Business and leisure travel have decreased significantly and in turn hotel occupancy rates have fallen greatly in many markets, with employee layoffs and property closures. It is uncertain when the industry will recover. Many hotel properties will need to file Chapter 11 Bankruptcy to successfully reorganize their debt obligations so that they can continue to operate. Recently I gave a bankruptcy consultation to a business that owned and operated a single hotel. That consultation made me realize that hotel bankruptcies present a unique set of issues, that attorneys and hotel owners need to be aware of when contemplating filing bankruptcy, particularly if it is a single hotel.
A hotel typically files a Chapter 11 case to avoid imminent foreclosure on its property because filing for bankruptcy gives the debtor the benefit of the automatic stay and the necessary breathing room to raise new capital, refinance debt, and offer a plan of reorganization. However, under Bankruptcy Code section 362(d)(3), if a bankruptcy case involves a single asset real estate (“SARE”), the creditor/lender secured by the real estate asset will be entitled to relief from Bankruptcy Code’s automatic stay as a matter of right unless the debtor does one of two things within 90 days of filing its case. In order to avoid relief from the automatic stay being granted to a secured creditor, the SARE debtor must, within 90 days, either (A) File a plan of reorganization in its case that has a reasonable possibility of being confirmed within a reasonable time; or (B) Commence making monthly, interest-only payments to the secured creditor at the then-applicable no default contract rate of interest on the value of the creditor’s interest in the SARE. If a SARE debtor fails to satisfy either of these requirements, the bankruptcy court is likely to grant the secured creditor relief from the automatic stay to begin or continue a foreclosure of the real estate. Without the hotel property the SARE debtor’s ability to reorganize is eliminated.
Section 362(d)(3) imposes a heightened requirement on the SARE debtor and places it on an expedited timeline to file a confirmable plan or make monthly interest payments. Hotels dealing with low occupancy rates or property closure due to COVID-19, would have a difficult time accomplishing the aforementioned within 90 days. There is an alternative, and that is for the debtor to assert that it is not a SARE debtor. When the debtor files bankruptcy the debtor can elect not to declare itself as a SARE debtor on its Chapter 11 Bankruptcy Petition. However, the secured creditor may file a motion with the bankruptcy court to designate the debtor as a SARE debtor. Single asset real estate is defined under section 101(51B) of the Bankruptcy Code as a single property or project that generates substantially all of the debtor's gross income and no substantial business is being conducted by the debtor other than operating the property. Therefore, to qualify as a SARE debtor, three elements must be met:
A debtor that owns and operates a single hotel, may appear to meet all three elements. However, the debtor should litigate and contest that it does not meet the third element. If the debtor is operating a business on the hotel property that is generating income independent or ancillary to the renting of hotel rooms, the other business, if significant, is not considered incidental to the business of operating the hotel, and therefore the debtor would not qualify as a SARE debtor. Courts have ruled that a hotel is not a SARE debtor when it operates significant other businesses, including a restaurant, bar, and gift shop, and provides room cleaning services and phone services for its guests (see Centofante v. CBJ Dev., Inc. (In re CBJ Dev., Inc.), 202 B.R. 467 (9th Cir. B.A.P. 1996); In re Whispering Pines Estate, Inc., 341 B.R. 134 (Bankr. D. N.H. 2006)).
Therefore, a debtor that owns and operates a single hotel that is contemplating filing chapter 11 Bankruptcy, should be prepared to be on an expedited timeline to file a confirmable plan or make monthly interest payments under section 362(d)(3); or be ready to litigate and contend that it does not meet the third element of the SARE definition. The former is the easier path.
The Bankruptcy Code can be hard to navigate. If you need assistance understanding how to safely proceed in Bankruptcy Court or out of court workouts, contact the experienced litigation attorneys at Goosmann Law in our Sioux City, Sioux Falls, and Omaha offices.