SW Boston Hotel Venture LLC and 30-32 Oliver Street Corporation

UNITED STATES BANKRUPTCY COURT
DISTRICT OF MASSACHUSETTS
(Eastern Division)
In re:
SW BOSTON HOTEL VENTURE, LLC, et
al.,1
Debtors.
Chapter 11
Case No. 10-14535-JNF
(Jointly Administered)
MEMORANDUM REGARDING MOTION BY SW BOSTON HOTEL
VENTURE, LLC FOR AUTHORITY TO LEASE CONDOMINIUM UNITS
IN THE ORDINARY COURSE OF BUSINESS
I. INTRODUCTION
The matter before the Court for determination is the Motion (the “Motion”) of SW
Boston Hotel Venture, LLC (the “Debtor”), one of the above-captioned debtors and debtors-in-
possession (collectively the “Debtors”) for entry of an Order, pursuant to Section 363 of the
Bankruptcy Code, authorizing the Debtor to lease a select number of condominium units located
at the W Boston Hotel and Residences (the “Property”). The Debtor requested expedited
determination of the Motion, which the Court granted.
The holder of the Debtor’s first mortgage on the Property, Prudential Insurance
Company (“Prudential”), filed an Objection to the Motion asserting two reasons: first, that the
information that the Debtor has provided in support of its leasing proposal is inadequate, and that
1 The other Debtors in the jointly administered cases are Auto Sales & Service, Inc. (Case No. 10-14528-JNF), General
Trading Company (Case No. 10-14532-JNF), Frank Sawyer Corporation (Case No. 10-14533-JNF), 100 Stuart Street,
LLC (Case No. 10-14534-JNF), 30-32 Oliver Street Corporation (Case No. 10-16173-JNF), General Land Corporation
(Case No. 10-16174-JNF), and 131 Arlington Street Trust (Case No. 10-16177-JNF).
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the Debtor has not shown a proper business justification for the proposal; and second, that
Prudential’s prior consent to leasing is required, which the Debtor did not obtain, either before or
after filing the Motion, and which consent Prudential does not give. The holder of the Debtor’s
second mortgage on the Property, the City of Boston, filed a Statement in support of the Motion.
Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”) filed a Reply to the Motion, which
the Debtor and Starwood reported resolved at the hearing held on August 26, 2010, with the
Debtor agreeing to comply with the provisions of the Condominium Marketing Licensing
Agreement executed by the Debtor and Starwood in all respects, including terms with respect to
leasing activity.
Prudential requested an evidentiary hearing, which the Court held on an emergency basis
on August 26, 2010. At the outset of the hearing, the Court directed, and the parties agreed, that
in lieu of direct testimony of witnesses, the Debtor would present an offer of proof through its
counsel, Prudential would conduct cross-examination of the Debtor’s witnesses, and the Debtor
would have the opportunity to conduct redirect examination. Prudential did not call any
witnesses. Based upon the evidence presented, the Court now makes the following findings of
fact and conclusions of law in accordance with Fed. R Bankr. P 7052.
II. FINDINGS OF FACT
The Debtor’s Property is a 26 story four–star hotel and luxury condominium development
in downtown Boston. 	In addition to a 235 room W Hotel, the Property has 122 condominium
units. 	The Debtor’s initial business plan was to sell all of the units and not engage in leasing.
The Debtor has sold 22 of the condominiums, but sales are “behind pace,” according to the
Debtor’s financial advisor, Derek Flanagan (“Flanagan”). Because the market for rentals is
currently better than the market for sales, the Debtor has embarked on a leasing strategy for up to
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25 of its condominium units, which approximates 25 percent of its inventory of available units.
The Debtor contemplates renting the units for terms of six months to one year. The Debtor
submits that there are a number of reasons for leasing a select number of units: namely, that
leasing will provide significant income for the Debtor, enhance the activity in the complex, and
create a pool of potential purchasers.
