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Ruling on bankruptcy financing cheered.

A recent U.S. Bankruptcy Court ruling has sent shock waves through the institutional lending community and has opened a brand new approach to refinancing distressed properties. It is likely to make a major impact on single-asset bankruptcies in which new capital is required to rejuvenate the asset.

The court ruled that shareholders of a single-property corporation under Chapter 11 bankruptcy protection could make a loan to a corporation, secured by senior liens, for the purpose of making necessary property improvements, over the objections of the existing mortgagees.

The decision - on a motion filed by our firm before a U.S. Bankruptcy judge in the Southern District of New York - paves the way for owners of an under-secured property to inject their own rescue capital into a workout from the position of secured lenders, superseding the existing mortgage-holders.

The case in question involves 495 Central Avenue Corporation, which an office and retail building at that address in Scarsdale, New York.

John Hancock Mutual Life Insurance Company, which holds a $3.95 million mortgage on the property, had vigorously opposed granting the new lenders senior secured status.

In its historic ruling, the court said the property owner had demonstrated that new financing was necessary to put the building on sound footing and could not be obtained in any other way. He also found that the existing mortgage holder had adequate protection because of the material improvement in value that would result from the funding. Under those conditions, a senior priority loan from a new lender is not prohibited by the Bankruptcy Code.

The case is expected to have broad ramifications in bankruptcy proceedings involving single-property real estate entities-including limited partnerships - that have under-secured debt. Among other things, it should give owners more flexibility in workouts and cause a chilling effect on the negotiating positions of under-secured creditors.

As an indication of the interest this relatively unpublicized case already has stirred, our firm has so far received inquiries from law, schools at the University of Texas, the University of Washington and Indiana State University, where articles and papers are under preparation. In addition, since the court's ruling was published in legal reporting journals, we have responded to no fewer than 50 requests for copies of the full decision.

The Central Avenue building was purchased early in 1991 and quickly ran into trouble as the economy faltered. Two large tenants, one retail and one office, fell seriously behind in their rents, and by mid-1991 the owner was in default of the mortgage held by Hancock. in addition, the appraised value of the building had fallen to a point significantly below the mortgage.

In seeking court permission for the new secured financing, we argued that 495 Central Avenue had concrete opportunities to obtain new long-term, credit-worthy tenants, but only if it could make about $600,000 of structural changes and improvements to accommodate them. The owner had made a diligent but futile effort to find a lender who would accept a junior position to the first mortgagee. The only remaining course of action was the loan from the shareholders.

It also was demonstrated that with the building improved and the rent roll restored, the increase in the property's appraised value would exceed the amount of the new loan. Therefore, Hancock's interest would be adequately protected, within the meaning of the Bankruptcy Code.
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Title Annotation:shareholders of single-property corporation under Chapter 11 protection allowed to make loan to corporation for property investments
Author:Rattet, Robert L.
Publication:Real Estate Weekly
Date:Jul 22, 1992
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