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Insider Lease Agreements (Series: Ethical Issues in Real Estate-Based Bankruptcies 2020)

It is a common play in real estate to create a separate operating entity to serve as a tenant and execute a lease between the owner of the property and himself. Typically, this happens in assets which serve as a real estate-based business, such as a retail property. The structure enables the operator to reduce the taxable income of the business and also provide a liability shield for the property owner. This arrangement can lead to some ethical issues should the property owner become distressed. For example, is the lease amount above market and therefore being used to inflate the property valuation? Is rent actually being paid? Is there a proper lease in place or just an internal handshake? Attorneys need to understand the set-up in order to know what is in bounds and what is outside the lines. This webinar looks at this leasing structure and examines the issues that may arise.

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Insider Lease Agreements (Series: Ethical Issues in Real Estate-Based Bankruptcies 2020)

  1. 1. 1
  2. 2. 2 Practical and entertaining education for attorneys, accountants, business owners and executives, and investors.
  3. 3. 3 Thank You To Our Sponsors
  4. 4. Disclaimer The material in this webinar is for informational purposes only. It should not be considered legal, financial or other professional advice. You should consult with an attorney or other appropriate professional to determine what may be best for your individual needs. While Financial Poise™ takes reasonable steps to ensure that information it publishes is accurate, Financial Poise™ makes no guaranty in this regard. 5
  5. 5. Meet the Faculty MODERATOR: David Levy - NRC Realty & Capital Advisors PANELISTS: Matthew Christensen - Angstman Johnson Gordon "Gordy" Gouveia - Fox Rothschild LLP Beth Jo Zeitzer - ROI Properties 6
  6. 6. About This Webinar Insider Lease Agreements It is a common play in real estate to create a separate operating entity to serve as a tenant and execute a lease between the owner of the property and himself. Typically, this happens in assets which serve as a real estate-based business, such as a retail property. The structure enables the operator to reduce the taxable income of the business and also provide a liability shield for the property owner. This arrangement can lead to some ethical issues should the property owner become distressed. For example, is the lease amount above market and therefore being used to inflate the property valuation? Is rent actually being paid? Is there a proper lease in place or just an internal handshake? Attorneys need to understand the set-up in order to know what is in bounds and what is outside the lines. 7
  7. 7. About This Series Ethical Issues in Real Estate-Based Bankruptcies It does not take a complex corporate chapter 11 bankruptcy to encounter serious ethical issues that must be confronted in a case. In fact, the relative simplicity of a real estate-based bankruptcy will shine the light on all of the main case details, bringing increased scrutiny to all of the debtor’s actions and decisions. Real estate-based bankruptcies are some of the most common matters filed. As an attorney, you are your client’s advocate and need to navigate the waters to provide effective counsel while playing within rules. In this series we tackle some common ethical scenarios that present themselves in real estate-focused bankruptcies frequently, including matters related to valuing assets, insider lease agreements, and a Single Asset Real Estate (SARE) cases. At the end you will be better equipped to answer questions like Is your client being astute or asinine? This this scheme clever or cagey? Under the rules of bankruptcy, is an inside arrangement shady or shrewd? Each Financial Poise Webinar is delivered in Plain English, understandable to investors, business owners, and executives without much background in these areas, yet is of primary value to attorneys, accountants, and other seasoned professionals. Each episode brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. Each episode in the series is designed to be viewed independently of the other episodes so that participants will enhance their knowledge of this area whether they attend one, some, or all episodes. 8
  8. 8. Episodes in this Series #1: Valuing Real Estate Assets Premiere date: 1/28/20 #2: Insider Lease Agreements Premiere date: 2/18/20 #3: Single Asset Real Estate Cases Premiere date: 3/17/20 9
  9. 9. Episode #2 Insider Lease Agreements 10