Kevin Ahearn (“Ahearn”), a licensed real estate broker with thirty years of real estate
sales and leasing experience, of the Boston firm Otis & Ahearn, has been employed by the
Debtor to market its condominium units. He testified that the Debtor currently has three pending
offers to purchase condominium units. Describing the Property as a “fluid situation,” Ahearn
explained that the leasing of the units will generate revenue in the form of monthly rent, will
generate interest in the development, and will enhance the prospects for sales of units to lessees
who may be interested in purchasing once they have occupied the premises.
As to the generation of revenue from the proposed leasing plan, the Debtor’s Second
Statement Regarding Continued Use of Collateral filed with the Court on August 13, 2010 and
served on Prudential’s Counsel contained the following projections of rental revenues: $37,000
for October 2010; $67,000 for November 2010; $95,000 for December 2010; and
$128,000 for January 2011. Ahearn indicated that it would take approximately six months to
obtain full occupancy of all units offered for lease. He testified that the Debtor proposes to list
the following units for lease for the following monthly rent: four studios for the sum of $2,250
per month; five standard one bedroom units for $3,650 per month; three large one bedroom units
for rent for $4,500 per month; three standard 2 bedroom units for rent for $5,500 per month; six
large two bedroom units for $9,000 per month; and a penthouse unit for the sum of between
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$10,000 and $12,500 per month. According to Ahearn, these prices are competitive with other
comparable rentals.
Ahearn’s firm does not circulate marketing materials for expensive apartments,
preferring instead to market high end units by word of mouth and through other real estate
brokers. Ahearn further explained that his firm pre-qualifies prospective tenants through analysis
of their cash flow, employment information, and credit reports. His firm does not intend to
obtain personal financial statements from tenants, which is not industry practice. The Debtor will
present to prospective tenants the standard form of lease of the Greater Boston Real Estate
Board, who will be required to pay first month’s and last month’s rent and a security deposit, all
of which are customary in the industry. In addition, the leases will contain an Addendum by
which tenants would agree to be bound by the condominium documents, including their
restrictions on use, and the rules and regulations of the condominium association. The proposed
leases do not contain provisions giving a tenant any credit for lease payments in the event of a
purchase.
Ahearn explained that in addition to generating revenue, the leasing strategy will generate
interest in the Property. Moreover, the Debtor is optimistic that once a tenant occupies a unit
pursuant to a lease, the tenant will be incentivized to purchase the leased unit. Ahearn explained
that this phenomenon has occurred in several other upscale condominium properties in Boston,
including Battery Wharf and the Intercontinental.
Flanagan testified that the Debtor has entered into negotiations with Ajax Consulting
Services, LLC (“Ajax”), a project and construction manager to real estate owners and
developers, to expand services to include the management of the leased units. According to
Flanagan, Ajax has experience in property management and is capable and competent to render
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property management services. It is expected that Ajax’s compensation for the new services will
be a fee of $2,000, according to Flanagan, this is “de minimis” compensation. However, the
specific details of Ajax’s proposed employment have not been finalized.
III. ISSUE PRESENTED
The issue presented is whether the Debtor has shown that its decision to lease up to 25
condominium units at the Property is based on reasonable business judgment.
IV. DISCUSSION
Although the Debtor denominates the Motion as “a Motion by SW Boston Hotel Venture,
LLC Authority to Lease Condominium Units in the Ordinary Course of Business,” the Debtor’s
argument in the Motion focuses on the standard for approval of use and lease of property of a
debtor other than in the ordinary course of business. As approval by the Court is required for a
transaction out of the ordinary course of business, the Court assumes that the Debtor concedes
that the decision to lease and not sell units is such a transaction.
Section 363(b) of the Bankruptcy Code provides that a trustee “after notice and a hearing,
may use, sell, or lease other than in the ordinary course of business, property of the estate.” 11
U.S.C. § 363(b). A Chapter 11 debtor in possession has the power of a trustee to use or lease
property of the estate under § 363(b). See 11 U.S.C. §§ 1107, 1108. Courts approve a Chapter
11 debtor in possession’s use, sale or lease of property of the estate where the debtor has used
reasonable business judgment and articulated a business justification for such use. See, e.g., In re
Chateaugay Corp., 973 F. 2d 141, 143 (2d Cir. 1992). Commonly referred to as the “business
judgment” test, the standard applies to a debtor’s decision to enter into a postpetition lease of real
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estate. See In re Six Forks LHDH, LLC, No. 10-01254-8-SWH, 2010 WL 1740544, at *1-2
(Bankr. E.D. N.C. April 28, 2010) (recognizing that the business judgment test applies to a
proposed lease and denying the debtor’s request for authority to enter into the lease for lack of
information regarding the lessee’s financial viability and the lease’s long-term market terms).
