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January 12, 2022

Senior Living Bond Defaults: Do Bondholders or Residents Have Priority Over Entrance Fees?


Nearly eight percent of the $41 billion in outstanding senior living bonds were in default as of December 2021, with the sector accounting for almost one-quarter of defaulted debt in the muni market, not including bonds caught up in Puerto Rico’s bankruptcy.1 As challenges to the senior housing sector persist, including staffing shortages, rising labor costs, occupancy volatility, skepticism of congregate living arrangements and other pandemic-related disruptions, we are likely to see more distressed-related activity in this sector, including defaults on municipal debt issued by such projects.

A bankruptcy or receivership of such a project has the potential to pit two very different groups of creditors against each other: (i) holders of municipal debt issued by the project and (ii) the project’s residents. More specifically, a dispute may arise over which group is entitled to priority over the residents’ “entrance fees,” or the portion of such fees that is refundable to the resident upon termination of its occupancy.

Recently, in In re Atrium of Racine, Inc., the Wisconsin Court of Appeals (Court of Appeals) faced this very issue and determined that under principles of Wisconsin landlord/tenant law, entrance fees are security deposits with priority over the claims of the municipal bondholders.

By way of background, the Atrium is a 76-unit senior housing facility in Racine, Wisconsin. As is typical in these types of facilities, its residents were required to enter into a residency agreement and pay: (i) an entrance fee of approximately $40,000 to $238,000; (ii) in certain instances, a security deposit; and (iii) a monthly fee to live in the rented unit. Although there were different versions of residency agreements, each provided that a portion of the entrance fee would be reimbursed upon termination of a resident’s occupancy.

Atrium issued bonds to finance the construction and operation of a separate assisted living facility. The bonds were secured by a first mortgage on Atrium’s property, which was subject to “Permitted Liens.”2 Permitted Liens was defined to include “Entrance Fees or similar funds deposited by or on behalf of [residents].”3 The Prospectus and Project Contract for the bonds defined Entrance Fees as “the fees, other than monthly service charges, paid by residents of a Facility to the [Obligor/Corporation] for the purpose of obtaining the right to reside in a Facility, including any refundable resident deposits described in any lease or similar residency agreements.”4 The Prospectus further stated that “residents … may have certain rights with respect to their entrance fees and therefore the entrance fees held by [Atrium] may not be available to pay the [bonds] in the event of a foreclosure.”5

In May 2017, Atrium went into receivership owing approximately (i) $7.5 million to its residents on account of entrance fees, and (ii) $6.1 million to its bondholders.

Both the residents and the receiver asked the court for a determination as to whether the claims of the residents or the claims of the bondholders had priority over the assets of Atrium. The trial court (Circuit Court) concluded the bondholders’ claims had priority over the residents’ claims, but for the reasons discussed below, the Court of Appeals reversed (its decision is currently pending on appeal).

In reaching its conclusion, the Court of Appeals primarily relied on its decision in M&I First National Bank v. Episcopal Homes Management, Inc.6 Episcopal Homes Management owned and operated a senior housing facility which defaulted on its mortgage obligations, and its bondholders similarly claimed a priority over the residents’ entrance fees.

In Episcopal Homes, the Court of Appeals held that the fundamental goal of the residency agreements was housing in exchange for rent. Thus, as a matter of law, and notwithstanding language to the contrary in the agreements,7 the agreements constituted rental agreements under Wisconsin law and the parties contracted in a landlord/tenant capacity. Having determined the parties contracted within a landlord/tenant relationship, the Episcopal Homes court looked to Wis. Admin. Code § 134, titled “Residential Rental Practices” to determine the nature and priority of the entrance fees.

The court first evaluated whether the entrance fees were “security deposits” under Wisconsin law, which are defined as “the total of all payments and deposits given by a tenant to the landlord as security for the performance of the tenant’s obligations …”8 The Court of Appeals noted that, in Episcopal Homes, it found that the entrance fees served as security for the resident’s performance of their obligations.9 Comparing the entrance fees in Episcopal Homes to Atrium, the Court of Appeals determined the Atrium entrance fees (and security deposits) were also contractually held for payment of any delinquent fees upon a resident vacating its unit. Thus, the entrance fees in Atrium were “security deposits” under Wisconsin law. The Court of Appeals noted language in the resident agreement indicating that the entrance fees were not security deposits, however, it determined that such language was not dispositive in light of its analysis based on applicable Wisconsin law.

After concluding the Atrium entrance fees were security deposits under Wisconsin law, the Court of Appeals again looked to Wisconsin law, as well as the language of the Prospectus and Project Contract, to determine which group of creditors had priority over the entrance fees.

First, the Court of Appeals noted that, under Wisconsin law, a landlord “shall” return to the “tenant the full amount of any security deposit paid by the tenant, less any amounts that may be withheld” pursuant to applicable law, upon the tenant vacating the premises.10 The Court of Appeals then noted the bondholders were aware from the Prospectus and Project Contract that the entrance fees constituted Permitted Liens and “had priority over their claims when they purchased their bonds.”11 A contrary assertion by the bondholders would be “disingenuous.”12

Thus, the Court of Appeals determined that the rights of the residents to their entrance fees and security deposits were superior to the bondholders’ rights.

State laws and contractual provisions, as well as their interpretations, are relevant as senior housing bond issuers continue to face distress. Bondholders should analyze both the language of their indentures and related documents, as well as applicable state statutes, to determine the extent to which any other project creditor can claim a superior interest to the project’s assets, including deposits/entrance fees that are payable or refundable to the residents.

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. Heather Gillers, Retirement Communities Lose Residents, Attract Muni Investors, Wall Street Journal, last visited Jan. 10, 2022). Quoting a Municipal Market Analytics report.

  2. In re The Atrium of Racine, Inc., 2019AP2063, 2021 Wisc. App. LEXIS 407 at *2-3 (Wis. Ct. App. Jul. 30, 2021)

  3. Id.

  4. Id.

  5. Id. at *4.

  6. 195 Wis. 2d 485, 536 N.W.2d 175 (Ct. App. 1995).

  7. In re The Atrium of Racine, Inc., 2019AP2063, 2021 Wisc. App. LEXIS 407 at *10 n.10.

  8. Id. at *9, citing WIS. ADMIN. CODE § ATCP 134.02(11).

  9. Id. at *10.

  10. Id. at *10, citing WIS. ADMIN. CODE § ATCP 134.06(2), (3).

  11. Id. at *11.

  12. Id. at *12-13. The Court of Appels also addressed the subordination clause contained in one form of resident agreement, and concluded the clause was of no legal effect as it did not comply with requirements for “nonstandard rental provisions” under Wisconsin law and the bondholders did not argue to the contrary. Id. at *11 n.11.