Judge González (Bankr. D.P.R.) Denies Debtor’s Request to Use Cash Generated by Post-petition Rent

Judge González (Bankr. D.P.R.) Denies Debtor’s Request to Use Cash Generated by Post-petition Rent

A recent bankruptcy decision out of the District of Puerto Rico shows just how hard it is to reorganize for a debtor whose primary activity is the business of owning single asset real estate (“SARE”).

This is especially so if the secured creditor has a perfected lien over the rents generated by the debtor’s only property. Issue: could the debtor use the secured creditor’s cash collateral, which in this case included rents generated post-petition?

Applicable Law

• Ordinarily, 11 U.S.C. §552(a) stops a pre-petition lien from attaching to post-petition property.
• This protection is crucial for most debtors since many enter bankruptcy without unencumbered assets.
• It allows the debtor to offer replacement liens over property acquired post-petition as adequate protection to a secured creditor for the use cash collateral.
• However, §552(b) provides several exceptions to §552(a).
• One such exception is if the pre-petition lien encumbering a property also extends to amounts paid as rent of such property.
• In such circumstance, the debtor will not be able to offer replacement liens over post-petition rents in exchange for the use of cash collateral because the secured lender already has a lien over those rents. Decision
• Since all that the debtor offered as adequate protection was a replacement lien over post-petition rent proceeds, the court denied the use of cash collateral.
• Because the use of post-petition rent proceeds would result in a dollar-for-dollar reduction in the secured creditor’s collateral, other unencumbered assets—which the debtor lacked—were required to compensate such reduction.

Without any other source of funds to operate, reorganization is unlikely. Parting thought:

• The perfection of a security interest over amounts paid as rent of

real property is not governed by Article 9 of the UCC, as such body of law generally only applies to security interests over personal property and, in most states, the right to collect rents generated by real property is not considered personal property.

• However, in Puerto Rico, the right to collect rents generated by

real property is considered personal property. This has led to a confusing state of affairs as to how such security interest is perfected, leading to a common practice of recording the lien in the property registry (if accessory to a mortgage) as well as in the State Department’s commercial transactions registry. See In re Manuel Mediavilla, Inc. 505 B.R. 94, 107 (Bankr.

D.P.R. 2014) (describing the “curious case of assignment of rents in Puerto Rico”).

• In this case, the court agreed with the secured creditor in that such lien was perfected because the assignment of the rents was executed before a notary public, in accordance with In re Nat'l Promoters & Servs., 499 B.R. 192, 198 (Bankr. D.P.R. 2013).