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A manager's role in bankruptcy.

Managing property has always required adapting to a variety of internal and external factors. Unfortunately, many property managers in today's turbulent real estate markets have found it necessary to adapt to a disturbing new external circumstance--bankruptcy.

Increased management involvement is required to continue the effective day-to-day operation of a property, while dealing with legal and administrative aspects of the bankruptcy proceeding.

Bankruptcy overview

Bankruptcy is designed to provide relief to debtors, whether individuals, corporations, or other legal entities, when they are unable to pay their debts at current levels. There are two options available for those considering bankruptcy.

A Chapter 7 bankruptcy requires liquidation of the debtor's non-exempt property by a court-appointed trustee, who administers the bankruptcy estate. Creditors look to the proceeds of the sale of assets to satisfy their claims.

The other forms of bankruptcy, Chapters 11 and 13, are intended to allow the debtor to rehabilitate and reorganize, rather than liquidate, assets. Creditors in these cases look to the debtor's future earnings to satisfy their claims.

This article will deal only with the management of properties in Chapter 11. Further, it will deal only with those cases in which the owner/debtor is allowed to continue to operate the property while formulating a plan of reorganization (debtor-in-possession cases).

Technical requirements

Each region of the United States is supervised by a U.S. Trustee, who, in turn, delegates the responsibility for cases in each judicial district to Assistant U.S. Trustees. Each of these trustees may promulgate rules for debtors in his or her region. The technical requirements mentioned below are consistent with the rules in the judicial districts of Kentucky and Tennessee. You should consult legal counsel or the U.S. Trustee's office in your district for local rules.

Although the rules apply to the debtor, you as managing agent of the debtor's property will typically share the burden of compliance. (Note that the nature of the decision to file often precludes a manager having any advance notice.)

Once the debtor (your client) files a petition for reorganization:

* Payment of all existing debts or obligations, with a few court-approved exceptions, is prohibited, or "stayed."

* The management will generally be required to supply a schedule of the 20 largest unsecured creditors, their addresses, and the nature and amount of each of their claims.

* Evidence of insurance must be supplied to the trustee.

* All existing bank accounts must be closed at the moment the bankruptcy petition is filed and new "debtor in possession" accounts must be opened at an approved depository bank.

* A voided sample check with the required "debtor-in-possession" imprint must be supplied to the court.

* Applications for the employment of any professionals, such as lawyers, accountants, and appraisers, must be submitted to and approved by the court.

* All executory contracts--most notably, your management contract--must be accepted or rejected.

Generally, the trustee will conduct an initial debtor's conference within ten days of the filing. If requested by your client and the trustee, it is very helpful for you to attend this conference.

It is important to establish a good working relationship with the trustee and address any questions you may have on the front end. For example, the trustee may agree to accept your standard operating reports, rather than requiring the use of prescribed monthly and quarterly forms.

Management challenges

Although bankruptcies are being filed in record numbers, the subject is still foreign to many people with whom you, as the property manager, will have to negotiate, including your staff, vendors, contractors, and tenants.

Your most immediate concern is to inform and educate your staff about what bankruptcy entails. Even though many properties emerge none the worse from reorganizations, your staff will most certainly feel anxiety and apprehension about the ultimate fate of the property, their job security, and the often protracted legal proceedings involved. Your task is ongoing because typical proceedings can last a year or longer.

Your next priority should be the vendors and contractors affected, particularly those with whom you have long-term working relationships. There is a critical need to remind contractors and vendors of your agency status, especially if you use them for other properties. Nevertheless, some vendors will somehow feel you are responsible for the bankruptcy, at least morally, and will refuse to work with you.

For those that agree to continue supplying the property, some will no longer extend credit. Even in those cases in which it is highly probable that creditors' claims will be paid in full, the time required to have a reorganization plan approved is often too long in the eyes of those affected. As a result, long-term vendor/contractor relationships can be seriously jeopardized.

