Senate bills target bankruptcy reform.

Congress is focusing on a bankruptcy reform package that could significantly affect lending and workouts.

In Mid-June the U.S. Senate voted 97-0 in favor of an entire bankruptcy amendment package. The House of Representatives's Judiciary Committee has held some hearings on the subject including one last week. Among the principal issues considered by this Subcommittee were the impact of recent court decisions and economic developments on operation of the reference automatic stay rules applicable to Chapter 11-the Bankruptcy Code's commercial debtor reorganization provisions. A decision to move forward with legislation will be made when Congress returns from its recess. Whatever they come up with will go through a conference committee for agreement on one package to present to the entire Congress.

Philip Corwin, director of retail banking for the American Bankers Association, said he believes the only way to get such a measure passed is to put together a package that is non controversial. The House is trying to come up with its own proposal, he said, noting that the lopsided vote in the Senate indicates that something will be passed.

Certain proposed provisions could affect bankruptcies which involve single asset real estate owners -- such as corporations or partnerships established for the purpose of owning an asset such as a building or shopping center. If the changes are adopted, Edelstein said, they will be the most significant changes since the bankruptcy code was amended in 1978.

While the Senate bill is very pro lender, because the credit crunch still exists, Mark S. Edelstein, a partner in the real estate workout and bankruptcy group of Milbank Tweed Hadley & McCloy, believes it will help real estate financing in the long run by making it clear what the rules are, particularly for disbursing income.

Corwin said: "This will make banks more comfortable in their lending which will ultimately affect real estate. No lender today cannot take into consideration where they are going to stand if there is a bankruptcy. Some of the abuses perpetrated in bankruptcies don't encourage lenders to make loans."

If lenders are assured of expedited procedures, Corwin said, "They won't be gun shy in making new loans."

But given the oversupply of commercial real estate, he warned, "I don't think that is enough to get new money out there for projects. No one is going to make a loan on a building that needs $40 a square foot to break even when the prevailing market is $20." Corwin also expressed some surprise that the real estate community has not objected to some of the changes. Cary Brazeman, a spokesman for the National Realty Committee, said they are aware of the measure but are not going to take a position on it.

Edelstein said one provision in the Senate bill would allow lenders to continue a foreclosure action through the moment of obtaining a judgment.

"The bankruptcy filing, under the proposal, would not automatically stay the foreclosure as it does under current law," he noted.

Another provision will change the preference period, which outlines how long a lender must hang onto collateral before a bankruptcy proceeding to consider it theirs. Case law, in some instances, has expanded this period from 90 days to over a year and this legislation would set by statute the 90-day period.

Other provisions Congress is considering deal with the actions a lender must take to "perfect" its interest in rents from income producing properties for purposes of obtaining "cash collateral" protection in the event of a subsequent bankruptcy filing.

Because the law regarding rent perfection prior to a bankruptcy filing varies from state to state, and the application of Federal bankruptcy standards to a particular situation is usually uncertain, Edelstein said, lenders rarely know with absolute certainty whether they will have an adequate claim to rents in a bankruptcy proceeding.

He said the law is "confused" around the country as to the steps needed to allow a lender to have a claim in the rents and not have them retained by the debtor to pay for the bankruptcy and other costs.

There are similar issues for those who lent to hotels and resorts. "Hotels are an odd bird," Edelstein explained. "They are not as much real estate as they are a business."

In many jurisdictions, recording a mortgage or an assignment of rents will not perfect a security interest in favor of the lender in room revenues.

This is because these revenues are viewed by most courts as accounts receivable, generated from services rendered by the hotel owner. So to perfect an interest in these revenues, a lender must file a U.C.C. financing statement.

In many cases, he said, lenders learn too late that their counsel recorded only the mortgage and assignment of rents but failed to file the U.C.C. "In workouts, some lenders learn the hard way that they do not have a lien on room revenues," Edelstein noted.

Even if the lender's counsel perfected its lien in room revenues appropriately, this is no guaranty that the lender will have a claim to those revenues generated after a bankruptcy filing, he warned.

"Under the bankruptcy code," he said, "accounts receivable -- such as these hotel room revenues -- created after the commencement of the bankruptcy case -- are not covered by liens granted prior to the case."

Corwin said the Bankers remain optimistic that a bankruptcy bill will be sent to this president. "If we get it to him he'll sign it," he said.