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Foreclosure On Equity120308

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1. FIRST AMERICAN TITLE INSURANCE COMPANY 2. FORECLOSURE ON EQUITY INTERESTS IN REAL ESTATE MEZZANINE LENDING TRANSACTIONS 3. Our Mission Cover foreclosure of Article 9…
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  • 1. FIRST AMERICAN TITLE INSURANCE COMPANY
  • 2. FORECLOSURE ON EQUITY INTERESTS IN REAL ESTATE MEZZANINE LENDING TRANSACTIONS
  • 3. Our Mission Cover foreclosure of Article 9 security interests on equity collateral in real estate mezzanine lending.
  • 4. <ul><li>The potential liability exposure associated with becoming the proud owner of the borrower’s distressed business following the foreclosure of a lien on an equity interest (an equity play). </li></ul><ul><ul><li>Piercing the Veil </li></ul></ul><ul><ul><li>Equitable Subordination </li></ul></ul><ul><ul><li>Management Risks </li></ul></ul><ul><ul><li>Fiduciary (Competence and loyalty) </li></ul></ul><ul><ul><li>Duty to Creditors </li></ul></ul>What We Are Not Exploring in Depth
  • 5. Other Sources <ul><li>Lynn L. Soukup, Securities Law and the UCC: When Godzilla Meets Bambi , Uniform Commercial Code Law Journal [Vol. 38, #1]. </li></ul><ul><li>Dennis B. Arnold, Enforcing Security Interests in Membership Interests and Partnership Interests Under Revised Article 9 of the Uniform Commercial Code , Commercial Real Estate Finance 2007. </li></ul>
  • 6. Other Sources <ul><li>John C. Murray, Carveouts to Nonrecourse Loans: Are They Enforceable? </li></ul><ul><li>Donald W. Glazer and Jonathan C. Lipson, Courting the Suicide King, Closing Opinions and Lawyer Liability, Business law Today, Volume 17, No. 4,March/April 2008. </li></ul>
  • 7. <ul><li>But Now: </li></ul><ul><li>What is mezzanine lending? </li></ul>
  • 8. What is Mezzanine Lending? <ul><li>“ Mezzanine lending. . .means lending to a borrowing entity or group of entities that directly or indirectly owns a real property-owning entity, which debt is secured by a perfected first security interest in the mezzanine borrower’s pledged ownership interests in the property owner” </li></ul><ul><li>(Report by Moody’s Investors Service titled “US CMBS and CRE CDO: Moody’s Approach to Rating Commercial Real Estate Mezzanine Loans,” the “Moody’s Report,” page 3) </li></ul>
  • 9. What is Mezzanine Lending? <ul><li>“ Financing secured by pledges of ownership interests in the real property owning entity rather than by security in the real property itself…” (Moody’s Report page 2) (emphasis in original) </li></ul>
  • 10. What is Mezzanine Lending? <ul><li>THEREFORE A PERSONAL PROPERTY SECURED TRANSACTION! </li></ul>
  • 11. <ul><li>Finances difference between senior mortgage and amount investor wants to invest </li></ul><ul><ul><li>Senior Mortgage: 40 - 70% LTV </li></ul></ul><ul><ul><li>Mezzanine Financing: up to 90% LTV </li></ul></ul>What is Mezzanine Lending?
  • 12. RE TURN RISK DEBT EQUITY Mezzanine Financing What is Mezzanine Lending?
  • 13. <ul><li>Generally: a non-mortgage form of subordinate financing (replaces traditional 2 nd mortgage) </li></ul><ul><ul><li>No lien against real estate </li></ul></ul><ul><ul><li>Lien/ownership is in equity interests in entity which owns the real estate </li></ul></ul><ul><ul><li>Upon foreclosure mezzanine lender owns the entity and takes over mortgage borrower </li></ul></ul>What is Mezzanine Lending?
  • 14. <ul><li>Developed after real estate foreclosure debacles in early 1990’s cause by junior lenders: </li></ul><ul><ul><li>Prevents delays on foreclosure, maybe </li></ul></ul><ul><ul><li>Eliminates forced bankruptcy of mortgage borrower </li></ul></ul><ul><ul><li>Requirements are set by rating agencies for first mortgage to qualify for securitization pools </li></ul></ul>What is Mezzanine Lending?
