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If my experience is representative, the absolute assignment theory is often the first strategy portfolio lenders and special servicers will suggest for protecting future rents from becoming a SARE debtor���s war chest for legal fees or other questionable, expenses. So, under what I will call the ���notwithstanding��� loophole of 362(d)(3)(B)(i), the SARE debtor arguably is allowed to use a portion of assigned rents (the lender���s cash collateral) to make the required monthly interest payments and get a free pass on paying any adequate protection for the privilege. Savvy SARE debtors with decent rent rolls will be quick to take advantage of this statutory quirk in defending lift-stay efforts. But the ���notwithstanding��� loophole is often purely academic. In many negative-equity SARE cases, the rents (net of operating costs) aren���t large enough to fund monthly interest, so that option immediately comes off the table. In these ���poor��� cases, the debtor���s only chance of staving off a lender lift-stay motion is the file-a-plan-in-90days option of 362(d)(3)(B)(ii). If the debtor chooses this option, two questions arise: Does the debtor have to pay the lender any adequate protection for use of assigned rents during the 90 days, or does the debtor get a free ride under the SARE rules? If adequate protection is required, can the debtor use all of the assigned rents but still adequately protect the lender���s interest in the rents with a ���replacement lien��� in future rents? The Lender���s Best Bet Unlike with the monthly interest option of 362(d)(3)(B)(i), the plan-filing option of 362(d) (3)(B)(ii) does not have any obvious exception or loophole giving the debtor relief from the baseline adequate protection requirements found elsewhere in the Bankruptcy Code. So, if a SARE debtor wants to take advantage of the plan-filing option, keep assigned rents, and still defend a lender lift-stay motion, it will have to come up with some form of adequate protection. The problem, however, is that the typical SARE debtor doesn���t have any unencumbered assets from which to source adequate protection. If there is equity in the property, the debtor may be able to use this ���equity cushion��� as adequate protection. But if there isn���t any equity, the debtor is left with only two long-shot arguments: (i) give the lender a ���replacement lien��� on post-bankruptcy rents or (ii) argue that the debtor���s maintenance and upkeep of the property adequately protects 64 the lender���s security interest in the rents. I describe these two debtor arguments as ���long-shot��� because, under developing precedent, they will face increasingly low likelihood of success. The first significant development was the 2010 In re Buttermilk Towne Center, LLC, decision, in which the Sixth Circuit Bankruptcy Appellate Panel (BAP) declined to qualify either a replacement lien in assigned rents or property upkeep as valid forms of adequate protection. In Buttermilk, the debtor proposed to keep assigned net rents for attorneys��� fees and other non-operational expenses and adequately protect the lender, who had both a mortgage lien on the zero-equity property and a perfected assignment of rents, by giving the lender a replacement lien on future rents and promising to use a portion of the rents to maintain the property during the bankruptcy. The debtor���s replacement lien argument was based on a notion, endorsed by various bankruptcy courts in other jurisdictions, that as long as the future stream of rental income is expected to remain consistent, there is no diminution in the value of the lender���s security interest in the rents requiring any adequate protection. But the Sixth Circuit BAP didn���t buy this position (or its inexplicable logic). Following an earlier unpublished decision of the Sixth Circuit Court of Appeals in In re Stearns Bldg., the BAP pointed out that a lender���s security interest in assigned rents and mortgage lien on the underlying property are two separate security interests that require separate adequate protection analyses. The court reasoned that, while paying for upkeep on the property may adequately protect the value of the lender���s mortgage lien on the property, it won���t necessarily protect the lender from the loss of pledged rents being paid to third parties for non-upkeep items (like debtor legal fees). The Buttermilk debtor���s ���replacement lien��� argument similarly died when the court concluded that, because Bankruptcy Code section 552(b) specifically preserves security interests in pre-bankruptcy rents for rents generated post-bankruptcy, a ���replacement lien��� on postbankruptcy rents didn���t give the lender anything more than it already had. The linchpin of this analysis was the court���s endorsement of the theory that the debtor���s use of assigned rents results in dollar-for-dollar diminution in the lender���s lien on the rents. The reasoning of Buttermilk and Stearns has been acknowledged by bankruptcy courts in several jurisdictions with some consistency; in fact, the Eastern District of New York endorsed Buttermilk���s logic in the South Side House decision. This developing law is significant for portfolio lenders and special servicers on zero-equity SARE properties because it creates something of a checkmate for SARE debtors who would otherwise use Chapter 11 to frustrate and delay recoveries in foreclosure and other modes of nonbankruptcy disposition. Minimizing Costly Delay Prosecuting an adequate protection strategy under the rule of Buttermilk is straightforward enough (assuming you don���t have any dispute as to the valuation of the property or defects in the mortgage/assignment of rents). The real strategic question for portfolio lenders and special servicers in these situations is whether to advance the adequate protection argument in tandem with an absolute assignment argument. The answer to that question requires a frank assessment of real-world context. Most zero-equity SARE Chapter 11 cases are filed as last-ditch efforts to avoid foreclosure, receiver sale, or other lender-driven disposition of the property. The most immediate concern lenders and special servicers face in these situations is losing a purchaser who might not have the patience for a drawn-out Chapter 11 proceeding. This means speed to lifting the automatic stay and exiting the property from Chapter 11 becomes a top priority. Where haste is the prime motivator, and the underlying law is rather technical and complex��� as it is with the SARE rules in the Bankruptcy Code���it can prove rather unwise to advance alternative arguments in a lift-stay motion. This holds especially true where one of the arguments���the absolute assignment argument���is easily diluted by an enormous body of conflicting precedent. Ultimately, an absolute assignment argument may do nothing other than give the debtor an opportunity to poke holes in an otherwise ironclad relief-stay request. While every case is different, portfolio lenders and special servicers should bear this in mind as they formulate Day One strategies in difficult SARE cases. Stuart A. Laven Jr. is a partner of Benesch Friedlander Coplan & Aronoff, LLP, where his practice focuses on distressed commercial real estate transactions, Chapter 11 reorganization, and financial restructuring.

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