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April 3, 2024

A Real Estate Workout That Didn’t Work Out: A Cautionary Tale on the Effectiveness of Escrowed Rights


The Bankruptcy Court for the Southern District of New York (the Bankruptcy Court) recently addressed whether Hudson 888 Owner LLC (the Mortgage Debtor) and Hudson 888 HoldCo LLC (Holdco and, together with the Mortgage Debtor, the Debtors) — subsidiaries of Chinese real estate developer Xinyuan Real Estate — had corporate authority to commence their Chapter 11 cases.1 In doing so, the Bankruptcy Court analyzed the provisions of certain prepetition loan workout agreements — a forbearance agreement, a strict foreclosure agreement, and an escrow agreement — governing the effectiveness and release of the Amended Holdco LLC Agreement (as defined below), which was being held in escrow and, upon its proper release, required the secured lenders’ consent to authorize the bankruptcy filings.

The Bankruptcy Court held that the secured lenders did not satisfy the predicate escrow conditions in the loan workout agreements for the Amended Holdco LLC Agreement to be released and become effective. Hudson serves as a cautionary tale to lenders in structuring and enforcing workout arrangements with a “deed in a box” or similar escrow agreements.


The Mortgage Debtor owns a mixed-use condominium and commercial building located at 502 West 45th Street, New York, New York that serves as collateral for a mortgage loan (the Mortgage Loan). Holdco also obtained a mezzanine loan (the Mezzanine Loan and, together with the Mortgage Loan, the Loans) with its 100% membership interest in the Mortgage Debtor securing the Mezzanine Loan. As the residential condominium units at the building became available for sale in 2021, the impact of COVID and the onset of interest rate increases negatively impacted the market and the Debtors’ ability to sell the residential units. As a result, the Debtors defaulted on payments under the Loans in late 2022 and eventually entered restructuring discussions with the original lenders. In April 2023, while restructuring discussions were ongoing, DOF II-Bloom Senior LLC (the Mortgage Lender) and DOF II-Bloom Mezz LLC (the Mezz Lender and, together with the Mortgage Lender, the Lenders)2 acquired the Mortgage Loan and the Mezzanine Loan, respectively.

Less than one month after purchasing the Loans, the Lenders delivered a notice of default and acceleration of the Loans and on August 4, 2023, the Mezz Lender delivered to Holdco a notice of UCC foreclosure in which the Mezz Lender notified Holdco that it intended to sell Holdco’s interests in the Mortgage Debtor at a foreclosure auction scheduled on October 11, 2023. The parties eventually entered into a forbearance agreement dated September 29, 2023 (the Forbearance Agreement) that provided for, among other things, the (1) payment of restructuring fees to the Lenders; (2) agreement to a strict foreclosure with no right of redemption in the event there was a “Termination Event” under the Forbearance Agreement; (3) agreement to interest continuing to accrue at the default rate; and (4) agreement to no extension of the February 5, 2024 maturity date. Additionally, the Lenders required the Debtors to execute an escrow agreement (the Escrow Agreement) that provided for the release of a strict foreclosure agreement (the Strict Foreclosure Agreement) and an amended and restated operating agreement for Holdco (the Amended Holdco LLC Agreement) following a “Termination Event” that would give ownership of the property and control of Holdco to the Lenders.

The Debtors were ultimately unable to make the payments required by the Forbearance Agreement, as amended.3 In anticipation of a default, on November 6, 2023, the Debtors advised the escrow agent that the Debtors and Lenders were in dispute about whether there was a cure period for the current payment and advised the escrow agent that if the Lenders declared a “Termination Event” under the Forbearance Agreement, the Debtors would be objecting to such declaration and to any release by the escrow agent of any of the escrowed items.4 On November 17, 2023, the Lenders sent (a) to the Debtors a termination notice in which the Lenders alleged that a “Termination Event” had occurred relating to the missed November 6 payment and (b) to the escrow agent and the Debtors, an escrow notice advising the escrow agent of the “Termination Event” and that the Mezz Lender deemed the Amended Holdco LLC Agreement released from escrow. As a result of the alleged “Termination Event,” the Lenders claimed to have the right to (1) commence and enforce a UCC Disposition and (2) cause the release from escrow of, among other things, the Amended Holdco LLC Agreement. That same evening, the Debtors sent to the escrow agent and the Lenders an objection to the termination and escrow notices.

