Episode 2: Foreclosures and Bankruptcy in the Age of COVID

     

Bilzin Sumberg attorneys Jeffrey Snyder and Jake Greenberg discuss the nuances of foreclosures and bankruptcy as the economy emerges from the coronavirus pandemic and grapples with its fallout. They cover current developments related to this area of the law, and conduct a deep dive into a case with key takeaways for both lenders and business owners.

Transcript:

GREENBERG: Hello everybody. I'm Jake Greenberg, an attorney in Bilzin Sumberg's Litigation Group.

SNYDER: And I'm Jeffrey Snyder, a partner in Bilzin Sumberg's Business, Finance & Restructuring Group. We'd like to welcome you to Bilzin Sumberg's interview series, Opportunities in the New Reality: Asset Distress and Revitalization, where we explore timely and salient issues as they relate to distressed assets from both a business and legal perspective.

GREENBERG: Today we're going to explore the dynamic and sometimes complex interplay of foreclosures and bankruptcy. The COVID-induced recession has led to a dramatic rise in distressed assets that has affected the economy, which has only served to underlie the multifaceted nature of dispute resolution.

SNYDER: As a result of the pandemic-driven downturn, we are likely to see an uptick in foreclosures and bankruptcies in the near future. So it's important to understand the nuances of commercial foreclosures and bankruptcy proceedings. We hope that this discussion will be informative and timely for all relevant players in the business community.

GREENBERG: All right, Jeff, let's start off with an overview. What have you seen that's changed between the current economic crisis and the great recession in 2008?

SNYDER: Well, that's a good question, Jake. Many things are different this time around. The 2008 recession was systemic, created by pre-existing economic weakness, and had its origins in the global financial system, which led to a liquidity crisis. In 2020 it's a bit different. The downturn was caused by a global health crisis which is an experience that is global in application and has a disparate impact on certain industries. It didn't result in a lack of capital in the marketplace in the same way that occurred in 2008. To the contrary, although there are plenty of defaults that have been caused by the pandemic, there are very few distressed asset deals out there that are trading at substantial discounts. And there's plenty of money in the marketplace chasing the few deals that are out there.

The 2008 crisis was preceded by a loosening of underwriting standards, and thus loans were made with low loan to value ratios. When the crisis struck, these loans were quickly underwater, and were not refinance-able in 2008. But in 2020, the loans in the marketplace were generally underwritten to higher standards, which means that fewer loans are wildly underwater at this point. To me, this suggests there will be more loans that can be worked out, particularly once we have a better understanding of what the post-pandemic world looks like, particularly for office, hospitality and retail. And at least for some sectors such as travel, there may be pent up demand and the recovery may occur more quickly than expected. But there will also be an overhang to the extent that businesses owe back rent or mortgage payments, for example, or consumers need to dig out from their own similar situations.

GREENBERG: You know, Jeff, you raise a lot of important points. And of course, the current pandemic's impact on the economy is hopefully a once in a lifetime occurrence, but it is one that lenders were prepared for in light of the 2008 crisis. Like you mentioned there, the underwriting standards have improved since 2008. And the loan to value ratios provided to lenders in today's economy are much better than they were in 2008. However, that's led to the lenders being in a more unique position of deciding whether they want to continue financing the borrower with a working asset, or pushing the borrower towards a refinance. In the latter situation this could leave lenders with excess cash and no deals on the horizon. In light of this, some lenders are providing attractive workout options to keep their investments while others prefer to avoid the risks and pull out through refinancing.

Following up on that, we should discuss how the foreclosure and eviction moratoriums affect lenders and the impact such orders will have on lenders on a forward looking basis. From my perspective, the impact of these foreclosure and eviction moratoria varies by jurisdiction and by situation. Many are limited to residential payment defaults, but some are more far reaching. The problem with these orders is that the lender or the landlord answers to someone also and they too have expenses. The landlord may have a mortgage and whatever is owed and is continuing to accrue, and that overhang may be with us for a long time to come.

SNYDER: That said, with the loans and the properties that we are dealing with, I've not seen a rush to exercise remedies anyway, particularly where a borrower or a tenant is making some effort to cover operating expenses or to pay some rent, as compared to situations where the lender is being forced to advance to protect their interests of the property. And commercial landlords are not exactly flush with alternatives at the moment. And lenders are being reasonable as long as the borrower is continuing to support the property. Once the economy reopens, this will start to change and we will see more longer term workouts as well as more foreclosures and bankruptcies where the parties cannot come to terms. I'm starting to see this slowly happen over the past few weeks, and I think the trend will begin to accelerate as we get later into 2021.

