Sppecial Servicers and Defaulted or Delinquent CMBS...

Presenting a live 90‐minute webinar with interactive Q&A

Special Servicers and Defaulted or pDelinquent CMBS LoansLegal Considerations When Restructuring or Foreclosing Securitized Loans

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, JULY 26, 2011

Today’s faculty features:

Susan C. Tarnower, Senior Counsel, Thompson Hine, Atlanta

Patrick E. Mears, Partner, Barnes & Thornburg, Grand Rapids, Mich.

Patrick F. McManemin, Partner, Patton Boggs, Dallas

Mindy S. Planer, Partner, Kilpatrick Townsend & Stockton, Atlanta

The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

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Loan Documents and Restructuringand Restructuring

Presented by: Susan Tarnower | Thompson Hine LLP

Two Alliance Center, 3560 Lenox Road, Suite 1600Atl t G i 30326Atlanta, Georgia 30326

[email protected]

Part 1 – Loan Documentation:Things to look for: Check for allonges and recorded assignments into current

noteholder. Check for prior modifications. Check for side letter agreements or verbal agreements. Check for notices of default Check for notices of default. Check for correct addresses for all parties. Check notice provisions in documents.

Ch k f M t L Check for any Master Lease. Check for Guarantees. Check UCC chain for assignments and continuations.

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Part 2 – Questions to ask:Part 2 Questions to ask:

Is this the complete file? Was a final title policy issued at the time the loan

closed?closed? Who are the current parties in interest? Was there an assumption? Was there an assumption? What is the complete outstanding amount owed?

How long does it take to get a full payoff quote? Do you have current financials for borrower and

property?

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Part 3:

Triggers in Loan Documents

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A “t i ” “t i t” iA “trigger” or “trigger event” is an event that occurs which causes something to happen; for example if A occurs (the “trigger”), then B must ( gg ),happen (the consequence)

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Typical trigger events include:

lockboxes/cash management reserves/escrow amounts/ letter of credit drawdown/release/expiration change in interest rate change in interest rate change in taxes short falls short falls ltv/dscr tests

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Where are triggers found?

anywhere and everywhere read each loan document carefully read each loan document carefully

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Deed to Secure Debt:

Insurance: Borrower’s failure to maintain required policies/force placed insurance makes borrower liable for amounts advanced plus default interest until repaid

ACMs/institution of Maintenance Program Escrows: Reserve too high/credit to

b f d bsubsequent payment or refund to borrower

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Escrows: Reserve too low/borrower to deposit deficiency within 10 days of written noticedeficiency within 10 days of written notice

Release of funds from Repair and Remediation Reserve: written request,Remediation Reserve: written request, invoices, certificate, lien waiver - once every 30 days

Leases: Deemed approved if no response in 15

daysdays Prior approval requirements Certified Rent Roll annually

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Certified Rent Roll annually

Transfers, further liens and encumbrances Transfers, further liens and encumbrances

Voluntary or involuntary Percent considered a transfer, i.e. 49% Percent considered a transfer, i.e. 49%

OK Direct or indirect change Permitted transfers

Failure to provide financial statements If 20 days late, $1,500 penalty plus default

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interest until delivered.

Additional Event(s) of Default

Events of Default: Look for notice requirements Look for notice requirements. Look for grace or cure periods. Look for extensions of cure periods Look for extensions of cure periods.

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Other Items:

Key dates Payments/prepayments Payments/prepayments Side letter agreements

f Waivers of reserves Errors and discrepancies Nonrecourse triggers

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Part 4 - Restructuring Options:

Look at the current NOI. What loan terms will this property realisticallyterms will this property realistically support? How do we get there?

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Principal Paydown

From borrower From new equity partner From new equity partner From reserves on hand – usually not

acceptable to lenderacceptable to lender

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Outstanding Amounts Owedf l Default interest

Late fees Enforcement fees

May be forgiven unless another default Capitalized into balloon at Maturity Date

Get a complete pay-off quote to be sure you have included everything outstanding

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Interest Rate

IO payments for x months Change rate – for short Change rate – for short

term/permanentlyWaive collection of full amount owed Waive collection of full amount owed for certain time; roll waived amount into principal or into B note to beinto principal or into B note to be forgiven at maturity

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Maturity Date

Extend and pretend Forbearance/modification Forbearance/modification How long is realistic?

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A/B Note Structure

Set up supportable loan amount, interest rate and maturity date. This ybecomes the A note.

Roll amounts waived or forgiven into a gseparate note – B note (wish note) Can be collected upon disposition of

t if t t th thproperty if an amount greater than the amount owed on the A note is collected.

Can be waived at maturity

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Can be waived at maturity.

Tax Ramifications for Borrower

Advise borrower to get its own counsel on the tax ramifications of anyon the tax ramifications of any modifications.

Do not offer your own ideas or options Do not offer your own ideas or options. Tax losses can be mitigated through

different kinds of structuring Be awaredifferent kinds of structuring. Be aware of how these operate.

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Fees What do the loan documents say regarding attorneys’

fees or other types of professional fees? What does the PSA say?What does the PSA say? Who is affected if these are waived? Various types:

late fees servicing fees processing fees processing fees recording fees title update fees

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third party vendor fees, i.e. appraisal, environmental

SPECIAL SERVICERS AND DEFAULTEDSPECIAL SERVICERS AND DEFAULTED OR DELINQUENT CMBS LOANS:

Seeking the Appointment of a Receiver,Commencing Mortgage

Foreclosure Proceedings andgPursuing Claims Against Guarantors

P t d bPresented by:Patrick E. MearsBarnes & Thornburg LLPGrand Rapids, Michigan616 742 3936

CONFIDENTIAL

© 2011 Barnes & Thornburg LLP. All Rights Reserved. This page, and all information on it, is confidential, proprietary and the property of Barnes & Thornburg LLP, which may not be disseminated or disclosed to any person or entity other than the intended recipient(s), and may not be reproduced, in any form, without the express written consent of the author or presenter. The information on this page is intended for informational purposes only and shall not be construed as legal advice or a legal opinion of Barnes & Thornburg LLP.