  • 15. Intercreditor Agreement <ul><li>In 2002, CMBS World published a “suggested standard form” of Intercreditor Agreement – the “CMSA form” (also the “Dechert form”). The form is “credit neutral” platform against which Moody’s weighs modifications. (Moody’s Report page 6) </li></ul>
  • 16. Real Property Lender Owner of Real Property Mezzanine Lender A B Mortgage Loan Equity Secured Loans Equity Owners Mezzanine Lending
  • 17. Property Lender Owner of Property Mezzanine Lender #1 A B Mortgage Loan Equity Owners Co-Borrowers D C E Mezzanine Lender #2 F G H Mezzanine Lender #3 I Mezzanine Lender #4 Mezzanine Loans Mezzanine Lending
  • 18. Lender Borrower A B Asset Based Loan Equity Secured Guarantees Equity Owners PLEDGED EQUITY LENDING Law is the Same
  • 19. A GUIDE TO THINKING ABOUT PERFECTION <ul><li>Step 1: Does Article 9 Apply? </li></ul><ul><li>Step 2: Attachment </li></ul><ul><li>Step 3: Categorize the Collateral </li></ul><ul><li>Step 4: Perfection Step </li></ul><ul><ul><ul><li>Filing ( §9-310) </li></ul></ul></ul><ul><ul><ul><li>Perfection under non-Article 9 law ( §9-311(a)) </li></ul></ul></ul><ul><ul><ul><li>Possession ( §9-313) </li></ul></ul></ul><ul><ul><ul><li>Control ( §§9-314, 9-104, 9-106, 8-106) </li></ul></ul></ul><ul><li>Step 5: Priority Consequences </li></ul>
  • 20. Perfection of liens (security interests) in equity interest collateral. Lien Perfection
  • 21. US CMBS and CRE CDO: Moody’s Approach to Rating Commercial Real Estate Mezzanine Loans <ul><li>“ Moody’s expects that 100% of the beneficial ownership interests in the property owning entity will be pledged as collateral, so that any foreclosure of the mezzanine loan will produce a transfer of all of the equity interests in the property owner, leaving behind no minority interests.” </li></ul>
  • 22. “ Therefore, Moody’s expects that mortgage loan borrowers will irrevocably “ opt-in ” to Article 8 of the UCC and will certificate the partnership or LLC membership interest that will be pledged to the mezzanine lender.” Moody’s Report
  • 23. “ UCC-1 financing statements should additionally be filed, as “fail-safe” protection.” Moody’s Report
  • 24. <ul><li>The mortgage borrower’s organizational documents should have provisions prohibiting both the issuance of additional interests and opting-out of Article 8 without the lender’s written consent. </li></ul>Moody’s Report
  • 25. <ul><li>“ Therefore, Moody’s generally expects that mezzanine loans presented for rating will have the benefit of … in all cases … of a ‘ UCC insurance policy ’ where available.” </li></ul>Moody’s Report
  • 26. US CMBS and CRE CDO: Moody’s Approach to Rating Commercial Real Estate Mezzanine Loans <ul><li>Pledge of 100% of the equity </li></ul><ul><li>Opt In to Article 8 </li></ul><ul><li>Certificate the Equity </li></ul><ul><li>File a Financing Statement </li></ul><ul><li>Control the ability to Opt Out </li></ul><ul><li>– hardwire or proxy </li></ul><ul><li>UCC Insurance </li></ul>
  • 27. <ul><li>NEED TO CONSIDER NOT ONLY </li></ul><ul><li>SECURED CREDITOR STATUS UNDER ARTICLE 9 OF THE UCC; </li></ul><ul><li>BUT ALSO </li></ul><ul><li>PROTECTED PURCHASER STATUS UNDER ARTICLE 8 OF THE UCC </li></ul>
  • 28. Protected Purchaser Status and Equity Ownership Coverage LENDER’S POLICY Mezzanine Endorsement – Primary Obligor Pledged Equity Endorsement – Secondary Obligor BUYER’S POLICY Equity Ownership Endorsement
  • 29. <ul><li>NEMO DAT </li></ul><ul><li>QUOD NON </li></ul><ul><li>HABET* </li></ul><ul><li>*“No man can give what he does not have” </li></ul>
  • 30. <ul><li>EXCEPTIONS TO NEMO DAT: </li></ul><ul><li>◦ Negotiable Promissory Notes </li></ul><ul><li>◦ Negotiable Bills of Lading </li></ul><ul><li>◦ Securities under Article 8 – if a Protected Purchaser </li></ul>
