OBTAINING RELIEF FROM THE AUTOMATIC STAY OF ALL ACTIONS TO FORECLOSE UPON REAL PROPERTY SECURITY
You are a lender secured by a mortgage or deed of trust against real property. Your borrower is now in bankruptcy. You want to foreclose, but you are automatically stayed by the bankruptcy filing. What do you do?
Depending upon the circumstances, you may have one or more of four options. The same Bankruptcy Code Section that automatically bars a lender from starting or continuing any act that may interfere with a debtor’s property, or the reorganization of its financial affairs, also contains three ways to ask the bankruptcy court for relief from the automatic stay. The first way is for equitable cause, and cause often includes a lack of adequate protection for your security interest. The second way arises if the debtor has no equity in the real property security and the property is unnecessary for an effective reorganization of the debtor’s affairs. The third way may arise if the real property security is “single asset real estate” and the debtor fails to take certain prescribed actions within the first 90 days of the bankruptcy proceeding. The fourth way to gain relief is to ask that the bankruptcy proceeding itself be dismissed. All four grounds depend on the circumstances existing at the time, and all are discussed below.
If the situation warrants, a lender may move to dismiss the bankruptcy proceeding for “cause.” Dismissal dissolves the automatic stay. “Cause” may be anything that provides good reason to end the proceeding, including unreasonable, prejudicial delay by the debtor, serious post-filing erosion of assets and, in a proceeding where the debtor is seeking to reorganize its business, an inability to propose a feasible plan of reorganization or to carry out the plan. When a bankruptcy proceeding is dismissed for cause, frequently the cause cited is that the bankruptcy was filed in “bad faith.” Bad faith is an abuse of the bankruptcy process, and may be found where the debtor has few creditors and there is other evidence that the debtor acted only to stymie creditors, such as filing bankruptcy on the eve of foreclosure. Often a bad faith filing involves what is sometimes called the “new debtor syndrome.” That is when an entity, such as a corporation, is formed and the real property security is transferred to it, usually on the eve of foreclosure, and then the new entity files for relief in bankruptcy.
Given appropriate circumstances a bankruptcy court will dismiss a case, but where there is doubt, the borrower will usually be given the benefit.
One ground for providing relief from the automatic stay is relief for “cause.” Much like the cause needed to dismiss a case, cause for relief from the stay is anything that justifies the court in granting relief. If the lender’s real property security is uninsured, for example, that may provide sufficient cause to justify granting relief from the stay because of the risk of destruction. Cause for relief from stay most often means that the lender’s interest in the real property security is not adequately protected. The lack of adequate protection may appear where the lender’s collateral is declining in value below the amount owed, and the debtor is unable to make payments to the lender to offset the declining value. In that situation the court probably would grant relief from stay for cause because of the lack of adequate protection. Conversely, relief for cause probably will not be given if the debtor insures the property, if the debtor make payments to offset declining value, if the debtor gives a replacement lien on other property with equity, or if there is sufficient equity left in the real property security itself –- an “equity cushion” -- to ensure that the value of the lender’s security interest is not eroding. Unfortunately, a lender cannot obtain relief from stay for cause because the lender is deprived of the value of the use of its money.
3. Lack of Equity and a Prospect for Reorganization.
Another ground for relief from stay is if the debtor lacks equity in the real property security, and the property is not necessary to the debtor’s effective reorganization.
Equity is determined by adding the costs of sale to the amount of all the liens, encumbrances and taxes against the real property, and subtracting from the property's value. Valuation of the real property security often requires an appraisal.
If there is no equity, then the debtor must show that the real property is necessary for an effective reorganization. Where the debtor has filed a liquidation proceeding, there is no prospect for reorganizing and necessity is never an issue. More likely, though, the debtor filed for relief under the reorganization provisions of the Bankruptcy Code. In opposition to the debtor, the lender will argue that reorganization is not feasible, or that the real property is unneeded for a reorganization. The debtor has the burden of proof on the issue of necessity.
4. Single Asset Real Estate.
Another ground for relief concerns “single asset real estate.” Single asset real estate is a single property or project, but is not residential real property with less than four units. The real property also must generate substantially all of the debtor’s gross income. Further, there can be no substantial business conducted on the real property, other than the business of operating the property. Finally, the aggregate of the non-contingent, liquidated, secured debts may not exceed $4,000,000.00.
A lender can obtain relief from stay against a debtor holding only single asset real estate if, 90 days or more after the date that the debtor files for relief, (a) the debtor has not filed a plan of reorganization that has a reasonable prospect of approval within a reasonable time, or (b) the debtor has not begun making monthly payments to the creditors secured by the real property that are equal to the current fair market interest rate on the value of the creditor’s interest in the real property. Note that the value of the real property security may be less than the amount owed and so the value of the creditor’s interest in the real property is also less than the amount owed. Such an undersecured creditor can receive interest only on the portion of the amount owing that is secured.
5. Choosing between grounds.
If the facts warrant, any and all the four grounds may be pursued to advance the lender’s goal of foreclosing the real property security. Yet one ground or another may better serve a lender’s interests. For example, dismissal of a case allows all creditors to pursue the debtor, while relief from stay only benefits the creditor that successfully moves for relief. Furthermore, the factors that support dismissing a case frequently support granting relief from stay too.
Relief from stay may take the form of termination of the stay, annulment of the stay (a retroactive termination), modification of the stay, conditions on maintaining the stay, or some combination of the foregoing. As a practical matter, in a newly filed bankruptcy case a bankruptcy court is less likely to grant relief from stay than later in the case.