Moreover, even if the debtor proposes a 100-percent plan, it will schedule payments to vendors over time in order to ensure they are an impaired class for "cram-down" purposes.

The bankruptcy code gives the debtor/owner the exclusive right to file a plan of reorganization for up to 120 days, and the court may extend the deadline for cause. Practically speaking, the debtor may wait much longer unless the case is moved sooner by the court or by creditor pressure.

Subsequent motions, changes to the plan, and other legal proceedings can easily result in there being no distributions to creditors for a year or longer. Even then, 100-percent plans can provide for full payment over time, often several years, further delaying ultimate action to satisfy the claims of those involved.

All but the largest of these creditors will probably be unfamiliar with bankruptcy proceedings, and much of the property manager's time will be spent educating and reassuring those vendors and contractors on which the property manager depends, not only to service the bankrupt property, but perhaps many other properties in the manager's portfolio.

The property manager should be particularly careful that all trade accounts are properly opened in the appropriate property's name. Many vendors tend to lump all properties managed by an agent into one account. As noted above, credit problems with any one of the properties in the manager's portfolio can be disastrous.

Lastly, you should be prepared to briefly discuss the situation with tenants. Most cases receive little publicity, and residential tenants are usually unaware that a bankruptcy has been filed. Commercial tenants are more likely to be impacted, particularly if involved in lease negotiations or tenant improvement projects.

Determine those affected, and discuss their situations immediately. A general announcement to all tenants, unless they are all impacted, is usually not warranted. In any case, it is important to be as forthright and informative as possible.

Perhaps the best way to understand the many issues and decisions facing the manager of a bankruptcy property is by reviewing the following real-life case study.

Case study

Shady Meadows (a fictitious name) is a 250-unit apartment complex in the Middle Tennessee area. The property was built in phases between the late sixties and early seventies. It was acquired by the present owners, a limited partnership, in 1984 for a purchase price far in excess of its debt; thus, the debtor is concerned about preserving the property for the limited partnership.

The partnership's original objective was to convert the apartments to condominiums. The conversion market deteriorated, however, and management recommended that the owners abandon their original objective and continue to operate the property as apartments until a buyer could be found and the partnership liquidated.

This decision virtually coincided with the passage of the 1986 Tax Reform Act. Acquisition of the property had been financed by short-term bank debt and assumption of an existing mortgage in anticipation of conversion to condominiums and sale. Therefore, in mid-1986, it was restructured with a loan of approximately $3 million amortized over 30 years, with a balloon payment due after four years.

Efforts to sell the property began with offers presented as early as January 1987. However, the market had been overbuilt and values were depressed by both lower net operating incomes and drastically reduced tax benefits. No satisfactory offers were received. Marketing efforts continued, subjecting on-site management to repeated property inspections and recordkeeping audits.

Although a sale was pending in mid-1989, work was also underway to refinance the loan, which was to mature in November. The pending sale had hampered an aggressive leasing program, and vacancies had increased to a high of 20 percent by June.

When this sale fell through, marketing efforts were renewed, and vacancies declined to 8.5 percent by November. The lender had agreed to an extension of the loan for two months, while an application for a new loan was in process with a government programs lender.

The day before the loan request was to go to a committee, the government program declared a lending moratorium in this market. The existing lender refused an additional extension, declared the loan in default, and advertised the property for foreclosure. Subsequently, the owner filed a Chapter 11 bankruptcy petition.

Concerned that the lender, who had scheduled a foreclosure sale of the property, would be tipped off and take further action to ensure that the rents generated from the property would become its cash collateral, the decision to file was not widely disseminated. A foreclosure sale can be conducted in Tennessee after advertising for three weeks, so the owners had very little time in which to act. As a result, the managing agent had very little notice that a bankruptcy petition would be filed.

This illustrates a serious dilemma for the property manager. The property must operate day-to-day, incurring normal operation expenses with regular suppliers and contractors. The managing agent authorizes and directs this work in good faith, then discovers that all expenses incurred prior to the filing of the bankruptcy petition are pre-petition obligations and thus cannot be paid until a reorganization plan is approved.

