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Working Group on Small Business
Proposal # 4, Repeal the $4 Million Cap on the Definition of Single Asset Real Estate

The topic of single asset real estate cases is one of significant and broad-ranging debate. The prototypical single asset realty debtor is an entity or individual who operates a single property, such as an apartment or office building. The debtor has one principal creditor, and the secured debt on the real property often equals or exceeds the value of the property. When the real estate market turns sour, the mortgage holder falls behind on mortgage payments and files chapter 11 to stave off foreclosure. [ FN: See, e.g. ,In re Philmont Development Co. , 181 B.R. 220, 223 (Bankr. E.D. Pa. 1995)( " The terms single asset case, or single asset real estate case, are well-known and often used colloquialisms which essentially refer to real estate entities attempting to cling to ownership of real property in a depressed market . . . rather than businesses involving manufacturing, sales or services. " (citation omitted)).] Regardless of the amount of secured debt or the number of employees involved, [ FN: The number of employees needed to manage and operate a single asset property does not depend on who owns the property, but rather the nature of the asset. Thus, single asset real estate cases do not implicate bankruptcy policy considerations regarding employees. See infra p. 7.] the realty debtor’s attempt to reorganize under chapter 11 is in reality little more than a two-party dispute between the secured creditor and the debtor to gain control over the property.


The $4 million cap on the definition of "single asset real estate" should be repealed.


The downturn of the real estate market beginning in the late 1980's and continuing into the 1990's prompted record numbers of single asset real estate ventures to seek protection under chapter 11. These cases have spawned litigation and allegations of abuse of the bankruptcy system. [ FN: See, e.g., Shannon C. Bogle, Bonner Mall and Single-Asset Real Estate Cases in chapter 11: Are the 1994 Amendments Enough? , 69 S. C AL . L. R EV . 2163 (1996).] A key concern is that debtors with a slim chance of reorganizing nonetheless can avail themselves of the broad protection of the automatic stay to deprive their secured creditor of its foreclosure rights for an indefinite period. As the Honorable Lisa Hill Fenning has stated,

[T]he plans proposed in most of these [single-asset] cases attempt to buy a few years’ delay in foreclosure in the hope that the real estate market will improve, shifting the risk of failure to the secured creditor, while trying to preserve the upside potential for the equity holders. [ FN: The Honorable Lisa H. Fenning, The Future of chapter 11: One View From the Bench , Advanced Bankruptcy Workshop 1993 (650 P LI /C OM. L. AND P RAC . C OURSE H ANDBOOK S ERIES 317 at 331).]

Resolving single asset real estate issues in chapter 11 is time-consuming and extremely costly, [ FN: Proposed Amendments to the United States Bankruptcy Code: Hearings Before the Subcomm. on Comm. and Admin. Law , 105 th Cong., 1 st Sess. (April 30, 1997) [hereinafter Hearings ] (testimony of Donald R. Ennis, noting that the average commercial loan at risk in the single asset context is $10 million.).] primarily because such cases routinely implicate two particularly complex and unsettled areas of bankruptcy law, including the new value exception [ FN: 11 U.S.C. § 1129(b)(2)(B)(ii) (1994). Courts are divided on the issue of whether the new-value exception to the absolute priority rule survived the enactment of the 1978 Bankruptcy Code. Compare Bank of America, Illinois v. 203 N. LaSalle St. Apts. , 195 B.R. 567 (Bankr. N.D. Ill. 1995), aff ’ d 195 B.R. 692 (N.D. Ill. 1996) with In re Outlook/Century Ltd. , 127 B.R. 650, 656 (Bankr. N.D. Cal. 1991).] and issues related to claims classification. [ FN: 11 U.S.C. § 1122 (1994). Whether legally similar claims must be place in a single class for purposes of plan confirmation has spawned prolific amounts of litigation. As of 1994, one bankruptcy court counted over one hundred and fifty published opinions discussing the issue. In re Bloomingdale Partners , 170 B.R. 984, 988 (Bankr. N.D. Ill. 1994).] For example, the secured lender in the Bonner Mall case spent three years, and undoubtedly substantial legal fees and expenses, to litigate whether the new-value exception survived codification of theabsolute priority rule. [ FN: The case was filed in March 1991, and the parties ultimately settled in the Spring of 1994. See supra Bogle note 3, at 2166-67.] In another case, litigation over claims classification [ FN: Boston Post Road Ltd. Partnership v. Federal Deposit Insurance Corp. , 21 F.3d 477 (2d Cir. 1994).] caused two years of delay while the district and appellate courts reviewed the permissibility of the debtor’s classification scheme.

