In re Chicora: Obtaining Injunctive Relief for Non-Debtors is Difficult, But Not Impossible

Lenders frequently require that the insiders of single-asset real estate borrowers[1] personally guarantee their companies’ debt to the lender. If the borrower defaults on its obligations and files for bankruptcy, the automatic stay prohibits the lender from pursuing or continuing any collection efforts against the borrower in bankruptcy. However, the automatic stay does not prohibit the lender from exercising remedies against the insider with respect to the insider’s guaranty liability. In many instances, the bankrupt borrower’s only pathway to successfully exit bankruptcy is by obtaining an equity contribution or new capital loan from the guarantor-insider. In turn, the guarantor-insider may be unwilling or unable to make such an investment absent the certainty of a court order extending the scope of the automatic stay to prevent the lender from exercising its remedies against the guarantor.

Recently, in Chicora Life Center LC v. UCF 1 Trust 1, the U.S. Bankruptcy Court for the District of South Carolina examined the contours of when it is appropriate to enjoin a lender from bringing a collection action against a single-asset real estate debtor’s insider who guaranteed the debtor’s defaulted obligations to the lender.[2] Although the Chicora court ultimately determined that it was appropriate to extend the stay to the debtor’s principal, the case is a stark reminder that these extensions are granted only in unusual circumstances.

Background

Chicora Life Center LC is a limited liability corporation that is a single-asset real estate entity whose sole substantial asset is a strip mall in Charleston, S.C. (the “Real Property”). Douglas Durbano is Chicora’s manager and ultimate beneficial owner. Chicora entered into a loan agreement, secured by the Real Property, that indebted Chicora to UCF 1 Trust 1 (“UCF”). Durbano personally guaranteed Chicora’s obligations to UCF.

Following financial difficulties stemming from litigation with its anchor tenant, Chicora filed a chapter 11 bankruptcy petition on May 16, 2016. As of the petition date, Chicora owed UCF approximately $15 million. Chicora’s bankruptcy filing triggered a default under Durbano’s guaranty that caused UCF to demand that Durbano satisfy Chicora’s outstanding debt. In response, Chicora initiated an adversary proceeding seeking to extend the automatic stay and to obtain an injunction prohibiting UCF from bringing a collection action against Durbano on account of his guaranty of Chicora’s indebtedness to UCF.

During a hearing on Chicora’s motion for a preliminary injunction, Durbano testified that he would make a $1 million equity contribution to help Chicora pay its operating expenses and necessary improvements to the Real Property during the pendency of Chicora’s bankruptcy case. Durbano testified that he would obtain those funds from a line of credit that an unrelated entity, which he managed and ultimately owned, had with an unrelated lender. According to Chicora’s uncontroverted evidence, Durbano’s ability to obtain the $1 million contribution would be jeopardized if UCF was allowed to seek to collect Chicora’s debt from Durbano. Chicora also presented evidence that the Real Property had a market value of between $35 and $37 million and introduced into evidence the appraisal that UCF had obtained when the loan was originated in August 2014, which valued the Real Property at between $29 and $42 million. In short, Chicora’s evidence showed that UCF’s interests in the Real Property were protected by a substantial equity cushion worth between $14 and $27 million — i.e., the difference between the Real Property’s value and Chicora’s and Durbano’s obligations to UCF.

Analysis

The court began its decision by noting that courts may enjoin actions against nondebtor third parties when the court finds that a failure to enjoin the action would have an adverse impact on the debtor’s bankruptcy estate and its ability to formulate a chapter 11 plan.[3] The Chicora court then set forth a multi-factor test that Chicora needed to satisfy to obtain the injunction: (1) that Chicora was likely to succeed on the merits, which in the bankruptcy context requires the debtor to show that it has a reasonable likelihood of reorganization; (2) that Chicora would likely suffer irreparable harm in the absence of the relief; and (3) that the balance of equities tips in Chicora’s favor.[4]

The court began its analysis by observing that Durbano’s contribution was likely the only source of funding available for Chicora to fund its ongoing expenses and reorganization plan.[5] The court also found that UCF’s collection efforts against Durbano would hinder Durbano’s ability to obtain the funds necessary for Chicora to pay its ongoing operating costs, including insurance, utilities, security, payroll, professional fees and other costs necessary to maintain the Real Property while Chicora attempted to successfully exit bankruptcy.[6] The court concluded that Chicora’s inability to maintain its ongoing operations without the contribution would likely have a detrimental effect on its bankruptcy estate — namely, an inability to reorganize.[7]

The court found that UCF’s interest in the Real Property was protected by a substantial equity cushion, which suggested a strong likelihood that Chicora would successfully reorganize and even pay all of its creditors in full.[8] As such, the court held that Chicora would likely succeed in obtaining a permanent injunction against UCF. The court also found that Chicora demonstrated that, in the absence of the preliminary injunction, it would be irreparably harmed because it would be unable to fund its ongoing operations and reorganize.[9] Finally, the court determined that due to the equity cushion protecting UCF’s interests in the Real Property, and the lack of evidence indicating that the Real Property was likely to decrease in value in the near future, the issuance of an injunction would not prejudice UCF’s ability to collect because the lender’s lien would “remain fully secured during the duration of the injunction.”[10] As such, the court found that Chicora satisfied its burden of showing that the balance of equities tipped in favor of the requested injunction.

Conclusion and Takeaways

The court ultimately found that Chicora had satisfied its burden of establishing that a preliminary injunction staying UCF from filing or taking further collection actions against Durbano on account of his guaranty was appropriate.[11] Although third-party injunctions are entered only in a limited set of circumstances, the facts in Chicora presented a perfect occasion for such relief. Attorneys seeking extensions of the automatic stay or third-party litigation bars should focus their arguments on quantifying and qualifying (1) the damage to the debtor’s estate or ability to successfully reorganize absent entry of the injunction, and (2) the prejudice that the injunction would impose on the enjoined party. If the former heavily outweighs the latter, then the movant has a good case for a third-party injunction. It may be difficult for a movant to meet this burden, but in the appropriate circumstances the injunction could be the difference between a successful and a failed bankruptcy case.