  10. 10. What Are Ethics? Webster: (noun) The discipline dealing with what is good and bad and with moral duty and obligation; The principles of conduct governing an individual or a group; A guiding philosophy; A set of moral issues or aspects (such as rightness) 11
  11. 11. Legal Ethics The American Bar Association (ABA) Model Rules of Professional Conduct were adopted by the ABA House of Delegates in 1983. They supply the general ethical rules which govern the practice of law which have been adopted by most states and jurisdictions. A number of the Model Rules are implicated in bankruptcy cases (as they are in litigation in general). Examples include the lawyer’s duty to bring meritorious claims, to be truthful with the Court (and not withhold information relating to criminal or fraudulent enterprises), to be fair to opposing party/counsel, to refrain from engaging in conduct which would disrupt a proceeding or seek to exert undue influence on any Judge or party, and to be truthful in statements to the Court and to others. 12
  12. 12. Model Rules of Professional Conduct Rule 1.7: Conflict of Interest: Current Clients (a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer. 13
  13. 13. Model Rules of Professional Conduct Rule 1.7: Conflict of Interest: Current Clients (cont’d) (b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and (4) each affected client gives informed consent, confirmed in writing. 14
  14. 14. Model Rules of Professional Conduct Rule 3.3: Candor Toward the Tribunal Advocate (a) A lawyer shall not knowingly: (1) make a false statement of fact or law to a tribunal or fail to correct a false statement of material fact or law previously made to the tribunal by the lawyer; (2) fail to disclose to the tribunal legal authority in the controlling jurisdiction known to the lawyer to be directly adverse to the position of the client and not disclosed by opposing counsel; or (3) offer evidence that the lawyer knows to be false. If a lawyer, the lawyer’s client, or a witness called by the lawyer, has offered material evidence and the lawyer comes to know of its falsity, the lawyer shall take reasonable remedial measures, including, if necessary, disclosure to the tribunal. A lawyer may refuse to offer evidence, other than the testimony of a defendant in a criminal matter, that the lawyer reasonably believes is false. 15
  15. 15. Model Rules of Professional Conduct Rule 3.3: Candor Toward the Tribunal (cont’d) (b) A lawyer who represents a client in an adjudicative proceeding and who knows that a person intends to engage, is engaging or has engaged in criminal or fraudulent conduct related to the proceeding shall take reasonable remedial measures, including, if necessary, disclosure to the tribunal. (c) The duties stated in paragraphs (a) and (b) continue to the conclusion of the proceeding, and apply even if compliance requires disclosure of information otherwise protected by Rule 1.6. (d) In an ex parte proceeding, a lawyer shall inform the tribunal of all material facts known to the lawyer that will enable the tribunal to make an informed decision, whether or not the facts are adverse. 16
  16. 16. Model Rules of Professional Conduct Rule 4.3: Dealing with Unrepresented Person In dealing on behalf of a client with a person who is not represented by counsel, a lawyer shall not state or imply that the lawyer is disinterested. When the lawyer knows or reasonably should know that the unrepresented person misunderstands the lawyer’s role in the matter, the lawyer shall make reasonable efforts to correct the misunderstanding. The lawyer shall not give legal advice to an unrepresented person, other than the advice to secure counsel, if the lawyer knows or reasonably should know that the interests of such a person are or have a reasonable possibility of being in conflict with the interests of the client. 17
  17. 17. Applicable Bankruptcy Code Bankruptcy Code Section 327 (a)Except as otherwise provided in this section, the trustee, with the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under this title. Bankruptcy Code Section 101(14) The term ―disinterested person‖ means a person that— (A) is not a creditor, an equity security holder, or an insider; (B) is not and was not, within 2 years before the date of the filing of the petition, a director, officer, or employee of the debtor; and (C) does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason. 18