In addition to these obvious expenses, delay in chapter 11 can have other, more hidden, costs. During the chapter 11 proceeding, it is not uncommon for single asset real estate properties to receive minimal repairs, capital improvements, and capital replacements. [ FN: E.g. , Alan Robin & James Lipscomb, Real Estate Bankruptcies and the Bankruptcy Process , A M . B ANKR . I NST . W INTER L EADERSHIP C ONF . (Dec. 5-7, 1996)(unpublished article on file with the American Bankruptcy Institute and the National Bankruptcy Review Commission).] If the single asset real estate case involves an apartment building that receives such care, it is the tenants who suffer the inconveniences and dangers of living in a poorly maintained property. [ FN: E.g. , Chris Greer, Deputy Assistant Secretary, Office of Multifamily Housing Programs, Statement to the National Bankruptcy Review Commission (March 21, 1997)(on file with the National Bankruptcy Review Commission).] Inadequately maintained properties also contribute to the decline in values of surrounding properties, and a concomitant decline in the community’s tax base. [ FN: A financially troubled property owner will likely spend its capital on debt service before repairs and improvements.] The sooner the secured creditor may foreclose on the property, the sooner the property can be sold and put to its economic use.

Congress responded to these concerns of cost, delay, and abuse of chapter 11 when it amended the Bankruptcy Code in 1994 [ FN: 3 L AWRENCE P. K ING , C OLLIER ON B ANKRUPTCY ô 362.07[5][b] (1996) (citing S. Rep. No. 168, 103d Cong., 1 st Sess. (1993) ( " This amendment will ensure that the automatic stay provision is not abused, while giving the debtor an opportunity to create a workable plan of reorganization. " ); 140 Cong. Rec. 10, 764 (daily ed. October 4, 1994), reprinted in App. Pt. 9(b) (statements of Rep. Brooks, chairperson of the House Judiciary Committee): Without bankruptcy reform, companies, creditors, and debtors alike will continue to be place on endless hold until their rights and obligations are adjudicated under the present system--and that slows down ventures, new extensions of credit and new investments. Id.] to require single asset real estate debtors to file a plan ofreorganization or begin paying monthly adequate protection payments to creditors within ninety days of the order for relief. [ FN: 11 U.S.C. § 362(d)(3) (1994).] Failure to do so entitles any creditor whose interest is secured by the real estate to relief from the automatic stay. [ FN: Id.] Thus, the amendments endeavor to balance the interests of debtors and creditors by attempting to expedite the chapter 11 process, while providing debtors a reasonable opportunity to file a workable plan. [ FN: See H.R. R EP . N O . 835, 103d Cong., 2d Sess. 50 (1994), reprinted in 1994 U.S.C.C.A.N. 3340, at 3340-42 (identifying the goals of the proposed bill were to " increase efficiency of bankruptcy process and resolve some uncertainties regarding application of the Code, " and more specifically to expedite hearings concerning the automatic stay).]

As defined under the Bankruptcy Code, the "single asset real estate" amendments of 1994 apply to those debtors with:

real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross in come of a debtor and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto having aggregate, noncontingent, liquidated secured debts in an amount no more than $4,000,000. 11 U.S.C. õ 101(51B) (emphasis added).

The debt limitation on the definition of "single asset real estate" is commonly referred to as the four million dollar cap. Although there is no legislative history explaining the cap, it appears that it was a compromise of necessity struck between the Senate and the House. Whereas the Senate reportedly wanted no dollar limitation, the House Democrats, led by Jack Brooks (R. Tex.), flatly refused to consent to any bankruptcy bill which did not somehow limit the single asset real estate definition. The apparent concern was that a broad-sweeping definition would threaten to derail valid reorganization efforts of larger debtors such as Rockefeller Center. Ultimately, Representative Brooks and Senator Grassley mutually assented to a four million dollar cap on liquidated secured debts, a conservative figure which they tenuously agreed would capture the bulk of abusive realty cases.

The compromise figure appears to be loosely based on the two million dollar "small business"definition rather than on any principled determination. A "technical corrections" bill, currently pending before the House, would eliminate the four million cap. [ FN: H.R. 764, § 2 (2)(B), 105 th Cong., 1 st Sess. (1997). Section 2(2)(B) of H.R. 764 is based on H.R. 73, the " Single Asset Bankruptcy Reform Act, " introduced by Rep. Knollenberg on January 7, 1997.] On April 30, 1997, the House Subcommittee on Commercial and Administrative Law held a hearing at which repeal of the cap was discussed. [ FN: Hearings, supra note 5.]

Need for Reform

It seems ironic that the enhanced remedies provided for under section 362(d)(3), although deemed essential by Congress, are available only to those creditors with the least to lose. From a policy perspective, such disparate treatment is indefensible. Regardless of the aggregate level of the debtor’s secured debt in a single asset real estate case, the bankruptcy issues in such cases are the same. From the debtor’s perspective, the debtor must obtain financing sufficient to confirm a feasible plan. The court, on the other hand, must consider whether the debtor has either filed a plan that has a reasonable possibility of being confirmed within a reasonable time or commenced monthly adequate protection payments to the secured creditor. [ FN: 11 U.S.C. § 362(d)(3) (1994).] The resolution of these issues is irrelevant to the level of secured debt involved.

