Contiguous Condominiums Are Not “SARE”

Background

Debtor Nuovo Ciao Di LLC (“Nuovo Ciao”) filed for chapter 11 nearly two and a half years after DCC Vigilant, LLC (“DCC”) initiated a foreclosure action against it. DCC holds the first mortgage on two adjacent commercial condominium units previously conveyed to Nuovo Ciao under a single deed but listed as two separate parcels. The first-floor unit is subject to a Metropolitan Transit Authority easement, is valued at $22 million, and has been vacant since 2018, while the second-floor unit is designated as a “community facility,” is valued at $8.85 million, and has been vacant since 2021.

Although Nuovo Ciao did not designate its business as “single asset real estate,” DCC sought the designation, arguing that the units should be considered a “single property” because they were sold under a single deed to the same owner, were subject to a single mortgage, and were treated as one unit by Nuovo Ciao. Relying on those same features and the units’ proximity to one another, DCC alternatively argued that the units should be considered a “single project.”

The Bankruptcy Code’s “Single Asset Real Estate” Provisions

During the real estate crash of the 1980s, bankruptcy courts faced a wave of unique chapter 11 cases: debtors whose only assets were a single real property, and whose only significant creditors were the mortgagees of those properties. Congress reacted by creating the “single asset real estate” (SARE) designation, which subjects SARE debtors to more onerous treatment than non-SARE debtors.

Section 101(51B) of the Bankruptcy Code defines “single asset real estate” as “real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto.” A debtor may designate its business as single asset real estate when it commences its case, or a creditor may move to have the case designated as such.

SARE designation only benefits the debtor’s secured creditor. The Bankruptcy Code provides that a secured creditor is entitled to relief from the automatic stay—the statutory injunction that prohibits enforcement actions against the debtor or its property—if the debtor does not commence interest payments to the secured creditor or file a plan reasonably susceptible to confirmation within 90 days of the commencement of the case or 30 days after the court determines the debtor is a SARE debtor, whichever is later.

The Bankruptcy Court’s Decision

The Bankruptcy Court held that two adjacent commercial condominium units owned by the same debtor and subject to the same mortgage and deed, but having different tenants, commercial uses, plans for commercial development, and lot numbers, did not constitute a “single property or project” because they were not linked by a common scheme or plan.

The Bankruptcy Court quickly disposed of DCC’s argument that the units were a “single property,” finding that the units’ separate valuations, different lot numbers and distinctive characteristics overcame the shared deed and single mortgage considerations. The Bankruptcy Court also emphasized the units’ unique characteristics, as one unit was subject to an easement while the other was designated a “community facility,” and reasoned that because the units could be valued, used and sold independently of each other, they were not a “single property.”

In considering whether properties constitute a “single project,” the Bankruptcy Court explained that the key determinative factor is whether the properties are linked by a common plan or scheme concerning their use. Secondary, non-exclusive factors include the location and proximity of the properties, the circumstances surrounding the debtor’s acquisition of the properties, whether they are subject to a single mortgage or deed, and the debtor’s future plans for development, sale or abandonment of the properties. The Bankruptcy Court found that Nuovo Ciao’s properties were not linked by a common scheme or plan and that Nuovo Ciao had no plans to combine the properties or use them for a single purpose. Instead, Nuovo Ciao was contemplating selling only one of the units. The Bankruptcy Court also noted that Nuovo Ciao rented the units at separate times to unrelated tenants who had vacated the units at least three years apart.

Conclusion

A lender intending to make a loan with the expectation that the borrower would be designated a SARE debtor in chapter 11 should carefully investigate the prospective borrower’s intentions for its real property and consider obtaining a representation and warranty of intent to use the mortgaged premises as part of a single project. If a bankruptcy case is expected to be a SARE case but is not designated as such, the lender should assess whether it can establish a common scheme or plan for the debtor’s property and promptly move to designate the case as a SARE case. If successful and the debtor does not timely commence interest payments or file a reasonably-confirmable plan, then the lender can seek expedited relief from the automatic stay and potentially secure a faster recovery.

In contrast, most debtors will not want to self-designate (if there is a colorable argument against it) to avoid the timelines and burdens imposed on SARE debtors, especially since the burden on creditors to impose the designation is significant.

***

(This is another in our series of client alerts related to the intersection of bankruptcy and real estate.)