By James E. Nugent, Senior Managing Director, Mesirow Financial Consulting, LLC and George R. Mesires, Partner, Ungaretti & Harris LLP
Overview of Senior Housing Industry
The combination of the aging Baby Boomer population and the apparently unbridled growth in the value of investments characterized much of the 1990s. As is often the case in investment bubbles in purported “new economies,” many assumed that the world had now changed and that we would never see another downturn. Further, advances in healthcare were resulting in longer, healthier, more active and happier lives.
One manifestation of this environment was the aggressive development and growth of senior living facilities including continuing care retirement communities (CCRCs). These facilities provide residences for active seniors that want to downsize their living accommodations, live in a community of their peers, complete with activities, fitness centers and organized trips. These seniors also want a residence and community living environment that can provide additional services as they age, as their situations require. Further, residents often want these facilities all on the same campus to accommodate those that want to be near their spouse or friends that may require greater care.
Terms of residency at a CCRC are typically governed by a residency agreement (also referred to as a lifecare contract) covering all the services, amenities and activities for an active retirement. The lifecare contracts at many CCRCs are based on an “entrance fee model,” (i.e., a financial model that includes both a substantial entrance fee and a continuing monthly service fee). Further, many CCRCs offer refunds of most or all of the resident’s entrance fees to the resident’s heirs after the resident dies, allowing the resident’s estate to remain largely intact.
Typically under an entrance fee model, retiring or downsizing seniors would sell their homes and use the proceeds to pay the sizable entrance fee into these senior living facilities. Seniors could also use their savings, income from investments, pensions and social security to make monthly service fee payments. Many senior living developers, including religious orders that historically have served the elderly and those in need, pursued the development of CCRCs and senior living facilities, often adopting an entrance fee model to fund the development.
The Recession of 2008 and Its Implications on CCRCs
The recession of 2008 resulted in substantial decreases in portfolio values home values and a stalled housing market. The decline in net worth for many retirees resulted in a “perfect storm” to adversely affect the CCRC market. The impact of this was immediately obvious:
- Prospective residents could no longer sell their homes for the amount they expected, thereby reducing the number of prospective new tenants.
- Reduced number of residents resulted in reduced operating cash, making it challenging to provide the required services and capital expenditures.
- Due to reduced cash balances, cash flow and declining census and monthly service fee revenues, some CCRCs utilized entrance fees received for re-occupied units (not new developments) to fund continued operations, debt service and capital expenditures, rather than to hold in reserve to pay refunds to prior independent living unit residents when due.
- Entrance fee refunds were funded through the collection of new tenant entrance fees. The reduced demand, led to a shortage of funds to pay refunds as they become due, leading to an outstanding liability balance that was growing much faster than the rate new entrance fees were collected.
- These difficulties made marketing to prospective new residents challenging, as many prospective residents sought assurances and guarantees that the entrance fee refund would be honored.
- This cycle resulted in a downward spiral for many facilities as census levels continued to fall or remain depressed.
Fairview Ministries and Its CCRCs
Fairview Ministries, Inc., (FMI) a not-for-profit, Christian-based organization, owned and operated three senior living facilities: 1.) Fairview Village, a continuing care retirement community in Downers Grove, IL; 2.) an assisted living facility in Rockford, IL and 3.) an assisted living facility in Seattle, WA. Prior to the recession, FMI made substantial investments to prepare for expansion and acquire land to expand its CCRC capacity and service offering. FMI’s heritage of serving seniors extended back more than 100 years, when it opened its first community in 1905.
The Downers Grove Campus (Fairview Village) is a large 40-acre campus including 28 single story townhomes, 28 garden homes, a five-story apartment building containing 218 residential units, and a healthcare center that includes 59 assisted living units and 119 skilled nursing and rehabilitation units. The Fairview Village facility had approximately 300 employees. The Rockford Campus consists of a 54,000 square foot, two-story building containing 73 assisting living apartments located on 3.2 acres of land in Rockford.