[email protected]

I. Seeking the Appointment of a Receiver Upon the Mortgagor’s Default

A. The Origin of Receivers and Statutory Grounds for Appointment

1. Origin of Receivers dates back to Elizabethan England. See, e.g., The Duchess of Marlborough v. The Duke of Marlborough, 27 Eng. Rep. 588 in Barnardston’s Reports, p. 69 (1740-1741). The Judiciary Act of 1873 extended the jurisdiction to appoint receivers beyond the chancery court to all divisions of the high court, the court of appeals, every inferior court having law or equity jurisdiction and the admiralty court 36 and 37 Victoriaequity jurisdiction and the admiralty court. 36 and 37 Victoria, Chapter 66.

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I. Seeking the Appointment of a Receiver Upon the Mortgagor’s Default (cont’d)

2. In the United States, chancery courts were created by a number of states during the American Revolution and after I d d N Y k i M h 1778 Th tIndependence, e.g., New York in March 1778. These courts exercised their equity powers to appoint receivers in civil actions within the scope of their jurisdiction. See, e.g., 1 Ralph E. Clark, 1 A Treatise on the Law and Practice of Receivers §§7-10 (3d

d 1959) (h i ft “Cl k R i ”)ed. 1959) (hereinafter, “Clark on Receivers”).

3. Most state laws permit the appointment of receivers to take possession of commercial realty encumbered by mortgages orpossession of commercial realty encumbered by mortgages or deeds of trust in specific circumstances.

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(a) In Illinois, prior to the entry of a mortgage foreclosure judgment on commercial realty, if the mortgagee is permitted j g y g g pby the mortgage or other written instrument to obtain the appointment of a receiver and the court determines that there is a reasonable probability that the mortgagee will prevail in the underlying action the court may appoint a receiver on thethe underlying action, the court may appoint a receiver on the mortgagee’s request. 735 ILCS 5/15-1701(b)(2).

(b) In New York, a mortgagee will normally obtain the i t t f i i f l di happointment of a receiver in a foreclosure proceeding when

the mortgage permits such appointment upon the mortgagee’s application. However, the court of equity may deny the application in appropriate circumstances. N.Y. Real y pp pp pProp. Law § 254(10). See also GECMC 2007-C1 Ditmars Lodging, LLC v. Mohola, LLC, 2010-07000 (Index No. 700083/10) (2d Dept. May 31, 2011); Naar v. L.J. Litwak & Co 260 A D 2d 613 688 N Y S 2d 698 (2d Dept 1999)

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Co., 260 A.D. 2d 613, 688 N.Y.S. 2d 698 (2d Dept. 1999).


(c) In Michigan, a court may appoint a receiver in all pending litigation where appointment is “allowed by law.” MCL §g pp y §600.2926. This phase permits such action when authorized by another statute and where “the facts and circumstances justify appointment of a receiver in order to afford equitable relief ” Weathervane Window Inc v White Lakerelief. Weathervane Window, Inc. v. White Lake Construction Co., 192 Mich. App. 316, 480 N.W. 2d 377 (1991). Courts are also permitted to appoint receivers for mortgaged realty when the mortgage deems the failure to pay taxes or issuance on the real estate to be “waste” and such default occurs. MCL § 600.2927.

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4. If federal question or diversity jurisdiction can be established in the underlying action, a federal district court will have ancillary y g yjurisdiction to adjudicate an action seeking to foreclose a mortgage in real property. 28 U.S.C. § 1367. If the mortgagee seeks to requests the appointment of a receiver in this action, the district court will examine a number of factors in determiningdistrict court will examine a number of factors in determining whether to take such action including the following: (i) the existence of a valid claim held by the mortgagee; (ii) fraudulent conduct by the mortgagor; (iii) imminent danger that the property would be lost, concealed, injured, diminished in value or squandered; and (iv) the inadequacy of available legal remedies. See, e.g., Waag v. Hamm, 10 F.Supp. 1191, 1193 (D. Colo. 1998) Upon the appointment of a receiver he or she must1998). Upon the appointment of a receiver, he or she must operate the property according to the laws of the state in which the property is situated. 28. U.S.C. § 959(b).

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B. Considerations in Determining Whether to Seek the Appointment of a Receiver

1. All attempts to negotiate a restructuring of the mortgage debt or a voluntary surrender of the collateral have failed.

2. Mortgagor is suspected of fraud, conversion or other bad acts with respect to the mortgaged realty and income (e.g., rents) generated therefrom.

3. No other realistic alternatives exist to gain control quickly of the mortgaged realty and rents.

4. There is at least one interested purchaser of the real estate who pdesires to acquire title to the property by a receiver sale.

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C. Enforcement of Assignment of Rents

1. If your state will enforce rent assignments granted by the mortgagor to the mortgagee, then the mortgagee should exercise rights under the statute to terminate the debtor’s rights in the rents. This may require recording an affidavit of default or similar document in the local land records and serving thatsimilar document in the local land records and serving that document on the mortgagor and its tenants. See, e.g., MCL §554.231, et seq. (Michigan law).

2. Termination of a mortgagor’s rights in rents may cause that g g g yincome not to be deemed “cash collateral” of the mortgagor in its subsequent bankruptcy. See, e.g., In re Mount Pleasant Limited Partnership, 144 B.R. 727 (Bankr. W.D. Mich. 1992).

3 In some states courts will appoint receivers to enforce rent3. In some states, courts will appoint receivers to enforce rent assignments for the benefit of the mortgagee. See, e.g., Smith v. Mutual Benefit Life Ins. Co., 362 Mich. 114, 125, 106 N.W. 2d 515 (1960).

