Section 362(d)(3) prices a single-building Chapter 11 filing for the mortgage lender, and the base is the collateral value, not the claim.
A single asset real estate (SARE) debtor that wants to keep the automatic stay without filing a confirmable plan must start monthly payments equal to interest at the non-default contract rate on the value of each mortgage lender's interest in the property, not on the lender's claim. On an illustrative $40.0m claim secured on a building worth $32.0m at a 6.5 per cent contract rate, that is $173,333 a month, against $216,667 of contract interest on the full claim and $383,333 at the default rate.
Worked in full in The Real Estate Workout by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The SARE rules in section 362(d)(3) of the US Bankruptcy Code exist because an undersecured lender is otherwise paid nothing for the time a Chapter 11 case takes: it is not entitled to post-petition interest, and the Supreme Court held in Timbers of Inwood Forest that it is not compensated for the delay in foreclosing either. For a lender working out a loan on a single building, the formula sets the price of the borrower's filing.
A SARE debtor owns a single property or project, other than residential property with fewer than four units, that generates substantially all of its gross income, and conducts no substantial business other than operating it. Since 2005 there has been no debt ceiling. The court must lift the stay for a mortgage lender unless, by the later of 90 days after the order for relief (extendable for cause within that period) and 30 days after the court determines the debtor is a SARE debtor, the debtor has either filed a plan with a reasonable possibility of being confirmed within a reasonable time, or begun the monthly payments. The payments may be made from rents, even though rents are the lender's cash collateral.
| Input | Value |
|---|---|
| Senior loan principal / pre-petition unpaid interest | 39.0 / 1.0 |
| Non-default contract rate / default margin | 6.5% / 5.0% |
| Value of the property, as found by the court | 32.0 |
| Net operating income a year | 2.4 |
| Second mortgage, at 9.0% | 5.0 |
| Length of case / months before payments must start | 12 / 3 |
Claim = 39.0 + 1.0 = 40.0; value of the interest = min(claim, property value) = min(40.0, 32.0) = 32.0. The lender is undersecured by 8.0.
Payment = value of interest × non-default rate ÷ 12 = 32.0 × 6.5% ÷ 12 = 0.1733, or $173,333; 2.08 a year
Excel: =MIN(Claim,Value)*Rate/12
Value of the junior lender's interest = max(0, 32.0 − 40.0) = 0. It is out of the money and receives no payments.
NOI = 2.4 ÷ 12 = $200,000 a month, 1.15x the payment, leaving $26,667 a month for everything else in the case.
| Measure | Amount |
|---|---|
| SARE payments received, 9 months | 1.56 |
| Contract interest on the full claim, 12 months | 2.60 |
| Interest at the 11.5% default rate, 12 months | 4.60 |
| Shortfall against contract / against default interest | 1.04 / 3.04 |
The debtor collects 2.40 of NOI over the year and pays 1.56 to the lender, keeping 0.84 to fund its professionals. For the lender the filing costs 1.04 of carry at the contract rate on top of whatever value it loses in the plan, and 3.04 against the default interest it had been accruing. That is the number to set against a forbearance or a discounted payoff offered to avoid the filing.
| Property value, $m | Senior's interest, $m | Senior payment | A year, $m | NOI cover, both liens | Junior's interest, $m | Junior payment |
|---|---|---|---|---|---|---|
| 28.0 | 28.0 | 151,667 | 1.82 | 1.32x | 0.0 | 0 |
| 32.0 | 32.0 | 173,333 | 2.08 | 1.15x | 0.0 | 0 |
| 36.0 | 36.0 | 195,000 | 2.34 | 1.03x | 0.0 | 0 |
| 40.0 | 40.0 | 216,667 | 2.60 | 0.92x | 0.0 | 0 |
| 44.0 | 40.0 | 216,667 | 2.60 | 0.81x | 4.0 | 30,000 |
Each 1.0 of value adds $5,417 a month to the senior payment, until the value reaches the claim. That creates an odd incentive in the valuation fight. A higher value raises the payments the lender receives, but it also makes the payments harder for the debtor to meet: at 40.0 the NOI covers only 0.92x, and a debtor that cannot pay must file a confirmable plan or lose the stay. A lower value cuts the payments and strengthens the lender's separate argument for relief under section 362(d)(2), that the debtor has no equity in the property. With NOI of 1.8 instead of 2.4, $150,000 a month, the debtor could not pay even at a 32.0 value: cover would be 0.87x.
SARE payment = min(claim, property value) × non-default contract rate ÷ 12 per mortgage lender, starting about 90 days into the case. Here $173,333 a month on a 32.0 value, 1.15x covered by NOI, and 1.04 of carry lost to the lender over a 12-month case. What a lender gives up by delay in any enforcement route is in what a month of delay costs, and the alternative to a filing in whether a forbearance is worth it. The four ways out of one broken loan, each discounted over its own timetable, are in the free workbook for this case.
A debtor whose single property or project, other than residential property with fewer than four units, generates substantially all of its gross income, with no substantial business beyond operating it. There has been no debt ceiling since 2005. In the illustrative case an office building owner with a 40.0 million mortgage claim and 2.4 million of NOI qualifies.
By the later of 90 days after the order for relief, extendable for cause within that period, and 30 days after the court determines the debtor is a SARE debtor, unless the debtor has filed a plan with a reasonable possibility of being confirmed. In a 12-month case starting payments after month 3, the lender receives nine payments of 173,333, 1.56 million in all.
Only on the value of its own interest in the property. With a 32.0 million building behind a 40.0 million senior claim, a 5.0 million second mortgage has no value behind it and receives nothing. At a 44.0 million value its interest would be 4.0 million and its payment, at 9.0 per cent, 30,000 a month.
This article is one calculation from The Real Estate Workout. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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