A NEW COMMERICAL LENDERS' BILL OF RIGHTS UNDER THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005

By Gordon L. Gerson, Esq.
GERSON LAW FIRM APC

August 20, 2005

While never a front page story, for almost the past ten (10) years, newspapers have reported Congress' inability to enact bankruptcy reform legislation. This year Congress delivered.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), while designed in most respects for consumer lenders, also includes provisions which will be deeply appreciated by commercial real estate lenders -- especially those who witnessed prior real estate down cycles and the morass, and often times the moronity, of a bankruptcy system that seemingly always protected the debtor.

BAPCPA amends Section 362 of the Bankruptcy Code. Section 362(a) of the Bankruptcy Code is what has historically been the bane of lenders when borrowers file bankruptcy.

Pursuant to Section 362(a), an "automatic stay" goes into effect immediately upon the filing of bankruptcy petition. The automatic stay effectively bars any action by a lender against the debtor or the debtor's property without obtaining a court order for release. Thus, upon the filing of a bankruptcy case, Section 362(a) precludes such matters as seeking appointment of a receiver, commencement or completion of a foreclosure proceeding, offsetting against deposits, and any other like actions. BAPCPA at its core, creates a lender's Bill of Rights. While most in the lending industry will say it does not go far enough, it still has created a "new world" for debtors believing they can create unlimited hurdles and delays against lenders, by filing Chapter 11 or other bankruptcy actions.

Major provisions of BAPCPA, greatly benefit commercial lenders, and it is important to understand its impact in the areas of "serial filings" and single asset bankruptcy cases.

1. Serial Filings and the Automatic Stay.

Those experienced in loan servicing remember the problem in prior down cycles, of a borrower filing bankruptcy, and the lender obtaining relief from the automatic stay to foreclose; and shortly after obtaining an order for relief from an automatic stay, the borrower filing another bankruptcy proceeding, or possibly transferring the property to another entity that files bankruptcy. Either event would necessitate again seeking an order for relief from the automatic stay. It was not outside the realm of most loan servicers' experiences, to have a property subject to three or four sequential bankruptcy proceedings. This became known as "serial filings". Under BAPCPA, there are several new subsections of Section 362 designed specifically at preventing the abuse of serial bankruptcy filings to prevent foreclosures (see Sections 362(b)(20) and (21) and 362(c)(3) and (4) and 362(i)).

Under new Section 362(b)(20), the automatic stay will no longer preclude enforcement of a lien against property if the automatic stay went into effect by virtue of a bankruptcy case being filed within two years after the entry or an order in a prior bankruptcy case dismissing that case as being part of a "scheme to delay, hinder and defraud creditors involving multiple bankruptcy filings or a transfer of an interest in the property not consented to by the secured creditor." Thus, there is now a burden upon the debtor who previously had a bankruptcy case dismissed as being part of a "scheme" as described above, to show good cause as to why an automatic stay should go into effect in the current bankruptcy case.

New Section 362(b)(21) provides a similar protection to lenders and creates a similar burden upon debtors in the event a debtor simply files a new bankruptcy case within 180 days after the dismissal of a prior bankruptcy case, or if the court entered an order in a prior bankruptcy case prohibiting the debtor from being a debtor in another bankruptcy case.

New Section 362(c)(3), when read together with Section 362(i), provides that the automatic stay is automatically lifted 30 days after the filing of a second bankruptcy case, unless the debtor can demonstrate to the court that it is acting in good faith.

New Section 362(d)(4) provides statutory authority for a bankruptcy court to enter an order for relief from stay in favor of a creditor whose claim is secured by real property. If the court finds that the filing of the bankruptcy petition was part of a "scheme to delay, hinder and defraud creditors involving either transfers of the property (or any interest in the property) without the secured creditor's consent or serial bankruptcy filings involving that property," then relief from the automated stay will be granted. This protection to lenders is commonly referred to by bankruptcy practitioners as "in rem" relief. In effect, in rem relief means that the remedy of the creditor follows the property no matter to whom it is transferred, as opposed to simply following the debtor. While the debtor may attempt to seek relief from the effect of an "in rem" order by showing good cause or changed circumstances, it will carry a burden in attempting to prove why it is not engaging in the filing of serial bankruptcy cases.

2. Single-Asset Real Estate Cases.

BAPCPA broadens protection to lenders in single-asset bankruptcy cases by amending two sections of the Bankruptcy Code.

Section 101(51B), as amended, provides the most significant benefit to lenders. Prior to BAPCPA, by definition a single-asset real estate case was one in which there was not more than $4 million of debt relating to the real property. Given that $4 million of debt is within many lenders' definition of a small loan, there was little true expectation among many lenders that protection would exist if a borrower on a larger loan filed bankruptcy. Section 101(51B), as amended, removes the cap.

Section 362(d)(3) provides that in single-asset real estate cases, the debtor must commence making monthly payments within 90 days after entry of an order for relief to each creditor with a real estate secured claim resulting from a negotiated loan, or that a plan of reorganization must have been filed by the debtor that "has a reasonable responsibility of being confirmed within a reasonable time." Section 362(d)(3), as amended, now defines payments as being an amount equal to interest at the applicable non-contract rate on the value of a creditor's secured claim (i.e., to the extent that the secured creditor's claim is not "underwater").

There are other provisions benefiting lenders under BAPCPA, including provisions relating to individual debtors. New Section 362(e)(2) provides for termination of the automatic stay 60 days after the filing of motion for relief from stay being filed, unless the court renders a final decision within that 60 day time period, thereby preventing relief to foreclose simply because decisions have not been made). Additionally, New Section 362(b)(24) validates foreclosure sales that occurred after the filing of a bankruptcy petition if the successful bidder is a good faith third-party purchaser without knowledge of the commencement of the bankruptcy case, paid the present fair equivalent value for the property at the foreclosure sale, and there being no copy of the petition or notice of the filing of bankruptcy recorded in the real property records.

The true significance of BAPCPA to the commercial real estate lending industry may not be known so long as the loan originators and loan servicers thrive in a robust real estate economy. Yet, while there may be greater predictability to weather patterns then a downtown turn in the economy, Congress has provided some level of predictability to lenders well aware of the need to always focus on the spector of the non-performing loan and on the borrower who might run for bankruptcy court protection.