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Every ten years, the Swinomish Tribal Owners and Shelter Bay Company must re-adjust the master rent the Company owes the Tribal Owners under two master leases. These leases include all property in Shelter Bay other than Division 1 – the fee simple lots. The Company and the Tribal Owners could not agree on a new master rent amount, so the parties entered mandatory arbitration. On January 23, 2008, the Arbitrator determined the master rent for 2003 to 2013 will be $1,358,000 per year. Because five years have passed since the new rent was due, Shelter Bay Company owes back rent, plus interest, of $6,234,158.
With the oversight of our legal counsel, we have developed a series of questions and answers to describe the potential consequences from not paying the new master rent amount. These answers are not the last word on the subject and the Board provides them to help you understand the layers of this complicated issue. One important layer is that if the Company fails to pay the master rent – in other words defaults on the master lease – the Company will most likely declare bankruptcy. Many of the consequences from default involve predicting what the bankruptcy judge will do, a difficult thing to predict. With that in mind, here are some important questions and answers on the consequences of default.
1. Who Owes The Master Rent?
Since the Master Lease is between the Company and the Tribal Owners (Tribe/Allottees), Company owes the back rent. Rent is collected from sub-leases between the Company and homeowners (sub-lessees). Shelter Bay Community, Inc., our homeowners’ association, owns all the shares of stock of Shelter Bay Company, a separate corporation, and is not a party to the master lease. The Community is the sole shareholder (owner) of the Company. Individual Community members, whether leaseholders or fee simple owners, are not shareholders of the Company and also are not parties to the master lease.
2. What Would Happen To The Company’s Assets If It Defaults?
Because default would violate the master leases, the Tribe would have a claim against the Company for breach of contract. The Tribe could sue the Company or force it into bankruptcy. Either way, all the Company’s assets – the marina, any retained earnings, and the right to collect annual sublease fees would go to the Tribe. If the marina goes to the Tribe, the marina operation, including the setting of moorage rates and tenant policies, would be under the Tribe’s control.
3. What Would Happen To The Community’s Assets If the Company Defaults?
The Company and Community are separate corporations. Of the approximately 400 acres in the master lease between the company and the Tribal Owners, only 54% of the acres are subleased to homeowners. The remainder is the common area with Community improvements built thereon – clubhouse, golf course, roads, sewer plant, water and sewer utilities and swimming pools, etc. – and there are subleases (except those in Division 1) between the Company and Community for these common area lands. The Community owns and manages these improvements on these common area lands leased from the Company. The first consequence to the Community on default is that the Tribal Owners will become the Sub-Lessors for all common areas on leased land.
The second consequence is that the Community’s assets might be used to satisfy the Company’s debt. There is a risk that the bankruptcy judge would “pierce the corporate veil” which currently separates the Company from its shareholder’s, the Community’s, assets. If the judge disregards the Company’s corporate structure, the Community’s assets could be used to pay the Company’s debt. The Board and management have intentionally operated Shelter Bay Company separately from Shelter Bay Community, respecting the boundaries between the two distinct corporations. This could prevent the judge from holding the Community’s assets liable for the Company’s debt. However, it is impossible to accurately predict how the bankruptcy judge will rule on this issue.
4. What Would Happen To Individual Subleases If The Company Defaults?
At the beginning of Shelter Bay, the Osbergs drafted the subleases to survive the Company’s default. If the Company fails to pay the master rent, the Tribal Owners become the Sub-Lessors to all individual Sub-Lessees. Termination of the master lease does not terminate the subleases. Individual Sub-Lessees would pay annual sublease fees directly to the Tribal Owners and the Tribal Owners would have to approve all assignments of subleases when members sell their houses. It is unclear just how the management of the individual sub-leases would sort out under a default scenario as individual tribal families (allottees) actually own a significant portion of Shelter Bay. So, there is reason to believe that after the sorting out process is complete, Shelter Bay individual Sub-Lessees may have different Sub-Lessors because of the various land owners involved.
There is a risk that the bankruptcy judge would terminate or modify the subleases. The likelihood of this risk is unknown and difficult to predict.
5. Are Community Common Areas At Risk, And If So, What Are Those Risks?
There is a risk that the bankruptcy judge would nullify the subleases between the Company and Community that charge no rent. If this happens, the Community would have to negotiate with the Tribal Owners for new subleases for the common areas, increasing the rent.
6. Would the Declaration of Protective Covenants, Which Run With The Land, Be Terminated?
The master lease provides that the subleases survive the Company’s default, but does not explicitly state that the covenants survive default. This creates a risk that the covenants could be nullified on default.
7. Would The Homeowners’ Association Be Nullified?
If the common area subleases do not survive and the covenants are terminated, then Shelter Bay Community, Inc. will survive in name only. It will not have common areas to manage. If, on the other hand, the common areas remain subleased to the Community and the covenants survive, then Shelter Bay Community would retain its powers as a homeowners’ association.
8. What Would Happen To The Community Infrastructure And Utilities?
If the common area subleases are terminated, the Tribal Owners would take control of the community utilities and infrastructure (sewer and water utilities, roads, golf course, clubhouse, greenbelts, etc.) and could charge consumers based on a new fee schedule they determine. The Tribal Owners would also determine the extent of infrastructure maintenance required. Other common areas and facilities, the marina for instance, would revert to the Tribal Owners.
9. Would The Potential For Lease Extensions For Individual Subleases Go Away?
The potential for extensions depends on the Tribal owners of the subleased lot. Negotiations would be similar to Pull-and-Be-Damned, in that individual leaseholders would negotiate with Tribal owners for the best deal possible. Given that different Tribal owners have interests in different locations within Shelter Bay, everyone would not be negotiating with the same individuals.
10. What Does Our Lawyer Recommend?
Our counsel, Philip Buri, recommends that the Company not default on the master rent. Although the cost of living at Shelter Bay will increase, the new master rent amount is not beyond reason. If the Company defaults, the consequences could be far-reaching and severe.
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