  18. 18. Applicable Bankruptcy Code Bankruptcy Rule 2014: (a) APPLICATION FOR AND ORDER OF EMPLOYMENT. An order approving the employment of attorneys, accountants, appraisers, auctioneers, agents, or other professionals pursuant to §327, §1103, or §1114 of the Code shall be made only on application of the trustee or committee. The application shall be filed and, unless the case is a chapter 9 municipality case, a copy of the application shall be transmitted by the applicant to the United States trustee. The application shall state the specific facts showing the necessity for the employment, the name of the person to be employed, the reasons for the selection, the professional services to be rendered, any proposed arrangement for compensation, and, to the best of the applicant's knowledge, all of the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the office of the United States trustee. The application shall be accompanied by a verified statement of the person to be employed setting forth the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the office of the United States trustee. 19
  19. 19. Key Bankruptcy Definitions Leasehold Interest: Claim or right to enjoy the exclusive possession and use of an asset or property for a stated definite period, as created by a written lease. A long-term lease interest is a valuable asset in its own right which can be traded or mortgaged as a physical asset. Insider: An insider is a person or business that’s in a close relationship with a debtor (the person filing for bankruptcy), including relatives, any partnership in which the debtor is a general partner, any general partner of the debtor or any corporation in which the debtor is a director, officer, or person in control. A variety of tests can be used to determine an insider relationship include closeness, similarity, and control. 20
  20. 20. Key Bankruptcy Definitions Executory Contract: Contract between a debtor and another party under which both sides still have important performance remaining. Such agreements may be rejected in the bankruptcy. A lease is considered an executory contract. Plan of Reorganization: The plan of reorganization outlines how the debtor will reorganize its business, administer its assets, make distributions to creditors and emerge from bankruptcy. In order to move forward with the plan of reorganization, it must be voted on by the various classes of creditors, satisfy the specific dictates of the Bankruptcy Code, and be confirmed by the Bankruptcy Court. Preferential Payment: When a company in trouble has made or elects to make payments to on creditor ahead of others without a sound reason to do so other than following the personal preferences of the Directors. 21
  21. 21. Non-Statutory Insider Tests • ―Closeness‖ approach, which considers ―whether there is a close relationship [between debtor and creditor] and ... anything other than closeness to suggest that any transactions were not conducted at arm’s length.‖ See, e.g., Schubert v. Lucent Techs. Inc. (In re Winstar Commc’ns Inc.), 554 F.3d 382, 396-97 (3d Cir. 2009). • ―Control‖ approach, which considers whether the alleged insider exercised ―sufficient authority over the debtor so as to unqualifiably dictate corporate policy and disposition of corporate assets.‖ See, e.g., Butler v. David Shaw Inc., 72 F.3d 437, 443 (4th Cir. 1996) • ―Similarity‖ approach, which examines whether the ―the alleged insider holds a position substantially similar to the position specified in [§ 101(31)].‖ See, e.g., In re Longview Aluminum LLC, 657 F.3d 507, 509 (7th Cir. 2011). 22
  22. 22. What Roles do Leases Play in Bankruptcy Cases • Income to debtor • Business operations footprint, particularly in retail • Obligation of debtor • Plan of reorganization 23
  23. 23. Sides of the Matter • Debtor: Are the leases an asset or burden to the business? • Lender: Do non-strategic leases have any value if sold? Does rationalizing store lead to a viable restructuring plan? • Judge: Is the debtor taking any actions that are preferential to some creditors versus others? Issues between insider relationship between landlords and debtor must be identified and resolved. 24
  24. 24. Ethical Situation Case Studies 25
  25. 25. In re Scott Acquisition Corp. Scotty's, Inc. is the wholly-owned subsidiary of Scott Acquisition Corp. Prior to their bankruptcy, Scotty's, Inc. and Scott Acquisition Corp. (collectively, the ―Debtors‖) were retailers of building materials and home improvement products for the ―do it yourself‖ home improvement market. The defendants were the individual officers and directors of Scotty's, Inc. (―Scotty's‖). The complaint alleges the defendants' misconduct as follows. In 1998, Scotty's entered into a Loan and Security Agreement with Congress Financial Corporation (―Congress‖). Under that agreement, Congress loaned Scotty's certain sums of money and took a security interest in substantially all of the Debtors' property. Scotty's, however, was unable to make the required loan payments. As a result, Scotty's and Congress made various amendments to the loan agreement. During negotiations relating to the loan, Congress expressed its desire to have Scotty's divest itself of its real estate holdings and pay down the amounts owed to Congress. This would not only reduce the amount owed to Congress, but would also allow inventory to be the sole focus of Congress' security interest. Having inventory as the only collateral would allow Congress with a quick exit strategy— payment on a potential Scotty's liquidation. 26
