By the time you read this article,it could be out of date. Builders are filing for bankruptcy protection faster than the media can keep up. And the likelihood that more companies will have to take that route hasn’t been this great in decades as foreclosures accelerate and credit tightens toward the point where builders run out of cash and options.
Through January, more than a dozen builders had filed for bankruptcy over the previous several months. The number of bankrupt contractors is unquestionably worse. In Northwest Arkansas alone, 70-plus building-related bankruptcies were filed in 2007, according to that market’s Morning News. “We’re just seeing the tip of the iceberg,” predicts Brett Weiss, an attorney representing Turner & Associates, an Upper Marlboro, Md.–based developer trying to reorganize under Chapter 11. The largest builder to file to date is TOUSA, which on Jan. 29 petitioned for Chapter 11 protection with more than $1.7 billion in liabilities. Bankruptcy provides TOUSA a haven to restructure its debt and keep its home building divisions running. Experts warn, though, that the process is never a panacea for what ails a failing business.
As more builders drift toward what, for most, would be uncharted waters, Builder took a closer look at companies that have filed either Chapter 11 or Chapter 7, to see what builders can expect from the ordeal. What emerges is expensive, complicated, and time-consuming. Builders must be prepared to relinquish some control of their operations and assets to creditors that usually include banks, municipalities, suppliers, and subcontractors. Even the smoothest bankruptcies have unforeseen circumstances. And while there have been successful builder reorganizations, such as NVR’s in the early 1990s, the odds of coming out of bankruptcy as a functioning entity are long.
“What drives a bankruptcy is the loss of liquidity,” says a source involved in Neumann Homes’ Chapter 11 case, who requested anonymity. “Even companies with lots of cash eventually run out.” Last October, the managing partner of America’s First Home in Florida insisted that his company would weather the downturn because it could draw on a $20 million cash reserve. When it filed for bankruptcy protection in December, this builder listed only $850,000 in cash on hand. In January, America’s First Home petitioned a bankruptcy court to liquidate its assets.
Builders in trouble shouldn’t count on lenders to bail them out, either. For one thing, more banks are having their own financial problems, so their patience has worn thin with debtors. Anthony Perry found this out when he started alerting his banks a year ago that his company, Oakwood Homes in Woodstock, Ga., was struggling. “Some stopped speaking to me, others cut me off and said they’d never lend me another cent, and a few tried to foreclose on us,” says Perry, who in January filed Chapter 7 and is liquidating his business. Builders that cross-collateralize their bank loans with overlapping parcels of land can run into problems when, under bankruptcy, they want to sell different pieces of that real estate and need to get multiple banks to sign off on the transaction, which bankruptcy experts say is usually easier said than done. When banks shut off their faucets, desperation inevitably ensues: RS Custom Homes in Clackamus, Ore., filed for bankruptcy in December with $557,105 in liabilities, a good chunk of it credit card debt on 15 accounts that served as “cash flow” for its owner, Robert Swelland, when RS couldn’t sell five homes it had built on spec. (Its lender repossessed those houses four months earlier.) Brad Elliott, owner of Elliott Building Group in Langhorne, Pa., which is liquidating under Chapter 7, tried to keep his business afloat last year by borrowing $1 million against personal assets from an investor that charged him 35 percent interest.
Still, experts recommend that builders secure financing to run their businesses prior to filing (as TOUSA did, with $135 million from Citigroup Global Markets) because “institutions don’t have much appetite” for funding companies in Chapter 11, says David Bruck, an attorney who represented Kara Homes in its bankruptcy case. Kara’s smartest move may have been hiring Perry Mandarino, senior managing director of Traxi, a New York–based bankruptcy consultant, as its chief restructuring officer. Mandarino “put together precisely what Kara had to sell,” says Bruck, and solicited 250 developers and other potential buyers. Mandarino ultimately connected Kara with Plainview Asset Management and Glen Fishman, a local developer, who together formed a joint venture to acquire 12 of Kara’s 29 properties. This joint venture not only agreed to complete construction on more than 600 homes, it also bought $50 million of Kara’s debt and provided Kara with around $20 million to cover Chapter 11 and administrative costs and to pay Kara’s unsecured creditors.
White knights can be a blessing, such as the private equity firm The Najafi Cos. agreeing in late January to acquire Trend Homes in Arizona for $65 million, and then taking that builder into Chapter 11. But such knights are rare. Mandarino couldn’t find a savior for Elliott Building Group, which despite approaching more than 300 prospects, could auction off only two of its 14 properties. What galls Elliott is that his company had two or three profitable communities around which it could have reorganized and was three weeks from negotiating new financing when, he says, it was forced into bankruptcy by a trade creditor that “tried to jump ahead of everyone and foreclose on one of our properties.”
Some builders file bankruptcy to manage the unmanageable. A bankruptcy court recently allowed Levitt and Sons to tap a $3.5 million loan it wouldn’t have had access to otherwise, so the builder could resume construction. Under Chapter 11, Neumann Homes transferred property and mechanic’s lien obligations to five lenders that assumed responsibility for paying trades and completing construction on about 200 homes. Each of Oakwood Homes’ 15 banks, to which the builder owed $30 million, had its own idea about how it should be repaid. Bankruptcy protection offered an orderly path for those lenders to equitably retrieve Oakwood’s assets, which include around 200 lots and 30 unfinished homes in four communities.
However, bankruptcy protection might seem emasculating to builders used to calling their own shots. “You’re in a fishbowl where banks, courts, and creditors are entitled to extensive financial reporting,” says Kenneth Rosen, an attorney with Rosewood, N.J.–based Lowenstein, Sandler PC, which is representing Weyerhaeuser in the Dunmore Homes bankruptcy and a large trade creditor in the Neumann case. Rosen also points to the relatively recent phenomenon of creditors selling their claims to illustrate bankruptcy’s unpredictability. “We’re seeing a lot of vulture investors entering the world of insolvency,” he cautions.
Unpredictability, though, is part of the drill. Neumann must cut a separate deal with Bank of America, which balked at the builder’s property-for-debt proposal. In January, a bankruptcy court judge ordered the trustee in the Levitt case to appoint a committee representing home buyers who could lose more than $15 million in deposits on homes that Levitt hadn’t finished or started. “That’s why you have to get to the banks’ workout departments early,” advises Elliott, “because the people who made the loans are never fully aware of the seriousness of your situation, and banks in general move like glaciers.”
Rosen tells his clients to do whatever they can to get in and out of bankruptcy quickly. “It’s not like wine. It doesn’t get better with age.” Bankruptcies can assume lives of their own and become endless. (The supermarket chain Grand Union has been in and out of bankruptcy since 1995, and its most recent case has dragged on for eight years.) Dunmore Homes’ contentious Chapter 11 already has spilled over into lawsuits filed by its former president against one of its creditors, the developer Reynen & Bardis; and by creditors against a struggling business started by the Dunmore family’s two sons.
Through January, nearly 500 notices, amendments, orders, and other documents had been filed in the Neumann case, including court approval for hiring Hilco Trading Co. as the builder’s real estate advisor. As of early February, Hilco was evaluating Neumann’s land, which could determine the ultimate sale of those assets. “We’re either dead by then, or we’ll have a game plan,” says a source familiar with this case. “We’ve told the banks they aren’t getting Neumann’s property for free, so tell us what you want us to do—like putting it in a trust or selling it—and we’ll do it.”
As banks retrieve distressed land to settle debt, a bankrupt builder such as Perry might get a second life by offering his construction services to build homes on those properties. “Who can do that better?” Perry asks. “The banks, or someone like me, with 30 years in the business?”