District Court Holds Non-Income Producing Hotel Is a Single Asset Real Estate Debtor

Overview

Recently, in Shady Bird Lending, LLC v. The Source Hotel, LLC (In re The Source Hotel, LLC), Case No. 8:21-cv-00824-FLA (C.D. Ca. June 8, 2022), the Central District of California District Court adopted the majority view that a non-income producing property could be a “single asset real estate,” or SARE, debtor. The district court held that a hotel, which was not yet producing income, met the definition of a SARE.

Background

Since 2014, The Source Hotel, LLC ("The Source Hotel") had been developing a hotel and intended to operate the hotel and its related businesses, including a restaurant and bars, on the hotel property. To finance construction, it obtained a $29.5 million loan from Evertrust Bank ("Evertrust"). In 2019, The Source Hotel stopped construction. In December 2020, Shady Bird Lending, LLC ("Shady Bird Lending") purchased Evertrust’s interests in the loan.

Shady Bird then filed a complaint against The Source Hotel in state court and took steps to foreclose. The state court appointed a receiver to take possession of the hotel, and a few days later The Source Hotel (the "Debtor") filed for Chapter 11 bankruptcy. In its voluntary petition, it did not designate itself as a “single asset real estate” debtor.

By way of background, 11 U.S.C. §101(51B) defines “single asset real estate” as “[(1)] real property constituting a single property or project, other than residential real property with fewer than 4 residential units, [(2)] which generates substantially all of the gross income of a debtor who is not a family farmer and [(3)] 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 SARE designation allows for a quick termination of the automatic stay under Section 362(d)(3) of the Bankruptcy Code. That subsection provides that after notice and a hearing, the court “shall grant relief from the stay” in the case of a SARE debtor, where the moving creditor’s claim is secured by an interest in the real estate, unless within 90 days of the filing (or within 30 days of the court making a SARE determination), (a) the debtor “filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time” or (b) the debtor has commenced appropriate monthly payments to the secured creditor.

Shady Bird Lending moved to designate the Debtor’s bankruptcy case as a SARE. The bankruptcy court denied the motion, and Shady Bird Lending appealed. On appeal, the district court found that the bankruptcy court had erred in its interpretation of Section 101(51B) and its finding that The Source Hotel did not satisfy the test for a single asset real estate case and reversed the bankruptcy court’s order, remanding for further proceedings.

Opinion

The district court analyzed the second and third elements of the SARE definition (element one was not disputed). As to the second element, property that generates substantially all of the gross income of a debtor, there was no dispute that the hotel was not producing income. The bankruptcy court concluded that the second element does not include property that produces no income, acknowledging that its view may be in the minority.

On appeal, the district court adopted what it considered the majority view, that the statutory definition of SARE includes property that generates no income. The district court found Section 101(51B) ambiguous with respect to undeveloped or partially developed real property and thus, it looked to the statutory scheme and legislative history for guidance. It found the reasoning of the court in In re Oceanside Mission Assocs., 192 B.R. 232 (Bankr. S.D. Cal. 1996) persuasive. The Oceanside court concluded that interpreting the statute to exclude raw land would not serve the purpose of the statutory scheme, stating there was no apparent purpose to excuse debtors who own only raw land from the expedited relief from stay and further, the legislative history demonstrated that “single asset real estate” had been applied to raw, undeveloped land.

Turning to the third element (no substantial business being conducted), the bankruptcy court had considered the intent for which the property was constructed, which included operation of a restaurant, bar, laundry services and other businesses, and concluded that this element was not satisfied.

The district court disagreed with this approach, concluding that Congress’ use of the present tense — “is being conducted” — requires courts to evaluate the current business activities of a property rather than the parties’ intentions. Here, the Debtor was not currently conducting any business related to the hotel outside of construction and development, and in fact, the hotel and other associated businesses were never in operation. Thus, the third element was satisfied. The fact that the hotel and its related businesses were never in operation distinguished this case from a Ninth Circuit BAP case in which the BAP found a hotel was not a SARE because the debtor had operated other businesses (a gift shop, restaurant and bar on the property) shortly before filing for Chapter 11 relief.  

Why This Case Is Interesting

Whether a debtor is a SARE affects the trajectory of a Chapter 11 case. In particular, if a debtor is designated a SARE, a creditor secured by that real property can obtain expedited relief from the automatic stay. With this decision, the Central District of California District Court joined the majority of courts that have found that the statutory definition of SARE includes undeveloped, non-income producing land. Relevant to the district court’s decision was that the hotel and its related businesses were never operational; thus, where a debtor was previously operational and conducted other businesses, the court’s reasoning might lead to the conclusion that it may not fall within the statutory SARE definition.