  26. 26. In re Scott Acquisition Corp. As such, Scotty's began divesting itself of its real estate holdings on a sale-and-leaseback basis. Some properties were sold to independent third parties. Others, however, were sold to entities controlled by certain of the defendants. These insider defendants, through the controlled entities, paid less than fair market value for Scotty's choice real estate. In return, Scotty's received no more favorable treatment on the terms of the leases than it would have with third parties. Throughout, Scotty's failed to solicit and consider third party offers for the purchase of its choice real estate. Further, Scotty's failed to seek any independent consideration or review of these insider sale-and-leaseback transactions. Accordingly, the complaint alleges that the defendants, the officers and directors of Scotty's, breached their fiduciary duties of care and loyalty in several respects. The complaint also alleges that the defendants had knowledge and rendered substantial assistance with regard to one another's breaches of fiduciary duties. 27
  27. 27. In re Edgewater Medical Center Background: Chapter 11 debtor-in-possession brought adversary proceeding against its landlord and their common principal to set aside alleged fraudulent transfers and to recover on breach of contract, breach of fiduciary duty and other theories. The Bankruptcy Court, Bruce W. Black, J., held that: 1.No ―transfer‖ of interest of the debtor in property occurred, of kind potentially subject to avoidance, upon expiration of debtor's purchase option under lease; 2.Debtor failed to show that it was insolvent or rendered insolvent by challenged rent payments; 3.Landlord breached covenant of good faith and fair dealing; 28
  28. 28. In re Edgewater Medical Center 4.Debtor's chief executive officer (CEO) breached his fiduciary duties in allegedly obtaining inflated appraisals of leased property that debtor had option to purchase at its appraised value, so as to ensure that debtor would not exercise this purchase option, and that lessor, another corporation that CEO controlled, would continue to collect allegedly exorbitant rent; 5.Debtor was entitled to specific performance of option, as well as return of rent; 6.Punitive damages were warranted; and 7.Doubts about whether debtor was prevailing party counseled against attorney fee award. 29
  29. 29. Validity of a Lease (Hypothetical) Pam owns a clothing company called “Knack” based in Tallahassee, Florida. Knack has a knack for designing outfits worn by celebrities and selling them online. After gaining a following and experiencing success, Pam decided she wanted to own her building, instead of just leasing space. She eventually found a building in a trendy area and decided to buy it in her name, just in case something ever happened with the business. After closing, Pam got a tip that she could lease the property from herself as a means of reducing the taxable income on Knack. Pam didn’t think it was necessary for her to actually sign a physical lease with herself as owner and President of the company. She paid as much in rent each month as the business could afford, which was typically about $3,000, Unfortunately, Knack began to lose its touch and “went long” on some fashion items that turned out to be a flash in the pan and the company began to struggle with cash flow. Ultimately, she had no choice but to file bankruptcy. Right before filing she went through the exercise of papering an actual lease with her company for 10-years at $3,000 per month, so that if she had no choice but sell the building to restructure, she could at least keep the space. Are there ethical implications of this lease arrangement? Is this shady or shrewd? 30