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D. Procedure for Court Appointment of a Receiver

1. The mortgagee will commence civil action in the proper court seeking relief relating to the mortgaged realty in addition to a claim for the appointment of a receiver. The filing of a one-count complaint demanding the appointment of a receiver is fraught withcomplaint demanding the appointment of a receiver is fraught with peril - - it may be subject to dismissal on the ground that such a claim is ancillary to other, independent claims concerning the real estate, which claims are missing from the Complaint. See, e.g., M D l H ti d & B d T M t i R R C 294McDougal v. Huntingdon & Broad Top Mountain R.R. Co., 294 Pa. 108, 143 A. 574 (1928). See generally 1 Clark on Receivers § 51. These additional claims may include the judicial foreclosure of the mortgage and an injunction against the mortgagor’s o t e o tgage a d a ju ct o aga st t e o tgago scontinued collection of rents and conversion of other collateral securing the mortgage debt.

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2. The mortgagee will then file and serve its motion for the appointment of a receiver and schedule a hearing date and ti f th h i i lt ti ith th t l ktime for the hearing in consultation with the court clerk.

3. The proposed Order Appointing Receiver should contain the following provisions:

• specifying the scope of receiver powers and duties:

File receiver reports, collect rents and other income, negotiate and terminate / reject leases and

contracts,

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eject defaulting tenants / file litigation, manage, preserve, and protect the receivership

propertproperty, operate any business related to the receivership

property, authorizing the receiver to lease, sell or otherwise

di f i hi tdispose of receivership property, hire and fire employees, agents, real estate brokers,

accountants, counsel, and other representatives to assist in the performance of receivership duties,

bt i / i t i i th i hi obtain / maintain insurance on the receivership property,

make repairs, pay taxes and other assessments related to the

i hi t d ibl fil t treceivership property and possibly file tax returns,

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prosecute and defend suits related to the receivership property without leave of court,

establish bank accounts, make capital and tenant improvements, apply or release security deposits (for example,

cannot return if not in receiver’s possession);cannot return if not in receiver s possession);• Prohibiting paying pre-receivership amounts;• limiting liability of receiver (for example, gross

negligence and no environmental);eg ge ce a d o e o e ta );• stating compensation of receiver (for example,

monthly, hourly, and brokerage);• identifying when court and lender approval is y g pp

required;

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• including particular property issues (for example liquor licenses capital improvements);example, liquor licenses, capital improvements);

• providing for formal appointment of the receiver and an identification of the property subject to the receivership;the receivership;

• granting the receiver possession and control of the receivership property (not title);

• entering into or terminating contracts;g g ;• obtaining a surety bond for amounts in bank

accounts over FDIC insurance limits;• providing for tenant attornment to the receiver;

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• requiring the mortgagor and its agents and employees to immediately turn over to the receiver possession of the

t d ll i (f l b k tproperty and all monies (for example, bank accounts, security deposits, and collected rents) and documents relating to the property (for example, information relating to accounts receivable and payables, leases, books, and

d i li i d th t t )records, insurance policies, and other contracts);• requiring the mortgagor and its agents and employees to

turn over all keys, alarm codes, and access devices to the receiver;;

• requiring the receiver to file reports with the court on a periodic basis and deliver copies of those reports to designated parties;

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• requiring that the mortgagor cooperate with the receiver; and

• describing the receiver’s fees and expenses.

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E. Sales of Real Estate Free and Clear of Liens and Interests

1 Federal and state laws permit sales of real and personal1. Federal and state laws permit sales of real and personal property that are subject to the receivership by court order. As such, these are judicial sales, the property being in custodia legis. See generally 2 Clark on Receivers §§ 482-531. See alsoy §§Lawrence M. Dudek, Strategic Use of Real Estate Receiver or Bankruptcy as an Alternative to Foreclosure, 30 Mich. Bus. L. J. 17 (2010).

2. Some state laws permit a receiver to sell mortgaged realty free and clear of all liens and interests with those interests attaching to the sale proceeds. See, e.g., In re Field Body Corp., 240 Mich 28 215 N W 158 (1927) (applying Michigan law); TheMich. 28, 215 N.W. 158 (1927) (applying Michigan law); The Park National Bank v. Cattani, 187 Ohio App. 3d 186 (2010) (applying Ohio law); John T. Callahan & Sons, Inc. v. Dykeman Electric Co., 266 F. Supp. 2d 208, 222 (D. Mass. 2003) (applying

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Rhode Island law). Sales of real estate by a federal court


receiver pursuant to 28 U.S.C. § 2001 may also be made free and clear of liens and interests. See, e.g., Spreckels v. Spreckels Sugar g p p gCorp., 79 F.2d 332 (2d Cir. 1935). See also 28 U.S.C. § 2001.

3. Other state courts will not permit sales of receivership property free and clear of liens and interests over theproperty free and clear of liens and interests over the objection of a junior lienor or other interested party. See, e.g., Wells Fargo Bank, N.A. v. Tippecanoe Associates, 923 N.E. 2d 423 (Ind. App. 2010); Melrose v. Industrial A i t I 72 A 2d 469 (C 1950) S ll 2Associates, Inc., 72 A. 2d 469 (Conn. 1950). See generally 2 Clark on Receivers § 500 and the cases cited therein.

4. Would transfer of the real estate by a receiver to the ymortgagee be permitted by state law? Title insurance company feedback on this question will be necessary.

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F. Termination of the Receivership Action

1. After all receivership assets have been disposed of and all receivership expenses have been paid, the receiver will normally file his final report with the court and seek a closing of the civil action.

2. The order closing the case will normally discharge the receiver from the performance of his or her duties andreceiver from the performance of his or her duties and dismiss the action.