As was the case for many facilities of this type, at the Fairview Village facility, FMI entered into a residency agreement with residents, which required residents to pay an entrance fee ranging from approximately $141,000 to $385,000, and a monthly service fee ranging from approximately $1,050 to $2,600 per resident. In most circumstances, after the resident no longer resided at the facility, the resident or resident’s estate would receive a refund of the entrance fee once the resident’s living unit has been resold — a standard and common feature in a lifecare contract at an entrance fee model CCRC.
In 2008, FMI issued tax-exempt bonds in the amount of $57.2 million through the Illinois Finance Authority to refund a 2004 bond issuance and to fund expansion and development. The bonds were secured by substantially all of FMI’s assets excluding the Seattle facility.
The senior housing market was hindered by the economic recession and the weakened credit environment. Most facilities experienced substantial declines in occupancy as a result of the market changes. Prospective residents were faced with difficulty selling their homes and many also experienced significant declines in their investment portfolio value. These economic circumstances made it difficult, if not impossible, for seniors to move into retirement housing facilities such as Fairview Village, since many older adults relied on the proceeds from the sale of their home to fund the entrance fee payments required by many continuing care retirement communities. Many seniors were further challenged to pay their senior living facility and other monthly living expenses because their investment balances and income had declined.
Historically, Fairview Village experienced 95% occupancy levels in independent living and assisted living. However, occupancy had slowly declined from mid-2008 to early 2010. The economic recession, real estate downturn, renovations at existing competitors and increased competition from newer developments contributed to the decline in the independent living census resulting in a rolling 12-month average census of 83.3% as of November 30, 2010.
Market conditions and the low occupancy levels contributed to significant declines in cash balances for FMI. Over the last two years through 2010, despite certain actions taken, days cash on hand had fallen significantly. This deteriorated cash position prevented the timely refunding of resident entrance fee claims. Over $2.9 million in accrued entrance fee refunds was owed to former residents that no longer resided on campus or to the estates of former residents, which caused significant stress on the facility. Indeed, even one resident’s estate filed a breach of contract lawsuit seeking a judgment for the remaining resident refund balance owed under the Residency Agreement.
In early-to-mid 2010, FMI sought to strategically affiliate, but was unsuccessful. Based on the financial and operational circumstances at FMI, the board of directors hired Mesirow Financial Interim Management to assist in the evaluation of the situation, seek strategic alternatives and negotiate with bank and bondholder representatives and constituents (the lender group). Further, Mesirow was retained to lead the team as interim managers of FMI and hired FMI’s advisors consisting of Ungaretti & Harris LLP (U&H) as lead restructuring counsel; Skadden Arps Slate Meagher & Flom as special counsel; RBC Capital Markets and B.C. Ziegler & Company as investment bankers, and Continuum Development Services and Retirement DYNAMICS as operational consultants.
After conduct of the evaluations and negotiations with the lender group, FMI and the lender group reached a consensual plan and course of action to address the refund obligations owed to residents or their estates, maximize value and obtain the funding to support and implement the plans. Accordingly, with the lender group’s support, the board of directors authorized and directed Mesirow and U&H to conduct a sale process, negotiate transactions to maximize value and protect resident and creditor interests and move forward with a bankruptcy filing and §363 asset sales.
To protect new residents’ interest in the event of a bankruptcy proceeding, FMI placed new residents’ entrance fees in escrow. The escrow arrangement was necessary to assure future residents that their reservation deposits and entrance fees would not be disturbed. Without such assurance, the ability to market to new residents would have been severely weakened. As of early 2011, FMI held approximately $1 million in escrow on behalf of prospective residents and residents who had provided a deposit or paid an entrance fee.
On February 2, 2011, FMI filed for Chapter 11 in the U.S. Bankruptcy Court for the Northern
District of Illinois. Mesirow and U&H secured a $13.7 million debtor-in-possession (DIP) facility from the current bank lenders in the Lender Group, which was necessary to maintain confidence by the elderly residents and prospects. Mesirow and U&H were able to convince the lender group and the bankruptcy court that all resident refunds, including post-petition and contingent contract liabilities in excess of $50 million and those previously contractually promised before the bankruptcy filing (approximately $2.9 million in unsecured pre-petition claims), should be made in advance of the lender group asserted secured claims to preserve the going-concern value of the existing business. With lender group’s support, the bankruptcy court made a precedent establishing ruling to pay the pre-petition resident refund liabilities.
