With a host of commercial real estate owners likely to declare chapter 11 bankruptcy as a result of the coronavirus pandemic, organizations that lend to these companies should keep one thing in mind: bankruptcy court judges are aware of the unprecedented economic damage of COVID-19—and they handle cases as such.

In good times and bad, there are many ways a commercial real estate owner might end up in bankruptcy—loss of a major tenant, inability to lease a property in the time period originally projected, construction delays, construction cost overruns, etc. Lenders tend to act quickly once the filing happens and they often seek relief from the automatic stay implemented at the commencement of the bankruptcy. If it’s granted, they can move forward with foreclosure proceedings in state courts and obtain clear title on the property. 

The bankruptcy court judge, in making the decision about the relief, considers a host of factors, including the value of the property compared with the amount of indebtedness secured by the property. The lender will assert that the equity cushion—the difference between the value of its collateral and the amount of the claim—is negative (or rapidly declining) and thus demand “adequate protection payments” to be kept at bay. That, of course, would defeat the reason why the borrower sought bankruptcy protection in the first place. 

There’s also the thorny issue of valuation, namely whether the property should be valued in the current moment or based on a fair assumption of the property’s worth when market conditions improve. Valuation in a “once in a hundred year” market doesn’t make sense, and a lender could conceivably take advantage of other large parties in interest who also have large stakes in the property. Regardless, the drafters of the bankruptcy code never anticipated the shutdown of the economy that we are seeing. 

Additionally, the bankruptcy code was designed to preserve value whenever reasonably possible, which is inconsistent with permitting foreclosure at the bottom of the market. Bankruptcy judges should (and probably will) ask the question “What can the lender do with the property that the borrower is not doing?” If the borrower is a mall operator—and the lender is not—the answer is fairly obvious. 

With all of this as a backdrop, lenders should remember that bankruptcy judges take current events into account in their decisions during times of economic hardship—particularly in unprecedented moments. We saw that after the Sept. 11, 2001, terrorist attacks and after the global financial crisis. 

Generally speaking, equitable considerations prevent bankruptcy judges from contravening express provisions of the bankruptcy code. But they do exercise the equitable powers granted to them to provide relief where Congress has been silent or to further the congressional intent behind the code. And while these judges are bound by precedent, they also understand business and finance—to say nothing of current events. 

Judges also appreciate alternative dispute resolution procedures such as mediation or settlement conferences and they know how to control their calendars and interpret the law to bring about a fair outcome. We’ve already seen examples of this sort of discretion from bankruptcy judges in the early days of the coronavirus pandemic. 

Recently, some wise jurists permitted chapter 11 cases to be suspended when the borrower couldn’t control its circumstances and environment amid the COVID-19 pandemic, which is far from unusual these days. Some of these decisions have occurred when granting the lender relief that it seeks would not necessarily benefit the lender—or would disproportionately benefit the lender at the expense of other parties. 

Those instances showed judges who were being wise and fair, and it lends credence to the idea that bankruptcy judges are a combination of social workers, financial engineers and lawyers. 

Those qualities are especially important in unprecedented moments like the one we’re living in. And if the proper message is sent clearly to real estate lenders, they will properly calibrate their actions regarding bankrupt properties—and possibly avoid some messy disputes. 

Reprinted with permission from the April 21, 2020, issue of GlobeSt.com. © 2020 ALM Media Properties, LLC. All Rights Reserved. Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 - reprints@alm.com.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

Click here to view the full article