A Silver Lining in the Dark Clouds of the Great Recession?
While it takes an accomplished clairvoyant to predict where RevPar 1, ADRs2 and Occupancy3 will be in the coming months, or for that matter the coming years, for those hospitality owners and operators trying to weather the economic storm there has been some positive news recently out of a place that few wish to spend “too many a night” – the United States Bankruptcy Court4. In the spring of 2011 an oceanfront hotel owner was successful in arguing that it is permitted to use the revenues generated from its guests’ stay and use of amenities to assist in the reorganization of the company. This court ruling of first impression5 was made despite vociferous opposition from its secured lender. The secured lender claimed that by virtue of judicial precedent and its Absolute Assignment of Leases and Rents that it “owned” all hotel revenues6 and therefore the hotel owner had no funds from which to fund its proposed reorganization and accordingly the Chapter 11 bankruptcy case should be dismissed and the lender immediately permitted to foreclose on its collateral.
Ocean Place Resort and Spa occupies a prominent beachfront location on the New Jersey Coast, roughly a one hour drive south of Manhattan and five miles from the Garden State Parkway. With 254 rooms, 40,000 square feet of meeting space, three restaurants, a bar/lounge, tennis courts, a parking garage and a full service spa, Ocean Place sits alongside 1000 feet of sandy beach. Its 17 acres included the “economic amenity” of a redevelopment agreement with the City of Long Branch granting it rights for a full “mixed-use” build-out approaching 1.4 million square feet.
Ocean Place Development, LLC, for all intents and purposes, was a single asset special purpose entity7. The original lender, Barclays Capital Real Estate Inc. (“Barclays”) advanced, on a non-recourse basis, approximately $53,000,000 to Ocean Place (the “Loan”) secured by a plethora of legal documents including a Mortgage, Absolute Assignment of Rents and Leases, a Security Agreement and UCC and fixture filings. Also included in the “collateral” was a “bad boy” a/k/a “springing” guaranty where in the case of fraud or a bankruptcy filing the loan becomes fully recourse to the borrower and its principals. The omnipotent loan structure was and is the “financing du jour” to prevent, and in the case of a risk tolerant borrower, protect the secured lender in the event of a bankruptcy filing.
LOAN DEFAULT, LOAN SALE AND ATTEMPTED FORECLOSURE
The Barclays Loan matured in January of 2008. Up until the maturity date Ocean Place was current on its loan. Post maturity it paid interest to Barclays at the default rate of 9.8% but then in January of 2010 ceased making payments. After several months of marketing of the loan for sale, in October of 2010 AFP 104 Corp. (“AFP”)8 purchased the Loan from Barclays for a purported $40.5 million. Following the purchase AFP obtained a Judgment of Foreclosure and, subsequent to several statutory adjournments obtained by Ocean Place, scheduled a foreclosure sale for February 22, 2011. On February 15, 2011 Ocean Place filed Chapter 11 in New Jersey which stayed the foreclosure sale. At the time of the bankruptcy filing the secured lender, now AFP, was purportedly owed $57,245,372.00 (AFP “stepped into the shoes” of Barclays notwithstanding the discounted price it paid to purchase the loan).
THE FIRST BANKRUPTCY BATTLE: THE ABSOLUTE ASSIGNMENT OF LEASES AND RENTS AND “OWNERSHIP” OF THE HOTEL REVENUES
There is no argument that in order to successfully reorganize in Chapter 11, or for that matter, to pay one’s own daily living expenses, that “income” is the life blood. In the case of the battle between AFP and Ocean Place that “life blood” took the form of Hotel Revenues. In bankruptcy parlance such revenue is referred to as “cash collateral.” 9
Two days after the bankruptcy filing Ocean Place sought the court’s permission to use its cash collateral, the Hotel Revenues, in order to pay its ordinary and necessary operating expenses and to reorganize. In the legal battle that ensued the secured lender, AFP argued that it “owned” the Hotel Revenues and therefore they were not available as income to assist Ocean Place in its Chapter 11 reorganization. AFP relied on the precedential authority of In re Jason Realty, 59 F.3d 423, (3d. Cir. 1995) as well as the Absolute Assignment of Leases and Rents given by Ocean Place to AFP as successor-in-interest to Barclays. The language of the Absolute Assignment of Leases and Rents defined “rents” to include: . . . all revenues and credit card receipts collected from guest rooms, restaurants, bars, meeting rooms, banquets rooms and recreation facilities, all receivables, customer obligations, installment payment obligations and other obligations now existing or hereafter arising or created out of the sale, lease, sublease, license, or rendering of services by Borrower [Ocean Place] or any operator or manager of the hotel or the commercial space located in the Improvements [the premises] or acquired by others . . ., license, lease, sublease and concession fees and rentals, health club membership fees, food and beverage wholesale and retail sales, service charges, vending machines sales and process, if any . . .whether paid or accruing before or after the filing by or against Borrower of any petition for relief under the Bankruptcy Code.
