5 Tips For Doing Real Estate Deals In Bankruptcy Court

March 29, 2013 Posted in Firm News

March 29, 2013 - Law360 - Real estate investors and developers can find great value-add assets in bankruptcy sales, but experts warn that since most such sales come with no representations, warranties or indemnifications, attorneys representing buyers should make due diligence their No. 1 priority.

Section 363 of the U.S. Bankruptcy Code allows a company in Chapter 11 or Chapter 7 proceedings to dispose of real property in order to help pay off its debts through a highly structured process aimed at getting the most out of each asset while retaining the least liability.

"All of these bank deals in the end are 'as is, where is,' with no representations and no warranties," said Richard Ormond of Buchalter Nemer PLC. "You're taking on the potential for a lot of risk."

As such, properties are sold "free and clear" from all liens and encumbrances, but it's not uncommon to later discover hidden issues, experts say, and the buying process itself can present various other hurdles.

Here are five tips for navigating a real estate deal for a buyer in bankruptcy court.

Conduct Exhaustive Due Diligence

Depending on whether the company has filed for Chapter 11 or Chapter 7, conducting due diligence can be the hardest part of buying a property out of bankruptcy, according to Ormond.

The trustee or debtor-in-possession rarely has access to all of the materials a buyer would typically need to see before making a decision to purchase property; sometimes a debtor has destroyed the documentation prior to the bankruptcy, or not kept it in good enough shape, he said.

As a result, it's important to make every effort to visit the actual property the client is considering acquiring, experts say. Bank sales can move quickly, and buyers often don't have a chance to walk the full property, but doing so can prevent a situation in which an issue, such as environmental contamination, is discovered later and becomes a headache for the buyer.

"Even if the sale order says the seller is released of all future claims, the environmental authorities might challenge the effect of that order years later," said Christopher Mirick of Pillsbury Winthrop Shaw Pittman LLP.

"Conversely, if the seller is liquidating, then as a practical matter it won't be around to be held liable, and the buyer may find itself responsible for cleaning up the property and unable to make a claim for contribution against the now-dissolved former owner."

Take Advantage of Being 'Free and Clear'

For some of the same reasons that it can be risky, buying a piece of property through a bankruptcy sale can also hold a huge advantage over doing a typical transaction, according to Linda Jackson of Salazar Jackson LLP.

The transfer of the property comes with no representations or warranties, but also with no liens or encumbrances. If an environmental, structural or other issue is found later at the property, the new owner won't be held liable, assuming that all due diligence has been properly done and the pertinent creditors and lienholders notified of the bankruptcy sale of the property.

"You can get a court order that cleans all of that up for you, says you are not liable as the buyer for any of those liens, claims, encumbrances and title defects, and you might even be able to get title insurance where you couldn't for [a similar property not in bankruptcy]," Jackson said.

This puts the buyer in the unique position of owning a "blank slate" that is a covetable situation in the real estate world, experts say.

Enlist a Knowledgeable Real Estate Professional

Though an attorney representing a client looking to buy a piece of property out of
bankruptcy will likely have a good deal of experience with this type of transaction, it can be helpful to enlist the help of a broker or other type of real estate expert if the client isn't particularly familiar with the type of asset they're looking at purchasing, experts say.

Investor and developer clients can be wowed by a great deal on a good piece of property with no liens, but if the asset is a hotel and the client is used to working with condominiums, they may not know what to look for when conducting due diligence or how to properly bid in an auction setting, according to Ormond.

"There's always some sort of pitfall that is unique to that type of property, and if you're not familiar with it, you're going to have trouble," he said.

Prepare to Move Quickly and Compete

While there is a court approval process for selling a property in bankruptcy proceedings, the sale itself can be very quick, and attorneys should counsel potential buyer clients to be prepared to conduct due diligence and make a bid quickly.

There's a limited window to conduct any appraisals or inspections, and depending on if and how the sale was advertised, there could be a large pool of other bidders.

In addition to consulting an outside real estate professional and walking the property to know exactly what's at stake, one of the best ways to compete, experts say, is to set a buyer up as the stalking horse bid for a property auction.

Stalking horse bidders are great for the seller in that they set a floor for the price, but they also give the bidder a good deal of control over the contract terms, experts say.

"Unless you have been selected as the stalking horse, you are likely to be asked to mark up the purchase agreement that the debtor negotiated with the stalking horse, and changes to that agreement may make your bid less attractive even if the gross dollars are higher," Mirick said.

Limit Commission and Bring Cash

In addition to — or instead of — being the stalking horse, attorneys can help push their clients to the front of the buyer pack by lowering the cost and hassle of the transaction for the seller as much as possible, experts say.

The court's goal is to divest the seller of the property quickly and for the best value, so a buyer that can lower or eliminate their commission cost by either not using a broker or using one with a flexible commission rate can increase their chances of winning the bid, according to Ormond.

Buyers often don't think in those terms when it comes to transactions, he said, so reminding a prospective buyer that if their broker will agree to take 2 percent commission instead of 3, putting that 1 percent back in the hands of the estate, their deal becomes much more attractive.

Another way to convince the seller and the court that your deal is the best is to pay in cash. It's not a common tactic, but it can sway any court in favor of your buyer's deal.

"Bankruptcy courts respond well to cash," Ormond said.

--Editing by Lindsay Naylor and Katherine Rautenberg.