Numerous commentators, ranging from scholars to real estate finance industry professionals, have argued for the exclusion of single asset real estate cases from chapter 11. [ FN: E.g. , Robert M. Zinman, No chapter 11 For Single Asset Real Estate, No " New Value " for Single Asset Real Estate , A M . B ANKR . I NST . W INTER L EADERSHIP C ONF . (Dec. 5-7, 1996)(unpublished article on file with the American Bankruptcy Institute and the National Bankruptcy Review Commission); Bogle, supra note 3; Robin, supra note 10.] Their principal argument is that single asset real estate cases do not serve the traditional purposes of chapter 11, such as preservation of jobs and a company’s going concern value. Moreover, a single asset real estate case is a two-party dispute; whereas chapter 11 is designed to prevent a company’s piecemeal dismemberment by numerous creditors grabbing for assets. By definition in a single asset case, only one asset is available for distribution to creditors, and that asset is often fully encumbered by secured debt. Therefore, chapter 11 arguably does not enhance recoveries to unsecured creditors.

On the other side of the debate are equally impassioned arguments of the continuedavailability of chapter 11 for single asset real estate debtors. [ FN: E.g. , L.E. Creel III & Weldon L. Moore, III, Unjustified Criticism of Single Asset Real Estate Cases in Bankruptcy , A M . B ANKR . I NST . W INTER L EADERSHIP C ONF . (Dec. 5-7, 1996)(unpublished article on file with the American Bankruptcy Institute and the National Bankruptcy Review Commission).] Congress has determined, and the Working Group agrees, that there is no principled reason to uniformly deny single asset real estate debtors the right to attempt reorganization of their debts in bankruptcy. [ FN: See 11 U.S.C. § 109 (1994).] On the other hand, Congress has also recognized that such debtors should not be allowed to exploit chapter 11 delays and legal uncertainties as bargaining leverage over their secured lenders. Accordingly, the 1994 Bankruptcy Amendments effectively restrict relief in chapter 11 to those single asset realty debtors with a reasonable chance of reorganizing in a reasonable amount of time. [ FN: See 11 U.S.C. § 362(d)(3) (1994).] Limiting the definition of "single asset real estate" with a dollar cap on debt levels, however, seriously undermines the effectiveness of these amendments.

Arguably, the greater a debtor’s secured debt load, the longer it will take and the more difficult it will be to obtain sufficient financing to reorganize. Granting the single-asset debtor more time to reorganize, however, allows that debtor additional time, at the creditor’s expense, to gamble that the real estate market will improve. [ FN: Fenning, supra note 4 and accompanying text.] In addition, the obstacles faced by most single asset debtors in obtaining additional financing are likely to be the same regardless of the amount of money needed: the property is already fully encumbered by a mortgage, the real estate market is soft, and the debtor is in bankruptcy. [ FN: See id.]

Thus, framing the single asset real estate debate in terms of selecting an appropriate "cap" is asking the wrong question. The simple policy choice involved is whether a debtor should be able to gamble on the real estate market with the secured lender’s money? By capping the definition of single asset real estate, Congress has answered, "No, unless the debtor is gambling enough with borrowed money."

Competing Considerations

At a recent hearing on the issue, [ FN: See supra note 5 and accompanying text.] Congressman Nadler inquired whether elimination of thefour million cap would halt abuses, while not leading to the loss of jobs. Congressman Bryant asked about the likely procedural ramifications of eliminating the four million dollar cap.

The response to these questions depends upon the operation of Bankruptcy Code section 362(d)(3). In that regard, it is important to recognize what this provision does, and does not do. What section 362(d)(3) does is to require a debtor, within ninety days of the order for relief, to either file a plan or begin making monthly payments the mortgagee. What it does not do is to prohibit a debtor with legitimate needs for additional time to reorganize its debts from obtaining it. The debtor must simply pay its lender the costs associated therewith. [ FN: Congressman Nadler expressed concern that requiring the debtor to make postpetition adequate protection payments under section 362(d)(3) violates the Supreme Court ’ s ruling in Timbers , which prohibits the payment of pendency interest on unsecured claims. This issue will be addressed in the Working Group ’ s proposal to clarify section 362(d)(3)(B).] If a debtor were unable to make the required monthly payments, the secured creditor would be entitled to relief from the stay, at which time the creditor would foreclose upon the property and sell it to a new owner.

From an economic standpoint, the net effect of this foreclosure process and transfer of ownership would be neutral, and may even be positive (i.e., the going concern value enhanced), assuming the operation of the property were to improve under new ownership. [ FN: As noted above, single asset real estate properties may suffer in chapter 11 from lack of sufficient capital for repair and maintenance. A cash infusion from a new owner may be essential to economically rehabilitate the property.] While certain property managers may lose their jobs, or tenants may ultimately pay higher rents, transfer of property to a new owner does not obviate the needs to employ property managers or to lease space at market rates. Under the new ownership, the employees may be different people, or the lease contracts, upon renewal, may be offered on new terms. Thus, while foreclosure adversely impacts the lives of some, it has a corresponding positive impact on the lives of others, and possibly on the community as a whole.

Chairman Gekas queried whether the four million cap should simply be increased rather than repealed. As discussed above, placing a cap on the definition dodges the policy choice of whether a borrower should be allowed to gamble with its lender’s money. If the answer is no, then it is unfair to require lenders who have the most money at stake to be the exception to the rule.


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