Jason Realty, a decision of the United States Court of Appeals for the Third Circuit (Delaware, Pennsylvania and New Jersey) is followed by many other federal appellate and bankruptcy courts.10Jason Realty was a single asset limited partnership which owned and operated a two story retail and office building. Like Ocean Place it filed Chapter 11, also in New Jersey, to stave off a foreclosure sale. Like Ocean Place it also granted to its secured lender an Absolute Assignment of Leases and Rents. In Jason Realty, the Third Circuit Court of Appeals found for the secured lender, First Fidelity Bank, NA, in holding that the Absolute Assignment of Rents “evidences an absolute assignment of title to the rents, with the assignor [Jason Realty] receiving a license to collect the rents.” As a result, court found that the rent proceeds from the leases were not property of the Jason Realty but rather property of the lender, First Fidelity Bank, pursuant to the Assignment of Leases and Rents. Thus, the “life blood” of Jason Realty’s ability to reorganize, the rents, were not “available” to the debtor to fund its proposed plan of reorganization. In the case of Jason Realty, no rental income meant no “life blood” and the reorganization failed.
HOTEL REVENUES ARE NOT RENT
The court in Ocean Place, however, in a case of first impression11, held that hotel revenues were not “Rent” within the meaning of the Uniform Commercial Code explicitly adopting an analysis of hotel revenues found in a New York case12 and finding that the hotel room revenues were “accounts” or “payments intangible” and are not interests in the realty.13 Specifically, the court held that hotel revenues [defined as revenues generated from room occupancy, food and beverage sales, catering, gift shop purchases, and spa and related hotel services] generated by the Debtor [Ocean Place] did not constitute “rents” and therefore the hotel revenues could be used to pay its ordinary and necessary operating expenses and to reorganize. 14
While the court did find that the secured lender had a perfected security interest in the hotel revenues as “personal property” and not rent, and was “adequately protected,”15 Ocean Place was granted permission by the bankruptcy court to use the hotel revenues, as its “life blood” to attempt to reorganize. Needless to say, AFP was not happy with the outcome. However, the case is on-going and the battles rage-on as of the date of this article.
The court in Ocean Place found that Hotel Revenues were not “rent” within the meaning of the Third Circuit Court of Appeals decision of In re Jason Realty, LLC. While the court arguably had the judicial prerogative to extend the Jason Realty decision to assignment of Hotel Revenues, its decision not to do so can be seen as a victory to hospitality owners and operators weathering the economic storm by allowing the use of the revenues to attempt to reorganize. No doubt, however, legal counsel to hospitality lenders will be scrutinizing the decision and their loan documents for a “work around.” In the meantime, the question has been posed whether owners of other distressed property, such as parking garages, storage facilities and other real property that generate revenues which are not necessarily “rent”16 will seek a further legal extension of the Ocean Place decision17 .
- 1 1RevPar: revenue per available room; a metric used in the hotel industry which is calculated by multiplying a hotel’s average daily room rat
- 2 ADR (Average Daily Rate): a measure of the average rate paid for rooms sold, calculated by dividing room revenue by rooms sold. See id.
- 3 Occupancy (Occ): is the percentage of available rooms that were sold during a specified period of time. Occupancy is calculated by dividing
- 4 In re Ocean Place Development, LLC., 447 B.R. 726 (Bankr. D.N.J. 2011).
