Hotel Avoids Single Asset Real Estate Classification— Preserving Eligibility to File Subchapter V Reorganization

Over a year ago, the Small Business Reorganization Act (“SBRA”) became effective, adding new Subchapter V to Chapter 11 of the United States Bankruptcy Code. The purpose of the Act is to make the restructuring process faster, easier, and more affordable than the routine Chapter 11 process for struggling small businesses.¹

Initially, SBRA’s relief was available to those businesses with less than $2,725,625.00 in debt. However, SBRA was in the works immediately before the COVID-19 pandemic struck, and fortuitously, the CARES Act was enacted upon its heels. The CARES Act further amplified the reach of Subchapter V’s relief measures by temporarily increasing the debt limit to $7,500,000 for one year. And, even more recently, the COVID-19 Bankruptcy Relief Extension Act of 2021 once again extended the debt limit of $7,500,000, such that it is now effective until March 27, 2022.

Significantly, nothing in the CARES Act or subsequent legislation has prompted any deviation from the historically tough treatment aimed at single asset real estate (SARE) debtors. Indeed, 11 U.S.C. §1182(1)(A) excludes a SARE debtor from Subchapter V relief, leaving debtors desperate to avoid being considered a SARE case under the definition provided in 11 U.S.C. §101(51B). And very recently, an owner of a 79-room hotel, was able to do just that and avoid the SARE classification of its business.

On April 20, 2021, the United States Bankruptcy Court for the Middle District of Florida, Orlando Division ruled that “hotels generally, and this hotel in particular, do not constitute single asset real estate projects,”—and, as such, the debtor (Debtor) in the case was eligible to file and proceed with the Subchapter V case.² This ruling is hoped to signify a favorable turning point for at least some small hotel owners, especially during the pandemic.

First, the court acknowledged that §1182(1)(A) of the Bankruptcy code excludes from Subchapter V relief those small business debtors with SARE property as defined in 11 U.S.C. §101(51B):

The term “single asset real estate” means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto.

According to the court, this definition is to be read as requiring a debtor who owns a single asset real-estate business to demonstrate that it does more than real property management. Specifically, the court asked, “Does the debtor provide additional value or activities (other than property management) that would remove it from categorization as a “single asset real estate” project?”³

The court then proceeded to describe the Debtor as a Texas LLC which owns and operates a hotel with 79 rooms. The court noted that the Debtor employs 15 individuals and provides various services, including but not limited to: room cleaning, laundry, parking, and serving breakfast. Additionally, the court stated that the Debtor performs administrative functions (such as budgeting and quality control) and indicated that some of the services typically provided are simply unavailable during the pandemic.

Citing In re Iowa Hotel Invs. LLC,⁴ the court then explained that courts have used the following three-item checklist to characterize a SARE case: (1) the real property constitutes a single property or project; (2) the real property substantially generates all of the gross income of the debtor; and (3) the debtor is not involved in any substantial business besides the business of operating the real property. If all three of these prongs are satisfied, the court stated that a debtor would be classified as a SARE debtor.

Regarding the Debtor in this case, the court was clear that the last prong was not established. Specifically, the court clarified that the facts demonstrated that Debtor’s hotel operations constitute more than simply operating the real property and any activities incidental to that operation. The court emphasized that here that:

The Hotel operates a substantial business other than merely managing the real estate, even if these additional services and amenities are gratis for hotel guest and do not generate additional income.⁵

Notably, the court was clear that relevant Bankruptcy code sections do not require a debtor to earn additional income from the other services—rather, the debtor is simply required to do something other than rent hotel rooms. According to the court, hotels may easily meet this test because rooms must be cleaned, upgraded and maintained, a 24-hour receptionist must be staffed, and a myriad of other services must be provided. The court considered it entirely irrelevant that these additional services do not result in a separate income.

Conclusion

Again, this case offers considerable hope to at least some small hotel owners that need Subchapter V relief but worry that they will be disqualified if they are deemed to be single asset real estate debtors. According to this court, “with a hotel, it is easy” to demonstrate that it offers more services than nightly room rentals—and providing additional services is sufficient to avoid a SARE classification even if no extra income is earned from those extra services.⁶

If you are considering filing a Subchapter V case, contact us at (410) 497-5947 or requesting a consult online.