Evidence that a debtor in possession has used reasonable business judgment and has articulated a
business justification for a lease transaction includes generation of revenue which will benefit the
estate. See, e.g., In re Ernst Home Ctr., 209 B.R. 974, 980 (Bankr. W.D. Wash. 1997). In
evaluating a debtor’s exercise of business judgment, courts afford that debtor some deference
because the debtor is familiar with its business and industry. “A debtor's business decision
should be approved by the court unless it is shown to be so manifestly unreasonable that it could
not be based upon sound business judgment, but only on bad faith, or whim or caprice.” In re
Cadkey Corp., 317 B.R. 19, 22-3 (D. Mass. 2004); see In re Aerovox, Inc., 269 B.R. 74, 80
(Bankr. D. Mass. 2001) (internal quotations and citations omitted).
In the present case, the evidence presented by the Debtor establishes that its decision to
lease selected units is supported by sound business judgment and there is ample justification for
the leasing program. The evidence is unrebutted that the leasing program is projected to generate
substantial revenue for the estate and is likely to enhance sales of other units. The proposed
rental rates comport with industry standards. Unlike the lease in In re Six Forks, in which the
property could be locked in to the same rental rate for ten years, the leases proposed by the
Debtor are for periods of six months to a year. There is no evidence that the short-term nature of
the proposed lease agreements will disrupt the ability to sell units. The Debtor has provided
evidence that tenants will be screened through a careful vetting process, which includes a credit
check and verification of employment. This process will improve the likelihood that a lessee has
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the ability to pay rent. 	The expert testimony that the leasing program is likely to enhance unit
sales was credible and unrebutted.
Contrary to Prudential’s assertion, the Debtor has outlined a coherent leasing strategy.
During the evidentiary hearing, the Debtor presented evidence on all of the categories of
information sought by Prudential. 	The Debtor agreed to provide, and the Court directed the
Debtor to produce, documentation concerning proposed leases. 	Through the evidence adduced
at the hearing, the Debtor has sufficiently addressed Prudential’s concerns that the leasing
strategy was not a reasonable plan.
Prudential insists on the right to approve the leasing program and each lease with every
tenant. 	The provision in the loan documents that the Debtor shall not enter into a lease without
Prudential’s prior consent is subject to the condition that such consent shall not be unreasonably
withheld or delayed. In view of the evidence submitted at the hearing, any decision by
Prudential not to consent to the leasing program at this point would be unreasonable. Prudential
does not have the right to approve each and every lease entered into by the Debtor, because once
the leasing program is approved, such individual transactions become ordinary course of
business transactions of the debtor in possession. In the event Prudential believes that the
Debtor has mismanaged the process once leasing is implemented, Prudential has a number of
remedies under bankruptcy law available to it.
Finally, the Court notes that much time was spent on this contested matter and the
expenses of litigating this Motion were substantial. 	The details of the leasing program were not
set forth in the Motion. Apparently, counsel to the Debtor and Prudential did not communicate
with each other about the Motion before or after its filing and it does not appear that they
communicated with each other even after Prudential filed its objection. This evidentiary hearing
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would have been unnecessary had counsel effectively communicated with each other. 	In the
future, prior to filing any pleading with the Court, the Court directs counsel to Prudential and the
Debtor to confer and make a reasonable and good faith effort to resolve any dispute without the
necessity of an evidentiary hearing.
Based upon the foregoing, the Court grants the Motion. A separate order will be entered.
Dated: August 27, 2010
By the Court,
________________________________
Joan N. Feeney
United States Bankruptcy Judge
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