- 5 cf In re Kingsport Ventures, L.P. d/b/a Kingsport Comfort Inn, 251 B.R. 841, 846-50 (Bankr. E.D. Tenn. 2000). The Ocean Place court expressl
- 6 Hotel Revenues: The court in Ocean Place defined hotel revenues as including revenues generated from room occupancy, food and beverage sales
- 7 Hotels generally are not considered a single asset real estate entity (“SARE”) under existing bankruptcy case law. See In re CBJ Development
- 8 AFP 104 Corp. is the indirect subsidiary of United Capital Corporation (OTC Pink: UCAP, formerly NYSE Amex: AFP). United Capital Corporation
- 9 “Cash collateral” means cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents, whenever
- 10 See Wachovia Bank N. A. v. Encap Golf Holdings, LLC, 690 F. Supp. 2d 311 (S.D.N.Y. 2010); First Fidelity Bank, N. A. v. Eleven Hundred Metro
- 11 See Note 5.
- 12 See In re Kearney Hotel Partners, et.al. 92 B.R. 95 (Bankr. S.D.N.Y. 1988) (in the context of a bankruptcy avoidance action the court found
- 13 In re Ocean Place Development, LLC at 732-33.
- 14 Id at 733.
- 15 The term “adequate protection” is generally read as intending to protect a secured creditor from “diminution in the value of its collateral
- 16 The Ocean Place court made note that pursuant to the Uniform Assignment of Rents Act (“UARA”), adopted by the Uniform Law Commission in 2005
- 17 See Room Revenues are Not “Rents”: Hotel Creditors Cannot Check in to Jason Realty, 30-6 ABI Journal 24, 77 (July 2011).
About the Author
Francis L. Gorman is a former member of Cayuga Hospitality Consultants.
Unformatted text preview: Springing liens/collateral release Some loans have provisions that borrowers that sit on the cusp of investment-grade and speculative-grade must either attach collateral or release it if the issuer’s rating changes. A‘BBB’ or ‘BBB-’ issuer may be able to convince lenders to provide unsecured financing, but lenders may demand springing liens if the issuer’s credit quality deteriorates. Often, an issuer’s rating being lowered to ‘BB+’ or exceeding its predetermined leverage level will trigger this provision. Likewise, lenders may demand collateral from a strong, speculative-grade issuer, but will offer to release under certain circumstances, such as if the issuer gains an investment- grade rating. Asset-based lending Most of the information above refers to “cash flow” loans, loans that may be secured by collateral, but are repaid by cash flow. Asset-based lending is a distinct segment of the loan market. These loans are secured by specific assets and usually governed by a borrowing formula (or a “borrowing base”). The most common type of asset-based loans are receivables and/or inventory lines. These are revolving credits that have a maximum borrowing limit, say € 100 million, but also have a cap based on the value of an issuer’s pledged receivables and inventories. Usually, the receivables are pledged and the issuer may borrow against 80%, give or take. Inventories are also often pledged to secure borrowings. However, because they are obviously less liquid than receivables, lender advance rates are less generous. Indeed, the borrowing base for inventories is typically in the 50% to 65% range. In addition, the borrowing base may be further divided into subcategories—for instance, 50% of work-in-process inventory and 65% of finished goods inventory. In many receivables-based facilities, issuers are required to place receivables in a “lock box.” That means that the bank lends against the receivable, takes possession of it, and then collects it to pay down the loan. In addition, asset-based lending is often done based on specific equipment, real estate, car fleets, and an unlimited number of other assets. STRUCTURED LOANS IN EUROPE 17 1.11 Loans derivatives 1.11.1 Loan credit default swaps Traditionally, accounts bought and sold loans in the cash market through assignments and participations. Aside from that, there was little synthetic activity outside over-the-counter total rate of return swaps. By 2008, however, the market for synthetically trading loans was budding. Loan credit default swaps (LCDS) are standard derivatives that have secured loans as reference instruments. In June 2006, The International Settlement and Dealers Association issued a standard trade confirmation for LCDS contracts....
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