A federal appeals court's recent decision in the case of a Los Angeles property owner and its network of subsidiaries provides lenders with some leverage over commercial real estate companies trying to restructure in Chapter 11.
A three-judge panel of the Ninth U.S. Circuit Court of Appeals affirmed a lower court ruling that found a bankruptcy judge erred when she ruled that a subsidiary of Los Angeles real estate developer Meruelo Maddux Properties Inc. couldn't be split off from its parent company's Chapter 11 case.
Meruelo Maddux, a big Los Angeles real estate developer, had created the subsidiary, a special purpose entity known as MMP Hill, which owned a Los Angeles apartment complex called Union Lofts. Bank of America Corp. had loaned Union Lofts owner $28.7 million in 2006.
When Meruelo Maddux, along with more than 50 subsidiaries, filed for Chapter 11 in 2009, Bank of America sought a court order that the subsidiary was a "single-asset real estate" company.
Under bankruptcy law, these companies are on a shorter leash than a typical debtor: they must submit a Chapter 11 plan within 90 days of a bankruptcy filing or start making monthly interest payments to their lenders. Otherwise the lender can move to foreclose.
The bankruptcy court rejected Bank of America's request, finding the subsidiary was part of "whole business enterprise" and was too intertwined with the affairs of its parent. A district court reversed the decision, which the developer appealed.
"We agree with the district court, and we hold that the plain language of [the law] gives no basis for a 'whole business enterprise' exception," Judge Ronald Gould wrote in a Jan. 27 opinion. "Absent a substantive consolidation order, we must accept MMP Hill's chosen legal status as a separate and distinct entity from its parent corporation and sister subsidiaries, and look only to its assets, income, and operations in determining whether Union Lofts is single asset real estate."
The decision, lawyers at Dechert wrote in a recent client update, could "provide powerful rights" to commercial property lenders. It could also mark a new round of talks between property owners and investors in commercial real estate.
Like many big commercial property owners, Meruelo Maddux structured its business as a network of special purpose enterprises, each owning a single piece of real estate.
Such single asset structures are common in the securitization of commercial real estate assets, where a subsidiary owns just one mall or hotel and generates substantially all of its income from a single property. The idea behind the single purpose structures is to help prevent the financial woes of one affiliate from dragging down another.
Meruelo Maddux sought Chapter 11 protection in March 2009 as the real-estate market spiraled downward. At the time the company was known as the largest property owner in downtown Los Angeles, holding industrial, mixed-use and residential buildings in the city and elsewhere in Southern California.
Richard Meruelo and John Maddux lost control of the real-estate development firm they founded when the company emerged from Chapter 11 last year following a bitterly contested bankruptcy fight. They've appealed a bankruptcy court order approving a Chapter 11 plan that gave control of the company to Charlestown Capital Advisors LLC and Hartland Asset Management.
