Litigation: No whole business enterprise exception to single asset real estate provisions

9th Circuit rules that subsidiary be considered a single asset real estate debtor

Parent company Meruelo Maddux Properties Inc. (MMPI) and 53 of its subsidiaries filed Chapter 11 petitions in March 2009. Upon the bankruptcy filings, the cases of all entities were jointly administered but not substantively consolidated.

The debtors owned and developed real property in the Los Angeles area through a network of subsidiaries. The debtors had a centralized management team and the business was operated on a consolidated basis: revenues from operations of the subsidiaries’ properties were swept each day into a single general operating account that was then used to pay expenses for the parent and its subsidiaries. The parent and its subsidiaries filed consolidated tax returns with the Internal Revenue Service and filed consolidated financial reports with the Securities and Exchange Commission.

One of the subsidiaries, Meruelo Maddux Properties-760 S. Hill Street, LLC (MMP Hill), owned a 92-unit apartment complex commonly known as “Union Lofts.” Bank of America (BofA) loaned MMP Hill $28.72 million in 2006 and took a first priority security interest in Union Lofts as collateral. As additional collateral, BofA was provided a general unsecured guaranty by MMPI.

MMPI and all of its subsidiaries proposed competing plans of reorganization. Ultimately, one plan of reorganization was confirmed.

Prior to confirmation, MMPI filed a motion seeking a determination that it and other subsidiaries were not subject to the single asset real estate provisions of Bankruptcy Code sections 101(51B) and 352(d)(3). BofA filed a cross motion seeking to apply the single asset real estate provisions to MMP Hill and another subsidiary, not germane here.

Bankruptcy Code section 101(51B) defines “single asset real estate” as real property constituting a single property or project, other than residential real property with fewer than four units, which generates substantially all of the debtor’s gross income and on which no substantial business is being conducted other than the operation of the real property and the activities incidental thereto. Bankruptcy Code section 362(d)(3) authorizes the bankruptcy court to terminate, annul, modify or condition the automatic stay imposed upon the bankruptcy case filing in favor of a secured creditor holding a lien against the single asset real property after 90 days from the petition filing date if the debtor has failed to file a plan of reorganization that has a reasonable possibility of confirmation, or the debtor has failed to make monthly interest-only debt service payments in an amount equal to the nondefault contract rate.

The bankruptcy court concluded that MMPI appeared to have characteristics of a single asset real estate case, but determined that it was inappropriate to apply the single asset real estate provisions because of the consolidated and interrelated business operations of the parent and its subsidiaries.

BofA appealed to the district court, which reversed the bankruptcy court’s ruling as to MMPI. In reversing, the district court held that MMPI Hill should be treated as a single asset real estate debtor because there is no “whole enterprise” exception to the plain language of the Bankruptcy Code’s single asset real estate provisions. MMPI Hill appealed to the 9th Circuit, arguing that Congress did not intend to apply the single asset real estate to debtors like MMPI Hill.

The 9th Circuit affirmed the district court. See In re Meruelo Maddux Properties.

Agreeing with the district court, the 9th Circuit held that the plain language of section 101(51B) gives no basis for a “whole business enterprise” exception. The court further held that absent substantive consolidation, the court must accept MMP Hill’s chosen legal status as a separate and distinct legal entity from its parent corporation and sister subsidiaries and look only to its assets, income and operations in determining whether MMPI was a single asset real estate debtor. The court presumed that Congress said what it meant in the language it drafted.

Typically, the single asset real estate provisions of the Bankruptcy Code play an important role for moving along cases involving smaller enterprises than the Meruelo parent and its subsidiaries. Larger real estate entities often organize and operate in a manner similar to the Meruelo debtors. These larger real estate networked companies must be mindful of the Meruelo decision and either have the parent and each of the subsidiaries make monthly debt service to avoid the risk of a termination of the automatic stay or perhaps seek substantive consolidation at the initial filing stage and test whether the single asset real provisions will then apply.

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