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II. Commencing Mortgage Foreclosure Proceedingsg

A. Review and Analysis of Mortgage Loan Documents1 The loan documents that special servicers’ counsel will be1. The loan documents that special servicers counsel will be

required to review and analyze before commencing a judicial or nonjudicial proceeding to foreclose a commercial real estate mortgage will normally include the following:estate mortgage will normally include the following:a) promissory note and allongesb) mortgage and assignments thereof;c) assignment of rents and leases and assignments thereof;c) assignment of rents and leases and assignments thereof;d) Uniform Commercial Code financing statements and

assignments thereof;

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II. Commencing Mortgage Foreclosure Proceedings (cont’d)g ( )

e) guaranties;f) environmental indemnity agreement(s);f) environmental indemnity agreement(s);g) replacement, holdback, tenant and completion reserve

agreements; andh) omnibus assignment(s).) g ( )

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2. Counsel must review these documents to make certain that all of them (i) have been properly executed by all necessary parties, ( ) p p y y y pand

(ii) comply with applicable state law. Also, counsel must obtain a recent foreclosure search and/or title commitment to determinerecent foreclosure search and/or title commitment to determine whether the mortgage and rent assignment have been recorded in the proper recording office and contain the correct and complete legal description of the mortgaged realty.

The title search results will also disclose exceptions to coverage such as senior and junior liens, unpaid real estate taxes and assessments and any other title exceptions that should be addressed and resolved in the foreclosure proceedings.

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3. Counsel will need to verify that a default under the mortgage loan documents has occurred and is continuing and should obtain from his or her client a copy of the default notice that wasobtain from his or her client a copy of the default notice that was transmitted by the mortgagee to the mortgagor. Counsel must also carefully review the default provisions in the loan documents to make certain that they permit foreclosure of the mortgage upon the mortgagor’s default.g g p g g

4. Counsel must also verify that the note, mortgage, rent assignments and other loan documents have been properly assigned and otherwise transferred down the chain of title and are now held by the entity seeking to foreclose the mortgageare now held by the entity seeking to foreclose the mortgage.

Many special servicers will create a limited liability company in the state in which the mortgaged real estate is located and will transfer the loan documents to this new entity prior to y pforeclosure. Counsel may be required to organize the company and assign the loan documents to it as a prelude to foreclosure.

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If these documents have not been properly transferred down the chain of title prior to foreclosure, the judicial foreclosure action may b di i d b th t th j di i l f l lbe dismissed by the court or the nonjudicial foreclosure sale may be avoided later as defective. See, e.g., In re Simpson, 2011 WL 1645699 (N.C. App. May 3, 2011); Arnold v. DMR Financial Services, 448 Mich. 671, 532 N.W. 2d 852 (1995).

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B. Selecting the Method of Foreclosure: Judicial or Nonjudicial

Certain states e g Illinois Indiana and Connecticut do not permitCertain states, e.g., Illinois, Indiana and Connecticut, do not permit nonjudicial mortgage foreclosures. In these states, mortgage foreclosures may be accomplished only through judicial action. Other states, such as Michigan, Minnesota and New York, permit both judicial and nonjudicial mortgage foreclosures. If the mortgaged realty is located in themortgage foreclosures. If the mortgaged realty is located in the jurisdiction where both procedures are available, then counsel should recommend to the client which method of foreclosure should be pursued. In general, nonjudicial foreclosures are less costly, complex and time-consuming than judicial foreclosures. While this determination will d d l’ d l i i li ht f th ldepend upon counsel’s reasoned analysis in light of the loan documentation and applicable law, some general guidelines can be

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suggested. If the client’s mortgage is clearly a first priority lien on the realty and if there are no title exceptions otherlien on the realty and if there are no title exceptions other than junior liens and interests that are otherwise immune to foreclosure but nonthreatening, e.g., utility easements, then nonjudicial foreclosure may be the recommended route. If there are real or potential priority disputes between the client’s mortgage lien and other liens, e.g., construction liens, or if there are other adverse interests that cause the integrity of the mortgagor’s fee interest to be in question, then judicial foreclosure will often be the preferred course of action.

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C. Judicial Foreclosure

1 C t f A ti J di i l f l ti1. Commencement of Action. Judicial foreclosure actions are normally commenced by the filing of a complaint by the mortgagee in the jurisdiction where the property is situated. When preparing the complaint, counsel will need to consider and

l th f ll i it iresolve the following pre-suit issues.

a. The One-Action Rule. A few states have adopted a one-action rule that prohibits the commencement of an action on the mortgage debt that could result in a money judgmentthe mortgage debt that could result in a money judgment against the mortgagor when a similar action is pending in another jurisdiction. See, e.g., MCL § 600.3105 (Michigan). This creates problems of enforcement when debt evidenced b i t i d b t i diff tby one promissory note is secured by mortgages in different jurisdictions. Other states have adopted another form of one-action rule that prohibits a mortgagee from splitting a cause of action and suing more than once on the same claim.

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Thus, a mortgagee may waive his mortgage lien if he commences an action for a money judgment on the note but fails to simultaneously foreclose on its lien See e g Homefails to simultaneously foreclose on its lien. See, e.g., Home State Bank v. P.B. Hoidale Co., 718 P.2d 292 (Kan. 1986). In California, the state’s single action rule embodied in California Civil Code § 726(a) prohibits the mortgagee from pursuing any other cause of action without foreclosing on its p g y gmortgage lien.

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b. Joinder of Parties. Counsel will normally join as defendants all entities holding interests in the mortgaged realty that are g g g yjunior to the mortgage being foreclosed that the foreclosing mortgagee wishes to eliminate. Some interests, e.g., tenants of the mortgagor who are parties to leases that the mortgagee desires not to affect through foreclosure aremortgagee desires not to affect through foreclosure are often not joined as parties in the action. The mortgagee may elect to join the guarantors of the mortgage debt as parties to the action and seek a deficiency judgment against them.

c. Joinder of Claims. If there are real or potential priority disputes between the foreclosing mortgagee and other lienors, e.g., holders of construction liens, the mortgagee , g , , g gshould request in its complaint a determination of the mortgage liens priority vis-à-vis the competing liens’ priority.