On January 7, 2024 (the Petition Date),5 the Debtors commenced their Chapter 11 cases in the Bankruptcy Court. Some 45 days later, the Lenders moved to dismiss the Chapter 11 cases or, in the alternative, for relief from the automatic stay to obtain control of their collateral. The Bankruptcy Court denied the Lenders’ motion.

The Amended Holdco LLC Agreement’s Release Under the Workout Agreements

The Lenders moved to dismiss the Chapter 11 cases, asserting that the Amended Holdco LLC Agreement had been released from escrow upon the “Termination Event” which resulted in the Lenders gaining management control of Holdco thereby precluding the Debtors’ commencement of the Chapter 11 cases without the Lenders’ consent. The Bankruptcy Court disagreed, holding that the effectiveness and release of the Amended Holdco LLC Agreement was subject to the express terms of the Forbearance Agreement and the Escrow Agreement, both of which required proper instruction to be given for the Amended Holdco LLC Agreement to be released and that no such proper instruction had been given.

The Amended Holdco LLC Agreement provided that “[t]he effectiveness and release of this Executed Agreement, as delivered in escrow … is subject to the terms and conditions of that certain Escrow Agreement and that certain Forbearance Agreement ….”6 In turn, the Forbearance Agreement provided that the Amended Holdco LLC Agreement was in escrow “for the purpose of facilitating the strict foreclosure”7 and there was “no provision, in any of the governing documents, that permit[ed] the Lender[s] to pick and choose among the escrowed agreements and thereby to give itself some of the benefits of the deal (the right to control Holdco) without also at the same time giving Holdco the benefit of the release of obligations that the Strict Foreclosure Agreement contemplated.”8 Importantly, the Mezz Lender “did not ask for the release of all of the escrowed documents and did not elect to proceed with the strict foreclosure. Instead, the Mezz[ ] Lender notified Holdco of the alleged Termination Event in a letter … and stated that the Mezz[ ] Lender intended to instruct the Escrow Agent to release only the Conveyance Items [(i.e., the Amended Holdco LLC Agreement)] from escrow. All other items held in escrow shall remain so held by the Escrow Agent pending further notice from Lender.”9

The Bankruptcy Court held that the Lenders “did not invoke their rights to a strict foreclosure … [t]hey explicitly instructed the escrow agent not to release the Strict Foreclosure Agreement. The Escrow Agreement did not entitle the Lenders to ask for the [Amended Holdco LLC Agreement] separately from those other documents, and it did not give the Escrow Agent the authority to release any of the Escrow Items except as a complete package.10 Consequently, because the Lenders did not request the release of all Escrow Items pursuant to a strict foreclosure, no proper instruction was given to release the Amended Holdco LLC Agreement and it was of no force and effect. Accordingly, the Bankruptcy Court held that the Debtors were authorized to commence their Chapter 11 cases in accordance with the existing operating agreement and without the Mezz Lender’s consent.

The Debtors Did Not File Their Chapter 11 Cases in Bad Faith and Relief From the Automatic Stay Was Not Warranted

In bankruptcy, generally, “a motion seeking dismissal on grounds of bad faith must show ‘both objective futility of the reorganization process and subjective bad faith in filing the petition.’”11 Here, the Debtors and Lenders agreed that if the property was sold, the proceeds would be sufficient to repay the Lenders with residual proceeds available for Holdco’s equity holders. The Bankruptcy Court denied the Lenders’ motion to dismiss based on the Debtors’ “bad faith,” holding that it could not find that there was any “objective futility” to the reorganization process, nor could it find any evidence of “subjective bad faith.” Indeed, the Bankruptcy Court held that there was a “subjective reasonableness to the Debtors’ contention that a reorganization may maximize the value of the property and thereby maximize the recoveries of all parties in interest, including the Lenders.”12

The Bankruptcy Court also denied the Lenders’ request for relief from the automatic stay. While a debtor’s bad faith may be “cause” to grant such relief,13 the Bankruptcy Court, for the same reasons it denied the Lenders’ motion to dismiss based on the Debtors’ alleged bad faith, declined to lift the stay. Bankruptcy courts may also grant stay relief if the debtor does not have equity in the property for which stay relief is sought and such property is not necessary for the debtor’s reorganization efforts.14 The Bankruptcy Court denied the Lenders’ request for stay relief on this alternative basis, holding it was “subjectively and objectively reasonable to believe that there is equity value in the collateral that exceeds the obligations owed to the Lenders — in fact, the Lenders’ own valuations show that to be the case — and that the collateral is necessary to an effective reorganization.”15


With rising distress in commercial real estate, workout arrangements are increasingly common. Hudson serves as a reminder to secured lenders that they must be very careful in how their workout arrangements are drafted and constructed and to make sure that their ultimate exercise of remedies is done strictly in accordance with the terms of governing workout agreements. Bankruptcy courts are courts of equity and are typically debtor-friendly. Accordingly, lenders need to make sure that they are strictly abiding by their agreements to avoid giving the court a potential easy out to side in the debtor’s favor.