Obviously, it is critical that the property manager's relationship as an agent for the owner be established on the front end of any new management account. Unsecured repetition creditors will otherwise be inclined to look to the property manager for payment.

At the time of filing for Shady Meadows, there were over 60 creditors with payables totalling just over $200,000. This included two liens for construction services and materials which the contractor originally sought to collect from the property manager. It also concluded invoices for over $4,500 from a vendor that sued the management firm rather than the property based on an ambiguously completed credit application.

In many cases, the relief provided in a Chapter 11 reorganization results in only partial repayment to pre-petition creditors. In other cases, such as Shady Meadows, the property operation is economically sound, and creditors receive full repayment of their pre-petition claims. The owner's intent, however, to file such a plan (a "100-percent plan") is often not enough to placate many vendors and contractors.

Another educational task involved the Shady Meadows staff. The property had five full-time and two part-time employees. The property manager immediately called a meeting on-site after the petition was filed to explain the procedure to the employees, to reassure them as to the probability of continued employment, and to answer any questions. This type of communication was necessary frequently during the 11 months that Shady Meadows operated in Chapter 11 status.

In spite of repeated explanations and reassurances, the bankruptcy process is extremely technical and complex, and anxiety of the staff is inevitable. It is imperative that the property manager be sensitive to this very critical element in the continued operation of the property.

Establishing responsibilities

The requirements of the U.S. Trustee added to the property manager's role. Within ten days of the filing of the Chapter 11 petition by the owners of Shady Meadows, the initial debtor's conference was conducted by the trustee.

The property manager had moved to have the management agreement (an executor contract) assumed by the trustee. This required at least a 20-day period during which objections by the creditors are allowed. Assumption is necessary to preserve your contract and to allow for continued payment of post-petition management fees as ordinary business expenses of the property.

The property manager in his agency capacity also moved to be recognized by the court as one of the "natural persons" allowed to answer for the owners of Shady Meadows.

At the debtor's conference, the owner gave a brief history of the property. The attorney provided preliminary schedules and declarations required by the court. The property manager supplied documents relating to the status of insurance coverage and the opening of new bank accounts evidencing the property's "debtor-in-possession" status and bankruptcy case.

The trustee reviewed the monthly reporting requirements with the property manager and informed the manager that monthly operating reports and financial statements must be filed with the trustee by the 15th of each month. The trustee also may agree to the use of the property manager's reporting format for Shady Meadows.

A threshold issue in Chapter 11 cases is the debtor's right to continued use of rents collected. Lenders will always have a security interest in the property itself, but also will usually have an interest in the property's leases and rents. This money may then be termed as "cash collateral," which requires lender approval even to pay ordinary business expenses after the filing.

In the case of Shady Meadows, the question of cash collateral was not determined by the court for several months. In the interim, an emergency order from the court was necessary to conduct the daily operation of the property.

Every issue in the Shady Meadows case was contested by the lender, requiring a court decision in each instance. In some cases the lender and the debtor/owner agreed to the many issues involved. Nevertheless, these agreements had to be approved by the court.

The final reporting requirement for the property manager is a quarterly fee report to the U.S. Trustee's Office. A fee based on total disbursements from the bankruptcy estate must be paid each quarter. Failure to file this report or any other required report in a timely manner can seriously jeopardize the owner's case.

Planning for turnaround

Central to a Chapter 11 case is the owner's plan of reorganization. Initially the debtor has 120 days in which it may exclusively propose a plan to repay the pre-petition obligations, both secured and unsecured, and continue to operate as a viable business.

After the 120th day, creditors may also propose a plan. Obviously each creditor's plan is favorable to the creditor who files it and usually seeks to vest title in the property in the creditor or a creditor's affiliate.

The bankruptcy code requires that all creditors be treated at least as favorably as they would if the debtor's property were liquidated and the proceeds were distributed. This requirement does not guarantee that all creditors receive full repayment of the obligations owed them, however.