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If there are any other recorded interests that call into question the mortgagor’s fee interest in the realty, thequestion the mortgagor s fee interest in the realty, the mortgagee should seek a judgment quieting title with respect to these interests. If appropriate, the mortgagee may assert in its complaint claims for a deficiency judgment against the mortgagor and any guarantors.

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2. Entry of Foreclosure Judgment

a. Timing of Entry. The time necessary to complete a judicial foreclosure proceeding varies widely according to state law. In South Carolina, the minimum time that must pass after the case is commenced and before a foreclosure judgment iscase is commenced and before a foreclosure judgment is entered is 100 days with an additional 30 days if a deficiency judgment is sought. In Michigan, a foreclosure judgment cannot be entered until six months pass from the date the

l i t fil d I D l th i i ti f fcomplaint was filed. In Delaware, the minimum time frame for foreclosure actions commenced in Superior Court is seven months, if not contested. If the action is commenced in chancery court, however, the minimum period is one year.y , , p y

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b. Establishment of Upset Price. Some states permit the court to establish an upset or minimum price for the foreclosure p psale of the mortgaged realty. See, e.g., MCL § 600.3155 (Michigan law). The mortgagor and guarantors often seek to establish this amount in an effort to reduce their potential liability for any deficiency See e g United Growth Corp vliability for any deficiency. See, e.g., United Growth Corp. v. Kelly Mortg. & Inv. Co., 86 Mich. App. 82, 272 N.W. 2d 340 (1978).

c. Determination of Redemption Period. Not all states grant to p gmortgagors and nonforeclosing lienors rights to redeem the mortgaged realty from foreclosure. States which permit redemption vary the redemption period. In Iowa, the period will vary from zero to one year depending on various factorswill vary from zero to one year depending on various factors, e.g., the nature of the note, the type of collateral, etc. Michigan grants to the mortgagor and junior lienors a redemption period of six months. Montana’s redemption

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period is one year.


3. Conduct and Confirmation of Sale

a. Time, Place and Method of Sale. State foreclosure law and court rules must be consulted to determine when, where and how a foreclosure sale of mortgaged realty will be conducted. Many states require these sales to be held at the courthouseMany states require these sales to be held at the courthouse of the county in which the realty is located and that the sale be conducted by a court or law-enforcement officer.

b Determination of Bid Price If the mortgagee intends to bid inb. Determination of Bid Price. If the mortgagee intends to bid in all or a portion of its debt to purchase the mortgaged realty at the foreclosure sale, then the mortgagee should obtain an appraisal of the realty as an aid in establishing a bidding strategy. This is important to the mortgagee in states that permit the assertion of deficiency claims against the mortgagor and guarantors.

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D. Nonjudicial Foreclosure

1 Commencement of Proceeding1. Commencement of Proceeding

a. In General. Most states permit a mortgagee to foreclose its lien in real estate nonjudicially by means of publication pursuant to a power of sale contained in the mortgage Whatpursuant to a power of sale contained in the mortgage. What constitutes a power of sale is determined by applicable state law but will normally be satisfied by a statement in the mortgage that, upon the mortgagor’s default, the mortgagee may sell the real estate at public sale under a power of salemay sell the real estate at public sale under a power of sale. These sales authorize a public official (such as a county sheriff), a third party or the mortgagee to sell the mortgaged property at a public auction after prior notice specified by state law After the sale is conducted the winning bidder willstate law. After the sale is conducted, the winning bidder will be issued a foreclosure deed to the realty which will become effective only upon its recording in the proper land records and the expiration of any redemption rights.

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b. Advantages and Disadvantages of Nonjudicial Foreclosure Sales. Non-judicial mortgage foreclosures by advertisement are relatively inexpensive; the mortgagor will by definition y p ; g g ynot incur any litigation costs in foreclosing by this method. In addition, foreclosure by advertisement is a faster process than foreclosure by judicial action. The time between publication of the sale notice and the sale itself may be as short as four to five weeks depending upon applicable lawshort as four to five weeks, depending upon applicable law.

There are, however, some disadvantages to foreclosures made pursuant to a power of sale. If there is a lien priority dispute, this method of foreclosure cannot resolve that p ,dispute because no court is involved in the proceeding. Resolution of these priority disputes will require separate judicial action. In addition, the foreclosing mortgagee will be unable to obtain the appointment of a receiver to conserve and manage the realty pending sale and any redemptionand manage the realty pending sale and any redemption period under this mode of foreclosure. Finally, the recovery of a deficiency claim against the mortgagor and any guarantors (to the extent permitted by applicable law) may only be obtained after the commencement of a collection

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yaction against the obligors.


c. Requirements of Sale Notice. The contents of the notice of the foreclosure sale are determined by applicable law. y ppNormally, this notice must contain the following information:

(i) the correct legal names of the mortgagor, the mortgagee and any assignees;mortgagee, and any assignees;

(ii) the date on which the mortgage was recorded;

(iii) the amount of the unpaid mortgage indebtedness;( ) p g g ;

(iv) a legal description of the mortgaged realty; and

(v) a statement of any applicable redemption periods.

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This written notice must often be posted on the property and published in a local newspaper for a certain time period prior to th t l l A b f t t i th t if ththe actual sale. A number of states require that, if the mortgage extends to several parcels, those lots must be sold separately and not in bulk.

d Conduct of Foreclosure Sale The public mortgage foreclosured. Conduct of Foreclosure Sale. The public mortgage foreclosure sale will normally be conducted by a court officer, often a county sheriff or his deputy, and will take place at the court of general jurisdiction in the county where the property is located. The sale will be made to the highest bidder and the foreclosingThe sale will be made to the highest bidder and the foreclosing mortgagee will be entitled to bid in all or a portion of the mortgage indebtedness to purchase the realty. The public officer conducting the auction will deliver a foreclosure deed or other transfer instrument to the successful bidder once theother transfer instrument to the successful bidder once the sale closes. This instrument must then be recorded in a timely fashion with the local register of deeds office. If any redemption rights are involved, the foreclosure deed will be

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effective to convey legal title to the purchasers only upon the expiration of all redemption periods. If a surplus is generated by the sale those monies will be distributed togenerated by the sale, those monies will be distributed to those persons entitled to receive them under applicable law.

e. Redemption Rights. State statutory and case law will determine who may redeem the mortgaged realty fromdetermine who may redeem the mortgaged realty from foreclosure, the calculation of the redemption price and the time in which redemption must be made. Some states will vary the redemption period depending upon (i) the character of the real estate; (ii) the amount of the mortgage i d bt d t t di t th ti f l d (iii)indebtedness outstanding at the time of sale; and (iii) whether the realty has been abandoned. See, e.g., MCL §600.3240 (Michigan).

