Commercial Real Estate Distress - Part II

Using the Great Recession Bankruptcy Toolkit to Help Solve a $1.3 Trillion Problem

As discussed in the first installment of this analysis, companies can use a Chapter 11 to stay the enforcement actions of lenders and creditors and give themselves more time to facilitate a constructive, consensual value-maximizing transaction for all parties involved.  Therefore, instead of distressed commercial real estate owners simply handing the keys over to lenders (which has been the prevalent strategy thus far in the distressed commercial real estate cycle), the Chapter 11 process may provide them with a more viable alternative.

A recent example of a commercial office real estate company taking advantage of Chapter 11 is PWM Property Management LLC’s (“PWM”), which it filed for with two office buildings in 2021.  After prevailing on a motion to dismiss from certain creditors, PWM was able to use the Chapter 11 process to increase the time available to assess strategic alternatives.   This time allowed PWM to explore a comprehensive six-month sale and recapitalization process that ultimately resulted in:

1)     One building being restructured in conjunction with a capital infusion from the mezzanine lender that provided for the assumption of senior debt keeping its low interest rates intact, and

2)     The second building being retained by the original owner with certain modifications that were consented to by the senior lender. 

Absent a Chapter 11 filing, the original owner likely would have lost both properties.  While the PWM situation shows how distressed commercial real estate owners can benefit from filing for Chapter 11, there are several factors that must be considered to properly assess whether filing for Chapter 11 is an advisable strategy. 

1.     There must be an entity that controls the property that functions as an operating business to avoid any single real estate asset arguments. 

2.     The Debtor (Chapter 11-filing entity) must have financing through Debtor-in-Possession financing or be able to use its own cash to satisfy its operating obligations.  No one hands you money in Chapter 11, so the filing entity must be able to operate via financing or through using its own cash flow. 

3.     There needs to be rationale for the Chapter 11 filing.  This can be as simple as needing additional time to assess strategic alternatives or to navigate the current capital market dislocation.  Alternatively, the reason could be much more complex – for example, there may need to be a full-blown restructuring plan that summarizes how all lenders/creditors will be treated (typically consensually if presented early in the case). 

4.     “Bad boy” guarantees must also be assessed when evaluating a Chapter 11 filing and the impacts on any restructuring plan.  These guarantees (either provided by other entities or personally by owners) can sometimes be triggered by filing for Chapter 11 bankruptcy and may result in assets outside the purview of the bankruptcy court being allowed to satisfy a creditor or lender’s claim.   The disadvantages of these potential guarantees must be evaluated against the benefits of a Chapter 11 process.

If the debtor can satisfy these issues, they will have a strong chance of staying in Chapter 11 and having a meaningful opportunity to restructure.  Depending on their demographic and specific interests, lenders may also prefer this outcome, as opposed to having no choice but to take control of properties they do not want. 

Not every situation will benefit from or have the right conditions for a Chapter 11 filing, but a thorough evaluation of whether it is a viable alternative should be conducted to ensure that value is being maximized for owners and lenders.