  • 31. <ul><li>“ In addition to acquiring </li></ul><ul><li>the rights of a purchaser, </li></ul><ul><li>a Protected Purchaser </li></ul><ul><li>also acquires its interest </li></ul><ul><li>in the security </li></ul><ul><li>free of any adverse claim .” </li></ul><ul><li>§8-303(b) </li></ul>
  • 32. <ul><li>FIRST STEP IS TO BE A SECURED CREDITOR BY CONTROL OF A SECURITY UNDER ARTICLE 8 and INVESTMENT PROPERTY UNDER ARTICLE 9 </li></ul>
  • 33. NOTE: If entity subsequently opts-in to be a security under Article 8 (no way to prevent), then Protected Purchaser has priority in security over first lien-holder who perfected by filing! Entity Ownership Interests Is it a security under Art. 8? Perfection by Filing Financing Statement Perfection by Control Agreement Is it certificated or uncertificated ? NO YES Certificated Uncertificated WINS over filing! Perfection by Possession + Endorsement Control
  • 34. <ul><li>THEN BE A PROTECTED PURCHASER UNDER ARTICLE 8 </li></ul>
  • 35. Mezz/Pledged Equity Endorsement <ul><li>Section 8303 of the U.C.C. defines a “Protected Purchaser” as a purchaser of a security or an interest who: </li></ul><ul><ul><li>Gives value. </li></ul></ul><ul><ul><li>Does not have notice of any adverse claim to the security. </li></ul></ul><ul><ul><li>Obtains control of the security. </li></ul></ul>
  • 36. I WIN!!!!!! ARTICLE 8 and ARTICLE 9 - INTERRELATIONSHIP Perfection by Control Protected Purchaser Investment Property Opt-In to Article 8 – LLC or Partnership Interest a Security ARTICLE 9 ARTICLE 8
  • 37. Equity Owner – California LLC Property Owner – Delaware LLC Ultimate Parent The Property First Mezzanine Lender Loan Secured by Pledge of Equity In Delaware Sub Lender Perfects Security Interest in Pledged Equity by Filing UCC-1 with CA SOS Step #1 A Case Study
  • 38. Old Equity Owner – California LLC Property Owner – Delaware LLC Ultimate Parent The Property First Mezzanine Lender New Equity Owner- Delaware LLC 1. 3. 1. Sells Equity Ownership in Sub to Sister Sub for $100,000,000 Second Mezzanine Lender 2. 2. Provides New Mezzanine Loan Secured by Equity Ownership in Del. Sub – Perfects by Control and Protected Purchaser 3. Pays Off First Mezzanine Lender with Proceeds of Mezz Loan from Second Mezzanine Lender Step #2 A Case Study
  • 39. First Mezzanine Lender Sues Old Equity Owner for Conversion Based On Fraudulent Conveyance Alleging Property Worth $400,000,000 and Wants $2,000,000 kicker Old Equity Owner – California LLC Property Owner – Delaware LLC Ultimate Parent The Property First Mezzanine Lender New Equity Owner- Delaware LLC Second Mezzanine Lender Step #3 A Case Study
  • 40. <ul><li>FORECLOSURE </li></ul>
  • 41. Initial Steps –Evaluate Facts <ul><li>Evaluate Facts </li></ul><ul><li>Review Loan Documentation and Deal Structure </li></ul>> Confirm perfection of security interest > Confirm that you have a pledge of 100% of the equity > Check any requirements imposed by lender > Review guaranties; have other collateral? > Is there a lockbox or blocked account? > Determine which state’s UCC governs the exercise of the mezzanine lender’s remedies > Understand status of senior loan
  • 42. Evaluate Facts <ul><li>• Monetary default: interest, principal, other payments </li></ul><ul><li>• Non-monetary default: covenants, other </li></ul><ul><li>• Cure periods </li></ul><ul><li>• Always good practice to provide mezzanine borrower with written notice of default </li></ul><ul><li>• Written notice may be required to commence cure periods </li></ul>Consult with local counsel re state specific issues/concerns (transfer taxes etc.) Obtain updated UCC searches Confirm that an event of default has occurred
  • 43. Evaluate Facts Review senior loan documents – if mezzanine lender acquires the mezzanine collateral it will become the direct or indirect owner of the property/owner mortgage borrower and will be subject to the terms of the senior loan documents Review other material contracts and agreements such as ground leases and material contracts pertaining to the underlying property.