Typically, the most difficult issue is the treatment of the lender's mortgage. Shady Meadows proved to be an "oversecured" case--one in which there was considerable equity in the property above the mortgage. Appraisers for the lender and the debtor ultimately agreed upon a value of approximately $4 million, compared to the mortgage of approximately $3 million. This scenario resulted in use of what is known as the "cram-down" provision of the bankruptcy code.

In a cram-down, an oversecured lender may be forced by the court to extend financing under specified terms to the debtor consistent with the debtor's plan of reorganization as approved by other creditors.

The property manager often plays an integral role in assisting the debtor/owner in the formulation of a plan. One of the first tasks in the Shady Meadows case was the preparation of a projected operating budget for a 12-to-18-month period. Great care must be given to this projection, as this budget may well be one that the property manager is required to strictly follow over the term of the year.

One-, two- and three-year scenarios were proposed in the Shady Meadows case, as different plan terms were evaluated by the owner and his attorneys. The property manager was required to give depositions on two occasions and to appear in court numerous times, in order to explain and defend these budget projections.

The proposed plan of reorganization for Shady Meadows was ratified by all unsecured creditors as originally proposed. In most instances the creditors were to be repaid in full within six months of the effective date of the plan. Ultimately, they were paid within two months.

The lender opposed the plan, effectively delaying the approval by four months. On the eve of the final hearing, the lender agreed to terms that amortized all interest accrued during the case and all its attorneys' fees and costs over four years at a competitive market rate. The effective date of the plan was nearly 11 months after the case was filed.

Lessons learned

"Single-asset cases," ones in which the debtor's obligations are secured by only one property (such as Shady Meadows), are relatively straightforward. More complex cases often take much longer to resolve. Most Chapter 11 plans provide for less than full repayment to creditors over a term of at least three years.

In many instances the case dies, it is dismissed, or the principal secured creditor obtains relief from the automatic stay and forecloses on the premises. In such cases unsecured trade creditors receive nothing, and accrued management fees remain unpaid.

Particular mention should be made here of the extra demands on a property manager's time during a bankruptcy, including marketing efforts designed to improve occupancy levels. The Shady Meadows case required nearly 100 hours of additional attention from the property manager, as well as extra hours from many others on the management team.

Consideration should be given to providing for additional compensation in your management agreement in the event the property is involved in a bankruptcy proceeding. However, because the assumption of an executory contract required that the agreement be assumed "without modification," the extra management fees, if not deemed to be an illegal "ipso facto" bankruptcy clause, may be unpalatable to the court, to the U.S. Trustee, or to creditors of the bankruptcy estate.

The bankruptcy code provides for the retaining of certain professionals--i.e., attorneys, appraisers, and accountants--who are considered "administrative expenses" and are given certain priority status in the administration of the case. Such appointment requires approval by the court, and documented fee applications must be submitted and approved by the court before payment can be made.

Although there is some risk that your management agreement might not be assumed, which would relegate any repetition management fees due to unsecured creditor status, it would appear that the property manager's compensation is best addressed in the management agreement rather than in applying for appointment as a professional in the case.


A bankruptcy creates many challenges for the property manager. While satisfying the owner's goals and objectives is always foremost, the property manager must now deal with technical requirements of the court, apprehensive staff, frustrated or angry vendors/contractors, and curious tenants.

The job is a demanding one and is one in which the skills of a professional property manager are particularly important to ensure successful operation of the property.

Woody Camp, CPM |R~, is senior vice president and legal counsel for First Management Services, a full-service management firm based in Nashville. He is licensed to practice law in Tennessee and holds real estate broker's licenses in Tennessee, Georgia, and North Carolina.
COPYRIGHT 1993 National Association of Realtors
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Copyright 1993 Gale, Cengage Learning. All rights reserved.

Article Details
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Author:Camp, Woody
Publication:Journal of Property Management
Date:May 1, 1993
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