Maximizing the Value of Distressed CCRC Bonds | Arent Fox Schiff
Whether CCRC’s residence agreements are treated as leases or contracts under state law could affect the recovery of CCRC’s obligations in the event of the CCRC owner’s insolvency. Some states treat CCRC residency agreements as leases and others as contracts, while other state laws may not provide clear guidelines. This Client Alert will discuss the legal significance of this difference in treatment for bondholders and bondholders’ strategies for maximizing the value of CCRC bonds.
When issuing bonds, the collateral must be duly irreproachable. Failure to do so would allow another creditor to obtain a first lien on the security and would likely cause the security interest in the security to be voided in bankruptcy proceedings.
If the obligations are secured by a mortgage on the property, an assignment of leases and rents will be made. Therefore, if CCRC residence agreements are legally treated as leases under state law, filing the mortgage or a separate assignment of leases and rents will perfect the collateral assignment of residence agreements.
However, what if residency agreements are treated as contracts under state law? In this case, the assignment as collateral of the residence contracts must be completed by the filing of a UCC financing statement. Failure to do so would mean that another creditor could obtain a first lien and, in the event of bankruptcy, the bondholders would not be treated as secured by the residency agreements.
If state law is not very clear on the treatment of CCRC residency agreements, we recommend having both a mortgage and a separate assignment of residency agreements and filing both a mortgage and UCC financing statements to ensure the perfection of the security granted in these agreements. .
Additionally, it is important to note that if residence agreements are treated under state law like leases, there could be critical legal implications in a liquidation or bankruptcy proceeding for the treatment and priority for entry fee refunds. For example, in Wisconsin, an appeals court in 2021 was held in Root Atrium that upon liquidation of a CCRC, Wisconsin law requires that entry fee refunds be paid to residents first before any debt service on outstanding bonds. This decision is explicitly non-binding under Wisconsin law, but may be cited as persuasive authority. The legal reasoning is based on the fact that residence contracts are qualified as leases and entrance fees considered as security deposits which, according to the law, must be returned to the tenants. This decision is emblematic of the courts’ desire to protect residents.
Not surprisingly, another Wisconsin appeals court in 1995 also went to great lengths to protect elderly residents from a CCRC. In M&I First National Bank v. Episcopal houses, the court held that a bond trustee holding a security interest in entrance rights held by him in escrow held those rights under a constructive trust on behalf of the residents. And, notwithstanding a provision in all residency agreements that subordinates the rights of residents to the rights of bondholders in the entrance fees, the court held that since the entrance fees are security deposits under leases under Wisconsin law, security deposits were to be returned to residents. The court struck down the subordination clause in the residence agreements.
The Wisconsin cases also have implications for bankruptcies. Entrance fee refunds owed to former residents are unsecured claims in a bankruptcy. The bonds are guaranteed. Depending on typical bankruptcy priorities, one would think that secured bonds would be paid up front and handled better than unsecured entry fee refunds. Yet this has not been the case in the recent CCRC bankruptcies.
In states like Wisconsin, where state law requires that security deposits be returned to tenants, entry fees are treated as security deposits, and residence agreements are treated as leases, there is a legal basis for asserting that entry charge refunds may be treated better than secured bonds. The counter-argument is that state law priorities cannot trump bankruptcy priorities. We are not aware of this issue being litigated in CCRC bankruptcy cases, but it may be in the future.
Nonetheless, these Wisconsin cases involving liquidations are consistent with how bankruptcy courts have generally treated entry fee refunds. Whether residential agreements are considered leases or contracts, they are treated as enforceable contracts that can be accepted or rejected in bankruptcy proceedings. Unsurprisingly, for essential commercial reasons, these contracts are regularly assumed by debtor CCRCs. In recent cases, such as Amsterdam House Continuing Care Retirement Community (New York) and Buckingham Senior Living Community (Texas), residents who had to repay entry fees were largely unaffected, while bondholders were affected by a principal reduction of about 15% and a complete loss of accrued interest. This result is similar to how retirees were treated in Chapter 9 filings. holders of guaranteed bonds.
For these reasons, bondholders should be proactive in seeking to avoid liquidation or bankruptcy proceedings. In these scenarios, bondholders are likely to bear the brunt of the impairment which will be compounded by significant litigation costs. Basically, this means that pursuing recourse to seize properties is not a viable strategy, as any attempt to do so will likely result in a bankruptcy filing. Additionally, in the absence of a bankruptcy filing, foreclosure of the property would force the bondholders to own the property in hopes of improving its operations or selling the property. A sale in these circumstances would likely reduce rather than increase value. And, anyway, since the vast majority of these CCRCs are non-profit to maintain the tax exemption on the bonds, the ownership of the property would have to be transferred to another non-profit. Finally, compliance with state regulations in carrying out the various CCRC transfers would contribute to delays and additional costs.
The lack of effective remedy is similar to P-3 student housing projects. Generally, the non-profit owner is not the cause of the problem, which means that the exercise of recourse to replace the owner is not the solution. In summary, foreclosure is almost never an effective option.
So what is the best overall strategy for holders of distressed CCRC bond debt? Here are our suggestions.
1. We advocate an early proactive approach to help avoid bankruptcy or liquidation. When triggering a financial commitment, bondholders should organize a group to work with a friendly fiduciary and enter into a bondholder-protective forbearance agreement.
2. An assessment of the causes of the distress must be carried out quickly.
3. Based on this assessment, a forbearance agreement would address any need to change managers and/or operators to the extent and as permitted by applicable agreements, means to improve operations and marketing, appropriate budget controls, appropriate enhanced financial covenants, improved continuous disclosure, and any appropriate changes to documents or the warranty package. Replacements of managers and/or operators, in particular, may require compliance with national regulations. The purpose of a forbearance agreement is to “right the ship” as much as possible in particular facts and circumstances. This may include agreeing to explore affiliate options.
4. In order to avoid bankruptcy, it is essential to ensure that the liquidity necessary for operations is available to a borrower in difficulty, subject to significant protections and safeguards for bondholders. One of these protections is a “bad boy” guarantee, and we recommend asking for one as a condition of holders providing liquidity to the borrower. This guarantee would be provided by the non-profit or for-profit parent entity owning the CCRC owning entity. The guarantee would ensure that the entire bond loan reverts to the parent company in the event that CCRC’s owner files for bankruptcy or engages in other wrongdoings, such as misuse of facility funds. liquidity. Where the parent owns multiple properties, this security would serve as a deterrent to a bankruptcy filing for one or more of their distressed properties. However, this would not be a deterrent if the parent company were willing to file for bankruptcy with its subsidiaries. Such a guarantee has been quite effective in CMBS and the real estate market in preventing bankruptcy filings by owners of real estate projects, including senior living projects of all types, including CCRCs. We have also successfully used bad boy guarantees in municipal bond workouts in various industries.
5. Unfortunately, due to rising interest rates, the strategy of refinancing bonds to effect a debt service program that provides breathing space for a recovery is harder to achieve today than it once thought. was a few months ago. If a refinance is not an option, some sort of synthetic “refinance” can be implemented in a forbearance agreement to provide the breathing space needed to improve a successful project.
Developing a proactive strategic plan is the best way to maximize value for CCRC bondholders.
 Some bankruptcy courts give priority to secured claims of cardholders. In Village Henry Ford, the debtor was liquidated by the sale of the property. Holders of about $52.3 million in bond capital have fully recovered. About 212 residents who owed about $34.2 million in entrance fee refunds were significantly compromised, with the plan estimating a 24% to 40% recovery from a liquidating trust.