  • 44. Intercreditor Issues <ul><li>The intercreditor agreement governs the relationship between the senior and junior lenders </li></ul><ul><ul><li>Cross default provisions </li></ul></ul><ul><ul><li>Junior lender’s right to cure senior loan defaults </li></ul></ul><ul><ul><li>Junior lender’s right to purchase senior loans – mortgage and other tranches of mez </li></ul></ul><ul><ul><li>Can mezzanine lender foreclose on mezzanine loan collateral </li></ul></ul><ul><ul><ul><li>Qualified Transferee </li></ul></ul></ul><ul><ul><ul><li>Replacement guaranties </li></ul></ul></ul><ul><ul><ul><li>Replacement of property managers </li></ul></ul></ul><ul><ul><ul><li>Delivery of opinions </li></ul></ul></ul><ul><ul><ul><li>Cure of senior loan defaults ( strategy to stave off foreclosure ) </li></ul></ul></ul>
  • 45. Confirm Perfection of Security Interest <ul><li>Review organizational documents of the entity owned by the mezzanine to see if election to “opt-in” to Article 8 has been correctly made and whether or not the equity inertest has been certificated. </li></ul><ul><li>Depending on the scope of collateral and whether Article 8 applies, confirm that UCC financing statements have been filed in the appropriate jurisdictions. The appropriate jurisdiction is usually the jurisdiction of organization. </li></ul><ul><li>If the entity owned by the mezzanine has opted in to Article 8, determine if “control” has been obtained. </li></ul>
  • 46. Other Parties <ul><li>Are there any other interested parties? </li></ul><ul><ul><li>Guarantors </li></ul></ul><ul><ul><li>Pledgors </li></ul></ul><ul><ul><li>Other creditors – UCC searches </li></ul></ul><ul><ul><li>Any other parties that have requested notice of foreclosure sale </li></ul></ul>
  • 47. <ul><li>Foreclosure by Public Sale </li></ul><ul><li>Foreclosure by Private Sale </li></ul><ul><li>Retention of Collateral in Satisfaction </li></ul><ul><li>of the Debt </li></ul><ul><li>Judicial Enforcement </li></ul><ul><li>Collection Rights under UCC </li></ul><ul><li>Section 9-607 </li></ul>Methods of Foreclosure
  • 48. <ul><li>1. Analogies to real property law don’t work – as is generally true: </li></ul><ul><li>foreclosure cuts off right of redemption ( §9-623(c)) </li></ul><ul><li>rights of good faith transferee ( §9-617(b)) </li></ul><ul><li>2. Secured creditor rights upon default (including foreclosure) are covered in Part 6 of Article 9. </li></ul>Foreclosure 101:
  • 49. Sale Procedures Compared Purpose Judgment for deficiency? When final? Legal standard? By whom? Article 9 sale Judicial sale
  • 50. Sale Procedures Compared Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? When final? Legal standard? By whom? Article 9 sale Judicial sale
  • 51. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? When final? Legal standard? By whom? Article 9 sale Judicial sale
  • 52. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? When final? Legal standard? Sheriff, clerk By whom? Article 9 sale Judicial sale
  • 53. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? When final? Legal standard? Secured party Sheriff, clerk By whom? Article 9 sale Judicial sale
  • 54. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? When final? Fixed procedural requirements Legal standard? Secured party Sheriff, clerk By whom? Article 9 sale Judicial sale
  • 55. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? When final? Commercially reasonable Fixed procedural requirements Legal standard? Secured party Sheriff, clerk By whom? Article 9 sale Judicial sale
  • 56. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? On confirmation When final? Commercially reasonable Fixed procedural requirements Legal standard? Secured party Sheriff, clerk By whom? Article 9 sale Judicial sale
  • 57. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Judgment for deficiency? Upon sale On confirmation When final? Commercially reasonable Fixed procedural requirements Legal standard? Secured party Sheriff, clerk By whom? Article 9 sale Judicial sale
  • 58. Sale Procedures Compared Enforce SI Protect “surplus” Maybe fix deficiency Enforce mortgage Protect “equity” Maybe fix deficiency Purpose Varied rules Judgment for deficiency? Upon sale On confirmation When final? Commercially reasonable Fixed proced
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