian Towers, an 891-unit multifamily residential property in Silver Spring, Maryland, which was encumbered by mortgage and subordinate debt totaling approximately $185 million. The property was acquired through an indemnity deed of trust (IDOT) structure, which deferred transfer taxes until a future disposition of the property. By the time of the default, the loans exceeded the property’s value and the guarantor lacked enough incentive to put the borrowers in bankruptcy because of personal guaranty exposure. The subordinate lender seized on the opportunity to expeditiously sell the property free and clear of all liens for $168 million. In the process, the parties were exempt from paying the deferred transfer IDOT tax and the transfer tax based on Section 1146 of the Bankruptcy Code. The guarantor worked with the lenders in exchange for a release of the guaranty, payment of legal fees and a modest cooperation fee—all memorialized in a plan support agreement approved by the Bankruptcy Court. The costs of structuring and implementing the sale process through a bankruptcy were substantially less than the resulting value enhancement and tax benefits, all of which accrued to the subordinate lender’s benefit. The ability to call the guaranty at any time during the process helped to ensure the borrower’s compliance with the lenders’ plan.

In yet other cases, even where the debtor does not seek to stay actions against the guarantor and the lender does not support a bankruptcy strategy, the debtor and guarantor often hunker down and the lender decides not to pursue collection on the guaranty. For example, in the Bay Limited Partnership case, the debtor owned an 11-story, 276,000-square-foot Class A office building in Bethesda, Maryland, that was encumbered with $46 million of mortgage debt. The guarantors (as the original managing partners of the project) were unwilling to put the limited partnership into bankruptcy. Instead, the limited partner asserted control over the property under the partnership agreement, initiated a voluntary bankruptcy, and immediately filed a plan of reorganization seeking to reduce the allowed amount of secured debt to the market value of the property. After extensive lender-liability-type litigation with the lender on which the debtor prevailed (during which the lender never called the guaranties), the debtor confirmed a consensual chapter 11 plan.

The foregoing highlight certain situations—and there will be others—where the owner, the lender, or both, believe that bankruptcy is the best option for reorganizing around or disposing of real estate notwithstanding the lender’s theoretical ability to collect on a personal guaranty.

Planning and Exploring Options
No doubt the prospect of triggering personal recourse liability will cause a property owner to think hard about bankruptcy, often with a guarantor deciding against doing so. The decision-making process for each property, borrower, and lender, however, is unique. Those with a business plan best effectuated in chapter 11 will likely file for bankruptcy and seek an injunction protecting the guarantor, or will file for bankruptcy without lender cooperation with the hope or expectation that the guaranty will not be called, that the process can be delayed to avoid payment, or that the guarantor is judgment proof. Even in these latter situations, the borrower and guarantor would likely be well served to seek the lender’s cooperation. In other situations, lenders may prefer to dispose of their real estate collateral through a controlled process, supervised by a Bankruptcy Court, with certain benefits that only bankruptcy can afford. Because borrowers will consider bankruptcy notwithstanding the existence of personal guaranties, lenders should begin considering how best to respond to potential bankruptcy filings, recognizing that recovering on a personal guaranty could be an arduous process—both in terms of obtaining a judgment on the guaranty, and in terms of enforcing a judgment to recover assets once a judgment is obtained. In the present and anticipated economic climate, the process may be more difficult if the Bankruptcy Court believes in the legitimacy of the borrower’s and guarantor’s coordinated restructuring proposal, and that it could be derailed by guarantor litigation.

For more information, please reach out to your regular Pillsbury contact or the authors of this client alert.

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1. The merits of granting or denying the injunction are not the focus of this Client Alert. While some courts grant injunctive relief and others do not (depending on the facts), the Bray & Gillespie court did not create new law in the area of section 105 injunctions protecting guarantors from lender actions. See, e.g., Willis v. Celotex Corp., 978 F.2d 146, 150 (4th Cir. 1992) (“the bankruptcy court did not act improperly in enjoining execution” against the non-debtor surety); Noel Mfg. Co., Inc. v. Marathon Mfg. Co., 69 B.R. 120 (N.D. Ala. 1985); Hillsborough Holdings Corp. v. Celotex Corp., 123 B.R. 1004 (Bankr. M.D. Fla. 1990); Otero Mills, Inc. v. Security Bank & Trust (In re Otero Mills, Inc.), 21 B.R. 777 (Bankr. D.N.M.), aff’d, 25 B.R. 1018 (D.N.M. 1982). We note the injunctions we have seen were not permanent, but instead, apparently designed to afford parties a breathing spell to further negotiate. 

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