Why the “Single Asset Real Estate” Exception Does Not Exclude Hotels from Bankruptcy Protection

By Cecelia L. Fanelli and Jonathan D. Twombly

Cecelia L. Fanelli (cfanelli@stroock.com, 212.806.6158), is a Partner in the Hospitality Industry Practice Group of Stroock & Stroock & Lavan LLP, which Ms. Fanelli heads, and Jonathan D. Twombly is an Associate in Stroock’s Hospitality Industry Practice Group. The Group represents industry leaders from across the hospitality spectrum – from owners, investors, managers and lenders to franchisors and franchisees – and has extensive experience in negotiating hotel franchise and management agreements. Ms. Fanelli speaks and writes extensively on matters relating to the hospitality industry and has been a guest faculty lecturer at the Cornell Hotel School on a variety of franchising topics.

When distressed hotels file for bankruptcy protection, many lenders have argued that the hotels constitute “single asset real estate” (“SARE”) in an attempt to dismiss the bankruptcy case, lift the automatic stay of bankruptcy, and foreclose on the property. However, efforts to designate hotels as SAREs have consistently been unsuccessful. In light of the current economic downturn, this Stroock Hospitality Industry Practice Group Special Bulletin discusses why creditors will have difficulty employing the SARE device to foreclose on bankrupt hotels.

The Definition of a SARE and Why SARE Status Matters

Current bankruptcy law¹ requires three conditions to be met for a debtor’s property to be designated a SARE:

The debtor has real property constituting a single property or project (other than residential real property with fewer than four units);
The property generates substantially all of the debtor’s gross income; and
No substantial business is conducted on the property other than the business of operating the real property and activities incidental thereto.²

SARE status mandates a very streamlined bankruptcy process that provides debtors with narrow rights and creditors with fast resolution of their claims. In non-SARE bankruptcy cases, the automatic stay prevents creditors from moving against the debtor’s property absent leave of the court. However, where the property is a SARE, a court will lift the automatic stay unless, within 90 days after filing the bankruptcy petition, the debtor has:

Filed a reorganization plan that has a reasonable chance of confirmation by the bankruptcy court; or
Begun making regular monthly interest payments to each creditor whose claim is secured by the “single asset real estate.” ³

Examples of SAREs Found by Courts

Courts have found SAREs to exist in relatively limited circumstances, where the debtor merely profits by renting out a single property or selling it off in pieces. In the courts’ view, such properties do not involve an ongoing business requiring the provision of services and day-to-day management – i.e., a business that could be reorganized in a bankruptcy. Examples include:

Undeveloped property.⁴
Land on which single-family homes were being constructed and sold as completed.⁵
A group of more than four detached residential houses contained in a single development project.⁶
Apartment buildings. ⁷

Hotels Are Not SAREs Because They Are Ongoing Businesses

Courts have consistently found that hotels are not SAREs because, unlike the examples given above, a hotel is an ongoing business, rather than “a piece of real estate simply held for income.”⁸ With respect to hotels, courts have decided that:

Hotels do more than merely collect rents for rooms. They perform or offer such additional business functions as room cleaning, laundry, room service, restaurants, bars, catering, spas, gift shops, meeting space, banquets, and phone, internet and television connections, and have employees to carry out these functions. ⁹
A hotel’s ownership structure does not affect the SARE analysis. Just because a hotel is owned by a limited partnership or single purpose entity whose only asset is the hotel does not make the hotel a SARE. ¹⁰
A hotel property is not a SARE simply because the ownership has delegated day-to-day operation of the hotel to another entity, such as a management chain.¹¹
Because a hotel property is not a SARE, the fact that a creditor started foreclosure proceedings before the bankruptcy petition is not grounds for dismissing the petition. ¹²

Practical Considerations for Hotel Owners

Although the foregoing considerations seem straightforward, in a number of cases the fact that hotels are entitled to the same bankruptcy protections as other ongoing businesses (including the automatic stay of foreclosure proceedings) has escaped the notice of the parties, their counsel, and the bankruptcy court.¹³ In these cases, the courts offered no analysis to support the conclusion that the hotels were SAREs, and the debtor hotel owners appear not to have contested the courts’ characterizations. The reasoned court opinions, however, consistently hold that hotel properties are not SAREs. Hotel owner-debtors who are unaware of this precedent and permit bankruptcy courts to proceed under the assumption that hotels are SAREs do so at the expense of important legal rights.

¹ Courts originally developed the concept of a SARE to allow them to dismiss cases in which the owner of a delinquent property sought bankruptcy protection to block creditors from foreclosing. In such cases, courts dismissed the bankruptcy proceeding on the ground that bankruptcy protection is reserved only for “persons engaged in a business,” and a person who merely collects rents from a SARE is not “engaged in a business.” See In re Metro, Ltd., 108 B.R. 684, 686 (Bankr. D. Minn. 1988). In 1994, the concept of a SARE was codified in the Bankruptcy Code and given a formal definition. The original 1994 definition has since been revised to that cited herein. Both before and after 1994, courts analyzing the issue have consistently found that hotels are not SAREs.
²In re Scotia Pacific Co., 508 F.3d 214, 220 (5th Cir. 2007) (citing 11 U.S.C. § 101(51B) (2006)).
³11 U.S.C. § 362(d)(3).
⁴In re Webb MTN, LLC, Case No. 07-32016, 2007 WL 656271 (Bankr. E.D. Tenn. Mar. 6, 2008).
⁵In re Kara Homes, Inc., 363 B.R. 399 (Bankr. D. N.J. 2007).
⁶In re Philmont Dev. Co., 181 B.R. 220 (Bankr. E.D. Pa. 1995).
⁷See In re CBJ Dev., Inc., 202 B.R. 467, 472 (9th Cir. 1996).
⁸In re Kkemko, Inc., 181 B.R. 47, 51 (Bankr. S.D. Ohio 1995).
⁹See, e.g., In re CBJ Dev., Inc., 202 B.R. at 472, In re Whispering Pines Estate, Inc., 341 B.R. 134, 136 (Bankr. D.N.H. 2006), In re Newark Airport/Hotel L.P., 156 B.R. 444, 448-49 (Bankr. D.N.J. 1993), and In re North Redington Beach Assocs., Ltd., 91 B.R. 166, 169 (Bankr. M.D. Fla. 1988).
¹⁰In re Metro, Ltd., 108 B.R. at 686.
¹¹Id.; see also In re Dunes Hotel Assocs., 188 B.R. 162, 172 (Bankr. D.S.C. 1995) (while not a SARE case, denying motion to dismiss bankruptcy proceeding on basis of “bad faith” because hotel was engaged in an ongoing business that could be reorganized, even though debtor entity had delegated actual operation of the business to a management company).
¹²See, e.g., In re North Redington Beach Assocs., Ltd., 91 B.R. at 167 (bankruptcy petition filed ten minutes before foreclosure sale was scheduled to occur).
¹³See, e.g., In re LDN Corp., 191 B.R. 320 (Bankr. E.D.Va. 1996), and In re Equitable Dev. Corp., 196 B.R. 889 (Bankr. S.D. Ala. 1996).