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Freeborn Successfully Represents Dozens of TIC Owner Groups

In November 2008, DBSI, Inc. and certain of its affiliates (collectively, “DBSI”) filed for Chapter 11 relief in the U.S. Bankruptcy Court for the District of Delaware.  At the time of its filing, DBSI was one of the country’s largest sponsors of tenant-in-common (TIC) investments, having syndicated more than 200 such deals with respect to commercial, industrial and multi-family residential properties. In a typical TIC transaction syndicated by DBSI, DBSI would convey a property to the TIC owners, and would concurrently enter into a “master lease” agreement with the TICs, as lessors, as well as subleases with the tenants occupying the premises (or would take an assignment of already-existing leases with such tenants).  As such, DBSI typically acted as the de facto asset manager with respect to these properties, collecting rents from the tenants, and applying them to the TICs’ debt service obligations and property-related expenses. However, unlike a traditional traditional asset management arrangement in which the remaining amounts would flow to the TICs as a return on their investment, under the master lease structure, the TICs were paid a fix “lease” payment, which was not necessarily related to the actual cash flow of the property.

The DBSI cases presented a host of challenges to all of the affected parties, and underscored the inherent conflicts between the TIC structure and the bankruptcy process.  Indeed, the parties struggled mightily to devise a process that would permit DBSI to exit the TIC business altogether while preserving both the income stream and tax benefits accorded to TIC owners, not to mention the viability of the properties that were encumbered by TIC structures. This process was further complicated by the numerous disparate constituencies with a stake in the TIC business: the TIC owners, DBSI, the Creditors’ Committee, the TIC owners’ lenders, the subtenants and DBSI’s other secured and unsecured creditors. When also taking into account the specter of alleged fraud and mismanagement committed by DBSI’s principals, it appeared at times that these cases would eventually collapse under their own weight.

Notwithstanding these seemingly insurmountable hurdles, the parties ultimately succeeded in devising a novel, heavily-negotiated process that allowed DBSI to divest its TIC property business while putting TIC owners in a position to save their properties from foreclosure. Freeborn & Peters was intimately involved in the creation and negotiation of this process, based upon its representation of almost 30 TIC owner groups. The process that was ultimately agreed upon by key constituencies, and approved by the Bankruptcy Court, provided TIC owner groups with the option to direct the rejection, or assumption and assignment, of the underlying subleases (“TIC Options”). Hence, a TIC owner group seeking to terminate its relationship with DBSI while preserving its tenant base could elect to have the DBSI masterlease rejected while simultaneously having the underlying subleases assumed and assigned to the TICs. Indeed, dozens of TIC owner groups, including many of the groups represented by Freeborn & Peters, made this very election.

Given the highly contentious nature of the negotiations leading to this resolution, as well as the thorny legal issues permeating these cases, it should come as no surprise that the TIC Options process subsequently came under collateral attack by certain parties seeking to extract financial gain at the expense of the TIC owner groups.  For instance, the sole tenant of an office building in Dallas, Texas recently initiated litigation against a TIC owner group in Texas state court, seeking a declaratory judgment that notwithstanding the Bankruptcy Court’s approval of a transaction involving the rejection of a DBSI master lease and assignment of its sublease, the sublease had been terminated by operation of law.  Following the removal and transfer of the litigation to the Bankruptcy Court, the tenant filed motions seeking a remand of the litigation back to Texas, as well as to impose a preliminary injunction against the TICs that would have permitted the tenant to pay only market rent – rather than the agreed-upon contract rent.  The result of the proposed injunction would have been catastrophic to the TICs, as the “market” rent asserted by the tenant would have been insufficient to cover debt service and property-related expenses.

A Freeborn & Peters team led by Partners John Z. Lee (Litigation), Thomas R. Fawkes (Bankruptcy and Financial Restructuring) and Edward J. Hannon and Michael A. Moynihan (Real Estate) opposed the tenant’s motions on behalf of the TICs, asserting that the Bankruptcy Court’s approval of the TIC Options overrode state law, and that to grant the relief sought by the tenant would inevitably lead to a collapse of the TIC Option process and the unraveling of the DBSI cases. Fortunately, the Bankruptcy Court recognized the dire consequences that would result from permitting a collateral attack of its prior orders, and on August 10, 2009, issued a memorandum opinion rejecting the tenant’s arguments, denying both motions, and stating – in no uncertain terms – that the tenant’s chance of success on the merits was “slim to none.” While it is hoped that this significant victory will dissuade additional collateral attacks on the TIC Options process, it should also serve as a reminder of the challenges that will inevitably be faced should other TIC sponsors seek Chapter 11 relief.