Thursday, January 14, 2010

Bankruptcy concerns for the Main Street Real Estate Attorney

By Nicholas M. Moccia
Law Offices of Robert E. Brown, P.C.

I recently encountered an interesting article entitled “DIP Financing and Other Bankruptcy Concerns for the Transactional Real Estate Attorney” by S.H. Spencer Compton and Andrew D. Jaeger.  The stated purpose of the article is to familiarize real estate lawyers with some basic elements of bankruptcy law which may arise in connection with real estate transactional practice.

A key concept raised by the authors is Debtor in Possession (“DIP”) Financing.  DIP Financing is a creature of statute arising out of Section 364 of the Bankruptcy Code.  Section 364 authorizes a bankrupt debtor to borrow money to preserve the “bankruptcy estate” or to further the debtor’s rehabilitation efforts during the reorganization process.  Section 364 purportedly provides special protections to prospective lenders, allowing for what is called a “§ 364 lien” on all the debtor’s assets.  Should the debtor default, the bankruptcy court will enforce the order granting such a lien.  The Section 364 lien is some circumstances is given a senior or equal lien priority on previously encumbered assets (§364(d)).  Better still, § 364 liens may even acquire “super-priority” over administrative expenses incurred during the course of a bankruptcy (§364(c)(1)).  It should be noted that, with exception of certain domestic support obligations, administrative expenses have priority over all other claims on the bankruptcy estate. See § 507.  

One question that the authors raise is whether a real estate attorney can expect a state court to honor the DIP lender’s lien where no mortgage is of record, especially in situations where the bankruptcy court no longer has jurisdiction.  In a similar vein, questions arise as to whether § 364 liens should be recorded, and if so, whether the applicable mortgage tax should be paid.  According to the authors, these issues are all questions of first impression and have not been address by case law.  After running a few searches, it appears the authors’ observation in this regard is correct--at least as far New York State case law is concerned.

I welcome comment from practitioners experienced in this area.

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