Bringing down the house: restructuring Western real estate development projects requires co-operation to succeed , Report on Business Magazine, November 23 2009 (Lexpert Special edition/insert on Insolvency and Restructuring)*
Full text: If the financial meltdown of late 2008 had a canary in the mine in the West, it was cash-strapped real estate development projects. Long before insolvency lawyers on Bay Street started shaking the dust off their long-unused editions of the Companies’ Creditors Arrangement Act and relearning exactly how one shepherds a client through a restructuring (or into a full-out receivership), their Vancouver counterparts were seeing first one developer and then another run into cash-crunch troubles. Of course, they didn’t know how massive the fall would be. But from the get-go, there were indications that this wave of restructurings and receiverships would be quite different from the one they saw in the 1980s — and the smaller one in the early 1990s.
They’re hot, and they’re a whole new animal,” says Heather Ferris, an insolvency partner with Vancouver’s Lawson Lundell LLP.
The first major real estate restructuring file (“in years,” says Ferris, wryly) hit her desk three years ago. Riverbend, a development by CB Developments, went sideways at the height of the boom, a victim of escalating construction costs. “The project was mostly pre-sold, but the cost of construction had gone through the roof and the developer didn’t have enough funds secured to complete it,” Ferris recalls. Ferris’ client, The Bowra Group Inc., the receiver/manager of the project, had a controversial recovery plan: to rescind all the pre-sale contracts, and to resell the units at the current – much higher – market value.
The resulting squabble – the courts allowed rescission of the pre-sales, but also permitted the pre-sale buyers to sue the lender – didn’t save CB Developments (the receiver, however, did build out and sell off the project). But it got insolvency practitioners anticipating a slew of “interesting” insolvencies and restructurings resulting from the then-still-continuing real estate boom.
Instead came the crash. As investors, cash and credit deserted the real estate market in droves, ambitious developments across British Columbia – as well as in Alberta – came to a halt. And lenders and creditors weren’t quite sure how to go about picking up the pieces.
Now, as Larry Robinson, an insolvency practitioner with the Calgary office of Davis LLP puts it, on the face of it, a real estate insolvency, “as much as we’d like to think that it’s complicated and mysterious, it’s just dirt and concrete and money.” But as recent case law from British Columbia underscores, post-2008 real estate flops are operating under different rules from those of their bankruptcy ancestors.
Back in the 1980s, they didn’t look like this,” says Ferris. One of the biggest changes, particularly in British Columbia, has been the rise of consumer protection legislation, notably the Real Estate Marketing Act. The legislation was designed and “tested out” during the upswing. When the real estate insolvencies came, says Ferris, “many of these files attempted to maneuver around pieces of legislation not designed for insolvency.”
In such a climate, instead of trying to rescind on pre-sales, troubled developers – and committed lenders – would apparently move heaven and earth to keep early stage buyers locked into contracts.
The flagship case here to date has been Jameson House, developer Tony Pappajohn’s 144-condo project on West Hastings Street. When its financing came apart last fall, Jameson House filed for CCAA protection. But with 105 of the 144 units pre-sold – a statistic critical for obtaining any new financing – the developer’s key goal was to prevent triggering any clauses that would allow buyers to walk from the deal.
It was, basically, a reverse of what the developer was trying to do in Riverbend,” notes Ferris. Indeed. In 2007, 2005 prices were too low. By fall of 2008, 2007 prices were the tops. Too tops for some buyers.
It’s been a big problem in the market,” says Ferris. As the housing market crashed, buyers panicked. Lawyers would gather up “a bunch of pre-buyers and start fighting right away, saying they were rescinding on their pre-sales.” This was a death knell to developers, whose entire future financing hopes hinged on those pre-sale numbers (and dollars).
The Jameson House decision may save them. It’s a complicated and much appealed(and still much debated) ruling, but as John Sandrelli, an insolvency practitioner with the Vancouver office of Fraser Milner Casgrain LLP – and representative of Jameson House’s developers – sees it, its gist is that “purchasers would not have rights of rescission as part of a successful reorganization.”
The key word here is successful. Partially balancing Jameson House has been the British Columbia Court of Appeal’s decision in The Cliffs Over Maple Bay, a Vancouver Island golf course development that ran afoul of creditors early in the crash.
The Cliffs was a poster child of what not to do,” says Shelley Fitzpatrick, a litigator with Davis LLP in Vancouver and Toronto. “When the financial crisis hit last year, a lot of real estate outfits thought a CCAA-style restructuring was their solution, and Cliffs was the first one out of the gate.”
It got slapped back, big time, with courts essentially saying that to enter CCAA, a company had to have something worth saving — and a plan for how to save it.
The support of at least some creditors and lenders helps too: “Cliffs and the cases that followed it have put a chill on real estate companies entering into this process,” says Fitzpatrick, “unless they have support of their lenders.”
The good news: many of them do. The British Columbia litigiousness hasn’t quite spilled over to Alberta, says Robinson, although local lawyers have closely followed the court decisions both in Jameson House and The Cliffs. So far, as Alberta developers run to CCAA – or fold into straight receiverships – the most notable thing for Robinson is the level of cooperation between debtors and creditors.
In this cycle, there has been a fair amount of cooperation between creditors and borrowers,” he says. Calgary in particular experienced a prolonged lull post-crash with numerous projects on hold but not on the chopping block. “Creditors and developers really worked together to try to avoid insolvencies of projects. But there comes a point in time when there is a joint recognition that the best of intentions aren’t enough, and you have to have formal proceedings,” Robinson sums up. Especially if – as has often been the case – builders’ liens start to pile up.
Holly Allen, managing director with PricewaterhouseCoopers LLP’s corporate advisory and restructuring practice, has noted that trend of cooperation as well. But her crystal ball forecasts a gloomy future for Western – and Canadian – real estate.
I don’t think the real estate bubble has fully burst yet,” she says. “The amount of dollars coming into the real estate space isn’t abundant, which means anything sizeable will not get done.”
The prognosis? More receiverships and outright bankruptcies among developers. “I think we haven’t hit the bottom yet and there will be more pain.”
But, as always, opportunity. “Some of the bigger developers have learnt from past cycles; they monetized when capitalization rates were at an all-time low — that was the signal to people who’ve been through a few incarnations of the cycle to get out,” Allen says. They may be able to take over some troubled projects, and they’re the ones most likely to squeeze out of lenders what few real estate dollars are available.
Most likely to be saved? “Projects that are partially developed,” Allen says, with a near-term “economic return for the buyer.”
And most likely to die? The holes in the ground that didn’t manage to hoist up a first story before the crash came. Expect a boom…in parking lots.