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E. Title Insurance Questions and Concerns

In foreclosing a mortgage in real estate either by judicial action or byIn foreclosing a mortgage in real estate either by judicial action or by nonjudicial proceedings, counsel to the mortgage is best advised to coordinate his actions at all stages with the title insurance company that issues the title of foreclosure commitment to the mortgagee listing all exceptions to coverage This commitment should list all existingall exceptions to coverage. This commitment should list all existing interests in the realty and reveal any potential lien priority disputes. In addition, this document should indicate all outstanding taxes and whether any collection actions have been taken by governmental units with respect to past due taxes If counsel intends to commence judicialwith respect to past due taxes. If counsel intends to commence judicial foreclosure proceedings, the commitment should list all potential defendants and describe their respective interests in the real estate. In addition, in preparing for a foreclosure sale, mortgagee’s counsel should seek the approval from the title company of all importantshould seek the approval from the title company of all important documents including any sale notices and transfer documents in order to guarantee the issuance of a clean title policy for the purchaser’s benefit at the end of the process.

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III. Pursuing Deficiency Claims Against Guarantors

A. Review and Analysis of Guaranties

The CMBS loan package that counsel to the mortgagee will receive after being retained by the special servicer will normally contain guaranties executed by affiliates of the mortgagor, who may be other business entities or individuals. These guaranties are likely to be nonrecourse guaranties that impose full or limited liability for the mortgage indebtedness on the

t l th f t i t Thguarantors only upon the occurrence of certain events. These guaranties are commonly referred to as either “springing” or “bad boy” guaranties.

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III. Pursuing Deficiency Claims Against Guarantors (cont’d)( )

These guaranty provisions impose full recourse upon the guarantor for the entire unpaid indebtedness upon the occurrence of events such as (i) the commencement of a voluntary bankruptcy case by the mortgagor; (ii) fraud or intentional misrepresentation relating to the mortgage loan or the mortgaged realty; (iii) the transfer of beneficialmortgage loan or the mortgaged realty; (iii) the transfer of beneficial interests in the mortgagor; and (iv) the violation of the SPV “separateness” covenants contained in the loan documents. Limited recourse liability will be imposed upon the guarantor for certain acts th t d t th t th t i bl f tthat cause damage to the mortgagee that is capable of measurement, e.g., by failing to pay real estate taxes assessed against the mortgaged realty. The reported case law tends to support the

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enforcement of these types of guaranties. See, e.g., UBS Commercial Mortgage Trust v. Garrison Special Opportunities Fund, L.P., g g p pp6532412/2010 N.Y.L.J. 1202486344330 (Sup. Ct. N.Y. Co. March 8, 2011); III Debt Acquisition LLC v. Six Ventures LTD, 2011 WL 383003 (6th Cir. Feb. 7, 2011); But see ING Real Estate Finance (USA) LLC v Park Avenue Hotel Acquisition LLC 26 Misc 3d 1226 (Sup Ctv. Park Avenue Hotel Acquisition, LLC, 26 Misc. 3d 1226 (Sup. Ct. N.Y. Co. Feb. 24, 2010) (“ING Real Estate”). See also Susan C. Tarnower, Trends in Commercial Real Estate Loan Guaranties, http://www.wealthstrategiesjournal.com/articles/2011/06/trends-in-commercial-real-estate.html.

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B. Commencement of Action

Actions impose liability under non recourse guaranties are breach ofActions impose liability under non-recourse guaranties are breach of contract actions commenced in either state or federal courts having subject-matter jurisdiction over the claim and personal jurisdiction over the defendants. These claims can be asserted as a separate count in a judicial mortgage foreclosure actiona judicial mortgage foreclosure action.

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C. Potential Defenses of Guarantors

Defendants in these actions have asserted a number of defenses to claims asserted by the holders of nonrecourse guaranties. In CSFB 2001-CP-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC, 2009 N.J. Super Lexis 199 (N.J. Superior Court, App. Div., Aug. 11,2009 N.J. Super Lexis 199 (N.J. Superior Court, App. Div., Aug. 11, 2009) (“SB Rental”), the defendants asserted that the “bad boy” carveout was an unenforceable penalty. This defense was rejected on appeal. Courts have also rejected the argument that the imposition of liability

d th t f i d/ i l ti f bli li SBunder these carveouts was unfair and/or violative of public policy. SB Rental, supra; Blue Hills Office Park LLC v. J.P. Morgan Chase Bank, 477 F. Supp. 2d 366 (D. Mass. 2007); EDIC v. Prince George Corp., 58 F. 3d 1041 (4th Cir. 1995). ( )

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In ING Real Estate, however, Judge James A. Yates dismissed the action against the guarantors on a nonrecourse guaranty for the mortgagor’s failure to pay real estate taxes assessed against the mortgaged realty, thereby resulting in the imposition of a tax lien against that property. As a result of this failure, the two mortgagees asserted that the guarantors were liable for the unpaid balance of the debt. Shortly thereafter, the mortgagor paid the past due taxes thereby extinguishing themortgagor paid the past due taxes, thereby extinguishing the tax lien.

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In granting the defendants’ motion to dismiss the full recourse claims arising under the guaranty, Judge Yates first declared, citing New York judicial precedent, that the terms of the guaranty must be strictly construed in favor of the guarantors. Because the guarantors discharged the tax debt and lien within a 30 day grace perioddischarged the tax debt and lien within a 30-day grace period contained in the loan documents, the Court declared that to impose a $90 million deficiency claim under these circumstances would be a “penalty” and under New York law and, therefore, the guaranty would not be enforced.

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D. Entry of Judgment and Collection Actions

Upon the entry of a final judgment against guarantors under aUpon the entry of a final judgment against guarantors under a nonrecourse guaranty, the mortgagee will then normally pursue collection actions against the guarantors and their properties as permitted under applicable law.

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Special Servicers and Defaulted orSpecial Servicers and Defaulted or Delinquent CMBS Loans

Recent REMIC Rule Changes and CMBS Loan Modifications by Special Servicers

Presented byPatrick McManemin

214-758-6675@[email protected]

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General REMIC CharacteristicsGeneral REMIC Characteristics

T t ti REMIC t• To preserve tax-exemption, REMICs must continually hold “qualified mortgages,” meaning they:y

– have a LTV ratio not greater than 125%, and– are transferred to the REMIC on the first day the REMIC

issues securitiesissues securities.

“Significant” modifications to loans are held to be “deemed exchanges” under IRS rules thereby violating the secondexchanges under IRS rules, thereby violating the second prong of the “qualified mortgage” test and incurring tax penalties.

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Exceptions to “Significant” Modification

• Prior to 2009, 4 exceptions to the “significant modification” rule were in place:

1 Modification occasioned by default or “reasonably1. Modification occasioned by default or reasonably foreseeable” default.

2. Assumption of mortgage pursuant to waiver of due-on sale/due on encumbrance clauseon-sale/due-on-encumbrance clause.

3. Assumption of loan by Trust.4. Interest rate conversions pursuant to convertible

tnotes.

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2009 Changes to REMIC Exceptions2009 Changes to REMIC Exceptions

• In response to the economic collapse, REMIC rules were changed in three ways:1 The interpretation of the e ception for1. The interpretation of the exception for

modifications occasioned by default or “reasonably foreseeable” default was expanded to allow a broader interpretation of the phrase “reasonably foreseeable.”

- The intent was to allow special servicers to begin addressing p g gproblematic loans earlier in the loan’s life-cycle, instead of immediately prior to default.

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2009 Changes to REMIC Exceptions (cont.)

2 T dditi l ti dd d2. Two additional exceptions were added:A. Changes involving substitution/release of collateral

securing a loanB. Changes in recourse/non-recourse nature of the loan.

Under either rule the loan must continue to beUnder either rule, the loan must continue to be “principally secured by” an interest in real property after the modification.

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2009 Changes to REMIC Exceptions(cont.)

3 Lien Release Rule3. Lien Release Rule

Prior rule: if REMIC released lien on real property, loan ceased to be qualified mortgage unless pursuant toq g g pdefeasance or provided for in terms of loan documentation.

New rule: release of lien does not disqualify mortgage if:l i t i ifi t difi tia. release is not a significant modification per

the exceptions noted above; andb. loan continues to be principally secured by

interest in real property.p p y

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Servicing Standard and PSAServicing Standard and PSA

• In addition to any requirements under the REMIC rules special• In addition to any requirements under the REMIC rules, special servicers are bound by the servicing standard and relevant provisions of the PSA:

The Special Servicer shall diligently service and administer the loans it isThe Special Servicer shall diligently service and administer the loans it is obligated to service pursuant to the PSA on behalf of the trust and in the best interests of and for the benefit of the certificateholders.

The Special Servicer shall service the loans in accordance with the higher p gof the following standards of care: (1) the same manner in which, and with the same care, skill, prudence and diligence with which the Special Servicer services and administers similar mortgage loans for other third party portfolios and (2) the same care, skill, prudence and diligence with which the Special Servicer services and administers similar mortgage loans p g gowned by the Special Servicer, with a view to the maximization of timely recovery of principal and interest on a net present value basis on the loans, and in the best interests of the trust and the certificateholders.

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PSA RequirementsPSA Requirements

I l th PSA’ t ill t k REMIC- In general, the PSA’s terms will track REMIC requirements, as avoiding tax penalties under REMIC rules is the primary duty of the special p y y pservicer.

- Consent of Directing Certificateholder§3 20 f S l PSA§3.20 of Sample PSA:• If the Special Servicer determines that a modification, waiver

or amendment is reasonably likely to produce a greater recovery on a net present value basis then the Specialrecovery on a net present value basis, then the Special Servicer may agree to a modification, waiver or amendment subject to the approval of the Directing Certificateholder.

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Typical ModificationsTypical Modifications

R d ti i I t t R t• Reduction in Interest Rate• Extension of maturity date

Addition of new guarantor(s)• Addition of new guarantor(s)• Additional collateral• Forbearance agreements• Forbearance agreements• Deed in lieu of foreclosure• The special servicer also has authority to• The special servicer also has authority to

institute foreclosure proceedings and/or a receivership action.

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Sample Scenariop

• Loan in 2007 securitization secured by multifamily development. Borrower is current, but several leases are about to expire withoutbut several leases are about to expire without renewal or new tenants. Borrower is concerned about future ability to service debtconcerned about future ability to service debt in about a year’s time, and approaches Master/Special Servicer to reduce the interest rate and extend the maturity date. Result?

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Rules of CautionRules of Caution

Regardless of the seemingl increased fle ibilit gi en to special• Regardless of the seemingly increased flexibility given to special servicers under the changes in the REMIC rules, the servicing standard and the terms of the PSA remain unchanged and continue to bind the special servicer. Any constraints imposed p y pby those provisions remain in place, regardless of any changes in REMIC rules.

• In addition, note that the post-default landscape remains h d b h t th REMIC l Th lunchanged by changes to the REMIC rules. The new rules were

meant to provide special servicers with greater leeway to “get out in front” of potentially problematic loans and enter into modifications to prevent default. Once default has occurred, the od cat o s to p e e t de au t O ce de au t as occu ed, t etraditional remedies remain in place.

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PRESENTATION TITLE

SPECIAL SERVICERS AND DEFAULTED ORSPECIAL SERVICERS AND DEFAULTED OR DELINQUENT CMBS LOANS

JULY 26, 2011JULY 26, 2011

STRAFFORD PUBLICATIONS WEBINARSTRAFFORD PUBLICATIONS WEBINAR

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REMIC CONCERNS WITH RESPECT TO REO

CONSTRUCTION ON REO

MULTIPLE SALES OF REO

FORECLOSURE PROPERTY EXTENSIONS FORECLOSURE PROPERTY EXTENSIONS

Mindy PlanerMindy PlanerKilpatrick Townsend & Stockton [email protected]

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ANALYSIS ANALYSIS• PSA

• CREDIT/SERVICING STANDARD

• REMIC –FOCUS OF THIS PRESENTATION

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REMICS HOLD:

QUALIFIED MORTGAGES• QUALIFIED MORTGAGES

PERMITTED INVESTMENTS• PERMITTED INVESTMENTS– Foreclosure property is a permitted investment

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REMICS ARE PASSIVE INVESTORS

A REMIC MUST BE PASSIVE

CAN REMIC REMAIN PASSIVE IN CONNECTION WITH • CONSTRUCTION ON REO• SALE OF REO

IF NOT, REMIC SUBJECT TO TAX• PSA VIOLATION• ADVANCE LIMITATIONS

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CONSTRUCTION ON REO

A REMIC IS SUBJECT TO TAX ON ACTIVE INCOME FROMINCOME FROM

– Construction unless underway at the time of default andconstructed by an independent contractorconstructed by an independent contractor 10% complete before default becomes imminent Construction more than 90 days after property became

REO is performed by an independent contractorREO is performed by an independent contractor.

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CONSTRUCTION ON REO

CONSTRUCTION INCLUDES:

• RENOVATIONS

• REMODELING TO RECONFIGURE LAYOUT

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CONSTRUCTION ON REO

DETERMINING WHETHER BUILDING / IMPROVEMENT IS GREATER THAN 10%IMPROVEMENT IS GREATER THAN 10% COMPLETE• Based upon cost of constructionBased upon cost of construction• Modifications required by a Federal, State or

Local Agency• Certain modifications required by a prospective

tenant or purchaser or are necessary for the property to be used for its planned purposep p y p p p

• Separate issue under PSA as to funding construction

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CONSTRUCTION ON REO

CONSTRUCTION DOES NOT INCLUDE:• Repair / maintenance of a building / improvement

to offset normal wear and tear or obsolescenceR t ti b f lt• Restoration because of casualty

• Preparation for a new tenant provided:Useful life of building/improvement not extended– Useful life of building/improvement not extended

– No significant increase in value*Doesn’t bringing in a new tenant always increase value?

• Deferred maintenance

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CONSTRUCTION ON REO

REGULATIONS ARE DIFFICULT TO APPLY• Single Tenant Buildings• Hotel PIP• Obsolescence• Tenant Construction• Modifications Required by a Federal, State or

Local Agency

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A REMIC MUST BE PASSIVE A REMIC MUST BE PASSIVE• REMIC is subject to tax if it generates active

income from co e o– the use of REO in a trade or business (except through

an independent contractor) No bright line test No bright line test

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SALE OF REO IN MULTIPLE TRANSACTIONS• No specific REMIC requirement that sales be p q

separate

• Could result in REMIC being engaged in trade or business of developing or selling REO

• Must analyze facts and circumstances

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FACTS AND CIRCUMSTANCES TO CONSIDERCONSIDER:• Location• Reason for Sales• Identity of Purchasing Party

f S• Number of Sales• Preparatory Work

M k ti d A• Marketing and Appearance

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OBSERVATIONS– CONSTRUCTION/MULTIPLE SALES

OBSERVATIONS• Regs create a framework for allowing liquidation

of REO in a manner that makes sense while preserving the passive nature of the REMICpreserving the passive nature of the REMIC

• These goals are often at odds and result in uncertaintyy– Regs often provide limited guidance– Results are fact and circumstance specific

C d dit d ’t t l– Common sense and credit don’t control

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TIME LIMIT FOR FORECLOSURE PROPERTIES

HOW LONG CAN REO REMAIN “FORECLOSURE PROPERTY”?“FORECLOSURE PROPERTY”?• Grace Period - End of 3rd tax year following the

tax year of foreclosuretax year of foreclosure• Automatic 3 year extension if proper process

followedfollowed

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Process for Extensions• When?

– Prior to October 31 of the year in which the grace period expires

• Where?– Regs say the filing must be with the District Director

No District Director– No District Director– File with:

Internal Revenue Service, Industry Director-Financial Services and Healthcare and the Director of FieldServices and Healthcare and the Director of Field Operations

Ogden Submission Processing Center

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TIME LIMIT FOR FORECLOSURE PROPERTY

• What?• What?– Regs require

Name, address, taxpayer ID of REMIC Date foreclosure property was acquired Statement as to whether previous extensions requested Statement as to when the grace period should be extendedg p Description of the efforts to dispose of the property

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– Additional Information currently requested by IRS Most recently filed tax return Statements as to nature and operation of the foreclosure

property Check with counsel for other items

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LATE FILINGS• No Automatic extension• Given for reasonable cause at discretion of

Di t i t Di tDistrict Director• Regs do not define reasonable cause

There is no District Director• There is no District Director• Even if you think REO will be sold by end of grace

period file a protective extension (October 31) justperiod file a protective extension (October 31) just in case

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Observations• If proper extension filed REO can remain

“foreclosure property” for almost 7 years (depending on date of foreclosure)(depending on date of foreclosure)

• Important to follow the procedure for 3 year extension of grace periodg p

• Unclear process for late filings• Get extension filing in on time

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