  30. 30. Over-Market Lease (Hypothetical) Jim is a savvy real estate investor and entrepreneur. He combined these interests and started selling a full line of CBD products online at through and entity by the same name. He operates out of a warehouse in Memphis, Tennessee. When he decided to get into business he initially was working out of the office in an small industrial property he owns. The building had recently lost a tenant so he used the vacant space to hold his inventory. Eventually, they grew out of the space and Jim obtained financing through the business to purchase another warehouse space. The bank had Jim put the new property in an LLC that Jim created and then Jim entered into a lease with LLC. However, because Jim is savvy he decided to charge the business double the “market” rent because the business could afford it and if he ever needed more capital he thought he could sell the warehouse for more money given the high rent. Jim’s lender did not love this arrangement, but did not think they had any right to object. Ultimately, between the high rent, increased competition, and inventory mismanagement, started running out of cash and ultimately had to file bankruptcy. Suddenly, this high rent that Jim is paying himself is a major issue in the case. Are there ethical implications of this insider lease arrangement? Is this asinine or astute? 31
  31. 31. Preferred Lease (Hypothetical) Richie was following the trends toward increasing popularity towards hemp-based products in Illinois for many years. He formed a retail hemp-based product chain called “Hemp City” and got seed money from his father and his dad’s long-time friend Vinny. Vinny owns 50% of the company and Richie and his dad each own 25%. As part of the deal, Richie agreed to lease space in two of Vinny’s properties. The company quickly opened up 12 locations total, all leased space. While the business initially had first mover advantage, in time the market became over-crowded. To make ends meet, they took out an operating line of credit from a local bank, but eventually their line was tapped out and they had to file for chapter 11 bankruptcy to restructure. It was clear what their best stores were and clear that 4 needed to closed, so they immediately rejected those leases. The stores owned by Vinny were marginal, but they decided to keep those and just make some personnel changes. Are there ethical implications of this valuation method? Is this cleaver or cagey? 32
  32. 32. About the Faculty 33
  33. 33. About The Faculty David Levy - David Levy is Vice President of Business Development for NRC Realty & Capital Advisors. NRC conducts structured sales, sealed bid sales, and auctions of all types of real estate and real estate-based businesses. NRC is distinguished for being the largest broker of gas stations and convenience stores in the U.S. The firm also provides financial advisory services with a focus on the gas station and convenience store and franchise restaurant sectors. NRC’s clients include corporations, small businesses, banks, private equity, hedge funds, non- traditional lenders, receivers, trustees, investors, and more. The firm has experience in consensual sales of premium, surplus or non-strategic assets, as well as those involved bankruptcy, restructuring, and other distressed situations. NRC has sold $1.5 billion in commercial and residential real estate assets in its 26-year history. Mr. Levy has an MBA from Miami University and holds the prestigious CCIM designation. 34
  34. 34. About The Faculty Matthew Christensen - Matt Christensen joined Angstman Johnson in 2008 as an associate attorney. Now a member of the firm, Matt has a civil litigation practice involving commercial law (finance and secured transactions), bankruptcy, real property, and business matters. He also has a transactional practice involving real estate, finance and business matters, including franchising. Matt frequently represents bankruptcy trustees and other fiduciaries in recovering assets and administering estates. Prior to joining the firm, Matt was a Junior Partner at a Meridian, Idaho, law firm and also established a solo practice. In addition to practicing law, Matt is an adjunct professor at the University of Idaho College of Law where he teaches international trade/business, real estate transactions and law practice management courses. Matt obtained his Bachelor of Arts in International Studies from Brigham Young University in 2002. He earned his J.D. and LL.M in International and Comparative Law degrees from Duke University School of Law in 2005. While at Duke, he was an Articles Editor for the Duke Journal of Gender Law & Policy. In addition to practicing law and teaching, Matt also enjoys spending as much time as possible with his wife and five children and expanding his ever-growing library of books. To read more, go to: 35
