An [In]Subordinate Lender: Delaware Bankruptcy Court Dismisses Mezzanine Borrower's Chapter 11 Case for Bad Faith

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In an opinion that has wide-ranging implications for the structured finance industry, the Delaware bankruptcy court recently dismissed a mezzanine borrower’s chapter 11 case as a bad faith filing pursuant to section 1112(b) of the Bankruptcy Code. In re JER/Jameson Mezz Borrower II, LLC, No. 11-13338, 2011 WL 6749058 (Bankr. D. Del. Dec. 22, 2011). At the core of the motion to dismiss were allegations that the debtor had filed for bankruptcy in bad faith, solely to benefit the lender to a parent entity, and to the detriment of the debtor’s lender. The opinion stands in contrast to In re General Growth Properties, Inc., 409 B.R. 43 (Bankr. S.D.N.Y. 2009) (“GGP”), and may leave structurally senior lenders breathing a sigh of relief.

In 2006, JER/Jameson Mezz Borrower II, LLC (“Mezz II”) and certain of its affiliates borrowed approximately $400M to acquire the hotel chain Jameson Inns and Signature Inns (the “Jameson Hotels”). The loan was structured as a multi-tiered facility made up of five different tranches of debt. Operating companies, which owned or leased and operated the Jameson Hotels (the “Operating Companies”), borrowed $175M, secured by the hotel properties. Four mezzanine borrowers, which were formed for the sole purpose of the financing (referred to herein as “Mezz I,” “Mezz II,” “Mezz III,” and “Mezz IV”), each borrowed $40M. Mezz IV’s loan was secured by its 100% equity interest in Mezz III, Mezz III’s loan was secured by its 100% equity interest in Mezz II, Mezz II’s loan was secured by its 100% equity interest in Mezz I, and Mezz I’s loan was secured by its 100% equity interest in the Operating Companies. The Operating Companies provided the sole source of revenue for the Jameson Hotel enterprise.

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