Court Ruling Reinforces Importance of Bankruptcy Remote Entities in Commercial Real Estate

The Bankruptcy Court for the Northern District of Illinois recently issued a decision in In re 301 W North Avenue, LLC, emphasizing the critical role of properly structured bankruptcy remote entities (BREs) in commercial real estate finance. The case serves as a reminder of why BREs are essential tools for lenders seeking to mitigate bankruptcy-related risks.

Understanding Bankruptcy Remote Entities (BREs)

BREs are commonly required in commercial real estate loans to protect lenders from borrowers who might attempt to file for bankruptcy strategically, such as right before a foreclosure sale. These entities are designed to limit a borrower’s ability to seek bankruptcy relief while still maintaining legal independence from lender control.

A well-structured BRE ensures that specific governance requirements, like the presence of an independent manager, are in place to preserve the entity’s bankruptcy remote status.

The Court’s Decision in 301 W North Avenue, LLC

In this case, the debtor, 301 W North Avenue, LLC, had obtained a $26 million loan secured by commercial real estate. As part of the agreement, the lender required the debtor to operate as a BRE, including appointing an independent manager whose consent was necessary for any bankruptcy filing.

Despite these clear requirements, the debtor proceeded with a Chapter 11 filing without obtaining the independent manager’s approval. The lender swiftly moved to dismiss the case, arguing that the debtor lacked proper authorization. The bankruptcy court agreed, holding that the debtor’s governing documents explicitly required independent manager approval before seeking bankruptcy protection. As a result, the case was dismissed.

The court also rejected the argument that the independent manager’s post-bankruptcy resignation constituted a tacit approval of the filing. Instead, it reaffirmed that the manager’s role was to serve as a gatekeeper, ensuring the entity adhered to its bankruptcy remote obligations.

National Trend: Growing Focus on Bankruptcy Remote Structures

Across the country, lenders and investors are increasingly emphasizing bankruptcy-remote structures in commercial real estate finance. With rising concerns over economic volatility and borrower defaults, financial institutions are tightening requirements for BREs to safeguard their collateral.

Recent case law has reinforced the importance of independent managers and well-defined governance provisions in preventing unauthorized bankruptcy filings. Additionally, lenders are favoring Delaware-based BREs due to their strong legal protections and well-established corporate governance standards.

As the commercial real estate market continues to evolve, the role of BREs remains a crucial component in structured finance, ensuring stability and predictability for lenders and borrowers alike.

Key Takeaways

This decision underscores several important considerations for lenders and borrowers in commercial real estate finance:

• For Lenders: It’s essential to structure loan agreements and governing documents with clear bankruptcy-remote provisions to protect collateral from unauthorized filings.
• For Borrowers: Compliance with BRE requirements is critical to avoiding legal challenges that could jeopardize a bankruptcy case.
• For Independent Managers: Their role is far more than symbolic—courts recognize them as key figures in maintaining a BRE’s integrity.

The 301 W North Avenue ruling highlights the importance of carefully structured BREs in real estate finance. By adhering to these structural safeguards, both lenders and borrowers can maintain financial stability and mitigate bankruptcy-related risks. For inquiries regarding bankruptcy remote entities, please reach out to Jack R. O’Connor, Harold D. Israel, Pamela J. Sandborg, or another member of the LP’s Financial Services & Restructuring Group.