  35. 35. About The Faculty Gordon "Gordy" Gouveia - Gordon Gouveia is a partner in Fox Rothschild LLP’s Financial Restructuring & Bankruptcy department with 15 years of experience working on insolvency-related matters. After graduating from Vanderbilt Law School in 2004, Gordon was judicial clerk to Judge Eugene Wedoff in the Bankruptcy Court for the Northern District of Illinois. Following his clerkship, Gordon worked at the commercial bankruptcy and litigation boutique law firm Shaw Fishman Glantz & Towbin LLC where he was elected a member of the firm in 2012. In that role, Gordon handled various business insolvency matters in and out of court, including representation of debtors, secured creditors and unsecured creditor committees in chapter 11 cases, and representation of chapter 7 trustees, receivers and other fiduciaries in connection with liquidations and complex litigation such as fraudulent transfer lawsuits. In 2018, Gordon and his Shaw Fishman colleagues joined Fox Rothschild LLP, where Gordon continues to handle the same types of complex insolvency-related matters throughout the country. 36
  36. 36. About The Faculty Beth Jo Zeitzer - Beth Jo Zeitzer is the President and Designated Broker of R.O.I. Properties, a full service real estate firm focused on the enhancement of real estate assets. Beth Jo serves as Court-Appointed Receiver, Real Estate Special Commissioner, Special Master, Bankruptcy Trustee and Expert Witness in numerous real estate matters and legal proceedings. Prior to founding R.O.I. in 2003, Beth Jo was the Director of Commercial Properties at Del Webb. She managed a $96 million, 600-acre commercial property portfolio and supervised all phases of commercial development. Beth Jo also developed and implemented the Strategic Plan for all commercial properties which involved the vision, project positioning, budgets, and marketing/branding. Beth Jo served as Corporate Counsel for Del Webb Corporation, and prior to that, was in private practice, performing loan workouts and real estate transactions during the RTC period. She is a graduate of the University of Arizona with a B.A. with Real Estate and Marketing Emphasis, and the University of San Diego Law School, where she was the Research Editor of the Law Review, and the recipient of the Hahn Award for Excellence in Real Estate. Beth Jo is a licensed attorney in the States of Arizona and California, as well as a licensed Real Estate Broker in Arizona. She is also a Real Estate Special Commissioner (Judicial Branch of Arizona, Maricopa County). Beth Jo was named one of the 50 Most Influential Women in Arizona Business, by AZ Business Magazine, in 2013. She is a Board Member of APLA (Arizona Private Lenders Association), Past President of AZCREW (Arizona Commercial Real Estate Women), Past President of TMA (Turnaround Management Association), a member of the Arizona Bankers Association, Arizona Trustee Association, Valley Partnership, Urban Land Institute, California Receivers Forum, the Arizona Credit Union Collectors Council, Risk Management Association and other Real Estate trade organizations 37
  37. 37. Questions or Comments? If you have any questions about this webinar that you did not get to ask during the live premiere, or if you are watching this webinar On Demand, please do not hesitate to email us at with any questions or comments you may have. Please include the name of the webinar in your email and we will do our best to provide a timely response. IMPORTANT NOTE: The material in this presentation is for general educational purposes only. It has been prepared primarily for attorneys and accountants for use in the pursuit of their continuing legal education and continuing professional education. 38
  38. 38. ABOUT DailyDAC is the leading source of information about assignments, article 9, bankruptcy, receiverships, out-of-court workouts and vulture investing, designed for business owners and vulture investors. Visit us at Premium Public Notice Service DailyDAC’s Premium Public Notice Service helps market asset sales on behalf of fiduciaries (e.g., Chapter 11 debtors- in-possession and committees, trustees, receivers, assignees), secured lenders selling collateral under UCC Article 9, and auctioneers to a very large and self-selected group of potential bidders and their advisors. The Service also assists with noticing other events, deadlines, and milestones – including tombstones and other press releases. Our free weekly newsletter, DailyDAC contains our latest bankruptcy article, current Public Notices and all opportunistic deals added to our proprietary database that week. Sign up at:
  39. 39. About Financial Poise 42 Financial Poise™ has one mission: to provide reliable plain English business, financial, and legal education to individual investors, entrepreneurs, business owners and executives. Visit us at Our free weekly newsletter, Financial Poise Weekly, updates you on new articles published on our website and Upcoming Webinars you may be interested in. To join our email list, please visit: