The Real Deal New York

Developers bracing for bankruptcy

Chapter 11 cases soar for developers, but not to 1980s levels
By Adam Pincus | July 01, 2009 12:13PM

In 2006, a young Brooklyn developer envisioned selling 130 units in a building he was about to construct, called the Viridian, in the emerging Brooklyn neighborhood of Greenpoint. The developer, Joel Schwartz, borrowed money at the height of the market and managed to complete his project this past January.

However, the lender on his $36 million first mortgage, Bank of New York, withheld its final payment. Subsequently, the lender of a $12 million mezzanine note, which counted basketball legend Magic Johnson as an investor, wanted to take over the property, so Schwartz was left with little choice but to file for Chapter 11 protection in early February.

Note: Correction appended

Schwartz’s attorney, Kevin Nash of the firm Goldberg Weprin Finkel Goldstein, said his client made the right decision because he has a viable restructuring plan and needed protections from Bank of New York and Canyon-Johnson Urban Fund, the joint-venture fund between Canyon Capital Realty Advisors and Johnson’s development corporation.

“He has a C of O,” Nash said, referring to a certificate of occupancy obtained in January.

Bankruptcy beckons

In the coming year, the number of bankruptcies in the city is expected to accelerate, but it is not expected to hit the levels seen after the last major real estate recession, experts said. In that period, major developers such as Peter Kalikow, Donald Trump and Battery Park City builder Olympia & York all took the bankruptcy plunge. “The pressure is just starting to build. I expect there will be more, but not like the abundance in the late 1980s and early 1990s,” said Carl Schwartz, partner and chair of the real estate department at law firm Herrick, Feinstein.

Two decades ago, in the last major real estate downturn, bankruptcies like Joel Schwartz’s were a popular path to recovery. But since then, new laws have forced judges to be more lender-friendly, and lenders have added loan provisions making borrowers personally liable if they file for protection. Nash noted that developers must now prove to a judge that they are not simply trying to cut the debt on an overleveraged property (known as “cramming down” the lender), but instead show that they have a roadmap out of their financial crisis.

Because of such changes, far fewer developers than might be expected have filed for bankruptcy in this cycle, a change that The Real Deal noted in its February issue.

But bankruptcy still has its upside.

Perhaps the single most powerful aspect of filing for bankruptcy is that it halts foreclosure proceedings, which have become increasingly common lately.

“In the prior cycle, [defensive bankruptcy filings] happened all the time. It was one of the negotiating tactics and frankly, it was fairly effective in terms of helping developers negotiate deals with lenders and potentially shield them from foreclosure,” said Steven Lichtenfeld, a partner at the law firm Proskauer Rose and co-chair of its real estate finance practice.

Today, a developer can file for personal bankruptcy or can file on behalf of the development entity. And if the developer chooses to, he can file for both.

The bankruptcies early in this cycle have been in smaller developments. But with the number of foreclosure lawsuits rising in high-profile projects such as Kent Swig’s 25 Broad Street and 45 Broad Street, experts wonder if larger firms will seek protection soon.

Nash, who filed a mechanic’s lien against one of Swig’s buildings on behalf of a client, said that type of distress may force a developer to file for bankruptcy. A spokesperson for Swig declined to comment.

Rewritten rules

There have been several key changes since the 1990s that have kept the number of bankruptcy filings down somewhat.

For example, Lichtenfeld said new rules in the bankruptcy code in 2005 forced debtors to file a viable reorganization plan within 90 days and begin making payments to the lenders.

In addition, the inclusion of so-called “springing” guarantees that became common in mortgage documents often makes the borrower or principals personally liable for recourse.

Nash said another reason few bankruptcies have been filed is the steep decline in the value of real estate. The purpose of the Chapter 11 filing is to buy time to reorganize, find financing or sell the assets, he noted, but in a falling market all those efforts are impeded.

Despite the obstacles, companies large and small have filed in the city over the past six months, including General Growth Properties, the owner of the South Street Seaport mall in Lower Manhattan; Water Street Realty Group, the developer of the 52-unit condominium 133 Water Street in Dumbo; and Fred Deutsch, whose LD Development was the builder of a four-story residential building at 338-342 22nd Street in Greenwood, Brooklyn.

In addition, dozens of other real estate-related cases have been filed, experts said.

The most recent data from the Administrative Office of the United States Courts showed that the number of Chapter 11 cases filed in federal court in Manhattan and Brooklyn more than doubled from 85 in the fourth quarter of 2007 to 198 in the same period of 2008.

Bankruptcies not all equal

Some developers survive bankruptcies, while others disappear.

Donald Trump, for example, has sought bankruptcy protection for his companies numerous times. Trump’s Plaza Hotel at Fifth Avenue and Central Park filed for bankruptcy in November 1992. He lost control of the building, but in exchange received favorable treatment on debt. Most recently, Trump Entertainment Resorts filed for Chapter 11 in February in New Jersey, days after Trump resigned as chairman of the company. The company wants to push the due date for a reorganization plan to September, and Trump himself is reportedly trying to take back control with the help of Dallas-based Beal Bank.

For his part, Peter Kalikow survived after filing for personal bankruptcy and bankruptcy on behalf of his company, Kalikow Real Estate Company, in 1991. By 1994 his real estate holdings were recovering, and he is now president of H.J. Kalikow & Co.

But others were not so fortunate. Olympia & York, the builder of the World Financial Center, disappeared after its bankruptcy in the 1990s. The World Financial Center is now controlled by the Canadian firm Brookfield Properties.

Meanwhile, the bankruptcy process has been sped up since the 2005 laws were passed, said Jeffrey Wurst, partner with law firm Ruskin Moscou Faltischek. Going forward, most bankruptcies should take four to five months to complete.

And, during the bankruptcy process the debtor retains the right to borrow, and in fact, often must borrow in order to reorganize. But a stigma can follow the filing, even if it is successful, because the debtor has to acknowledge the filing in future loan applications.

Kenneth Patton, associate dean at the Schack Institute of Real Estate at New York University, said about 16 percent to 20 percent of an asset’s value is generally lost in a bankruptcy or foreclosure.

“Your hands are tied,” Patton said. “Lost tenants, inability to negotiate, you have to put cash out. It’s harder to renew leases without a full pocketbook.”

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