Here, the Lenders likely viewed it more desirable to proceed solely under the Amended Holdco LLC Agreement rather than the strict foreclosure because they wanted to avoid triggering a transfer tax, particularly if the Lenders’ intention was to effect a further sale of the property that would require them to pay transfer taxes for a second time. But, the consequence of that choice was that they failed to comply with the strict terms of the workout arrangements. The Lenders could have drafted the workout arrangements and the Escrow Agreement to afford more flexibility in their exercise of remedies. Otherwise, in order to avoid the bankruptcy result, they needed to live with the construct that was negotiated even if that triggered an adverse tax consequence.

In exercising remedies, lenders should also be mindful of an important issue that Hudson did not need to address: Had the Amended Holdco LLC Agreement been properly released from escrow, with no conveyance to the Lenders of their collateral, and provided the Lenders with veto authority over any future bankruptcy filing, would that veto power have been enforceable? Several courts have considered whether bankruptcy blocking rights are enforceable and the answers have been mixed.16

© Arnold & Porter Kaye Scholer LLP 2024 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. See Case No. 24-10021 (MEW), 2024 WL 1145664, at *1 (Bankr. S.D.N.Y. Mar. 15, 2024) (“Hudson”).

  2. The Lenders are affiliates of BH3 Management LLC.

  3. The Debtors’ inability to make such payment seems to have stemmed, at least in part, from the logistical difficulties of monetary transfers from China to the United States and the significant restrictions placed on those transfers by the Chinese government. The Debtors asked the Lenders to (1) roll over any shortfall in the payment required on November 6, 2023 to the succeeding payment date on November 24, 2023 and (2) confirm the provision in the Forbearance Agreement that purportedly gave the Debtors a 30-day cure period for the November 6 payment. The Lenders did not agree with the Debtors’ requests.

  4. The Debtors then asked the Lenders to agree to an amendment to the Forbearance Agreement that would, among other things, extend the time for making the November 6 payment and extend the maturity date. In response, on November 13, the Lenders asked for fees that aggregated in excess of US$4 million in exchange for a nine-day deferral of the November 6 payment. The Debtors declined the Lenders’ request.

  5. In the intervening period between November 17 and the Petition Date, the Debtors sued the Lenders on November 22 in the Supreme Court of the State of New York, New York County. See Hudson 888 Owner LLC and Hudson 888 Holdco LLC v. DOF II-Bloom Senior LLC, DOF II-Bloom Mezz LLC, and Reed Smith LLP, Index No. 161355/2023 (Sup. Ct. N.Y. County), seeking a judgment declaring that a 30-day cure period exists under the Forbearance Agreement with respect to the US$1.9 million payment that was due on November 6, 2023. On November 28, 2023, the Debtors and the Lenders entered into a stipulated temporary restraining order that preserved the status quo enjoining the Lenders from taking any action to exercise rights of ownership pending a hearing on the Debtors’ preliminary injunction request scheduled for January 8, 2024. The Debtors commenced the bankruptcy a day before that hearing.

  6. Hudson, 2024 WL 1145664, at *4 (emphasis added).

  7. Id. at *1.

  8. Id. at *4.

  9. Id. at *2 (emphasis added) (internal quotation omitted).

  10. Id. at *4 (emphasis added).

  11. In re Kingston Square Assocs., 214 B.R. 713, 725 (Bankr. S.D.N.Y. 1997).

  12. Hudson, 2024 WL 1145664, at *5.

  13. See 11 U.S.C. § 362(d)(1) (providing relief from the stay may be granted “for cause,” and courts have interpreted cause to include a debtor’s bad faith).

  14. See 11 U.S.C. § 362(d)(2).

  15. Hudson, 2024 WL 1145664, at *6.

  16. See Maja Zerjal Fink and Justin G. Imperato, “‘Golden Shares’ in U.S. Bankruptcy Cases: Can the Right to Block a Bankruptcy Filing Be Enforced?,” Int’l Corp. Rescue Journal, Vol. 18, Issue 2 (2021).