FMI also decided that an orderly sale of the facilities was in the best interest of the residents, the creditors and the debtor’s other constituents. Accordingly, Mesirow and U&H moved forward with two §363 sales.
- The Rockford facility was sold to Senior Housing Properties Trust for $8.75 million on May 2, 2011.
- The Downers Grove facility was sold to Lifespace DG, LLC for $20 million on August 1, 2011.
- The Seattle facility was separately spun off, and was not included in either of the above transactions.
Outcome of the Transactions
On September 30, 2011, following the successful sales of the Rockford and Downers Grove facilities, collection of receivables and other assets and spin-off of the Seattle facility, the FMI Chapter 11 bankruptcy case was converted to Chapter 7. Administrative claims were paid and unsecured creditors would receive approximately 10% in distributions. Had the bankruptcy sale transactions not closed, FMI may have been forced to liquidate, forcing over 500 seniors to find new homes and potentially losing their contractually promised refunds, often representing their life savings.
One of the greatest challenges of the case was to appease all the constituents. The board of directors wanted the highest and best deal for all constituents, including creditors. The board also wanted to ensure that the charitable mission continued including the delivery of high quality care and services, and to ensure that resident contracts were honored so there would be minimal disruption to the residents living at the facility. The lender group was concerned about the highest return to minimize losses, but recognized the importance of the buyer honoring resident contracts. The creditors’ committee and residents were concerned about continuing quality operations, honoring resident contracts and a return for the unsecured creditors.
It took significant marketing and negotiations to identify a buyer that the board of directors, creditors committee and lender group could agree was the highest and best offer. Early in the sales process, the highest offer was approximately $15 million. Mesirow and U&H, with the assistance of the investment bankers, negotiated with the buyers to obtain offers totaling approximately $30 million for all the FMI assets, plus the assumption of over $50 million in contingent liabilities to residents.
A significant benefit was preserving the homes for the elderly residents and preventing the loss of their life savings. Mesirow and U&H convinced the court to allow the payment of approximately $3 million in pre-petition past due resident refund liabilities associated with Fairview Village. Lifespace, the buyer of the Fairview Village Campus, assumed all the resident contract liabilities, totaling approximately $50 million in contingent resident refunds. If these contracts had not been assumed, hundreds of seniors would have lost a significant portion of their life savings.
Lifespace also promised to make at least $8 million in capital expenditures over a three-year period at the Downers Grove facility, improving the facilities as well as the quality of life for the residents. Further, the buyers retained all 300 employees. Despite lower occupancy levels, Mesirow and the operational consultants restructured the business to return to profitable performance and generated a waiting list of potential residents, all of whom were prepared to move into the Downers Grove facility once the deal was finalized.
The outcome of this case had positive outcomes for the major stakeholders:
- Residents that had committed to enjoying their retirement in a positive community environment were able to do so.
- Residents that left the facility as well as the estates of residents that anticipated the refund of their entrance fee were paid as promised.
- Three hundred employees that would have lost their jobs had FMI had to be liquidated remain gainfully employed at the facility.
- The religious community’s commitment to serving the senior population was honored.
- The buyers were able to purchase profitable operations with embedded growth.
In fact, the bankruptcy court judge, Judge Susan Sonderby, who oversaw the proceedings, described the case as “…an exquisite job…,” a sentiment surely shared among the residents, their estates, the lender group constituents and the FMI employees.
James Nugent is senior managing director at Mesirow Financial Consulting, LLC and a member of the Chicago/Midwest Turnaround Management Association. He has over 25 years of experience in providing corporate recovery, interim management, business planning, debt restructuring and operations and performance improvement management consulting services.
George R. Mesires is a partner in the Finance and Restructuring Practice, Ungaretti & Harris LLP and a member of the Chicago/Midwest Turnaround Management Association. He concentrates his practice on corporate restructuring, distressed mergers and acquisitions, creditors’ rights and insolvency matters.