GREENBERG: So as you mentioned, as the economy reopens, we will see more longer term workouts, but also foreclosures and bankruptcies. Now, when you mentioned bankruptcies, I understand that's one final step that borrowers can take to prevent or delay a foreclosure sale. Well, what can lenders do to protect their interests pre-bankruptcy?

SNYDER: That's right. Bankruptcy is often a last resort used by a borrower to avoid foreclosure, either for the purpose of buying time to attempt to complete a sale or refinancing, or is an attempt to adjust terms or extend repayment over time either by forcing an agreement or by using the bankruptcy code in the bankruptcy court to try and impose those types of adjustments on the lender non-consensually. Often filing bankruptcy triggers liability to a sponsor or guarantor. But in a situation where the sponsor believes the property is worth more than the debt, the risk of liability under the guarantee may not be a sufficient deterrent to prevent a filing. Loan documents also often require that an independent director or manager sign off on a bankruptcy filing, which can be an obstacle or delay a sudden decision to file in that it requires that that independent director consider the interests of the borrower itself as opposed to perhaps the sponsor or the larger enterprise.

Other than requiring steps like an independent director in the loan documents and making the filing of a bankruptcy a trigger on a guarantee, a lender should make sure its ducks are in a row as far as perfection of its security interests and the like. But there's not much else a lender can do to stop a borrower from commencing a bankruptcy case, as public policy prevents a borrower from agreeing to waive its bankruptcy rights in advance. That said, once the loan is in trouble, out of court workouts can be informed by what options might be available in bankruptcy. And if a truly comprehensive deal can be reached out of court, that is analogous to what might be achieved through a bankruptcy plan.

It is possible in that context to get a potentially enforceable waiver of the ability to get another bite at the apple in subsequent bankruptcy. Just prior to the pandemic, we had such a matter with similar facts. After a loan had matured, the lender and borrower had negotiated a forbearance to allow the borrower additional time to sell or refinance. And when the borrower failed to do either of those things, the lender sought to foreclose. Once the case got to summary judgment, the lender again reached an agreement with the borrower this time in exchange for consensual summary judgment. The lender agreed not only to forbear from proceeding to enforce the judgment, and to not study foreclosure sale for several months, but also agreed upfront to a discounted payoff during that standstill time period. In order to help the borrower go out to the marketplace and facilitate a sale or refinance and promise not to seek to recover the difference from the guarantors.

The borrower, though ultimately did neither of those things, and instead eventually put its parent into a bankruptcy case, which was followed by on the eve of the foreclosure sale, putting the borrower itself into a bankruptcy. In both the first and second forbearance agreements, the borrower had agreed to waive the automatic stay in the event of a future bankruptcy. On the strength of those facts, we were able to persuade a bankruptcy court to honor that agreement and to grant stay relief to permit the lender to reset its foreclosure sale, which was concluded as soon as foreclosure sales resumed during the pandemic.

It's very difficult to enforce a pre-bankruptcy waiver of the automatic stay or other rights in a future bankruptcy, but it's not impossible. This case was unique in that the lender had given the borrower substantial additional time on two separate instances, and a discounted payoff, which was more than just a short 60 or 90 day extension, but a real workout opportunity. The borrower agreed to waive the automatic stay twice with the advice of well-qualified counsel that is known to the bankruptcy court and understood the ramifications of what was agreed to. By the time we got to the hearing, two years had passed since the original maturity and the borrower was still offering basically more of the same and not a real concrete strategy. The takeaway is that bankruptcy courts value real workouts outside of bankruptcy, and that these type of provisions can be enforced under the right circumstances and should be included when a lender provides a borrower with substantial relief outside of or in advance of a bankruptcy.

GREENBERG: Yeah, I recall that case. I agree those were very unique facts. However, one thing I think lenders can learn from it is that bankruptcy courts really want to see that borrowers had a true and meaningful chance at a workout. In that case, I recall that the judge put a significant focus on the fact that the lender had already provided the borrower with multiple opportunities, significant time to sell the property or obtain refinancing, as well as you mentioned, the discounted payoff. It was in light of those unique facts that the judge granted us the relief from the automatic stay. But the takeaway is that a pre-petition waiver of the automatic stay will not be enforceable unless the lender makes significant concessions.

Jeff, thanks very much for your time today in this excellent discussion. I think we've shed a lot of light on a topic that's so important in today's economy that appears opaque to so many outside the legal profession. To our audience, thank you for tuning in. We look forward to bringing you the next episode of our series Opportunities in the New Reality, Asset Distress and Revitalization.